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FIRST KEYSTONE CORP - Quarter Report: 2023 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2023

or

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

For the transition period from ________ to ________

Commission File Number: 000-21344

FIRST KEYSTONE CORPORATION

(Exact name of registrant as specified in its charter)

Pennsylvania

 

23-2249083

(State or other jurisdiction of
incorporation or organization)

 

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

111 West Front Street, Berwick, PA

 

18603

(Address of principal executive offices)

 

(Zip Code)

Registrant’s telephone number, including area code: (570) 752-3671

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

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) 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

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

Title of each class

Trading symbol

Name of each exchange on which registered

Common stock

FKYS

OTC: Pink

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date:

Common Stock, $2 Par Value, 6,064,772 shares as of August 4, 2023.

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(Dollars in thousands, except share and per share data)

June 30, 

December 31, 

 

    

2023

    

2022

    

 

ASSETS

 

  

 

  

 

Cash and due from banks

$

12,597

$

9,441

Interest-bearing deposits in other banks

 

1,178

 

1,297

Total cash and cash equivalents

 

13,775

 

10,738

Debt securities available-for-sale, at fair value

 

331,580

 

373,444

Marketable equity securities, at fair value

 

1,476

 

1,699

Restricted investment in bank stocks, at cost

 

8,617

 

7,136

 

  

 

  

Loans

 

871,239

 

858,398

Loans held for sale

 

 

71

Allowance for credit losses

 

(7,157)

 

(8,274)

Net loans

 

864,082

 

850,195

Premises and equipment, net

 

19,764

 

19,024

Operating lease right-of-use assets

1,523

1,541

Accrued interest receivable

 

4,173

 

4,391

Cash surrender value of bank owned life insurance

 

25,691

 

25,389

Investments in low-income housing partnerships

 

5,491

 

3,763

Goodwill

 

19,133

 

19,133

Deferred income taxes

 

8,879

 

9,129

Other assets

 

3,715

 

3,612

TOTAL ASSETS

$

1,307,899

$

1,329,194

 

  

 

  

LIABILITIES

 

  

 

  

Deposits:

 

  

 

  

Non-interest bearing

$

220,519

$

231,754

Interest bearing

 

715,322

 

761,745

Total deposits

 

935,841

 

993,499

Short-term borrowings

 

193,359

 

153,418

Long-term borrowings

 

25,000

 

25,000

Subordinated debentures

25,000

25,000

Operating lease liabilities

2,019

2,029

Accrued interest payable

 

1,171

 

563

Other liabilities

 

4,324

 

9,299

TOTAL LIABILITIES

 

1,186,714

 

1,208,808

 

  

 

  

STOCKHOLDERS’ EQUITY

 

  

 

  

Preferred stock, par value $2.00 per share; authorized 1,000,000 shares as of June 30, 2023 and December 31, 2022; issued 0 as of June 30, 2023 and December 31, 2022

Common stock, par value $2.00 per share; authorized 20,000,000 shares as of June 30, 2023 and December 31, 2022; issued 6,296,383 as of June 30, 2023 and 6,250,763 as of December 31, 2022; outstanding 6,064,772 as of June 30, 2023 and 6,019,152 as of December 31, 2022

12,593

12,502

Surplus

 

43,217

 

42,439

Retained earnings

 

100,600

 

100,712

Accumulated other comprehensive loss

 

(29,516)

 

(29,558)

Treasury stock, at cost, 231,611 shares as of June 30, 2023 and December 31, 2022

 

(5,709)

 

(5,709)

 

 

TOTAL STOCKHOLDERS’ EQUITY

 

121,185

 

120,386

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

$

1,307,899

$

1,329,194

See accompanying notes to consolidated financial statements.

2

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(Dollars in thousands, except per share data)

Three Months Ended

Six Months Ended

June 30, 

June 30, 

    

2023

    

2022

    

2023

    

2022

    

INTEREST INCOME

Interest and fees on loans

$

10,379

$

8,486

$

20,290

$

16,662

Interest and dividend income on securities:

 

 

  

 

 

  

Taxable

 

2,833

 

1,716

 

5,701

 

3,287

Tax-exempt

 

261

 

849

 

611

 

1,685

Dividends

 

12

 

11

 

24

 

24

Dividend income on restricted investment in bank stocks

162

 

49

 

326

 

70

Interest on interest-bearing deposits in other banks

 

4

 

 

6

 

12

Total interest income

 

13,651

 

11,111

 

26,958

 

21,740

INTEREST EXPENSE

 

 

  

 

 

  

Interest on deposits

 

3,833

 

706

 

6,884

 

1,391

Interest on short-term borrowings

 

2,302

 

182

 

4,349

 

210

Interest on long-term borrowings

 

134

 

168

 

266

 

358

Interest on subordinated debt

274

274

547

544

Total interest expense

 

6,543

 

1,330

 

12,046

 

2,503

Net interest income

 

7,108

 

9,781

 

14,912

 

19,237

Provision for credit losses

 

34

 

218

 

34

 

437

Net interest income after provision for credit losses

 

7,074

 

9,563

 

14,878

 

18,800

NON-INTEREST INCOME

 

 

  

 

 

  

Trust department

 

248

 

268

 

478

 

518

Service charges and fees

 

571

 

549

 

1,096

 

1,058

Increase in cash surrender value of life insurance

 

153

 

148

 

302

 

296

ATM fees and debit card income

 

566

 

558

 

1,098

 

1,067

Net gains (losses) on sales of mortgage loans

 

17

 

 

34

 

(34)

Net securities losses

 

(69)

 

(68)

 

(125)

 

(131)

Other

 

53

 

59

 

108

 

129

Total non-interest income

 

1,539

 

1,514

 

2,991

 

2,903

NON-INTEREST EXPENSE

 

  

 

  

 

  

 

  

Salaries and employee benefits

 

3,733

 

3,462

 

8,119

 

7,016

Occupancy, net

 

559

 

478

 

1,087

 

970

Furniture and equipment expense

 

156

 

147

 

308

 

302

Computer expense

 

406

 

358

 

769

 

728

Professional services

 

346

 

370

 

781

 

668

Pennsylvania shares tax

 

241

 

324

 

482

 

648

FDIC insurance, net

 

178

 

120

 

354

 

257

ATM and debit card fees

 

278

 

242

 

585

 

370

Data processing fees

 

357

 

251

 

669

 

509

Advertising

 

154

 

118

 

228

 

190

Other

 

749

 

725

 

1,528

 

1,453

Total non-interest expense

 

7,157

 

6,595

 

14,910

 

13,111

Income before income tax expense

 

1,456

 

4,482

 

2,959

 

8,592

Income tax expense

 

317

 

660

 

463

 

1,227

NET INCOME

$

1,139

$

3,822

$

2,496

$

7,365

PER SHARE DATA

 

  

 

  

 

  

 

  

Net income per share:

 

  

 

  

 

  

 

  

Basic

$

0.19

$

0.64

$

0.41

$

1.24

Diluted

 

0.19

 

0.64

 

0.41

 

1.24

Dividends per share

 

0.28

 

0.28

 

0.56

 

0.56

See accompanying notes to consolidated financial statements.

3

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(Unaudited)

(Dollars in thousands)

Three Months Ended

June 30, 

    

2023

    

2022

Net income

$

1,139

$

3,822

 

  

 

  

Other comprehensive loss:

 

  

 

  

Unrealized net holding losses on debt securities available-for-sale arising during the period, net of income taxes of $(993) and $(2,850), respectively

 

(3,736)

 

(10,723)

Less reclassification adjustment for net gains included in net income, net of income taxes of $(0) and $(6), respectively (a) (b)

(21)

Total other comprehensive loss

 

(3,736)

 

(10,744)

Total Comprehensive Loss

$

(2,597)

$

(6,922)

(Dollars in thousands)

Six Months Ended

June 30, 

    

2023

    

2022

    

Net income:

$

2,496

$

7,365

 

  

 

  

Other comprehensive income (loss):

 

  

 

  

Unrealized net holding gains (losses) on debt securities available-for-sale arising during the period, net of income taxes of $32 and $(7,445), respectively

 

120

 

(28,006)

Less reclassification adjustment for net gains included in net income, net of income taxes of $(21) and $(6), respectively (a) (b)

(78)

(21)

Total other comprehensive income (loss)

 

42

 

(28,027)

Total Comprehensive Income (Loss)

$

2,538

$

(20,662)

______________________________

(a)Gross amounts are included in net securities losses on the consolidated statements of income in non-interest income.
(b)Income tax amounts are included in income tax expense on the consolidated statements of income.

See accompanying notes to consolidated financial statements.

4

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

SIX MONTHS ENDED JUNE 30, 2023 AND 2022

(Unaudited)

Accumulated

(Dollars in thousands, except

Other

Total

per share data)

Common Stock

Retained

Comprehensive

Treasury

Stockholders’

    

Shares

    

Amount

    

Surplus

    

Earnings

    

Loss

    

Stock

    

Equity

Balance at January 1, 2023

 

6,250,763

$

12,502

$

42,439

$

100,712

$

(29,558)

$

(5,709)

$

120,386

Cumulative effect of adoption of ASU No. 2016-13

768

768

Net income

 

1,357

 

1,357

Other comprehensive income, net of taxes

 

3,778

 

3,778

Issuance of common stock under dividend reinvestment plan

 

20,787

41

381

 

422

Dividends - $0.28 per share

 

(1,685)

 

(1,685)

Balance at March 31, 2023

 

6,271,550

$

12,543

$

42,820

$

101,152

$

(25,780)

$

(5,709)

$

125,026

Net Income

 

1,139

 

1,139

Other comprehensive loss, net of taxes

 

(3,736)

 

(3,736)

Issuance of common stock under dividend reinvestment plan

 

24,833

50

397

 

447

Dividends - $0.28 per share

 

(1,691)

 

(1,691)

Balance at June 30, 2023

 

6,296,383

$

12,593

$

43,217

$

100,600

$

(29,516)

$

(5,709)

$

121,185

Accumulated

(Dollars in thousands, except

Other

Total

per share data)

Common Stock

Retained

Comprehensive

Treasury

Stockholders’

    

Shares

    

Amount

    

Surplus

    

Earnings

    

Loss

    

Stock

    

Equity

Balance at January 1, 2022

 

6,178,835

$

12,358

$

40,940

$

93,378

$

7,588

$

(5,709)

$

148,555

Net income

 

  

 

  

 

  

 

3,543

 

  

 

  

 

3,543

Other comprehensive loss, net of taxes

 

  

 

  

 

  

 

  

 

(17,282)

 

  

 

(17,282)

Issuance of common stock under dividend reinvestment plan

 

16,297

 

32

 

372

 

  

 

  

 

  

 

404

Dividends - $0.28 per share

 

  

 

  

 

  

 

(1,665)

 

  

 

  

 

(1,665)

Balance at March 31, 2022

 

6,195,132

$

12,390

$

41,312

$

95,256

$

(9,694)

$

(5,709)

$

133,555

Net Income

 

3,822

3,822

Other comprehensive loss, net of taxes

 

(10,744)

(10,744)

Issuance of common stock under dividend reinvestment plan

 

17,840

36

379

415

Dividends - $0.28 per share

 

(1,669)

(1,669)

Balance at June 30, 2022

 

6,212,972

$

12,426

$

41,691

$

97,409

$

(20,438)

$

(5,709)

$

125,379

See accompanying notes to consolidated financial statements.

5

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

SIX MONTHS ENDED JUNE 30, 2023 AND 2022

(Unaudited)

(Dollars in thousands)

    

2023

    

2022

CASH FLOWS FROM OPERATING ACTIVITIES:

 

  

 

  

Net income

$

2,496

$

7,365

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

 

 

Provision for credit losses

 

34

 

437

Provision (credit) for credit losses on unfunded commitments

45

(60)

Depreciation and amortization

 

540

 

528

Net premium amortization on securities

 

799

 

1,633

Deferred income tax expense (benefit)

 

34

 

(25)

Common stock issued

 

856

 

805

Net (gains) losses on sales of mortgage loans

 

(34)

 

34

Proceeds from sales of mortgage loans originated for sale

 

1,121

 

4,429

Originations of mortgage loans originated for sale

 

(1,016)

 

(6,068)

Net securities losses

 

125

 

131

Decrease (increase) in accrued interest receivable

 

218

 

(112)

Increase in cash surrender value of bank owned life insurance

 

(302)

 

(296)

Net losses on disposals of premises and equipment

 

2

 

10

Increase in other assets

 

(87)

 

(639)

Amortization of investment in low-income housing partnerships

 

106

 

120

Increase in accrued interest payable

 

608

 

22

(Decrease) increase in other liabilities

 

(5,188)

 

97

NET CASH PROVIDED BY OPERATING ACTIVITIES

 

357

 

8,411

CASH FLOWS FROM INVESTING ACTIVITIES:

 

  

 

  

Proceeds from sales of equity securities and debt securities available-for-sale

 

23,230

 

170

Proceeds from maturities and redemptions of debt securities available-for-sale

 

17,987

 

28,871

Purchases of debt securities available-for-sale

 

 

(38,324)

Net decrease in time deposits with other banks

 

 

247

Net change in restricted investment in bank stocks

 

(1,481)

 

(3,834)

Net increase in loans

 

(12,873)

 

(50,331)

Purchase of premises and equipment

 

(1,251)

 

(325)

Purchase of investment in real estate venture

 

(1,834)

 

(645)

NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES

 

23,778

 

(64,171)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

  

 

  

Net decrease in deposits

 

(57,658)

 

(84,361)

Net increase in short-term borrowings

 

39,941

 

102,346

Repayment of finance lease obligations

(5)

(5)

Repayment of long-term borrowings

 

 

(10,000)

Dividends paid

 

(3,376)

 

(3,334)

NET CASH USED IN (PROVIDED BY) FINANCING ACTIVITIES

 

(21,098)

 

4,646

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

 

3,037

 

(51,114)

CASH AND CASH EQUIVALENTS, BEGINNING

 

10,738

 

61,338

CASH AND CASH EQUIVALENTS, ENDING

$

13,775

$

10,224

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

 

  

 

  

Interest paid

$

11,438

$

2,481

Income taxes paid

 

209

 

949

SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES

 

  

 

  

Loans transferred from held for sale to held for investment portfolio

 

 

(6,652)

Common stock subscription receivable

13

14

Right-of-use assets obtained in exchange for lease liabilities

33

35

See accompanying notes to consolidated financial statements.

6

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 ― BASIS OF PRESENTATION, SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND SUBSEQUENT EVENTS

The consolidated financial statements include the accounts of First Keystone Corporation (the “Corporation”) and its wholly owned subsidiary First Keystone Community Bank (the “Bank”) (collectively the “Company”). All significant intercompany accounts and transactions have been eliminated.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete consolidated financial statements. In the opinion of management, all adjustments considered necessary for fair presentation have been included. Operating results for the three and six months ended June 30, 2023, are not necessarily indicative of the results for the year ending December 31, 2023. For further information, refer to the consolidated financial statements and notes thereto included in First Keystone Corporation’s Annual Report on Form 10-K for the year ended December 31, 2022.

Subsequent Events

The Company has evaluated events and transactions occurring subsequent to the consolidated balance sheet date of June 30, 2023 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.

NOTE 2 ― RECENT ACCOUNTING STANDARDS UPDATES (“ASU”)

Adopted ASUs:

In January of 2023, the Corporation adopted ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU No. 2016-13 required financial assets measured at amortized cost to be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. The Corporation took steps to prepare for the implementation over the past several years, such as: forming an internal committee, gathering pertinent data, consulting with outside professionals, subscribing to a new software system, and running existing and new methodologies concurrently through the period of implementation. The Corporation also completed a data and model validation analysis and prepared policies related to the adoption process. The Corporation adopted the ASU’s provisions using the modified retrospective method and evaluated the impact the current expected credit loss (“CECL”) model had on the accounting for credit losses, and recognized a one-time, cumulative-effect adjustment to retained earnings at the beginning of the first reporting period in which the new standard became effective. The cumulative-effect adjustment resulted in an increase to retained earnings of $768,000, an additional reserve for unfunded commitments of $147,000, a decrease in the allowance for credit losses of $1,119,000, and a decrease in deferred tax assets of $204,000, as outlined in the table on the next page. There was no impact on the securities portfolio upon adoption. This adoption method is considered a change in accounting principle requiring additional disclosure of the nature of and reason for the change, which is solely a result of the adoption of the required standard.

7

January 1, 2023

As Reported Under ASU
2016-13

Pre-
ASU
2016-13 Adoption

Impact of
ASU
2016-13 Adoption

Assets:

Allowance For Credit Losses

$

(7,155)

$

(8,274)

$

1,119

Deferred Income Taxes

8,925

9,129

(204)

A

Liabilities:

Other Liabilities

9,446

9,299

147

B

Equity:

Retained Earnings

101,480

100,712

768

C

A. Effect on deferred tax assets related to the adjustment to the allowance for credit losses and reserve for unfunded lending commitments from the adoption of ASU 2016-13 using a 21% tax rate

B. Adjustment to the reserve for unfunded lending commitments related to the adoption of ASU 2016-13

C. Adjustment to undistributed profits related to the adoption of ASU 2016-13

In January of 2023, the Corporation adopted ASU No. 2022-02, Financial Instruments-Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures, which eliminated the accounting guidance on troubled debt restructurings (“TDRs”) by creditors that have adopted the CECL model and enhances disclosure requirements for certain loan refinancing and restructurings by creditors made to borrowers experiencing financial difficulty. The ASU also amended the guidance on “vintage disclosures” to require disclosure of current-period gross charge-offs by year of origination. The Corporation adopted the ASU’s provisions using the modified retrospective method in conjunction with the CECL adoption. The adoption of ASU 2022-02 did not have a material impact on the Corporation’s consolidated financial statements.

Pending ASUs:

In March of 2023, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2023-02, Investments- Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method. ASU 2023-02 allows for standardization of accounting methodology for tax credit equity investments when certain requirements are met. The standard provides the ability for both current and prospective tax credit investors to avoid the complexities of accounting for tax credits outside of the proportional amortization method. To qualify for the proportional amortization method, the following conditions must be met: 1. it is probable that the income tax credits allocable to the investor will be available, 2. the investor does not have the ability to exercise significant influence over the operating and financial policies of the underlying project, 3. substantially all of the projected benefits are from income tax credits and other income tax benefits, 4. the investor’s projected yield based solely on the cash flows from the income tax credits and other income tax benefits is positive, and 5. the investor is a limited liability investor in the limited liability entity for both legal and tax purposes and the investor’s liability is limited to its capital investment. The amendments in this ASU will be applied either on a modified retrospective basis or a retrospective basis. The amendments in this update are effective for public business entities for fiscal years, and interim periods within those fiscal years beginning after December 15, 2023. Early adoption is permitted for all entities in any interim period. The Corporation is currently evaluating the provisions of ASU 2023-02 and does not expect the adoption of the standard to have a material impact on the Corporation’s financial statements.

8

NOTE 3 — SECURITIES

Debt Securities

The Company classifies its securities as either “Held-to-Maturity” or “Available-for-Sale” at the time of purchase. Securities are accounted for on a trade date basis. Debt securities are classified as Held-to-Maturity when the Company has the ability and positive intent to hold the securities to maturity. Securities classified as Held-to-Maturity are carried at cost adjusted for amortization of premium and accretion of discount to maturity.

Debt securities not classified as Held-to-Maturity are included in the Available-for-Sale category and are carried at fair value. The amount of any unrealized gain or loss, net of the effect of deferred income taxes, is reported as accumulated other comprehensive loss in the consolidated balance sheets and consolidated statements of changes in stockholders’ equity. Management’s decision to sell Available-for-Sale securities is based on changes in economic conditions, controlling the sources and applications of funds, terms, availability of and yield of alternative investments, interest rate risk and the need for liquidity.

The cost of debt securities classified as Held-to-Maturity or Available-for-Sale is adjusted for amortization of premiums to the earliest call date and accretion of discounts to expected maturity. Such amortization and accretion, as well as interest and dividends, are included in interest and dividend income from securities. Realized gains and losses are included in net securities gains and losses. The cost of securities sold, redeemed or matured is based on the specific identification method.

The Corporation invests in various forms of agency debt including residential and commercial mortgage-backed
securities and callable debt. The mortgage-backed agency securities are issued by Federal Home Loan Mortgage
Corporation (“FHLMC”), Federal National Mortgage Association (“FNMA”), Government National Mortgage
Association (“GNMA”) or Small Business Administration (“SBA”). The other mortgage-backed securities consist of private (non-agency) residential and commercial mortgage-backed securities. The municipal securities consist of general obligations and revenue bonds. Asset-backed securities consist of private (non-agency) student loan pools backed by the Federal Family Education LoanProgram (“FFELP”) which carry a 97% federal government guarantee. Corporate debt securities consist of senior debt and subordinated debt holdings.

There was no allowance for credit losses for Available-For-Sale debt securities as of June 30, 2023; therefore, it is not present in the table below. The amortized cost, related estimated fair value, and unrealized gains and losses for debt securities classified as Available-For-Sale were as follows at June 30, 2023 and December 31, 2022:

Debt Securities Available-for-Sale

(Dollars in thousands)

    

    

Gross

    

Gross

    

Amortized

Unrealized

Unrealized

Fair

June 30, 2023:

Cost

Gains

Losses

Value

U.S. Treasury securities

$

7,867

$

$

(1,021)

$

6,846

Obligations of U.S. Government Agencies and Sponsored Agencies:

 

 

 

 

Mortgage-backed

140,777

(15,648)

125,129

Other

 

9,224

 

176

 

(45)

 

9,355

Other mortgage backed securities

 

32,341

 

 

(3,258)

 

29,083

Obligations of state and political subdivisions

 

100,161

 

9

 

(12,110)

 

88,060

Asset-backed securities

 

32,831

 

7

 

(794)

 

32,044

Corporate debt securities

 

45,741

 

129

 

(4,807)

 

41,063

Total

$

368,942

$

321

$

(37,683)

$

331,580

9

Debt Securities Available-for-Sale

(Dollars in thousands)

    

    

Gross

    

Gross

    

Amortized

Unrealized

Unrealized

Fair

December 31, 2022:

Cost

Gains

Losses

Value

U.S. Treasury securities

$

7,853

$

$

(1,052)

$

6,801

Obligations of U.S. Government Agencies and Sponsored Agencies:

 

 

 

 

Mortgage-backed

146,707

(15,032)

131,675

Other

 

10,992

 

233

 

(45)

 

11,180

Other mortgage backed securities

 

36,767

 

 

(3,079)

 

33,688

Obligations of state and political subdivisions

 

125,176

 

266

 

(14,753)

 

110,689

Asset-backed securities

 

37,526

 

 

(1,108)

 

36,418

Corporate debt securities

 

45,838

 

183

 

(3,028)

 

42,993

Total

$

410,859

$

682

$

(38,097)

$

373,444

Securities Available-for-Sale with an aggregate fair value of $247,027,000 at June 30, 2023 and $315,836,000 at December 31, 2022, were pledged to secure public funds, trust funds, securities sold under agreements to repurchase and the Federal Discount Window aggregating $195,838,000 at June 30, 2023 and $241,385,000 at December 31, 2022.

The amortized cost and estimated fair value of debt securities, by contractual maturity, are shown below at June 30, 2023. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

June 30, 2023

Debt Securities Available-For-Sale

(Dollars in thousands)

U.S. Government

Other

Obligations

Agency &

Mortgage

of State

Asset

Corporate

 

U.S. Treasury

 

Sponsored Agency

 

Backed Debt

 

& Political

 

Backed

 

Debt

    

Securities

    

Obligations1

    

Securities1

    

Subdivisions

    

Securities

    

Securities

Within 1 Year:

 

  

 

  

 

  

 

  

 

  

 

  

Amortized cost

$

$

$

6,245

$

1,922

$

$

12,562

Fair value

 

 

 

6,119

 

1,911

 

 

12,587

1 - 5 Years:

 

Amortized cost

 

2,898

 

736

 

1,746

 

17,995

 

 

Fair value

 

2,560

 

726

 

1,627

 

17,231

 

 

5 - 10 Years:

 

Amortized cost

 

4,969

 

14,225

 

 

22,139

 

2,049

 

33,179

Fair value

 

4,286

 

14,307

 

 

19,203

 

2,039

 

28,476

After 10 Years:

 

Amortized cost

 

 

135,040

 

24,350

 

58,105

 

30,782

 

Fair value

 

 

119,451

 

21,337

 

49,715

 

30,005

 

Total:

 

  

 

  

 

  

 

  

 

  

 

  

Amortized cost

$

7,867

$

150,001

$

32,341

$

100,161

$

32,831

$

45,741

Fair value

 

6,846

 

134,484

 

29,083

 

88,060

 

32,044

 

41,063

1

Mortgage-backed securities are allocated for maturity reporting at their original maturity date.

At June 30, 2023, the Corporation had holdings of securities from one issuer in excess of ten percent of consolidated stockholders’ equity, other than the U.S. Government and U.S. Government Agencies and Corporations. Holdings in Sallie Mae Bank securities had a fair value of $16,095,000 as of June 30, 2023. There were no aggregate holdings of securities with a single issuer (excluding the U.S. Government and U.S. Government Agencies and

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Corporations) which exceeded ten percent of consolidated stockholders’ equity at June 30, 2022. The quality rating of the obligations of state and political subdivisions are generally investment grade, as rated by Moody’s, Standard and Poor’s or Fitch. The typical exceptions are local issues which are not rated, but are secured by the full faith and credit obligations of the communities that issued these securities.

There were no proceeds from sales of Debt Securities Available-For-Sale for the three months ended June 30, 2023 and 2022. Therefore, there were no gains or losses realized during these periods.

Proceeds from sales of Debt Securities Available-For-Sale for the six months ended June 30, 2023 and 2022 were $23,230,000 and $0, respectively. Gross gains realized on these sales were $447,000 and $0, respectively. Gross losses on these sales were $348,000 and $0 respectively.

The summary below shows the gross unrealized losses and fair value of the Company’s debt securities. Totals are aggregated by investment category where individual securities have been in a continuous loss position for less than 12 months or 12 months or more as of June 30, 2023 and December 31, 2022:

June 30, 2023

(Dollars in thousands)

Less Than 12 Months

12 Months or More

Total

Fair

Unrealized

Fair

Unrealized

Fair

Unrealized

Available-for-Sale:

    

Value

    

Loss

    

Value

    

Loss

    

Value

    

Loss

U.S. Treasury securities

$

$

$

6,846

$

(1,021)

$

6,846

$

(1,021)

Obligations of U.S. Government Agencies and Sponsored Agencies:

 

  

 

  

 

  

 

  

 

  

 

  

Mortgage-backed

41,155

(1,097)

83,974

(14,551)

125,129

(15,648)

Other

 

1,271

(6)

2,623

(39)

 

3,894

 

(45)

Other mortgage-backed debt securities

 

29,083

(3,258)

 

29,083

 

(3,258)

Obligations of state and political subdivisions

 

3,903

(36)

80,153

(12,074)

 

84,056

 

(12,110)

Asset-backed securities

 

6,302

(5)

21,544

(789)

 

27,846

 

(794)

Corporate debt securities

 

2,812

(298)

32,622

(4,509)

 

35,434

 

(4,807)

Total

$

55,443

$

(1,442)

$

256,845

$

(36,241)

$

312,288

$

(37,683)

December 31, 2022

(Dollars in thousands)

Less Than 12 Months

12 Months or More

Total

    

Fair

    

Unrealized

    

Fair

    

Unrealized

    

Fair

    

Unrealized

Available-for-Sale:

Value

Loss

Value

Loss

Value

Loss

U.S. Treasury securities

$

$

$

6,801

$

(1,052)

$

6,801

$

(1,052)

Obligations of U.S. Government Agencies and Sponsored Agencies:

 

  

 

  

 

  

 

  

 

  

 

  

Mortgage-backed

61,067

(2,184)

65,174

(12,848)

126,241

(15,032)

Other

 

1,589

(2)

3,168

(43)

 

4,757

 

(45)

Other mortgage-backed debt securities

 

16,167

(962)

17,521

(2,117)

 

33,688

 

(3,079)

Obligations of state and political subdivisions

 

56,565

(5,881)

35,704

(8,872)

 

92,269

 

(14,753)

Asset-backed securities

 

24,136

(405)

12,282

(703)

 

36,418

 

(1,108)

Corporate debt securities

 

15,827

(1,073)

18,345

(1,955)

 

34,172

 

(3,028)

Total

$

175,351

$

(10,507)

$

158,995

$

(27,590)

$

334,346

$

(38,097)

There were 173 individual debt securities in an unrealized loss position as of June 30, 2023, with a combined decline in value representing 10.13% of the debt securities portfolio. There were 183 individual debt securities in an

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unrealized loss position as of December 31, 2022, with their combined decline in value representing 9.11% of the debt securities portfolio.

Available-for-sale debt securities are required to be individually evaluated for impairment in accordance with ASC 326, Financial Instruments – Credit Losses. Management evaluates debt securities for impairment where there has been a decline in fair value below the amortized cost basis of a debt security to determine whether there is a credit loss associated with the decline in fair value on at least a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Credit losses are calculated individually, rather than collectively, using a discounted cash flow method, whereby Management compares the present value of expected cash flows with the amortized cost basis of the debt security. The credit loss component would be recognized through the provision for credit losses and the creation of an allowance for credit losses. Consideration is given to (1) the financial condition and near-term prospects of the issuer, (2) the outlook for receiving the contractual cash flows of the investments, (3) the length of time and the extent to which the fair value has been less than cost, (4) our intent and ability to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value or whether it is more-likely-than-not that we will be required to sell the debt security prior to recovering its fair value, (5) the anticipated outlook for changes in the general level of interest rates, (6) credit ratings, (7) third party guarantees, and (8) collateral values. In analyzing an issuer’s financial condition, management considers whether the debt securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the results of reviews of the issuer’s financial condition, and the issuer’s anticipated ability to pay the contractual cash flows of the debt securities. All issues of U.S. Treasury and Agency-Backed debt securities have the full faith and credit backing of the United States Government or one of its agencies. All other debt securities that do not have a zero expected credit loss are evaluated quarterly to determine whether there is a credit loss associated with a decline in fair value.

The Company made a policy election to exclude accrued interest receivable from the amortized cost basis of debt securities available for sale. Accrued interest receivable on debt securities available for sale is reported as a component of accrued interest receivable on the Company’s consolidated balance sheet and totaled $2,108,000 as of June 30, 2023. Accrued interest receivable on debt securities available for sale is excluded from the estimate of credit losses.

All debt securities available for sale in an unrealized loss position, as of June 30, 2023, continue to perform as scheduled and we do not believe that there is a credit loss or that a provision for credit losses is necessary. Also, as part of our evaluation of our intent and ability to hold debt securities for a period of time sufficient to allow for any anticipated recovery in the market, we consider our investment strategies, cash flow needs, liquidity position, capital adequacy and interest rate risk position. We do not currently intend to sell the debt securities within the portfolio and it is not more-likely-than-not that we will be required to sell the debt securities.

Management continues to monitor all of our debt securities with a high degree of scrutiny. There can be no assurance that we will not conclude in future periods that conditions existing at that time indicate some or all of its debt securities may be sold or would require a charge to earnings as a provision for credit losses in such periods.

Equity Securities

Equity securities with readily determinable fair values are stated at fair value with realized and unrealized gains and losses reported in income. Equity securities without readily determinable fair values are recorded at cost less impairment, if any.

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At June 30, 2023 and December 31, 2022, the Company had $1,476,000 and $1,699,000, respectively, in equity securities recorded at fair value. The following is a summary of realized gains and losses recognized in net income on equity securities during the six months ended June 30, 2023 and 2022:

(Dollars in thousands)

Six months ended

Six months ended

    

June 30, 2023

    

June 30, 2022

    

Net losses from market value fluctuations recognized during the period on equity securities

$

(224)

$

(158)

Less: Net gains recognized during the period on equity securities sold during the period

 

 

27

Net losses recognized during the reporting period on equity securities still held at the reporting date

$

(224)

$

(131)

Management evaluates equity securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. Equity securities are generally evaluated for OTTI under FASB ASC 320, Investments - Debt and Equity Securities. In determining OTTI under the FASB ASC 320 model, management considers many factors, including (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the equity security or more likely than not will be required to sell the equity security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time. If an impairment loss on an equity security is considered to be other-than-temporary, a loss in the amount of the difference between the cost and fair value of the security is recognized. Once the impairment is recorded, this becomes the new cost basis of the equity security and cannot be adjusted upward if there is a subsequent recovery in the fair value of the security.

The Company monitors the equity securities portfolio monthly with particular attention given to securities in a continuous loss position of at least ten percent for over twelve months. Based on the factors described above, management did not consider any equity securities to be other-than-temporarily impaired at June 30, 2023 or December 31, 2022.

NOTE 4 — LOANS AND ALLOWANCE FOR CREDIT LOSSES

Loans

Net loans are stated at their outstanding recorded investment, net of deferred fees and costs, unearned income and the allowance for credit losses. Interest on loans is recognized as income over the term of each loan, generally, by the accrual method. Loan origination fees and certain direct loan origination costs have been deferred with the net amount amortized using the straight line method or the interest method over the contractual life of the related loans as an interest yield adjustment.

The loans receivable portfolio is segmented into the following segments: Real Estate (including both commercial and residential loans), Agricultural, Commercial and Industrial, Consumer, and State and Political Subdivisions.

Real Estate Lending

The Company engages in real estate lending to commercial borrowers in its primary market area and surrounding areas. The commercial component of the Company’s Real Estate portfolio is secured primarily by commercial retail space, commercial office buildings, residential housing and hotels. Generally, these loans have terms that do not exceed twenty years, have loan-to-value ratios of up to eighty percent of the value of the collateral property, and are typically supported by personal guarantees of the borrowers.

13

In underwriting these loans, the Company performs a thorough analysis of the financial condition of the borrower, the borrower’s credit history, and the reliability and predictability of the cash flow generated by the property securing the loan. The value of the property is determined by either independent appraisers or internal evaluations performed by Bank officers.

Real estate loans secured by commercial properties generally present a higher level of risk than loans secured by residential real estate. Repayment of loans secured by commercial real estate is typically dependent upon the successful operation of the related real estate project and/or the effect of the general economic conditions on income producing properties.

The residential component of the Company’s Real Estate portfolio is comprised of one-to-four family residential mortgage loan originations, home equity term loans and home equity lines of credit. These loans are generated by the Company’s marketing efforts, its present customers, walk-in customers and referrals. These loans are originated primarily with customers from the Company’s market area.

The Company’s one-to-four family residential mortgage originations are secured principally by properties located in its primary market area and surrounding areas. The Company offers fixed-rate mortgage loans with terms up to a maximum of thirty years for both permanent structures and those under construction. Loans with terms of thirty years are normally held for sale and sold without recourse; most of the residential mortgages held in the Company’s residential real estate portfolio have maximum terms of twenty years. Generally, the majority of the Company’s residential mortgage loans originate with a loan-to-value of eighty percent or less, or those with private mortgage insurance at ninety-five percent or less. Home equity term loans are secured by the borrower’s primary residence and typically have a maximum loan-to-value of eighty percent and a maximum term of fifteen years. In general, home equity lines of credit are secured by the borrower’s primary residence with a maximum loan-to-value of eighty percent and a maximum term of twenty years.

In underwriting one-to-four family residential mortgage loans, the Company evaluates the borrower’s ability to make monthly payments, the borrower’s prior loan repayment history and the value of the property securing the loan. The ability and willingness to repay is assessed based upon the borrower’s employment history, current financial conditions and credit background. A majority of the properties securing residential real estate loans made by the Company are appraised by independent appraisers. The Company generally requires mortgage loan borrowers to obtain an attorney’s title opinion or title insurance and fire and property insurance, including flood insurance, if applicable.

Residential mortgage loans, home equity term loans and home equity lines of credit generally present a lower level of risk than consumer loans because they are secured by the borrower’s primary residence. Risk is increased when the Company is in a subordinate position, especially to another lender, for the loan collateral.

Residential mortgage loans held for sale are carried at the lower of cost or market on an aggregate basis determined by independent pricing from appropriate federal or state agency investors. These loans are sold without recourse. Loans held for sale amounted to $0 and $71,000 at June 30, 2023 and December 31, 2022, respectively.

Agricultural Lending

The Company originates agricultural loans to individuals in the farming industry for funding the production of crops or to purchase or refinance capital assets such as farmland, livestock, machinery, equipment, and farm real estate improvements. Agricultural loans are typical secured by collateral related to the farming activities. These loans originate from customers within the Company’s primary market area or the surrounding areas.

In underwriting agricultural loans, an analysis is performed regarding the borrower’s ability to repay the loan, the borrower’s capital and collateral, and the past, present, and future cash flows of the borrower, as well as the agricultural industry as a whole. In general, these loans would be secured by cropland, pastureland, orchardland, or timberland that is committed to ongoing management and agricultural production, with a maximum loan-to-value ratio of 70% and a maximum term of ten years.

14

Commercial and Industrial Lending

The Company originates commercial and industrial loans principally to businesses located in its primary market area and surrounding areas. These loans are used for various business purposes, which include short-term loans and lines of credit to finance machinery and equipment, inventory and accounts receivable. Generally, the maximum term for loans extended on machinery and equipment is based on the projected useful life of such machinery and equipment. Most business lines of credit are written on demand and are reviewed annually.

Commercial and industrial loans are generally secured with short-term assets; however, in many cases, additional collateral such as real estate is provided as additional security for the loan. Loan-to-value maximum thresholds have been established by the Company and are specific to the type of collateral. Collateral values may be determined using invoices, inventory reports, accounts receivable aging reports, business financial statements, collateral appraisals or internal evaluations, etc. Commercial and industrial loans are typically supported by personal guarantees of the borrower.

In underwriting commercial and industrial loans, an analysis is performed to evaluate the borrower’s character and capacity to repay the loan, the adequacy of the borrower’s capital and collateral, as well as the conditions affecting the borrower. Evaluation of the borrower’s past, present and future cash flows is also an important aspect of the Company’s analysis of the borrower’s ability to repay.

Commercial and industrial loans generally present a higher level of risk than other types of loans due primarily to the effect of general economic conditions. Commercial and industrial loans are typically made on the basis of the borrower’s ability to make repayment from cash flows from the borrower’s primary business activities. As a result, the availability of funds for the repayment of commercial and industrial loans is dependent on the success of the business itself, which in turn, is likely to be dependent upon the general economic environment.

As an addition to the commercial loans receivable portfolio, the Company may purchase the guaranteed portion of loans secured by the U.S. Government. The originating bank retains the unguaranteed portion of the loan. The loans are sponsored by one of the various government agencies including the SBA, United States Department of Agriculture (“USDA”), and the Farm Service Agency (“FSA”). Government Guaranteed Loans ("GGLs") carry no credit risk due to an unconditional and irrevocable guarantee (which is supported by the full faith and credit of the U.S. Government) on all principal and the balance of interest accruing through ninety days beyond the date that demand is made to the originating bank for repurchase of the loan. As of June 30, 2023, the Company's balance of GGLs was $4,542,000, compared to $4,631,000 at December 31, 2022.

Consumer Lending

The Company offers a variety of secured and unsecured consumer loans, including vehicle loans, stock secured loans and loans secured by financial institution deposits. These loans originate primarily with customers from the Company’s market area.

Consumer loan terms vary according to the type and value of collateral and creditworthiness of the borrower. In underwriting personal loans, a thorough analysis is performed regarding the borrower’s willingness and financial ability to repay the loan as agreed. The ability and willingness to repay is assessed based upon the borrower’s employment history, current financial condition and credit background.

Consumer loans may entail greater credit risk than residential real estate loans, particularly in the case of personal loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles or recreational equipment. In such cases, repossessed collateral for a defaulted personal loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, personal loan collections are dependent on the borrower’s continuing financial stability and therefore, are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

15

State and Political Subdivisions Lending

The Company, from time to time, may originate loans to state and political subdivisions that are within the Company’s primary market area or surrounding areas. These loans may be either taxable or tax-free. These loans may be issued for the purpose of land improvement, infrastructure changes, bond refinances, or the purchase of equipment. State and political loans are typically secured by the taxing power of the borrowing entity. In some cases, the loans may also be secured by the property/item being purchased. Audited financial statements are required as part of the underwriting for all state and political loans and a full analysis of all components of the audited statements is performed. If the loan is to be classified as tax-free, a letter from the entity’s solicitor stating such is required, as well.

The risk associated with these types of loans is considerably less than commercial loan transactions. Repayment is based on the full faith, credit, and ability of the borrowing entity to tax and then collect the payments. Delinquency or loss on these types of loans is de minimus.

Delinquent Loans

Generally, a loan is considered to be past-due when scheduled loan payments are in arrears 10 days or more. Delinquent notices are generated automatically when a loan is 10 or 15 days past-due, depending on loan type. Collection efforts continue on past-due loans that have not been brought current, when it is believed that some chance exists for improvement in the status of the loan. Past-due loans are continually evaluated with the determination for charge-off being made when no reasonable chance remains that the status of the loan can be improved.

Commercial and industrial loans and real estate loans issued for commercial purpose are charged off in whole or in part when they become sufficiently delinquent based upon the terms of the underlying loan contract and when a collateral deficiency exists. Because all or part of the contractual cash flows are not expected to be collected, the loan is considered to be impaired, and the Company estimates the impairment based on its analysis of the cash flows or collateral estimated at fair value less cost to sell. Should a GGL default, demand is made to the originating bank for repurchase of the loan. If the originating bank does not repurchase the loan, demand for repurchase is then made to the appropriate government agency which has provided the guarantee for the loan.

Real estate loans issued for residential purposes and consumer loans are charged off when they become sufficiently delinquent based upon the terms of the underlying loan contract and when the value of the underlying collateral is not sufficient to support the loan balance and a loss is expected. At that time, the amount of estimated collateral deficiency, if any, is charged off for loans secured by collateral, and all other loans are charged off in full. Loans with collateral are written down to the estimated fair value of the collateral less cost to sell.

Existing loans in which the borrower has declared bankruptcy are considered on a case by case basis to determine whether repayment is likely to occur (e.g. reaffirmation by the borrower with demonstrated repayment ability). Otherwise, loans are charged off in full or written down to the estimated fair value of collateral less cost to sell.

Generally, a loan is classified as non-accrual and the accrual of interest on such a loan is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest. A loan may remain on accrual status if it is well secured (or supported by a strong guarantee) and in the process of collection. When a loan is placed on non-accrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against interest income. Certain non-accrual loans may continue to perform; that is, payments are still being received. Generally, the payments are applied to principal. These loans remain under constant scrutiny, and if performance continues, interest income may be recorded on a cash basis based on management's judgment regarding the collectability of principal.

Allowance for Credit Losses - Loans

The allowance for credit losses (“ACL”) is an estimate of losses arising from borrowers’ inability to make loan payments as required, which is calculated via a valuation account that is deducted from the amortized cost basis to present the net amount expected to be collected on the loan portfolio. The Company completed a one-time adjustment to

16

decrease the ACL at the adoption of ASU 2016-13 through retained earnings, but all subsequent adjustments will be established through provisions for credit losses charged against income. Loans deemed to be uncollectible are charged against the ACL and subsequent recoveries, if any, are credited to the allowance.

The ACL is maintained at a level estimated by management to be adequate to absorb potential loan losses. Management’s periodic evaluation of the adequacy of the ACL is based on specific expectations for the future economic environment that are incorporated in the projection, with loss expectations to revert to the long-run historical mean after such time as management can make or obtain a reasonable and supportable forecast. Management also considers the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may impact the borrower’s ability to repay (including the timing of future payments), the estimated value of any underlying collateral (if the loan is collateral dependent), composition of the loan portfolio, and other relevant factors. This evaluation is inherently subjective as it requires material estimates based on management’s judgment regarding the projection of expected credit losses over the contractual lifetime of the loans.

Modeling of the ACL uses sophisticated statistical techniques to arrive at reasonable and supportable forecasts of expected losses. The Company has contracted with a third-party vendor to assist in developing models for the ACL related to the Company’s loan portfolio under ASU 2016-13. The Company has opted to utilize the Weighted Average Remaining Maturity (“WARM”) method to calculate the ACL which uses an average annual charge-off rate. This average annual charge-off rate contains loss content over several vintages and is used as a foundation for estimating the credit loss content for loans by segmented pools at the balance sheet date and is used to determine a historical charge-off rate. When estimating expected credit losses, the Company considers forward-looking information that is both reasonable, supportable, and relevant to assessing the collectability of cash flows. Reasonable and supportable forecasts may extend over the entire contractual term of a loan or a period shorter than the contractual term. Reasonable and supportable forecasts may vary by portfolio segment or individual forecast input. These forecasts may include data from internal sources, external sources, or a combination of both.

When the contractual term of a loan extends beyond the reasonable and supportable period, ASC Topic 326 requires reverting to historical loss information, or an appropriate proxy, for those periods beyond the reasonable and supportable forecast period (often referred to as the reversion period). The Company may revert to historical loss information for each individual forecast input or based on the entire estimate of loss. Reversion to historical loss information may be immediate, occur on a straight-line basis, or use any systematic/rational method. Management may apply different reversion techniques depending on the economic environment or applicable loan portfolio.

The methodology used to determine the ACL also includes a qualitative component in which the Company adjusts expected credit loss estimates for information not already captured in the loss estimation process. These qualitative factor adjustments may increase or decrease management’s estimate of expected credit losses. Changes in the level of the Company’s ACL may not always be directionally consistent with changes in the level of qualitative factor adjustments due to the incorporation of reasonable and supportable forecasts in estimating expected losses. Management considers qualitative factors that are relevant to the Company as of the reporting date, which may include but are not limited to: 1) changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere; 2) changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the loan portfolio, including the condition of various market segments; 3) changes in the nature and volume of the loan portfolio; 4) changes in the experience, ability, and depth of management and other relevant staff; 5) changes in the volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified or graded loans; 6) changes in the quality of the Company’s loan review system; 7) changes in the value of underlying collateral for collateral dependent loans; 8) the existence and effect of any concentrations of credit and changes in the level of such concentrations; and 9) the effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the Company’s existing loan portfolio.

The Company’s ACL is calculated by collectively evaluating and individually evaluating loans. The Company collectively evaluates applicable loans based on segments according to their homogeneous characteristics, aligned with the segmentation of the FDIC Bank Call Report. The Company collectively evaluates loans and determines applicable loss rates based on the following segments/classes:

17

Real Estate

Construction, land development, and other land loans
Residential construction (loans to build homes, both speculative and owner-occupied, and 1-4 family lot loans)
Agribusiness, farmland, or secured by farmland
Revolving, open-end, 1-4 family residential properties (and extended under lines of credit)
Loans secured by first liens
Loans secured by junior liens
Secured by multifamily (5 or more) residential properties
Loans secured by owner occupied, non-farm, non-residential properties
Loans secured by other non-farm, non-residential properties

Agricultural

Loans to finance agricultural production and other loans for farmers

Commercial and Industrial

Commercial and industrial loans

Consumer

Other revolving credit plans
Automobile loans
Other consumer loans

State and Political Subdivisions

Obligations (other than securities or leases) of states and political subdivisions in the U.S.

In accordance with ASC 326-20-30-2, the Company will evaluate individual loans for expected credit losses when the loans do not share similar risk characteristics with loans evaluated using the collective method. Management may evaluate loans on an individual basis even when no specific expectation of collectability is in place. Loans deemed to be impaired are specifically identified and measured for impairment. A loan is deemed to be 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 loan agreement. Loans to be considered for impairment include all non-accrual loans or any other selected loans where full collection is unlikely. Factors considered by management in determining impairment include payment status 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. Once identified as impaired, the loans are measured individually for impairment based on one of the following methods:

The present value of expected cash flows, discounted at the loan’s effective interest rate (i.e. the contractual interest rate adjusted for any net deferred loan fees or costs, premium, or discount existing at the origination or acquisition of the loan)

The loan’s observable market price

The fair value of the collateral if the loan is deemed to be collateral dependent. A loan is collateral dependent if the repayment of the loan is expected to be provided solely by the liquidation of the underlying collateral and there are no other available and reliable sources of repayment. Management will consider estimated costs to sell, on a discounted basis, in the measurement of impairment if these costs are expected to reduce the cash flows available to repay the loan. Any portion of the recorded investment for a collateral dependent loan (including any capitalized accrued interest, net deferred loan fees or costs, and unamortized premium or discount) exceeding the fair value of the collateral that can be identified as uncollectible is deemed a confirmed loss and will be charged off against the ACL

18

Loans that have been individually measured for impairment may have a portion of the allowance allocated to cover the calculated amount of impairment as determined by the methods listed above, referred to as a specific allocation. Loans individually evaluated for impairment may also have a zero specific allocation if the loans are deemed to have no impairment, or if the amount of the impairment will be charged off.

ASU 2022-02, Loan Modifications Experiencing Financial Difficulty, eliminated the accounting guidance for Troubled Debt Restructurings (“TDRs”) while enhancing disclosure requirements for certain loan refinancing and restructurings by creditors when a borrower is experiencing financial difficulty. In accordance with the new guidance, the Company no longer evaluates loans with modifications made to borrowers experiencing financial difficulty individually for impairment, nor establishes a related specific reserve for such loans, but rather these loans are included in their respective portfolio segment and evaluated collectively for impairment to establish an allowance for credit losses. Any modifications of loans to borrowers experiencing financial difficulty that are classified as non-accrual or are otherwise designated as collateral dependent are individually evaluated for determination of expected credit losses. There were no loan modifications made to borrowers experiencing financial difficulties during the three or six months ended June 30, 2023.

The most common types of concessions granted upon modification of a loan to a borrower experiencing financial difficulties include: (a) a reduction in the interest rate for the remaining life of the debt, (b) an extension of the maturity date at an interest rate lower than the current market rate for new debt with similar risk, (c) a temporary period of interest-only payments, and (d) a reduction in the contractual payment amount for either a short period or for the remaining term of the loan. A less common concession would be forgiveness of a portion of the loan’s principal. Loans so modified remain collectively evaluated for determination of expected credit losses, unless, during the process of evaluation, it is determined that the loan should be placed on non-accrual status until the Company determines that future collection of principal and interest is reasonably assured or the loan is otherwise deemed to be collateral dependent.

There may be certain types of loans for which the expectation of credit loss is zero after evaluating historical loss information, making necessary adjustments for current conditions and reasonable and supportable forecasts, and considering any collateral or guarantee arrangements that are not free-standing contracts. Factors considered by management when evaluating whether expectations of zero credit loss are appropriate may include, but are not limited to: 1) a long history of zero credit loss; 2) full securitization by cash or cash equivalents; 3) high credit ratings from rating agencies with no expected future downgrade; 4) principal and interest payments that are guaranteed by the U.S. government; 5) the issuer, guarantor, or sponsor can print its own currency and the currency is held by other central banks as reserve currency; and 6) the interest rate on the security is recognized as a risk-free rate.

A loan that is fully secured by cash or cash equivalents, such as a certificate of deposit issued by the lending institution, would likely have zero credit loss expectations. Similarly, the guaranteed portion of an SBA loan purchased on the secondary market through the SBA’s fiscal and transfer agent would likely have zero credit loss expectations because these financial assets are unconditionally guaranteed by the U.S. government.

ASC Topic 326 introduces the concept of purchased credit deteriorated (“PCD”) assets. PCD assets are acquired financial assets that, at acquisition, have experienced more-than-insignificant deterioration in credit quality since origination, as determined by the Company’s assessment. The Company does not possess loans classified as purchased credit deterioration at this time. Should the Company acquire purchased loans, these loans will be evaluated to determine if they are PCD.

A reserve for unfunded lending commitments is provided for possible credit losses on off-balance sheet credit exposures. Off-balance sheet credit exposures primarily include undrawn portions of revolving lines of credit and standby letters of credit. The reserve for unfunded lending commitments represents management’s estimate of losses inherent in its unfunded loan commitments and, if necessary, is recorded in other liabilities on the consolidated balance sheets. As of June 30, 2023 and December 31, 2022, the amount of the reserve for unfunded lending commitments was $260,000 and $68,000, respectively.

The Company made a policy election to exclude accrued interest receivable from the amortized cost basis of loans. Accrued interest receivable on loans is reported as a component of accrued interest receivable on the Company’s

19

consolidated balance sheet and totaled $1,906,000 as of June 30, 2023. Accrued interest receivable on loans is excluded from the estimate of credit losses.

The Company is subject to periodic examination by its federal and state examiners, and may be required by such regulators to recognize additions to the ACL based on their assessment of credit information available to them at the time of their examinations.

The Company utilizes a risk grading matrix as a tool for managing credit risk in the loan portfolio and assigns an asset quality rating (risk grade) to all loans. An asset quality rating is assigned using the guidance provided in the Company’s loan policy. Primary responsibility for assigning the asset quality rating rests with the credit department. The asset quality rating is validated periodically by both an internal and external loan review process.

The commercial loan grading system focuses on a borrower’s financial strength and performance, experience and depth of management, primary and secondary sources of repayment, the nature of the business and the outlook for the particular industry. Primary emphasis is placed on financial condition and trends. The grade also reflects current economic and industry conditions; as well as other variables such as liquidity, cash flow, revenue/earnings trends, management strengths or weaknesses, quality of financial information, and credit history.

The loan grading system for residential real estate secured and consumer loans focuses on the borrower’s credit score and credit history, debt-to-income ratio and income sources, collateral position and loan-to-value ratio.

Risk grade characteristics are as follows:

Risk Grade 1 – MINIMAL RISK through Risk Grade 6 – MANAGEMENT ATTENTION (Pass Grade Categories)

Risk is evaluated via examination of several attributes including but not limited to financial trends, strengths and weaknesses, likelihood of repayment when considering both cash flow and collateral, sources of repayment, leverage position, management expertise, and repayment history.

At the low-risk end of the rating scale, a risk grade of 1 – Minimal Risk is the grade reserved for loans with exceptional credit fundamentals and virtually no risk of default or loss. Loan grades then progress through escalating ratings of 2 through 6 based upon risk. Risk Grade 2 – Modest Risk are loans with sufficient cash flows; Risk Grade 3 – Average Risk are loans with key balance sheet ratios slightly above the borrower’s peers; Risk Grade 4 – Acceptable Risk are loans with key balance sheet ratios usually near the borrower’s peers, but one or more ratios may be higher; and Risk Grade 5 – Marginally Acceptable are loans with strained cash flow, increasing leverage and/or weakening markets. Risk Grade 6 – Management Attention are loans with weaknesses resulting from declining performance trends and the borrower’s cash flows may be temporarily strained. Loans in this category are performing according to terms, but present some type of potential concern.

Risk Grade 7 − SPECIAL MENTION (Non-Pass Category)

Assets in this category are adequately collateralized but have potential weakness which may, if not checked or corrected, weaken the asset or inadequately protect the Company’s credit position at some future date. The loans may constitute increased credit risk, but not to the point of justifying a classification of substandard. No loss of principal or interest is envisioned, but risk is increasing beyond that at which the loan originally would have been granted. Historically, cash flows are inconsistent; financial trends show some deterioration. Liquidity and leverage are above industry averages. Financial information could be incomplete or inadequate. A Special Mention asset has potential weaknesses that deserve management’s close attention.

Risk Grade 8 − SUBSTANDARD (Non-Pass Category)

Generally, these assets are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have “well-defined” weaknesses that jeopardize the full liquidation of the debt.

20

These loans are characterized by the distinct possibility that the Company will sustain some loss if the aggregate amount of substandard assets is not fully covered by the liquidation of the collateral used as security. Substandard loans have a high probability of payment default and require more intensive supervision by Company management.

Risk Grade 9 − DOUBTFUL (Non-Pass Category)

Generally, loans graded doubtful have all the weaknesses inherent in a substandard loan with the added factor that the weaknesses are pronounced to a point whereby the basis of current information, conditions, and values, collection or liquidation in full is deemed to be highly improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors that may work to strengthen the asset, its classification is deferred until, for example, a proposed merger, acquisition, liquidation procedure, capital injection, perfection of liens on additional collateral and/or refinancing plan is completed. Loans are graded doubtful if they contain weaknesses so serious that collection or liquidation in full is questionable.

The following table presents the classes of the loan portfolio summarized by risk rating and year of origination and gross charge offs by loan portfolio summarized by year of origination as of June 30, 2023.

(Dollars in thousands)

2023

2022

2021

2020

2019

Prior

Total

Real Estate:

1-6 Pass

$

41,847

$

192,228

$

142,849

$

117,438

$

56,819

$

202,536

$

753,717

7    Special Mention

631

631

8    Substandard

86

888

9,287

9,424

19,685

9    Doubtful

Unearned discount

Net deferred loan fees and costs

148

226

171

124

(14)

655

Total Real Estate Loans

$

41,995

$

192,540

$

143,908

$

117,562

$

66,092

$

212,591

$

774,688

Agricultural:

1-6 Pass

$

$

66

$

$

$

1

$

793

$

860

7    Special Mention

8    Substandard

9    Doubtful

Unearned discount

Net deferred loan fees and costs

1

1

2

Total Agricultural Loans

$

$

67

$

$

$

1

$

794

$

862

Commercial and Industrial:

1-6 Pass

$

6,191

$

10,954

$

5,790

$

7,762

$

6,822

$

22,681

$

60,200

7    Special Mention

8    Substandard

692

692

9    Doubtful

Unearned discount

Net deferred loan fees and costs

50

103

32

19

216

1

421

Total Commercial and
Industrial Loans

$

6,241

$

11,057

$

5,822

$

7,781

$

7,038

$

23,374

$

61,313

21

Consumer:

1-6 Pass

$

1,626

$

1,590

$

1,296

$

308

$

248

$

982

$

6,050

7    Special Mention

10

10

8    Substandard

9    Doubtful

Unearned discount

Net deferred loan fees and costs

24

27

11

4

3

69

Total Consumer Loans

$

1,660

$

1,617

$

1,307

$

312

$

251

$

982

$

6,129

State and Political Subdivisions:

1-6 Pass

$

50

$

5,442

$

15,098

$

1,953

$

$

5,697

$

28,240

7    Special Mention

8    Substandard

9    Doubtful

Unearned discount

Net deferred loan fees and costs

1

2

4

1

(1)

7

Total State and Political Subdivision Loans

$

51

$

5,444

$

15,102

$

1,954

$

$

5,696

$

28,247

Total Loans:

1-6 Pass

$

49,714

$

210,280

$

165,033

$

127,461

$

63,890

$

232,689

$

849,067

7    Special Mention

10

631

641

8    Substandard

86

888

9,287

10,116

20,377

9    Doubtful

Unearned discount

Net deferred loan fees and costs

223

359

218

148

205

1

1,154

Total Loans

$

49,947

$

210,725

$

166,139

$

127,609

$

73,382

$

243,437

$

871,239

2023

2022

2021

2020

2019

Prior

Total

Gross Charge Offs:

Real Estate

$

$

$

$

$

$

$

Agricultural

Commercial and Industrial

Consumer

23

8

4

3

38

State and Political Subdivisions

Total Gross Charge Offs

$

$

23

$

8

$

$

4

$

3

$

38

Commercial and Industrial Loans include loans categorized as tax-free in the amount of $10,000 and State and Political Subdivision Loans include loans categorized as tax-free in the amount of $28,140,000 as of June 30, 2023. Commercial and Industrial Loans also include $4,542,000 of GGLs as of June 30, 2023. Loans held for sale are included in the Real Estate Loans category. There were no loans held for sale at June 30, 2023.

22

The activity in the allowance for credit losses by loan class (post adoption of ASU No. 2016-13), is summarized below for the three and six months ended June 30, 2023.

(Dollars in thousands)

    

    

    

    

State and

    

Real

Commercial

Political

Estate

Agricultural

and Industrial

Consumer

Subdivisions

Total

As of and for the three months ended June 30, 2023:

Allowance for Credit Losses:

  

 

  

 

  

 

  

 

  

 

  

Beginning balance

6,735

1

265

93

48

7,142

Charge-offs

 

 

 

 

(21)

 

 

(21)

Recoveries

 

1

 

 

1

 

 

 

2

Provision (credit)

 

18

 

 

2

 

17

 

(3)

 

34

Ending Balance

$

6,754

$

1

$

268

$

89

$

45

$

7,157

(Dollars in thousands)

    

    

    

    

State and

    

Real

Commercial

Political

Estate

Agricultural

and Industrial

Consumer

Subdivisions

Total

As of and for the six months ended June 30, 2023:

Allowance for Credit Losses:

Balance at December 31, 2022

$

7,483

$

6

$

504

$

84

$

197

$

8,274

CECL adoption adjustment

(717)

(4)

(261)

11

(148)

(1,119)

Beginning balance January 1, 2023

6,766

2

243

95

49

7,155

Charge-offs

 

 

 

 

(38)

 

 

(38)

Recoveries

 

2

 

 

2

 

2

 

 

6

(Credit) Provision

 

(14)

 

(1)

 

23

 

30

 

(4)

 

34

Ending Balance

$

6,754

$

1

$

268

$

89

$

45

$

7,157

Ending balance: individually

 

  

 

 

 

 

 

evaluated for impairment

$

$

$

$

$

$

Ending balance: collectively

 

 

 

 

 

 

evaluated for impairment

$

6,754

$

1

$

268

$

89

$

45

$

7,157

Reserve for Unfunded Lending Commitments

$

225

$

$

35

$

$

$

260

Loans Receivable:

 

 

 

 

 

 

Ending Balance

$

774,688

$

862

$

61,313

$

6,129

$

28,247

$

871,239

Ending balance: individually

 

 

 

 

 

 

evaluated for impairment

$

4,445

$

309

$

644

$

$

$

5,398

Ending balance: collectively

 

 

 

 

 

 

evaluated for impairment

$

770,243

$

553

$

60,669

$

6,129

$

28,247

$

865,841

The Company's activity in the allowance for credit losses on unfunded commitments for the six months ended June 30, 2023 was as follows:

(Dollars in thousands)

    

2023

Balance at December 31, 2022

$

68

CECL adoption adjustment

147

Provision for credit losses on unfunded commitments

45

Balance at June 30, 2023

 

$

260

23

The recorded investment, unpaid principal balance, and the related allowance of the Company’s individually evaluated loans are summarized below at June 30, 2023:

(Dollars in thousands)

June 30, 2023

    

Unpaid

Recorded

Principal

Related

Investment

Balance

Allowance

With no related allowance recorded:

 

  

  

  

Real Estate

$

4,445

$

6,466

$

Agricultural

309

309

Commercial and Industrial

644

644

 

 

 

  

With an allowance recorded:

 

 

 

  

Real Estate

 

 

 

Agricultural

 

 

Commercial and Industrial

 

 

Total

$

5,398

$

7,419

$

Total consists of:

 

 

 

  

Real Estate

$

4,445

$

6,466

$

Agricultural

$

309

$

309

$

Commercial and Industrial

$

644

$

644

$

The recorded investment represents the loan balance reflected on the consolidated balance sheets net of any charge-offs. The unpaid balance is equal to the gross amount due on the loan.

The average recorded investment and interest income recognized for the Company’s individually evaluated loans are summarized below for the three and six months ended June 30, 2023:

(Dollars in thousands)

For the Three Months Ended

June 30, 2023

    

Average

    

Interest

Recorded

Income

Investment

Recognized

With no related allowance recorded:

 

  

 

  

Real Estate

$

4,367

$

Agricultural

 

309

 

6

Commercial and Industrial

 

653

 

 

  

 

  

With an allowance recorded:

 

  

 

  

Real Estate

 

 

Agricultural

 

 

Commercial and Industrial

 

 

Total

$

5,329

$

6

 

  

 

  

Total consists of:

 

  

 

  

Real Estate

$

4,367

$

Agricultural

$

309

$

6

Commercial and Industrial

$

653

$

Of the $6,000 in interest income recognized on individually evaluated loans for the three months ended June 30, 2023, $0 in interest income was recognized with respect to non-accrual loans.

24

(Dollars in thousands)

For the Six Months Ended

June 30, 2023

    

Average

    

Interest

Recorded

Income

Investment

Recognized

With no related allowance recorded:

 

  

 

  

Real Estate

$

4,390

$

Agricultural

 

309

 

12

Commercial and Industrial

 

659

 

 

 

With an allowance recorded:

 

 

Real Estate

 

 

Agricultural

 

 

Commercial and Industrial

 

 

Total

$

5,358

$

12

 

 

Total consists of:

 

 

Real Estate

$

4,390

$

Agricultural

$

309

$

12

Commercial and Industrial

$

659

$

Of the $12,000 in interest income recognized on individually evaluated loans for the six months ended June 30, 2023, $0 in interest income was recognized with respect to non-accrual loans.

The following table presents collateral-dependent loans by segment for the period ended June 30, 2023.

(Dollars in thousands)

June 30, 2023

    

Real Estate

    

Other

Real Estate

$

4,445

$

Agricultural

309

Commercial and Industrial

644

Total

$

4,445

$

953

At June 30, 2023, there were no commitments to lend additional funds with respect to individually evaluated loans.

Total non-performing assets (which includes loans receivable on non-accrual status, foreclosed assets held for resale and loans past-due 90 days or more and still accruing interest) as of June 30, 2023 and December 31, 2022 were as follows:

(Dollars in thousands)

June 30, 

December 31, 

    

2023

    

2022

Real Estate

$

4,445

$

4,387

Agricultural

Commercial and Industrial

644

664

Consumer

 

State and Political Subdivisions

 

 

Total non-accrual loans

 

5,089

 

5,051

Foreclosed assets held for resale

 

 

Loans past-due 90 days or more and still accruing interest

 

584

 

308

Total non-performing assets

$

5,673

$

5,359

25

There were no foreclosed assets held for resale at June 30, 2023 or December 31, 2022. Consumer mortgage loans secured by residential real estate for which the Company has entered into formal foreclosure proceedings but for which physical possession has yet to be obtained amounted to $138,000 at June 30, 2023 and $41,000 at December 31, 2022. These balances were not included in foreclosed assets held for resale at June 30, 2023 or December 31, 2022.

The following tables present the classes of the loan portfolio, including individually evaluated loans, summarized by past-due status at June 30, 2023 and December 31, 2022:

(Dollars in thousands)

    

    

    

    

    

    

    

90 Days

Or Greater

Past Due

90 Days

Current-

and Still

30-59 Days

60-89 Days

or Greater

Total

29 Days

Total

Accruing

Past Due

Past Due

Past Due

Past Due

Past Due

Loans

Interest

June 30, 2023:

 

  

 

  

 

  

 

  

 

  

 

  

 

  

Real Estate

$

1,433

$

631

$

5,029

$

7,093

$

767,595

$

774,688

$

584

Agricultural

862

862

Commercial and Industrial

621

621

60,692

61,313

Consumer

 

5

 

5

 

 

10

 

6,119

 

6,129

 

State and Political Subdivisions

 

 

 

 

 

28,247

 

28,247

 

Total

$

1,438

$

636

$

5,650

$

7,724

$

863,515

$

871,239

$

584

(Dollars in thousands)

    

    

    

    

    

    

    

90 Days

Or Greater

Past Due

90 Days

Current-

and Still

30-59 Days

60-89 Days

or Greater

Total

29 Days

Total

Accruing

Past Due

Past Due

Past Due

Past Due

Past Due

Loans

Interest

December 31, 2022:

 

  

 

  

 

  

 

  

 

  

 

  

 

  

Real Estate

$

2,682

$

59

$

4,694

$

7,435

$

757,445

$

764,880

$

308

Agricultural

860

860

Commercial and Industrial

62

63

639

764

55,313

56,077

Consumer

 

11

 

2

 

 

13

 

5,694

 

5,707

 

State and Political Subdivisions

 

 

 

 

 

30,945

 

30,945

 

Total

$

2,755

$

124

$

5,333

$

8,212

$

850,257

$

858,469

$

308

Pre-ASU No. 2016-13 Disclosures:

For periods prior to the adoption of ASU No. 2016-13, when management deemed the collection of contractual cashlows was unlikely for a specific instrument (mainly non-accrual loans and TDRs, then referred to as impaired loans), a specific reserve was calculated under ASC 310-10. Management further calculated a general reserve for performing assets under its previous methodology, following ASC 450-20 which utilized historical loss experience and qualitative factor adjustments to arrive at a calculated allowance for credit losses.

Upon adoption of ASU No. 2016-13, the classes of the loan portfolio were updated to match the segmentation used under the CECL model and have been updated from Commercial and Industrial, Commercial Real Estate, Residential Real Estate, and Consumer to Real Estate, Agricultural, Commercial and Industrial, Consumer, and State and Political Subdivisions. Comparative, pre-ASU No. 2016-13 adoption data has not been updated to reflect the new loan classes/segmentation utilized under the CECL model.

26

The following table presents the classes of the loan portfolio summarized by risk rating as of December 31,
2022:

Commercial and

(Dollars in thousands)

Industrial

Commercial Real Estate

December 31, 

December 31, 

    

2022

    

2022

Grade:

 

  

 

  

1-6 Pass

$

85,845

$

591,309

7    Special Mention

 

 

634

8    Substandard

 

725

 

18,781

9    Doubtful

 

 

Add (deduct):  Unearned discount

 

 

   Net deferred loan fees and costs

 

429

 

825

Total loans

$

86,999

$

611,549

Residential Real Estate

Including Home Equity

Consumer 

December 31, 

December 31, 

    

2022

    

2022

Grade:

1-6 Pass

$

153,902

$

5,349

7    Special Mention

 

 

8    Substandard

 

795

 

9    Doubtful

 

 

Add (deduct):  Unearned discount

 

 

   Net deferred loan fees and costs

 

(191)

 

66

Total loans

$

154,506

$

5,415

Total Loans

December 31, 

    

2022

Grade:

 

  

1-6 Pass

$

836,405

7 Special Mention

 

634

8 Substandard

 

20,301

9 Doubtful

 

Add (deduct):  Unearned discount

 

   Net deferred loan fees and costs

 

1,129

Total loans

$

858,469

27

The activity in the allowance for credit losses by loan class (prior to adoption of ASU No. 2016-13), is summarized below for the three and six months ended June 30, 2022 and the year ended December 31, 2022.

(Dollars in thousands)

Commercial

    

Commercial

    

Residential

    

    

    

and Industrial

Real Estate

Real Estate

Consumer

Unallocated

Total

As of and for the three months ended June 30, 2022:

Allowance for Loan Losses:

  

 

  

 

  

 

  

 

  

 

  

Beginning balance

$

665

$

5,759

$

1,538

$

78

$

897

$

8,937

Charge-offs

 

(9)

 

 

 

(4)

 

 

(13)

Recoveries

 

1

 

 

13

 

4

$

 

18

Provision (credit)

 

18

 

195

 

58

 

1

 

(54)

 

218

Ending Balance

$

675

$

5,954

$

1,609

$

79

$

843

$

9,160

(Dollars in thousands)

Commercial

    

Commercial

    

Residential

    

    

    

and Industrial

Real Estate

Real Estate

Consumer

Unallocated

Total

As of and for the six months ended June 30, 2022:

Allowance for Credit Losses:

  

 

  

 

  

 

  

 

  

 

  

Beginning balance

$

681

$

5,408

$

1,539

$

84

$

968

$

8,680

Charge-offs

 

(9)

 

 

 

(6)

 

 

(15)

Recoveries

 

2

 

38

 

14

 

4

 

 

58

Provision (credit)

 

1

 

508

 

56

 

(3)

 

(125)

 

437

Ending Balance

$

675

$

5,954

$

1,609

$

79

$

843

$

9,160

Ending balance: individually

 

  

 

  

 

  

 

  

 

  

 

  

evaluated for impairment

$

$

$

$

$

$

Ending balance: collectively

 

  

 

  

 

  

 

  

 

  

 

  

evaluated for impairment

$

675

$

5,954

$

1,609

$

79

$

843

$

9,160

Loans Receivable:

 

  

 

  

 

  

 

  

 

  

 

  

Ending Balance

$

82,539

$

568,258

$

148,621

$

5,402

$

$

804,820

Ending balance: individually

 

  

 

  

 

  

 

  

 

  

 

  

evaluated for impairment

$

991

$

10,448

$

845

$

$

$

12,284

Ending balance: collectively

 

  

 

  

 

  

 

  

 

  

 

  

evaluated for impairment

$

81,548

$

557,810

$

147,776

$

5,402

$

$

792,536

28

(Dollars in thousands)

Commercial

    

Commercial

    

Residential

    

    

    

and Industrial

Real Estate

Real Estate

Consumer

Unallocated

Total

As of and for the year ended December 31, 2022:

Allowance for Credit Losses:

  

 

  

 

  

 

  

 

  

 

  

Beginning balance

$

681

$

5,408

$

1,539

$

84

$

968

$

8,680

Charge-offs

 

(158)

 

(3)

 

(12)

 

(33)

 

 

(206)

Recoveries

 

3

 

40

 

16

 

5

 

 

64

Proviion (credit)

 

178

 

487

 

14

 

25

 

(968)

 

(264)

Ending Balance

$

704

$

5,932

$

1,557

$

81

$

$

8,274

Ending balance: individually

 

  

 

 

 

 

 

evaluated for impairment

$

$

$

$

$

$

Ending balance: collectively

 

 

 

 

 

 

evaluated for impairment

$

704

$

5,932

$

1,557

$

81

$

$

8,274

Loans Receivable:

 

 

 

 

 

 

Ending Balance

$

86,999

$

611,549

$

154,506

$

5,415

$

$

858,469

Ending balance: individually

 

 

 

 

 

 

evaluated for impairment

$

973

$

9,495

$

739

$

$

$

11,207

Ending balance: collectively

 

 

 

 

 

 

evaluated for impairment

$

86,026

$

602,054

$

153,767

$

5,415

$

$

847,262

During the three months ended June 30, 2022, one loan with a post modification balance of $372,000 was modified as a TDR. No loans were modififed as TDRs during the first three months of 2022. The loan modifications for the six months ended June 30, 2022 consisted of one payment modification.

The outstanding recorded investment of TDRs as of December 31, 2022 was $7,480,000. There were no unfunded commitments on TDRs at December 31, 2022.

The following table presents the outstanding recorded investment of TDRs at the dates indicated:

(Dollars in thousands)

    

December 31, 

2022

Non-accrual TDRs

$

1,324

Accruing TDRs

 

6,156

Total

$

7,480

At June 30, 2022, three Commercial and Industrial loans classified as TDRs with a combined recorded investment of $682,000, six Commercial Real Estate loans classified as TDRs with a combined recorded investment of $318,000 and one Residential Real Estate loan classified as a TDR with a recorded investment of $12,000 were not in compliance with the terms of their restructure.

Of the loans that were modified as TDRs within the twelve months preceding June 30, 2022, no loans experienced payment defaults during the three months ended June 30, 2022. One Commercial Real Estate loan that was modified as a TDR within the twelve months preceding June 30, 2022 experienced a payment default during the six months ended June 30, 2022, but the loan was subsequently paid off during the first quarter of 2022.

29

The following table presents information regarding the loan modifications categorized as TDRs during the three and six months ended June 30, 2022.

(Dollars in thousands)

For the Three Months Ended June 30, 2022

Pre-Modification

Post-Modification

Outstanding

Outstanding

Number of

Recorded

Recorded

Recorded

Contracts

Investment

Investment

Investment

Commercial Real Estate

1

$

347

$

372

$

372

Total

1

$

347

$

372

$

372

(Dollars in thousands)

For the Six Months Ended June 30, 2022

Pre-Modification

Post-Modification

Outstanding

Outstanding

Number of

Recorded

Recorded

Recorded

Contracts

Investment

Investment

Investment

Commercial Real Estate

1

$

347

$

372

$

372

Total

1

$

347

$

372

$

372

The following table provides detail regarding they types of loan modifications made for loans categorized as TDRs during the three and six months ended June 30, 2022.

For the Three Months Ended June 30, 2022

    

Rate

Term

Payment

Number

Modification

Modification

Modification

Modified

Commercial Real Estate

1

1

Total

1

1

For the Six Months Ended June 30, 2022

    

Rate

Term

Payment

Number

Modification

Modification

Modification

Modified

Commercial Real Estate

1

1

Total

1

1

30

The recorded investment, unpaid principal balance, and the related allowance of the Company’s impaired loans are summarized below at December 31, 2022.

(Dollars in thousands)

December 31, 2022

    

Unpaid

    

Recorded

Principal

Related

Investment

Balance

Allowance

With no related allowance recorded:

  

 

  

 

Commercial and Industrial

$

973

$

973

$

Commercial Real Estate

9,495

12,430

Residential Real Estate

739

771

 

 

 

With an allowance recorded:

 

 

 

Commercial and Industrial

Commercial Real Estate

Residential Real Estate

Total

$

11,207

$

14,174

$

Total consists of:

 

 

 

Commercial and Industrial

$

973

$

973

$

Commercial Real Estate

$

9,495

$

12,430

$

Residential Real Estate

$

739

$

771

$

At December 31, 2022, $7,480,000 of loans classified as TDRs were included in impaired loans with a total allocated allowance of $0 at December 31, 2022. The recorded investment represents the loan balance reflected on the consolidated balance sheets net of any charge-offs. The unpaid balance is equal to the gross amount due on the loan.

31

The average recorded investment and interest income recognized for the Company’s impaired loans are summarized below for the three and six months ended June 30, 2022.

(Dollars in thousands)

For the Three Months Ended

June 30, 2022

    

Average

    

Interest

Recorded

Income

Investment

Recognized

With no related allowance recorded:

 

  

 

  

Commercial and Industrial

$

998

$

3

Commercial Real Estate

 

10,801

 

70

Residential Real Estate

 

847

 

 

  

 

  

With an allowance recorded:

 

  

 

  

Commercial and Industrial

 

 

Commercial Real Estate

 

 

Residential Real Estate

 

 

Total

$

12,646

$

73

 

  

 

  

Total consists of:

 

  

 

  

Commercial and Industrial

$

998

$

3

Commercial Real Estate

$

10,801

$

70

Residential Real Estate

$

847

$

Of the $73,000 in interest income recognized on impaired loans for the three months ended June 30, 2022, $0 in interest income was recognized with respect to non-accrual loans.

(Dollars in thousands)

For the Six Months Ended

June 30, 2022

    

Average

    

Interest

Recorded

Income

Investment

Recognized

With no related allowance recorded:

 

  

 

  

Commercial and Industrial

$

1,004

$

5

Commercial Real Estate

 

11,247

 

142

Residential Real Estate

 

849

 

 

 

With an allowance recorded:

 

 

Commercial and Industrial

 

 

Commercial Real Estate

 

 

Residential Real Estate

 

 

Total

$

13,100

$

147

 

 

Total consists of:

 

 

Commercial and Industrial

$

1,004

$

5

Commercial Real Estate

$

11,247

$

142

Residential Real Estate

$

849

$

Of the $147,000 in interest income recognized on impaired loans for the six months ended June 30, 2022, $0 in interest income was recognized with respect to non-accrual loans.

32

NOTE 5 — DEPOSITS

Major classifications of deposits at June 30, 2023 and December 31, 2022 consisted of:

(Dollars in thousands)

    

June 30, 

December 31, 

2023

    

2022

Non-interest bearing demand

 

$

220,519

$

231,754

Interest bearing demand

 

280,929

 

335,559

Savings

 

225,631

 

260,086

Time certificates of deposits less than $250,000

 

179,202

 

151,575

Time certificates of deposits $250,000 or greater

 

28,044

 

13,400

Other time

 

1,516

 

1,125

Total deposits

$

935,841

$

993,499

Total deposits decreased $57,658,000 to $935,841,000 as of June 30, 2023 due to decreases in non-interest bearing demand, interest bearing demand and savings deposits. The decrease in deposits was mainly the result of a $39,273,000 decrease in municipal deposits and other normal fluctuations in deposits during the six months ended June 30, 2023.

NOTE 6 — BORROWINGS

Short-Term Borrowings

Short-term borrowings include federal funds purchased, securities sold under agreements to repurchase, the Federal Discount Window, and Federal Home Loan Bank of Pittsburgh (“FHLB”) advances, which generally represent overnight or less than 30-day borrowings.

Short-term borrowings and weighted–average interest rates at June 30, 2023 and December 31, 2022 are as follows:

(Dollars in thousands)

June 30, 2023

December 31, 2022

 

Average

Average

 

    

Amount

    

Rate

    

Amount

    

Rate

 

    

Federal funds purchased

 

$

%  

$

 

%

 

Securities sold under agreements to repurchase

 

19,308

2.90

%  

 

20,368

 

0.84

%

Federal Discount Window

 

4.82

%  

 

 

2.78

%

Federal Home Loan Bank of Pittsburgh

 

174,051

5.18

%  

 

133,050

 

2.82

%

Total

$

193,359

4.95

%  

$

153,418

 

2.21

%

Securities Sold Under Agreements to Repurchase (“Repurchase Agreements”)

The Company enters into agreements under which it sells securities subject to an obligation to repurchase the same or similar securities. Under these arrangements, the Company may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Company to repurchase the assets.

As a result, these repurchase agreements are accounted for as collateralized financing agreements (i.e., secured borrowings) and not as a sale and subsequent repurchase of securities. The obligation to repurchase the securities is reflected as a liability on the Company’s consolidated balance sheets, while the securities underlying the repurchase agreements remain in the respective investment securities asset accounts. In other words, there is not offsetting or netting of the investment securities assets with the repurchase agreement liabilities. In addition, as the Company does not enter into reverse repurchase agreements, there is no such offsetting to be done with the repurchase agreements.

The right of setoff for a repurchase agreement resembles a secured borrowing, whereby the collateral would be used to settle the fair value of the repurchase agreement should the Company be in default (e.g., fails to make an interest

33

payment to the counterparty). The collateral is held by a correspondent bank in the counterparty’s custodial account. The counterparty has the right to sell or repledge the investment securities.

The following table presents the short-term borrowings subject to an enforceable master netting arrangement or repurchase agreements as of June 30, 2023 and December 31, 2022.

(Dollars in thousands)

    

    

Gross

    

Net Amounts

    

    

    

Amounts

of Liabilities

Offset

Presented

Gross

in the

in the

Amounts of

Consolidated

Consolidated

Cash

Recognized

Balance

Balance

Financial

Collateral

Net

Liabilities

Sheet

Sheet

Instruments

Pledge

Amount

June 30, 2023

 

  

 

  

 

  

 

  

 

  

 

  

Repurchase agreements (a)

$

19,308

$

$

19,308

$

(19,308)

$

$

 

  

 

  

 

  

 

  

 

  

 

  

December 31, 2022

 

  

 

  

 

  

 

  

 

  

 

  

Repurchase agreements (a)

$

20,368

$

$

20,368

$

(20,368)

$

$

(a)As of June 30, 2023 and December 31, 2022, the fair value of securities pledged in connection with repurchase agreements was $24,285,000 and $34,160,000, respectively.

The following table presents the remaining contractual maturity of the master netting arrangement or repurchase agreements as of June 30, 2023:

(Dollars in thousands)

Remaining Contractual Maturity of the Agreements

Overnight

Greater

Greater

and

Up to

30 -90

than

Continuous

30 days

Days

90 Days

Total

June 30, 2023:

Repurchase agreements and repurchase-to-maturity transactions:

 

  

 

  

 

  

 

  

 

  

U.S. Treasury and/or agency securities

$

19,308

$

$

$

$

19,308

Total

$

19,308

$

$

$

$

19,308

Long-Term Borrowings and Letters of Credit

Long-term borrowings are comprised of advances from the FHLB. The Company’s long-term borrowings consist of notes at fixed interest rates. Upon any default, under the terms of a master agreement, FHLB may declare all indebtedness of the Company immediately due. In addition, FHLB shall not be required to fund advances under any outstanding commitments. As of June 30, 2023 and December 31, 2022, the Company had $25,000,000 in long-term borrowings outstanding with the FHLB.

Irrevocable standby letters of credit may be issued to a customer/beneficiary by the FHLB on the Company’s behalf in order to secure public/municipal unit deposits, provide credit enhancement to certain transaction types, or to support payment obligations to third parties. These irrevocable standby letters of credit are supported by an irrevocable and independent guarantee by the FHLB for the Company’s pledging obligation to secure public/municipal unit deposits which eliminates the need for the Company to pledge collateral in the amount necessary to secure these funds. The Company began utilizing this service offered by the FHLB during the second quarter of 2021. There were no irrevocable standby letters of credit which could be drawn on through FHLB’s close of business on June 30, 2023. Any irrevocable standby letters of credit are issued as necessary in an amount appropriate to secure specific public/municipal unit deposits.

Under terms of a blanket agreement, collateral for the FHLB loans and letters of credit consists of certain qualifying assets of the Corporation’s banking subsidiary. Principal qualifying assets are certain real estate mortgages and investment securities. As of June 30, 2023, loans of $716,188,000 were pledged to FHLB which resulted in a FHLB

34

maximum borrowing capacity of $505,628,000. As of June 30, 2023, no securities were pledged as collateral to FHLB to secure FHLB loans and letters of credit.

NOTE 7 — SUBORDINATED DEBT

On December 10, 2020, the Corporation issued $25,000,000 aggregate principal amount of Subordinated Notes due 2030 (the “2020 Notes”) to accredited investors. The 2020 Notes are intended to be treated as Tier 2 capital for regulatory capital purposes. The Company utilized the net proceeds it received from the sale of the 2020 Notes to support organic growth and for general corporate purposes.

The 2020 Notes bear a fixed interest rate of 4.375% per year for the first five years and then float based on a benchmark rate (as defined). Interest is payable semi-annually in arrears on June 30 and December 31 of each year, which began on June 30, 2021, for the first five years after issuance and will be payable quarterly in arrears thereafter on March 31, June 30, September 30 and December 31. The 2020 Notes will mature on December 31, 2030 and are redeemable in whole or in part, without premium or penalty, at any time on or after December 31, 2025 and prior to December 31, 2030. Additionally, if all or any portion of the 2020 Notes cease to be deemed Tier 2 capital, the Corporation may redeem, in whole and not in part, at any time upon giving not less than ten days’ notice, an amount equal to one hundred percent (100%) of the principal amount outstanding plus accrued but unpaid interest to but excluding the date fixed for redemption.

Holders of the 2020 Notes may not accelerate the maturity of the 2020 Notes, except upon the bankruptcy, insolvency, liquidation, receivership or similar law of the Corporation or the Bank.

NOTE 8 — COMMITMENTS AND CONTINGENCIES

In the normal course of business, there are various pending legal actions and proceedings that are not reflected in the consolidated financial statements. Management does not believe the outcome of these actions and proceedings will have a material effect on the consolidated financial position or results of operations of the Company.

The Company currently leases two branch banking facilities and one parcel of land under operating leases. At June 30, 2023, right-of-use assets and lease liabilities were recorded related to these operating leases totaling $1,523,000 and $2,019,000, respectively. At December 31, 2022, right-of-use assets and lease liabilities stood at $1,541,000 and $2,029,000, respectively, in the consolidated balance sheets. Options to extend or terminate a lease may be included in our lease agreements. When it is reasonably certain that we will exercise those options, the right-of-use asset and lease liability will reflect the renewal or termination option. No significant assumptions or judgements were made in determining whether a contract contained a lease or in the consideration of lease versus non-lease components. None of the leases contained an implicit rate; therefore, our incremental borrowing rate was used for each of the leases.

The Company recognized total operating lease costs for the six months ended June 30, 2023 and 2022 of $113,000 and $90,000, respectively. Operating lease costs are included in occupancy, net in the accompanying statements of income. Cash payments totaled $106,000 and $83,000, respectively, for the six months ended June 30, 2023 and 2022.

The Company currently has one finance lease for equipment. At June 30, 2023, right-of-use assets and lease liabilities were recorded related to the finance lease totaling $34,000 and $1,000, respectively. At December 31, 2022, right-of-use assets and lease liabilities stood at $34,000 and $6,000, respectively. Amounts recognized as right-of-use assets and lease liabilities related to finance leases are included in premises and equipment, net and other liabilities, respectively, in the accompanying balance sheet. Further options to extend or terminate the lease are not applicable for the lease. No significant assumptions or judgements were made in determining whether a contract contained a lease or in the consideration of lease versus non-lease components. The lease did not contain an implicit rate; therefore, our incremental borrowing rate was used.

Total finance lease costs that were recognized by the Company for the six months ended June 30, 2023 and 2022 were immaterial. Cash payments totaled $5,000 for the six months ended June 30, 2023 and 2022.

35

The following table displays the weighted-average term and discount rates for operating and finance leases outstanding as of June 30, 2023 and December 31, 2022.

    

June 30, 

December 31, 

 

June 30, 

December 31, 

 

2023

2022

2023

2022

Operating

 

      

Operating

Finance

 

      

Finance

Weighted-average term (years)

 

20.25

 

20.56

0.17

 

0.67

Weighted-average discount rate

 

4.22%

 

4.23%

0.68%

 

0.68%

A maturity analysis of operating and finance lease liabilities and reconciliation of the undiscounted cash flows to the total operating or finance lease liability is as follows:

(Dollars in thousands)

June 30, 

December 31, 

June 30, 

December 31, 

 

2023

 

2022

 

2023

 

2022

Minimum Lease Payments due:

Operating

Operating

Finance

Finance

Within one year

$

158

$

175

$

2

$

7

After one but within two years

 

140

 

140

 

 

After two but within three years

 

140

 

140

 

 

After three but within four years

 

147

 

140

 

 

After four but within five years

 

156

 

154

 

 

After five years

 

2,395

 

2,474

 

 

Total undiscounted cash flows

 

3,136

 

3,223

 

2

 

7

Discount on cash flows

 

(1,117)

 

(1,194)

 

(1)

 

(1)

Total lease liability

$

2,019

$

2,029

$

1

$

6

NOTE 9 — FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND CONCENTRATIONS OF CREDIT RISK

Financial Instruments with Off-Balance Sheet Risk

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company does not engage in trading activities with respect to any of its financial instruments with off-balance sheet risk.

The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments.

The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

The Company may require collateral or other security to support financial instruments with off-balance sheet credit risk.

36

The contract or notional amounts at June 30, 2023 and December 31, 2022 were as follows:

(Dollars in thousands)

    

    

June 30, 2023

    

December 31, 2022

Financial instruments whose contract amounts represent credit risk:

 

  

 

  

 

Commitments to extend credit

$

143,998

$

121,938

Financial standby letters of credit

$

2,130

$

2,124

Performance standby letters of credit

$

3,551

$

3,472

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses that may require payment of a fee. Since some of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, owner-occupied income-producing commercial properties, and residential real estate.

Standby letters of credit are conditional commitments issued by the Company to guarantee payment to a third party when a customer either fails to repay an obligation or fails to perform some non-financial obligation. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company may hold collateral (similar to the items held as collateral for commitments to extend credit) to support standby letters of credit for which collateral is deemed necessary.

Financial Instruments with Concentrations of Credit Risk

The Company originates primarily commercial and residential real estate loans to customers predominately in the Company’s primary five county, Pennsylvania market area. The ability of the majority of the Company’s customers to honor their contractual loan obligations is dependent on the economy and real estate market in this area. At June 30, 2023, the Company had $774,688,000 in loans secured by real estate, which represented 88.9% of total loans. The real estate loan portfolio is largely secured by lessors of residential buildings and dwellings, lessors of non-residential buildings, and lessors of hotels/motels. As of June 30, 2023 and December 31, 2022, management is of the opinion that there were no concentrations exceeding 10% of total loans with regard to loans to borrowers who were engaged in similar activities that were similarly impacted by economic or other conditions.

As all financial instruments are subject to some level of credit risk, the Company requires collateral and/or guarantees for all loans. Collateral may include, but is not limited to property, plant, and equipment, commercial and/or residential real estate property, land, and pledge of securities. In the event of a borrower’s default, the collateral supporting the loan may be seized in order to recoup losses associated with the loan. The Company also establishes an allowance for credit losses that constitutes the amount available to absorb losses within the loan portfolio that may exist due to deficiencies in collateral values.

NOTE 10 — FAIR VALUE MEASUREMENTS

Fair value measurement and disclosure guidance defines fair value as the price that would be received to sell the asset or transfer the liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. This guidance provides additional information on determining when the volume and level of activity for the asset or liability has significantly decreased. The guidance also includes information on identifying circumstances when a transaction may not be considered orderly.

Fair value measurement and disclosure guidance provides a list of factors that a reporting entity should evaluate to determine whether there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability. When the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability, further analysis of the information from

37

that market is needed and significant adjustments to the related prices may be necessary to estimate fair value in accordance with the fair value measurement and disclosure guidance.

This guidance clarifies that when there has been a significant decrease in the volume and level of activity for the asset or liability, some transactions may not be orderly. In those situations, the entity must evaluate the weight of the evidence to determine whether the transaction is orderly. The guidance provides a list of circumstances that may indicate that a transaction is not orderly. A transaction price that is not associated with an orderly transaction is given little, if any, weight when estimating fair value.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own belief about the assumptions market participants would use in pricing the asset or liability based upon the best information available. Fair value measurement and disclosure guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

Level 1 Inputs:     Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2 Inputs:     Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability;

Level 3 Inputs:     Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth as follows.

Financial Assets Measured at Fair Value on a Recurring Basis

At June 30, 2023 and December 31, 2022, securities measured at fair value on a recurring basis and the valuation methods used are as follows:

(Dollars in thousands)

    

June 30, 2023

Level 1

    

Level 2

    

Level 3

    

Total

Debt Securities Available-for-Sale:

 

  

 

  

 

  

 

  

U.S. Treasury securities

$

6,846

$

$

$

6,846

Obligations of U.S. Government Agencies and Sponsored Agencies:

 

  

 

 

  

 

Mortgaged-backed

125,129

125,129

Other

 

 

9,355

 

 

9,355

Other mortgage backed debt securities

 

 

29,083

 

 

29,083

Obligations of state and political subdivisions

 

 

88,060

 

 

88,060

Asset-backed securities

 

 

32,044

 

 

32,044

Corporate debt securities

 

 

41,063

 

 

41,063

Total debt securities available-for-sale

 

6,846

 

324,734

 

 

331,580

Marketable equity securities

 

1,476

 

 

 

1,476

Total recurring fair value measurements

$

8,322

$

324,734

$

$

333,056

38

(Dollars in thousands)

    

December 31, 2022

Level 1

    

Level 2

    

Level 3

    

Total

Debt Securities Available-for-Sale:

 

  

 

  

 

  

 

  

U.S. Treasury securities

$

6,801

$

$

$

6,801

Obligations of U.S. Government Agencies and Sponsored Agencies:

 

  

 

  

 

  

 

  

Mortgaged-backed

131,675

131,675

Other

 

 

11,180

 

 

11,180

Other mortgage backed debt securities

 

 

33,688

 

 

33,688

Obligations of state and political subdivisions

 

 

110,689

 

 

110,689

Asset-backed securities

 

 

36,418

 

 

36,418

Corporate debt securities

 

 

42,993

 

 

42,993

Total debt securities available-for-sale

 

6,801

 

366,643

 

 

373,444

Marketable equity securities

 

1,699

 

 

 

1,699

Total recurring fair value measurements

$

8,500

$

366,643

$

$

375,143

The estimated fair values of equity securities and US Treasury debt securities classified as Level 1 are derived from quoted market prices in active markets; the equity securities consist mainly of stocks held in other banks. The estimated fair values of all debt securities classified as Level 2 are obtained from nationally-recognized third-party pricing agencies. The estimated fair values are derived primarily from cash flow models, which include assumptions for interest rates, credit losses, and prepayment speeds. The significant inputs utilized in the cash flow models are based on market data obtained from sources independent of the Company (observable inputs), and are therefore classified as Level 2 within the fair value hierarchy. The Company does not have any Level 3 inputs for securities. There were no transfers between Level 1 and Level 2 during 2023 or 2022.

Financial Assets Measured at Fair Value on a Nonrecurring Basis

Periodically, non-recurring adjustments may be applied to the carrying value of loans based on the fair value measurements for partial charge-offs of the uncollectible portions of those loans. Non-recurring adjustments can also include certain specific allocation amounts for individually evaluated collateral-dependent loans as calculated when establishing the allowance for credit losses. The Company’s valuation procedure for any individually evaluated loans greater than $250,000 requires an appraisal to be obtained and reviewed annually at year end unless the Board of Directors waives such requirement for a specific loan, in favor of obtaining a Certificate of Inspection instead, defined as an internal evaluation completed by the Company. A quarterly collateral evaluation is performed which may include a site visit, property pictures and discussions with realtors and other similar business professionals to ascertain current values. For individually evaluated loans less than $250,000 upon classification and annually at year end, the Company completes a Certificate of Inspection, which includes an onsite inspection, and considers value indicators such as insured values, tax assessed values, recent sales comparisons and a review of the previous evaluations.These assets are included as Level 3 fair values, based upon the lowest level that is significant to the fair value measurements. The fair value consists of the individually evaluated loan balances less the valuation allowance and/or charge-offs. There were no transfers between valuation levels in 2023 and 2022.

Following the adoption of ASU No. 2016-13, at June 30, 2023 measured at fair value on a nonrecurring basis are as follows:

(Dollars in thousands)

    

Level 1

    

Level 2

    

Level 3

    

Total

Assets at June 30, 2023

 

  

 

  

 

  

 

  

Individually evaluated loans:

 

  

 

  

 

  

 

  

Real Estate

$

$

$

2,370

$

2,370

Total individually evaluated loans

$

$

$

2,370

$

2,370

39

Prior to the adoption of ASU No. 2016-13, at December 31, 2022, impaired loans measured at fair value on a nonrecurring basis were as follows:

(Dollars in thousands)

    

Level 1

    

Level 2

    

Level 3

    

Total

Assets at December 31, 2022

 

  

 

  

 

  

 

  

Impaired loans:

 

  

 

  

 

  

 

  

Commercial Real Estate

$

$

$

5,167

$

5,167

Residential Real Estate

 

 

 

30

 

30

Total impaired loans

$

$

$

5,197

$

5,197

Nonfinancial Assets Measured at Fair Value on a Nonrecurring Basis

There were no foreclosed assets held for resale measured at fair value on a nonrecurring basis at June 30, 2023 and December 31, 2022.

The Company’s foreclosed asset valuation procedure requires an appraisal or a Certificate of Inspection, which considers the sales prices of similar properties in the proximate vicinity, to be completed periodically with the exception of those cases in which the Bank has obtained a sales agreement. These assets are included as Level 3 fair values, based upon the lowest level that is significant to the fair value measurements. There were no transfers between valuation levels in 2023 and 2022.

The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which the Company has utilized Level 3 inputs to determine the fair value:

(Dollars in thousands)

Quantitative Information about Level 3 Fair Value Measurements

Post-ASU No. 2016-13 Adoption:

Fair Value

Weighted

June 30, 2023

    

Estimate

    

Valuation Technique

    

Unobservable Input

    

Range

    

Average

Individually evaluated loans - collateral dependent

$

2,340

 

Appraisal of collateral1,3
Certificate of Inspection1,3

 

Appraisal adjustments2
Qualitative Adjustments4

 

(0%)(5%)

 

(5%)

 

  

 

  

 

  

 

  

 

  

Pre-ASU No. 2016-13 Adoption:

December 31, 2022

 

  

 

  

 

  

 

  

 

  

Impaired loans - collateral dependent

$

2,370

 

Appraisal of collateral1,3
Certificate of Inspection1,3

 

Appraisal adjustments2
Qualitative Adjustments4

 

(0%)(5%)

 

(5%)

Impaired loans - other

$

2,827

 

Discounted cash flow

 

Discount rate

 

(4%)(7%)

 

(6%)

1. Fair value is generally determined through independent appraisals or Certificates of Inspection of the underlying collateral, as defined by Bank regulators.

2. Appraisals may be adjusted downward by management for qualitative factors such as economic conditions and estimated liquidation expenses. The typical range of appraisal adjustments are presented as a percent of the appraisal value.

3. Includes qualitative adjustments by management and estimated liquidation expenses.

4. Collateral values may be adjusted downward by management for qualitative factors such as economic conditions and estimated liquidation expenses.

40

Fair Value of Financial Instruments Measured on a Nonrecurring Basis

(Dollars in thousands)

Carrying

Fair Value Measurements at June 30, 2023

    

Amount

    

Level 1

    

Level 2

    

Level 3

    

Total

FINANCIAL ASSETS:

 

  

 

  

 

  

 

  

 

  

Cash and due from banks

$

12,597

$

12,597

$

$

$

12,597

Interest-bearing deposits in other banks

 

1,178

 

 

1,178

 

 

1,178

Restricted investment in bank stocks

 

8,617

 

 

8,617

 

 

8,617

Net loans

 

864,082

 

 

 

827,402

 

827,402

Mortgage servicing rights

 

292

 

 

 

292

 

292

Accrued interest receivable

 

4,173

 

 

4,173

 

 

4,173

FINANCIAL LIABILITIES:

 

 

 

 

 

Demand, savings and other deposits

 

727,079

 

 

727,079

 

 

727,079

Time deposits

 

208,762

 

 

204,384

 

 

204,384

Short-term borrowings

 

193,359

 

 

193,403

 

 

193,403

Long-term borrowings

 

25,000

 

 

24,328

 

 

24,328

Subordinated debentures

25,000

22,821

22,821

Accrued interest payable

 

1,171

 

 

1,171

 

 

1,171

OFF-BALANCE SHEET FINANCIAL INSTRUMENTS

 

 

 

 

 

(Dollars in thousands)

Carrying

Fair Value Measurements at December 31, 2022

    

Amount

    

Level 1

    

Level 2

    

Level 3

    

Total

FINANCIAL ASSETS:

 

  

 

  

 

  

 

  

 

  

Cash and due from banks

$

9,441

$

9,441

$

$

$

9,441

Interest-bearing deposits in other banks

 

1,297

 

 

1,297

 

 

1,297

Restricted investment in bank stocks

 

7,136

 

 

7,136

 

 

7,136

Net loans

 

850,195

 

 

 

810,104

 

810,104

Mortgage servicing rights

 

319

 

 

 

319

 

319

Accrued interest receivable

 

4,391

 

 

4,391

 

 

4,391

FINANCIAL LIABILITIES:

 

 

 

 

 

Demand, savings and other deposits

 

827,399

 

 

827,399

 

 

827,399

Time deposits

 

166,100

 

 

160,472

 

 

160,472

Short-term borrowings

 

153,418

 

 

153,209

 

 

153,209

Long-term borrowings

 

25,000

 

 

24,090

 

 

24,090

Subordinated debentures

 

25,000

22,365

22,365

Accrued interest payable

563

 

 

563

 

 

563

 

OFF-BALANCE SHEET FINANCIAL INSTRUMENTS

 

 

 

 

41

NOTE 11 — REVENUE RECOGNITION

In accordance with ASU 2014-09 Revenue from Contracts with Customers – Topic 606, and all subsequent ASUs that modified ASC 606, the main types of revenue contracts included in non-interest income within the consolidated statements of income are as follows:

Deposits related fees and service charges

Service charges and fees on deposits, which are included as liabilities in the consolidated balance sheets, consist of fees related to monthly fees for various retail and business checking accounts, automated teller machine (“ATM”) fees (charged for withdrawals by our deposit customers from other bank ATMs) and insufficient funds fees (“NSF”) (which are charged when customers overdraw their accounts beyond available funds). All deposit liabilities are considered to have one-day terms and therefore related fees are recognized in income at the time when the services are provided to the customers. The Company elected to adopt practical expedient related to incremental costs of obtaining deposit contracts. As such, any costs associated with acquiring the deposits, except for time deposits with maturities in excess of one year, are recognized as an expense within non-interest expense in the consolidated statements of income when incurred as the amortization period of the deposit liabilities that otherwise would have been recognized is one year or less.

Wealth/Asset/Trust Management Fees

Wealth management services are delivered to individuals, corporations and retirement funds located primarily within our geographic markets. The Trust Department of the Company conducts the wealth management operations, which provides a broad range of personal and corporate fiduciary services, including the administration of estates.

Assets held in a fiduciary capacity by the Trust Department are not assets of the Company and, therefore, are not included in our consolidated financial statements. Wealth management fees, which are contractually agreed with each customer, are earned each month and recognized on a cash basis based on average fair value of the trust assets under management. The services provided under such a contract are considered a single performance obligation under ASC 606 because they embody a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer. Wealth management fees charged by the Trust Department follow a tiered structure based on the type and size of the assets under management. Wealth management fees are included within non-interest income in the consolidated statements of income. As of June 30, 2023 and December 31, 2022, the fair value of trust assets under management was $114,166,000 and $111,172,000, respectively. The costs of acquiring asset management customers are incremental and recognized within non-interest expense in the consolidated statements of income.

Interchange Fees and Surcharges

Interchange fees are related to the acceptance and settlement of debit card transactions, both point-of-sale and ATM, to cover operating costs and risks associated with the approval and settlement of the transactions. Interchange fees vary by type of transaction and each merchant sector. Net income recognized from interchange fees is included in non-interest income on the consolidated statements of income. A surcharge is assessed for use of the Company’s ATMs by non-customers. All interchange fees and surcharges are recognized as received on a daily basis for the prior business day’s transactions. All expenses related to the settlement of debit card transactions (both point-of-sale and ATM) are recognized on a monthly basis and included in non-interest expense on the consolidated statements of income.

NOTE 12 — EARNINGS PER SHARE

Basic earnings per share (“EPS”) is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Corporation. At June 30, 2023 and 2022, there were no potential common shares outstanding. The following table sets forth the computation of basic and diluted earnings per share.

42

(In thousands, except earnings per share)

Three Months Ended

June 30, 

2023

    

2022

Net income

$

1,139

$

3,822

Weighted-average common shares outstanding

6,040

5,964

Basic and diluted earnings per share

$

0.19

$

0.64

(In thousands, except earnings per share)

Six Months Ended

June 30, 

2023

  

2022

Net income

$

2,496

$

7,365

Weighted-average common shares outstanding

6,030

5,956

Basic and diluted earnings per share

$

0.41

$

1.24

NOTE 13 — GOODWILL

Goodwill resulted from the acquisition of the Pocono Community Bank in November 2007 and of certain fixed and operating assets acquired and deposit liabilities assumed of the branch of another financial institution in Danville, Pennsylvania, in January 2004. Such goodwill represents the excess cost of the acquired assets relative to the assets’ fair value at the dates of acquisition. In accordance with current accounting standards, goodwill is not amortized. Goodwill totaled $19,133,000 at June 30, 2023 and December 31, 2022.

Impairment testing is performed on an annual basis, using either a qualitative or quantitative approach. The assumptions used in the impairment test of goodwill are susceptible to change based on changes in economic conditions and other factors, including our stock price. Any change in the assumptions utilized to determine the carrying value of goodwill could adversely affect our results of operations.

Goodwill was evaluated for impairment at December 31, 2022, and it was determined that goodwill was not impaired. Management evaluated the need for an interim goodwill impairment analysis and determined that there were no triggering events or negative factors affecting goodwill since the previous test that would indicate goodwill was impaired as of June 30, 2023.

43

Item 2.  First Keystone Corporation Management’s Discussion and Analysis of Financial Condition and Results of Operation

This quarterly report contains certain forward-looking statements, which are included pursuant to the “safeharbor” provisions of the Private Securities Litigation Reform Act of 1995, and reflect management’s beliefs and expectations based on information currently available. These forward-looking statements are inherently subject to significant risks and uncertainties, including changes in general economic and financial market conditions, the Company’s ability to effectively carry out its business plans and changes in regulatory or legislative requirements. Other factors that could cause or contribute to such differences are changes in competitive conditions, and pending or threatened litigation. Although management believes the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially.

CRITICAL ACCOUNTING POLICIES

The Company has chosen accounting policies that it believes are appropriate to accurately and fairly report its operating results and financial position, and the Company applies those accounting policies in a consistent manner. The Significant Accounting Policies are summarized in Note 1 to the consolidated financial statements included in the 2022 Annual Report on Form 10-K.

Effective January 1, 2023, the Company elected to adopt ASU No. 2016-13, referred to as CECL. Please refer to Note 2- Recent Accounting Standards Updates, Note 3- Securities, and Note 4- Loans and Allowance for Credit Losses for updates reflecting the adoption of ASU No. 2016-13. These Notes supplement updates to the accounting policies previously disclosed in Note 1- Summary of Significant Accounting Policies of the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.

RESULTS OF OPERATIONS

Quarter ended June 30, 2023 compared to quarter ended June 30, 2022

First Keystone Corporation realized earnings for the three months ended June 30, 2023 of $1,139,000, a decrease of $2,683,000, or 70.2% from the second quarter of 2022. The decrease in net income for the three months ended June 30, 2023 was primarily due to increases in interest paid on deposits, interest paid on short-term borrowings through the Federal Home Loan Bank, and salaries and employee benefits expenses, as well as a reduction in PPP fees.

On a per share basis, for the three months ended June 30, 2023, net income was $0.19 versus $0.64 for the same three month period of 2022. Cash dividends amounted to $0.28 per share for the three months ended June 30, 2023 and 2022.

NET INTEREST INCOME

The major source of operating income for the Company is net interest income, defined as interest and loan fee income less interest expense. In the three months ended June 30, 2023, interest income amounted to $13,651,000, an increase of $2,540,000 or 22.9% from the three months ended June 30, 2022. The increase in interest income during the three months ended June 30, 2023 was mainly the result of an increase in interest earned on commercial real estate loans and an increase in interest earned on taxable securities. Interest expense amounted to $6,543,000 in the three months ended June 30, 2023, an increase of $5,213,000 or 392.0% from the three months ended June 30, 2022. As a result, net interest income decreased $2,673,000 or 27.3% to $7,108,000 from $9,781,000 for the same period in 2022.

The Company’s net interest margin for the three months ended June 30, 2023 was 2.38% compared to 3.36% for same period in 2022. The decrease in net interest margin was primarily a result of increased rates paid on deposit products and short-term borrowings.

44

PROVISION FOR CREDIT LOSSES

The provision for credit losses for the three months ended June 30, 2023 and 2022 was $34,000 and $218,000, respectively. The decrease in the provision for credit losses resulted from the Company’s analysis of the current loan portfolio, including historic losses, past-due trends, current economic conditions, loan portfolio growth, and other relevant factors. The provision for credit losses for the three months ended June 30, 2023 is also reflective of management’s assessment of the continued credit risk associated with the uncertainty surrounding geopolitical and economic concerns. Charge-off and recovery activity in the allowance for credit losses resulted in net charge-offs of $19,000 and net recoveries of $5,000 for the three months ended June 30, 2023 and 2022, respectively. See Allowance for Credit Losses on page 50 for further discussion.

NON-INTEREST INCOME

Total non-interest income was $1,539,000 for the three months ended June 30, 2023, as compared to $1,514,000 for the same period in 2022, an increase of $25,000, or 1.7%.

Net securities losses decreased $1,000 to ($69,000) for the three months ended June 30, 2023 as compared to the three months ended June 30, 2022. Net securities losses were the result of recognizing $69,000 in net losses on held equity securities in the second quarter of 2023 compared to $68,000 in net losses on held equity securities for the same period in 2022. Trust department income decreased $20,000 or 7.5% to $248,000 for the three months ended June 30, 2023 as compared to the same period in 2022.

Service charges and fee income increased $22,000 or 4.0%. The increase was mainly due to increases in overdraft fees as compared to the same period in 2022. ATM fees and debit card income increased $8,000 or 1.4% to $566,000 for the three months ended June 30, 2023.

Net gains (losses) on sales of mortgage loans increased $17,000 during the second quarter of 2023 as there were no sales of mortgage loans in the second quarter of 2022. Other non-interest income decreased $6,000 or 10.2% to $53,000 for the three months ended June 30, 2023. The decrease was due to lower building rental income and lower retail investment income as income from annuities was lower in the second quarter of 2023 as compared to the same period in 2022.

NON-INTEREST EXPENSE

Total non-interest expense was $7,157,000 for the three months ended June 30, 2023, as compared to $6,595,000 for the three months ended June 30, 2022.

Expenses associated with employees (salaries and employee benefits) continue to be the largest category of non-interest expense. Salaries and benefits amounted to $3,733,000 or 52.2% of total non-interest expense for the three months ended June 30, 2023, as compared to $3,462,000 or 52.5% for the three months ended June 30, 2022. The increase was due to normal merit increases for employees, filling existing open positions, plus new hires as compared to the same period in 2022.

Net occupancy, furniture and equipment, and computer expense amounted to $1,121,000 for the three months ended June 30, 2023, an increase of $138,000 or 14.0% which was mainly due to increased bank building costs as the result of purchasing and renovating a new branch and higher software costs as the bank implemented a new accounting system during the second quarter of 2023. Professional services decreased $24,000 or 6.5% to $346,000 as of June 30, 2023, versus the second quarter of 2022. Pennsylvania shares tax expense amounted to $241,000 for the three months ended June 30, 2023, a decrease of $83,000 or 25.6% as compared to the three months ended June 30, 2022. This decrease was due to lower equity due to the unrealized loss position in the securities portfolio at December 31, 2022.

Federal Deposit Insurance Corporation (“FDIC”) insurance expense amounted to $178,000 for the three months ended June 30, 2023, an increase of $58,000 or 48.3% as compared to the same period in 2022. FDIC insurance expense varies with changes in net asset size, risk ratings, and FDIC derived assessment rates.

45

ATM and debit card fees expense amounted to $278,000 for the three months ended June 30, 2023, an increase of $36,000 or 14.9% as compared to the three months ended June 30, 2022. This increase was a result of third party pricing increases, increased debit card transaction volume and increased ATM fraud. Data processing expenses amounted to $357,000 for the three months ended June 30, 2023 as compared to $251,000 for the same period of 2022, an increase of $106,000 or 42.2%. This increase was mainly the result of third party pricing increases, credits used to lower third party costs in the second quarter of 2022 and increased costs associated with preparation for the upgrade of the Bank’s online and mobile banking platforms.

Advertising expense amounted to $154,000 in the second quarter of 2023, an increase of $36,000 or 30.5% as compared to the three months ended June 30, 2023. The increase was due to the Bank marketing the new full-service Bethlehem branch, along with utilizing more television and newspaper advertising in the second quarter of 2023 as compared to the same period in 2022. Other non-interest expense amounted to $749,000 for the three months ended June 30, 2023, an increase of $24,000 or 3.3% as compared to 2022.

INCOME TAXES

Income tax expense amounted to $317,000 for the three months ended June 30, 2023, as compared to $660,000 for the three months ended June 30, 2022, a decrease of $343,000. The effective total income tax rate was 21.8% for the three months ended June 30, 2023 as compared to 14.7% for the three months ended June 30, 2022. The increase in the effective tax rate was mainly due to lower tax-exempt income earned on securities. The Company recognized $58,000 of tax credits from low-income housing partnerships in the three months ended June 30, 2023 and 2022.

Six months ended June 30, 2023 compared to six months ended June 30, 2022

 

First Keystone Corporation realized earnings for the six months ended June 30, 2023 of $2,496,000, a decrease of $4,869,000, or 66.1% from the same period in 2022. The decrease in net income for the six months ended June 30, 2023 was primarily due to less PPP loan fees and an increase in interest expense, mainly due to increases in interest paid on deposits and interest paid on short-term borrowings through the Federal Home Loan Bank.

 

On a per share basis, net income was $0.41 for the six months ended June 30, 2023 versus $1.24 for the same period in 2022. Cash dividends amounted to $0.56 per share for the six months ended June 30, 2023 and 2022

 

NET INTEREST INCOME

 

The major source of operating income for the Company is net interest income, defined as interest and loan fee income less interest expense. For the six months ended June 30, 2023, interest income amounted to $26,958,000, an increase of $5,218,000 or 24.0% from the six months ended June 30, 2022. The increase in interest income during the six months ended June 30, 2023 was mainly the result of an increase in interest earned on commercial real estate loans and an increase in interest earned on taxable securities. Interest expense amounted to $12,046,000 in the six months ended June 30, 2023 an increase of $9,543,000 or 381.3% from the six months ended June 30, 2022. As a result, net interest income decreased $4,325,000 or 22.5% to $14,912,000 from $19,237,000 for the same period in 2022.

 

The Company’s net interest margin for the six months ended June 30, 2023 was 2.50% compared to 3.28% for same period in 2022. The decrease in net interest margin was primarily a result of increased rates paid on deposit products and short-term borrowings.

 

PROVISION FOR CREDIT LOSSES

 

The provision for credit losses for the six months ended June 30, 2023 and 2022 was $34,000 and $437,000, respectively. The decrease in the provision for credit losses resulted from the Company’s analysis of the current loan portfolio, including historic losses, past-due trends, current economic conditions, loan portfolio growth, and other relevant factors. The provision for credit losses for the six months ended June 30, 2023 is also reflective of management’s assessment of the continued credit risk associated with the uncertainty surrounding geopolitical and economic concerns. Charge-off and recovery activity in the allowance for credit losses resulted in net charge-offs of

46

$32,000 and net recoveries of $43,000 for the six months ended June 30, 2023 and 2022, respectively. See Allowance for Credit Losses on page 50 for further discussion.

NON-INTEREST INCOME

 

Total non-interest income was $2,991,000 for the six months ended June 30, 2023, as compared to $2,903,000 for the same period in 2022, an increase of $88,000, or 3.0%.

ATM fees and debit card income increased $31,000 or 2.9% to $1,098,000 for the six months ended June 30, 2023 due to increased ATM interchange fees as the result of increased transaction volume. Service charges and fee income increased $38,000 for the six months ended June 30, 2023. The increase was mainly due to increased overdraft fees on DDA accounts. Gains on sales of mortgage loans increased $68,000 or 200.0% due to a low number of individual loans sold in the first half of 2022 and many of the loans sold in 2022 being sold at a loss. These factors were due to the current rate environment and fewer loans being originated with the intent to sell in 2022.

Trust department income was $478,000 for the six months ended June 30, 2023 a decrease of $40,000 or 7.7% as compared to the same period in 2022. Net securities losses increased $6,000 or 4.6% to ($125,000) for the six months ended June 30, 2023 as compared to the six months ended June 30, 2022. The increase was due to the Company recognizing $224,000 in net losses on held equity securities and $99,000 in net gains on the sales of debt securities in the first half of 2023 as compared to recognizing $131,000 in net losses on held equity securities in the same period in 2022.

 

NON-INTEREST EXPENSE

 

Total non-interest expense was $14,910,000 for the six months ended June 30, 2023, as compared to $13,111,000 for the six months ended June 30, 2022. Non-interest expense increased $1,799,000 or 13.7%.

 

Expenses associated with employees (salaries and employee benefits) continue to be the largest category of non-interest expense. Salaries and benefits amounted to $8,119,000 or 54.5% of total non-interest expense for the six months ended June 30, 2023, as compared to $7,016,000 or 53.5% for the six months ended June 30, 2022. The increase was mainly due to normal merit increases and new hires along with an increase in medical insurance costs and a bonus paid to all employees in January of 2023.

Net occupancy, furniture and equipment, and computer expense amounted to $2,164,000 for the six months ended June 30, 2023, an increase of $164,000 or 8.2%. The increase was due to increased bank building costs as the result of purchasing and renovating a new branch and higher software costs as the Bank implemented a new accounting system in the first half of 2023. Professional services increased $113,000 or 16.9% to $781,000 for the six months ended June 30, 2023. The increase was mainly the result of increases in annual audit expenses for 2023 along with additional audit expenses relating to year end 2022. Pennsylvania shares tax expense amounted to $482,000 for the six months ended June 30, 2023, a decrease of $166,000 or 25.6% as compared to the six months ended June 30, 2022. This decrease was due to lower equity due to the unrealized loss position in the securities portfolio at December 31, 2022.

 

FDIC insurance expense increased $97,000 or 37.7% for the six months ended June 30, 2023. FDIC insurance expense varies with changes in net asset size, risk ratings, and FDIC derived assessment rates.

ATM and debit card fees expense amounted to $585,000 for the six months ended June 30, 2023, an increase of $215,000 or 58.1% as compared to the six months ended June 30, 2022. The increase was the result of third party pricing increases, increased debit card transaction volume and increased ATM fraud. Data processing expenses amounted to $669,000 for the six months ended June 30, 2023, an increase of $160,000 or 31.4% as compared to the six months ended June 30, 2022. This increase was the result of third party pricing increases, credits used to lower third party costs in the first half of 2022 and increased costs associated with preparation for the upgrade of the Bank’s online and mobile banking platforms.

Advertising expense increased $38,000 or 20.0% during the six months ended June 30, 2023. This increase was mainly due to the Bank marketing the new full-service Bethelehem branch, along with utilizing more television and

47

radio advertising in the first half of 2023 as compared to the same period of 2022. Other non-interest expense amounted to $1,528,000 for the six months ended June 30, 2023, an increase of $75,000 or 5.2% as compared to the six months ended June 30, 2022. This increase was mainly the result of an increase in the provision for unfunded commitments as the result of increased funding rates and loss rates utilized in the methodology upon the adoption of ASU 2016-13 in 2023, as well as an increase in unfunded lending commitments.

INCOME TAXES

 

Income tax expense amounted to $463,000 for the six months ended June 30, 2023, as compared to $1,227,000 for the six months ended June 30, 2022, a decrease of $764,000. The effective total income tax rate was 15.6% for the six months ended June 30, 2023 as compared to 14.3% for the six months ended June 30, 2022. The increase in the effective tax rate was mainly due to fewer tax credits from low-income housing partnerships in the current year and lower tax-exempt income earned on securities. The Company recognized $116,000 and $132,000 of tax credits from low-income housing partnerships in the six months ended June 30, 2023 and 2022, respectively.

FINANCIAL CONDITION

SUMMARY

Total assets decreased to $1,307,899,000 as of June 30, 2023, a decrease of $21,295,000 from year-end 2022. Total assets as of December 31, 2022 amounted to $1,329,194,000.

Total debt securities available-for-sale decreased $41,864,000 or 11.2% to $331,580,000 as of June 30, 2023 from December 31, 2022. The decrease was mainly due to the sales of tax-exempt municipals and principal paydowns.

Total loans increased $12,770,000 or 1.5% to $871,239,000 as of June 30, 2023 from December 31, 2022. Loan demand grew in the six months ended June 30, 2023 as the Bank has realized an increase in loan originations, primarily commercial real estate loans.

Total deposits decreased $57,658,000 or 5.8% to $935,841,000 as of June 30, 2023 from December 31, 2022. The decrease was mainly due to a decrease in both non-interest and interest bearing deposits, primarily municipal deposits and savings and money market accounts, stemming from decreased stimulus funded deposits, etc.

The Company continues to maintain and manage its asset growth. The Company’s strong equity capital position provides an opportunity to further leverage its asset growth. Total borrowings increased in the six months ended June 30, 2023 by $39,941,000 to $218,359,000 from $178,418,000 as of December 31, 2022. Borrowings increased mainly due to decreased deposit balances and growth in the loan portfolio.

Total stockholders’ equity amounted to $121,185,000 at June 30, 2023, an increase of $799,000 or 0.7% from December 31, 2022.

SEGMENT REPORTING

Currently, management measures the performance and allocates the resources of the Company as a single segment.

EARNING ASSETS

Earning assets are defined as those assets that produce interest income. By maintaining a healthy asset utilization rate, i.e., the volume of earning assets as a percentage of total assets, the Company maximizes income. The earning asset ratio (average interest earning assets divided by average total assets) equaled 93.2% at June 30, 2023 and 94.1% at June 30, 2022. This indicates that the management of earning assets is a priority and non-earning assets,

48

primarily cash and due from banks, fixed assets and other assets, are maintained at minimal levels. The primary earning assets are loans and securities.

Our primary earning asset, total loans, increased to $871,239,000 as of June 30, 2023, up $12,770,000 or 1.5% since year-end 2022. The loan portfolio continues to be well diversified. Non-performing assets increased since year-end 2022, and overall asset quality has remained consistent. Total non-performing assets were $5,673,000 as of June 30, 2023, an increase of $314,000, or 5.9% from $5,359,000 reported in non-performing assets as of December 31, 2022. Total allowance for credit losses to total non-performing assets was 138.14% as of June 30, 2023 and 154.39% at December 31, 2022. See the Non-Performing Assets section on page 52 for more information.

In addition to loans, another primary earning asset is our overall securities portfolio, which decreased in size from December 31, 2022 to June 30, 2023. Debt securities available-for-sale amounted to $331,580,000 as of June 30, 2023, a decrease of $41,864,000 from year-end 2022. The decrease in debt securities available-for-sale is mainly due to the sales of $23,131,000 of tax-exempt municipals during the first quarter of 2023. There were also principal paydowns on debt securities of $15,611,000.

Interest-bearing deposits in other banks decreased as of June 30, 2023, to $1,178,000 from $1,297,000 at year-end 2022 due to decreased cash held at the Federal Home Loan Bank.

LOANS

Total loans increased to $871,239,000 as of June 30, 2023 as compared to $858,469,000 as of December 31, 2022. The table on page 21 provides data relating to the composition of the Company’s loan portfolio on the dates indicated. Total loans increased by $12,770,000 or 1.5%.

Steady demand for borrowing by businesses accounted for the 1.5% increase in the loan portfolio from December 31, 2022 to June 30, 2023. The Real Estate portfolio increased $9,808,000 or 1.3% from $764,880,000 at December 31, 2022 to $774,688,000 at June 30, 2023. The increase in the Real Estate portfolio for the six months ended June 30, 2023 was mainly the result of $41,847,000 in new loan originations, which were offset by loan payoffs of $18,002,000 and a decrease of $6,286,000 in utilization of existing real estate lines of credit, along with regular principal payments and other typical fluctuations in the Real Estate portfolio. The Agricultural portfolio increased $2,000 or 0.2% from $860,000 at December 31, 2022 to $862,000 at June 30, 2023. The increase in the Agricultural portfolio for the six months ended June 30, 2023 was mainly the result of an increase of $16,000 in utilization of existing agricultural lines of credit, offset with regular principal payments and other typical fluctuations in the Agricultural portfolio. There were no new agricultural loans originated during the six months ended June 30, 2023 and payoffs of agricultural loans for the six months ended June 30, 2023 did not have a material impact on the change in the portfolio balance. Overall, the Commercial and Industrial portfolio increased $5,236,000 or 9.3% from $56,077,000 at December 31, 2022 to $61,313,000 at June 30, 2023. The increase in the Commercial and Industrial portfolio during the six months ended June 30, 2023 was mainly attributable to the portion of the Commercial and Industrial portfolio excluding PPP loans which increased $5,260,000 during the six months ended June 30, 2023. The increase was attributable to $6,191,000 in new loan originations and an increase of $1,126,000 in utilization of existing commercial and industrial lines of credit, offset by loan payoffs of $671,000, as well as regular principal payments and other typical amortization in the Commercial and Industrial portfolio. The portion of the Commercial and Industrial portfolio attributable to PPP loans decreased $24,000 from December 31, 2022 to June 30, 2023. Consumer loans increased $422,000 or 7.4% from $5,707,000 at December 31, 2022 to $6,129,000 at June 30, 2023. The increase is mainly attributable to new loan originations of $1,630,000, offset by loan payoffs of $568,000 and a decrease of $40,000 in utilization of existing consumer lines of credit, along with regular principal payments. The State and Political Subdivisions portfolio decreased $2,698,000 or 8.7% from $30,945,000 at December 31, 2022 to $28,247,000 at June 30, 2023. The decrease is mainly the result of $2,419,000 in loan payoffs for the six months ended June 30, 2023 along with regular principal payments, offset by $50,000 in new loan originations and a $50,000 increase in utilization of existing state and political subdivision lines of credit.

The Company continues to originate and sell certain long-term fixed rate residential mortgage loans, which conform to secondary market requirements, when the market pricing is favorable. The Company derives ongoing income

49

from the servicing of mortgages sold in the secondary market. The Company continues its efforts to lend to creditworthy borrowers. Management believes that the loan portfolio is well diversified.

Overall, the portfolio risk profile as measured by loan grade is considered low risk, as $849,067,000 or 97.6% of gross loans are graded Pass; $641,000 or 0.1% are graded Special Mention; $20,377,000 or 2.3% are graded Substandard; and $0 are graded Doubtful. The rating is intended to represent the best assessment of risk available at a given point in time, based upon a review of the borrower’s financial statements, credit analysis, payment history with the Bank, credit history and lender knowledge of the borrower. See Note 4 — Loans and Allowance for Credit Losses for risk grading tables.

Overall, non-pass grades increased $83,000 to $21,018,000 at June 30, 2023, as compared to $20,935,000 at December 31, 2022. Real Estate non-pass grades increased $106,000 to $20,316,000 as of June 30, 2023 as compared to $20,210,000 as of December 31, 2022. Commercial and Industrial non-pass grades decreased $33,000 to $692,000 as of June 30, 2023 as compared to $725,000 as of December 31, 2022. Consumer non-pass grades increased to $10,000 as of June 30, 2023 as compared to $0 as of December 31, 2022. There were no Agricultural or State and Political Subdivision non-pass grades at June 30, 2023 or December 31, 2022.

The Company continues to internally underwrite each of its loans to comply with prescribed policies and approval levels established by its Board of Directors.

Total Loans

(Dollars in thousands)

June 30, 

December 31, 

    

2023

    

2022

    

Real Estate

$

774,688

    

$

764,880

Agricultural

862

860

Commercial and Industrial

 

61,313

 

56,077

Consumer

 

6,129

 

5,707

State and Political Subdivisions

 

28,247

 

30,945

Total Loans

$

871,239

$

858,469

ALLOWANCE FOR CREDIT LOSSES

The allowance for credit losses constitutes the amount available to absorb losses within the loan portfolio. As of June 30, 2023, the allowance for credit losses was $7,157,000 as compared to $8,274,000 as of December 31, 2022. The allowance for credit losses is established through a provision for credit losses charged to expenses. Loans are charged against the allowance for possible credit losses when management believes that the collectability of the principal is unlikely. The risk characteristics of the loan portfolio are managed through various control processes, including credit evaluations of individual borrowers, periodic reviews, and diversification by industry. Risk is further mitigated through the application of lending procedures such as the holding of adequate collateral and the establishment of contractual guarantees.

Management performs a quarterly analysis to determine the adequacy of the allowance for credit losses. The methodology in determining adequacy incorporates quantitative and qualitative allocations together with a risk/loss analysis on various segments of the portfolio according to an internal loan review process. This assessment results in an allocated allowance. Management maintains its loan review and loan classification standards consistent with those of its regulatory supervisory authority.

Management considers, based upon its methodology, that the allowance for credit losses is adequate to cover foreseeable future losses. However, there can be no assurance that the allowance for credit losses will be adequate to cover significant losses, if any, that might be incurred in the future. On a quarterly basis, management evaluates the qualitative factors utilized in the calculation of the Company’s allowance for credit losses and various adjustments are made to these factors as deemed necessary at the time of evaluation. Upon adoption of ASU No. 2016-13 in the first

50

quarter of 2023, the qualitative factors used in the allowance calculation were adjusted from five loan pools utilized under previous methodology to fifteen loan segmentation pools aligning with the segmentation of the quarterly call report. There were no material increases or decreases in the qualitative factors arising from the realigning of the qualitative factor pools/segments and no additional qualitative factor adjustments were deemed necessary for the first quarter of 2023. During the second quarter of 2023, qualitative factors related to delinquency trends were increased by four basis points for each of the following loan segmentation pools: (a) revolving, open-end, 1-4 family residential properties (and extended under lines of credit) and (b) secured by multifamily (5 or more) residential properties. Both of these loan segmentation pools are included in the Real Estate component of the loan portfolio.

The Analysis of Allowance for Credit Losses table contains an analysis of the allowance for credit losses indicating charge-offs and recoveries for the six months ended June 30, 2023 and 2022. Net charge-offs as a percentage of average loans was 0.004% for the six months ended June 30, 2023 and net recoveries as a percentage of average loans was 0.006% as of June 30, 2022. Net charge-offs amounted to $32,000 the six months ended June 30, 2023 as compared to net recoveries of $43,000 for the six months ended June 30, 2022.

For the six months ended June 30, 2023, the provision for credit losses was $34,000 as compared to $437,000 for the six months ended June 30, 2022. The provision, net of charge-offs and recoveries, resulted in the quarter end allowance for credit losses of $7,157,000, of which 94.4% was attributed to the Real Estate component, 0.0% attributed to the Agricultural component, 3.8% attributed to the Commercial and Industrial component, 1.2% attributed to the Consumer component, and 0.6% attributed to the State and Political Subdivisions component (refer to the activity in Note 4 – Loans and Allowance for Credit Losses on page 13).

Analysis of Allowance for Credit Losses (Post-Adoption of ASU No. 2016-13)

(Dollars in thousands)

June 30, 

As of and for the six months ended:

    

2023

    

Balance at prior year-end

$

8,274

    

CECL adoption adjustment

(1,119)

Beginning balance

7,155

Charge-offs:

 

  

Real Estate

 

Agricultural

 

Commercial and Industrial

Consumer

 

38

State and Political Subdivisions

 

 

38

Recoveries:

 

  

Real Estate

 

2

Agricultural

 

Commercial and Industrial

2

Consumer

 

2

State and Political Subdivisions

 

 

6

Net charge-offs

 

32

Additions charged to operations

 

34

Balance at end of period

$

7,157

Ratio of net charge-offs during the period to average loans outstanding during the period

 

0.004

%  

Allowance for credit losses to average loans outstanding during the period

 

0.828

%  

51

Analysis of Allowance for Credit Losses (Pre-Adoption of ASU No. 2016-13)

(Dollars in thousands)

June 30, 

As of and for the six months ended:

2022

Beginning balance

$

8,680

Charge-offs:

 

  

Commercial and Industrial

 

9

Commercial Real Estate

 

Residential Real Estate

 

Consumer

 

6

 

15

Recoveries:

 

  

Commercial and Industrial

 

2

Commercial Real Estate

 

38

Residential Real Estate

 

14

Consumer

 

4

 

58

Net recoveries

 

(43)

Additions charged to operations

 

437

Balance at end of period

$

9,160

Ratio of net recoveries during the period to average loans outstanding during the period

 

(0.006)

%  

Allowance for credit losses to average loans outstanding during the period

 

1.177

%  

It is the policy of management and the Company’s Board of Directors to make a provision for both identified and unidentified losses inherent in its loan portfolio. A provision for credit losses is charged to operations based upon an evaluation of the potential losses in the loan portfolio. This evaluation takes into account such factors as portfolio concentrations, delinquency trends, trends of non-accrual and classified loans, economic conditions, and other relevant factors.

The loan review process, which is conducted quarterly, is an integral part of the Bank’s evaluation of the loan portfolio. A detailed quarterly analysis to determine the adequacy of the Company’s allowance for credit losses is reviewed by the Board of Directors.

With the Bank’s manageable level of net charge-offs and recoveries along with the additions to the reserve from the provision out of operations, the allowance for credit losses as a percentage of year-to-date average loans amounted to 0.828% and 1.177% at June 30, 2023 and 2022, respectively.

NON-PERFORMING ASSETS

The table on page 55 details the Company’s non-performing assets and individually evaluated loans as of the dates indicated. Generally, a loan is classified as non-accrual and the accrual of interest on such a loan is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on non-accrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against current period

52

income. Foreclosed assets held for resale represent property acquired through foreclosure, or considered to be an in-substance foreclosure.

Total non-performing assets amounted to $5,673,000 as of June 30, 2023, as compared to $5,359,000 as of December 31, 2022. The economy remains unstable. Consumer spending remains high, allowing the inflation rate to continue to remain higher than desired. Business sentiment is downbeat and business investment has slowed. Many economists and influential thinkers believe at least a mild recession will hit the United States economy by the final quarter of 2023. Inflation has receded in recent months, but as of June 2023 was at 3%, above the Federal Reserve’s target rate of 2%. The war between Ukraine and Russia continues to produce worldwide consternation. The continued backing by the United States, both with money and weapons, to Ukraine to support the NATO initiative has been a strain on the economy. Values of new and used homes and automobiles have remained high, and higher interest rates have added to the curtailed borrowing. The Federal Reserve appears to be wrapping up its schedule of rate hikes, indicating a plan to potentially further raise interest rates at least one more time by years’ end if inflation does not continue to decrease, but expects at a minimum to hold rates steady through the end of the year and into next year. These forces have had a direct effect on the Company’s non-performing assets. The Company is closely monitoring all segments of its loan portfolio because of the current uncertain economic environment.. Non-accrual loans totaled $5,089,000 as of June 30, 2023, as compared to $5,051,000 as of December 31, 2022. There were no foreclosed assets held for resale as of June 30, 2023 and December 31, 2022. There were five loans past-due 90 days or more and still accruing interest at June 30, 2023 that carried a balance of $584,000 which were well-secured by commercial and residential real estate and in the process of collection, compared to December 31, 2022 when there were three loans carrying an aggregate balance of $308,000 that were past-due 90 days or more and still accruing interest. The loan past-due 90 days or more and still accruing interest as of December 31, 2022 consisted of three loans secured by commercial and residential real estate, all of which were well secured and in the process of collection.

Non-performing assets to total loans was 0.65% at June 30, 2023 and 0.62% at December 31, 2022. Non-performing assets to total assets was 0.43% at June 30, 2023 and 0.40% at December 31, 2022. The allowance for credit losses to total non-performing assets was 126.16% as of June 30, 2023 as compared to 154.39% as of December 31, 2022. Additional detail can be found on page 55 and 56 in the Non-Performing Assets and Individually Evaluated Loans (Post-Adoption of ASU No. 20016-13) and Non-Performing Assets to Impaired Loans (Pre-Adoption of ASU No. 2016-13) tables and page 25 in the Non-Performing Assets table. Asset quality is a priority and the Company retains a full-time loan review officer to closely track and monitor overall loan quality, along with a full-time loan workout department to manage collection and liquidation effortsand engages an annual external loan review.

Performing substandard loans which have not been designated for individual impairment have characteristics that cause management to have doubts regarding the ability of the borrower to perform under present loan repayment terms and which may result in reporting these loans as non-performing loans in the future. Performing substandard loans not designated for individual impairment amounted to $15,289,000 at June 30, 2023.

Individually evaluated loans were $5,398,000 at June 30, 2023 and $11,207,000 at December 31, 2022. The largest individually evaluated loan relationship at June 30, 2023 consisted of a non-performing loan to a student housing holding company which is secured by commercial real estate. At June 30, 2023, the loan carried a balance of $2,340,000, net of $1,989,000 that had been charged off to date. The second largest individually evaluated loan relationship at June 30, 2023 consisted of five non-performing loans to a plastic processing company focused on non-post-consumer recycling. Three loans are classified in the Commercial and Industrial portfolio and two loans are secured by commercial real estate. The loans carried an aggregate balance of $1,042,000 at June 30, 2023. The third largest individually evaluated loan relationship at June 30, 2023 consisted of a non-performing loan to the owner of a golf course and catering venue which is secured by commercial real estate. At June 30, 2023, the loan carried a balance of $582,000.

The Company determines the need for individual evaluation of loans based on its analysis of the cash flows or collateral estimated at fair value less cost to sell. For collateral dependent loans, the estimated appraisal or other qualitative adjustments and cost to sell percentages are determined based on the market area in which the real estate securing the loan is located, among other factors, and therefore, can differ from one loan to another. Of the $5,398,000 in individually evaluated loans at June 30, 2023, none were located outside of the Company’s primary market area.

53

The Company’s non-accrual loan valuation procedure for any loans greater than $250,000 requires an appraisal to be obtained and reviewed annually at year end, unless the Board of Directors waives such requirement for a specific loan, in favor of obtaining a Certificate of Inspection instead, defined as an internal evaluation completed by the Company. A quarterly collateral evaluation is performed which may include a site visit, property pictures and discussions with realtors and other similar business professionals to ascertain current values.

For non-accrual loans less than $250,000 upon classification and typically at year end, the Company completes a Certificate of Inspection, which includes the results of an onsite inspection, and may consider value indicators such as insured values, tax assessed values, recent sales comparisons and a review of the previous evaluations.

Improving loan quality is a priority. The Company actively works with borrowers to resolve credit problems and will continue its close monitoring efforts in 2023. Excluding the assets disclosed in the Non-Performing Assets and Individually Evaluated Loans (Post-Adoption of ASU No. 2016-13) and Non-Performign Assets and Impaired Loans (Pre-Adoption of ASU No. 2016-13) tables below, management is not aware of any information about borrowers’ possible credit problems which cause serious doubt as to their ability to comply with present loan repayment terms.

In addition, regulatory authorities, as an integral part of their examinations, periodically review the allowance for possible loan losses. They may require additions to allowances based upon their judgments about information available to them at the time of examination.

The economic climate remains in a very uncertain state. An elevated level of consumer spending, the war between Ukraine and Russia, inflationary pressures, OPEC cutting the oil supply, large bank failures, political turmoil, the inability for government to approve state and/or national budgets, and recession concerns have all exacerbated the difficulties in the national and state economy. Experts at all levels are attempting to calculate the intermediate or long term affects of such issues. The Company may experience difficulties collecting payments on time from its borrowers, and certain types of loans may need to be modified, which could cause a rise in the level of individually evaluated loans, non-performing assets, charge-offs, and delinquencies. Should such metrics increase, additions to the balance of the Company’s allowance for credit losses could be required. The extent of the impact of these stressors on the Company’s operational and financial performance will depend on certain developments including inflationary controls enacted, the labor force, the longevity of the war, the effectiveness in controlling the lingering effects of the COVID-19 outbreak, the ongoing political landscape, and the looming threat of a recession, and any after-effects of these factors. These factors may not immediately impact the Company’s operational and financial performance, as the effects of these factors may lag into the future. The Company is also susceptible to the impact of economic and fiscal policy factors that may evolve in the current economic environment.

A concentration of credit exists when the total amount of loans to borrowers, who are engaged in similar activities that are similarly impacted by economic or other conditions, exceed 10% of total loans. As of June 30, 2023 and December 31, 2022, management is of the opinion that there were no loan concentrations exceeding 10% of total loans.

54

Non-Performing Assets and Individually Evaluated Loans (Post-Adoption of ASU No. 2016-13)

(Dollars in thousands)

June 30, 

    

2023

    

Non-performing assets

 

  

    

Non-accrual loans

$

5,089

Foreclosed assets held for resale

 

Loans past-due 90 days or more and still accruing interest

 

584

Total non-performing assets

$

5,673

Individually evaluated loans

 

  

Non-accrual loans

$

5,089

Other Individually Evaluated loans

309

Total individually evaluated loans

 

5,398

Allocated allowance for credit losses

 

Net investment in individually evaluated loans

$

5,398

Individually evaluated loans with a valuation allowance

$

Individually evaluated loans without a valuation allowance

 

5,398

Total individually evaluated loans

$

5,398

Allocated valuation allowance as a percent of individually evaluated loans

 

%  

Individually evaluated loans to total loans

 

0.62

%  

Non-performing assets to total loans

 

0.65

%  

Non-performing assets to total assets

 

0.43

%  

Allowance for credit losses to individually evaluated loans

 

132.59

%  

Allowance for credit losses to total non-performing assets

 

126.16

%  

55

Non-Performing Assets and Impaired Loans (Pre-Adoption of ASU No. 2016-13)

(Dollars in thousands)

December 31, 

2022

Non-performing assets

  

Non-accrual loans

$

5,051

Foreclosed assets held for resale

 

Loans past-due 90 days or more and still accruing interest

 

308

Total non-performing assets

$

5,359

Impaired loans

 

  

Non-accrual loans

$

5,051

Accruing TDRs

 

6,156

Total impaired loans

 

11,207

Allocated allowance for credit losses

 

Net investment in impaired loans

$

11,207

Impaired loans with a valuation allowance

$

Impaired loans without a valuation allowance

 

11,207

Total impaired loans

$

11,207

Allocated valuation allowance as a percent of impaired loans

 

%  

Impaired loans to total loans

 

1.31

%  

Non-performing assets to total loans

 

0.62

%  

Non-performing assets to total assets

 

0.40

%  

Allowance for credit losses to impaired loans

 

73.83

%  

Allowance for credit losses to total non-performing assets

 

154.39

%  

Real estate mortgages comprise 88.9% of the loan portfolio as of June 30, 2023, as compared to 89.1% as of December 31, 2022. Real estate mortgages consist of both loans secured by residential and commercial real estate. The real estate loan portfolio is well diversified in terms of borrowers, collateral, interest rates, and maturities. Also, the residential component of the real estate loan portfolio is largely comprised of fixed rate mortgages. The real estate loans are concentrated primarily in the Company’s market area and are subject to risks associated with the local economy. The loans secured by commercial real estate typically reprice approximately every three to five years and are also concentrated in the Company’s market area. The Company’s loss exposure on its individually evaluated loans continues to be mitigated by collateral positions on these loans. The allocated allowance for credit losses associated with individually evaluated loans is generally computed based upon the related collateral value of the loans. The collateral values are determined by recent appraisals or Certificates of Inspection, but are generally discounted by management based on historical dispositions, changes in market conditions since the last valuation and management’s expertise and knowledge of the borrower and the borrower’s business.

DEPOSITS, OTHER BORROWED FUNDS AND SUBORDINATED DEBT

Consumer and commercial retail deposits are attracted primarily by the Bank’s nineteen full service office locations and through its internet banking presence. The Bank offers a broad selection of deposit products and continually evaluates its interest rates and fees on deposit products. The Bank regularly reviews competing financial institutions’ interest rates, especially when establishing interest rates on certificates of deposit and municipal deposits.

56

Total deposits decreased $57,658,000 to $935,841,000 as of June 30, 2023 as non-interest bearing deposits decreased by $11,235,000 and interest bearing deposits decreased by $46,423,000 from year-end 2022. The decrease in deposits was the result of a $39,273,000 decrease in municipal deposits and other fluctuations. Total short-term and long-term borrowings increased to $218,359,000 as of June 30, 2023, from $178,418,000 at year-end 2022, an increase of $39,941,000 or 22.4%. The increase in total borrowings was mainly the result of increased short-term borrowings due to decreased deposits and growth in the loan portfolio.

On December 10, 2020, the Corporation issued $25,000,000 aggregate principal amount of Subordinated Notes due December 31, 2030 (the “2020 Notes”). The 2020 Notes are intended to be treated as Tier 2 capital for regulatory capital purposes. The 2020 Notes bear a fixed interest rate of 4.375% per year for the first five years and then float based on a benchmark rate (as defined).

CAPITAL STRENGTH

Normal increases in capital are generated by net income, less dividends paid out. During the six months ended June 30, 2023, net income less dividends paid decreased capital by $880,000. The decrease was offset by a one-time cumulative effect adjustment that increased retained earnings by $728,000 upon the adoption of ASU 2016-13. Accumulated other comprehensive (loss) income derived from net unrealized gains on debt securities available-for-sale also impacts capital. At December 31, 2022 accumulated other comprehensive loss was ($29,558,000). Accumulated other comprehensive loss stood at ($29,516,000) at June 30, 2023, an increase of $42,000. Fluctuations in interest rates have regularly impacted the gain/loss position in the Bank’s securities portfolio, as well as its decision to sell securities at a gain or loss. The fluctuations from net unrealized gains on debt securities available-for-sale do not affect regulatory capital, as the Bank elected to opt-out of the inclusion of this item with the filing of the March 31, 2015 Call Report.

The Company held 231,611 shares of common stock as treasury stock at June 30, 2023 and December 31, 2022, respectively. This had an effect of reducing our total stockholders’ equity by $5,709,000 as of June 30, 2023 and December 31, 2022.

Total stockholders’ equity was $121,185,000 as of June 30, 2023, and $120,386,000 as of December 31, 2022.

At June 30, 2023 the Bank met the definition of a “well-capitalized” institution under the regulatory framework for prompt corrective action and the minimum capital requirements under Basel III. The following table presents the Bank’s capital ratios as of June 30, 2023 and December 31, 2022:

    

    

    

    

 

To Be Well

 

Capitalized

 

Under Prompt

 

June 30, 

December 31, 

Corrective Action

    

2023

    

2022

    

Regulations

 

Tier 1 leverage ratio (to average assets)

 

10.75

%  

10.38

%  

5.00

%

Common Equity Tier 1 capital ratio (to risk-weighted assets)

 

15.44

%  

15.24

%  

6.50

%

Tier 1 risk-based capital ratio (to risk-weighted assets)

 

15.44

%  

15.24

%  

8.00

%

Total risk-based capital ratio

 

16.24

%  

16.15

%  

10.00

%

Under the final capital rules that became effective on January 1, 2015, there was a requirement for a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not maintain this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement was phased in over three years beginning in 2016. The capital buffer requirement effectively raises the minimum required common equity Tier 1 capital ratio to 7.0%, the Tier 1 capital ratio to 8.5%, and the total capital ratio to 10.5% on a fully phased-in basis as of January 1, 2019. As of June 30, 2023, the Bank meets all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis.

The Corporation’s capital ratios are not materially different than those of the Bank.

57

LIQUIDITY

The Company’s objective is to maintain adequate liquidity to meet funding needs at a reasonable cost and provide contingency plans to meet unanticipated funding needs or a loss of funding sources, while minimizing interest rate risk. Adequate liquidity is needed to provide the funding requirements of depositors’ withdrawals, loan growth, and other operational needs.

Sources of liquidity are as follows:

Growth in the core deposit base;
Proceeds from sales or maturities of securities;
Payments received on loans and mortgage-backed and asset-backed securities;
Overnight correspondent bank borrowings on various credit lines, notes, etc., with various levels of capacity;
Securities sold under agreements to repurchase; and
Brokered CDs.

At June 30, 2023 the Company had $505,628,000 in maximum borrowing capacity at FHLB (inclusive of the outstanding balances of FHLB long-term notes, FHLB short-term borrowings, and irrevocable standby letters of credit issued by FHLB); the maximum borrowing capacity at ACBB was $15,000,000 and the maximum borrowing capacity of the Federal Discount Window was $9,261,000.

The Company enters into “Repurchase Agreements” in which it agrees to sell securities subject to an obligation to repurchase the same or similar securities. Because the agreement both entitles and obligates the Company to repurchase the assets, the Company may transfer legal control of the securities while still retaining effective control. As a result, the repurchase agreements are accounted for as collateralized financing agreements (secured borrowings) and act as an additional source of liquidity. Securities sold under agreements to repurchase were $19,308,000 at June 30, 2023.

Asset liquidity is provided by securities maturing in one year or less, other short-term investments, federal funds sold, and cash and due from banks. The liquidity is augmented by repayment of loans and cash flows from mortgage-backed and asset-backed securities. Liability liquidity is accomplished primarily by maintaining a core deposit base, acquired by attracting new deposits and retaining maturing deposits. Also, short-term borrowings provide funds to meet liquidity needs.

Net cash flows provided by operating activities were $357,000 for the six months ended June 30, 2023, compared to net cash flows provided by operating activities of $8,411,000 for the six months ended June 30, 2022. Net income amounted to $2,496,000 for the six months ended June 30, 2023 and $7,365,000 for the six months ended June 30, 2022. During the six months ended June 30, 2023 and 2022, net premium amortization on securities amounted to $799,000 and $1,633,000, respectively. Net gains on sales of mortgage loans amounted to $34,000 for the six months ended June 30, 2023, compared to net losses on sales of mortgage loans of $34,000 for the six months ended June 30, 2022. Proceeds (net of gains/losses) from sales of mortgage loans originated for resale exceeded originations of mortgage loans originated for resale by $105,000 for the six months ended June 30, 2023, compared to the six months ended June 30, 2022 when originations of mortgage loans originated for resale exceeded proceeds (net of gains/losses) from sales of mortgage loans originated for resale by $1,639,000. Net securities losses amounted to $125,000 and $131,000 for the six months ended June 30, 2023 and 2022, respectively. Accrued interest receivable decreased by $218,000 and increased by $112,000 during the six months ended June 30, 2023 and 2022, respectively. Other assets increased by $87,000 and $639,000 during the six months ended June 30, 2023 and 2022, respectively. Accrued interest payable increased by $608,000 during the six months ended June 30, 2023, compared to an increase of $22,000 during the six months ended June 30, 2022. Other liabilities decreased by $5,188,000 during the six months ended June 30, 2023 and increased by $97,000 during the six months ended June 30, 2022.

Investing activities provided cash of $23,778,000 during the six months ended June 30, 2023, compared to the six months ended June 30, 2022 when investing activities used cash of $64,171,000. Net activity in the available-for-sale

58

securities portfolio (including proceeds from sale, maturities, and redemptions, net against purchases) provided cash of $41,217,000 during the six months ended June 30, 2023 and used cash of $9,283,000 during the six months ended June 30, 2022. Changes in restricted investment in bank stocks used cash of $1,481,000 and $3,834,000 during the six months ended June 30, 2023 and 2022, respectively. Net cash used to originate loans amounted to $12,873,000 for the six months ended June 30, 2023, compared to $50,331,000 for the six months ended June 30, 2022. Purchases of premises and equipment used cash of $1,251,000 and $325,000 during the six months ended June 30, 2023 and 2022, respectively. Purchase of investment in real estate venture used cash of $1,834,000 during the six months ended June 30, 2023, compared to $645,000 for the six months ended June 30, 2022.

Financing activities used cash of $21,098,000 and provided cash of $4,646,000 during the six months ended June 30, 2023 and 2022, respectively. Deposits decreased by $57,658,000 during the six months ended June 30, 2023, and decreased by $84,361,000 during the six months ended June 30, 2022. Short-term borrowings increased by $39,941,000 and $102,346,000 during the six months ended June 30, 2023 and 2022, respectively. Dividends paid amounted to $3,376,000 for the six months ended June 30, 2023, compared to $3,334,000 for the six months ended June 30, 2022.

Managing liquidity remains an important segment of asset/liability management. The overall liquidity position of the Company is maintained by an active asset/liability management committee. The Company believes that its core deposit base is stable even in periods of changing interest rates. Liquidity and funds management are governed by policies and are measured on a monthly basis. These measurements indicate that liquidity generally remains stable and exceeds the Company’s minimum defined levels of adequacy. Other than the trends of continued competitive pressures and volatile interest rates, there are no known demands, commitments, events or uncertainties that will result in, or that are reasonably likely to result in, liquidity increasing or decreasing in any material way. Given our financial strength, we expect to be able to maintain adequate liquidity as we manage through the current environment, utilizing current funding options and possibly utilizing new options.

MARKET RISK

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates and equity prices. The Company’s market risk is composed primarily of interest rate risk. The Company’s interest rate risk results from timing differences in the repricing of assets, liabilities, off-balance sheet instruments, and changes in relationships between rate indices and the potential exercise of explicit or embedded options.

Increases in the level of interest rates also may adversely affect the fair value of the Company’s securities and other earning assets. Generally, the fair value of fixed-rate instruments fluctuates inversely with changes in interest rates. As a result, increases in interest rates could result in further decreases in the fair value of the Company’s interest-earning assets, which could adversely affect the Company’s results of operations if sold, or, in the case of interest-earning assets classified as available-for-sale, the Company’s stockholders’ equity, if retained. Under FASB ASC 320-10, Investments – Debt Securities, changes in the unrealized gains and losses, net of taxes, on debt securities classified as available-for-sale are reflected in the Company’s stockholders’ equity. The Company does not own any trading assets.

Asset/Liability Management

The principal objective of asset/liability management is to manage the sensitivity of the net interest margin to potential movements in interest rates and to enhance profitability through returns from managed levels of interest rate risk. The Company actively manages the interest rate sensitivity of its assets and liabilities. Several techniques are used for measuring interest rate sensitivity. Interest rate risk arises from the mismatches in the repricing of rates on assets and liabilities within a given time period, referred to as a rate sensitivity gap. If more assets than liabilities mature or reprice within the time frame, the Company is asset sensitive. This position would contribute positively to net interest income in a rising rate environment. Conversely, if more liabilities mature or reprice, the Company is liability sensitive. This position would contribute positively to net interest income in a falling rate environment. The Company’s cumulative gap at one year indicates the Company is liability sensitive at June 30, 2023.

59

Earnings at Risk

The Bank’s Asset/Liability Committee (“ALCO”) is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and limit exposure to interest rate risk. The guidelines established by ALCO are reviewed by the Company’s Board of Directors. The Company recognizes that more sophisticated tools exist for measuring the interest rate risk in the balance sheet beyond interest rate sensitivity gap. Although the Company continues to measure its interest rate sensitivity gap, the Company utilizes additional modeling for interest rate risk in the overall balance sheet. Earnings at risk and economic values at risk are analyzed.

Earnings simulation modeling addresses earnings at risk and net present value estimation addresses economic value at risk. While each of these interest rate risk measurements has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk to the Company.

Earnings Simulation Modeling

The Company’s net income is affected by changes in the level of interest rates. Net income is also subject to changes in the shape of the yield curve. For example, a flattening of the yield curve would result in a decline in earnings due to the compression of earning asset yields and increased liability rates, while a steepening would result in increased earnings as earning asset and interest-bearing liability yields widen.

Earnings simulation modeling is the primary mechanism used in assessing the impact of changes in interest rates on net interest income. The model reflects management’s assumptions related to asset yields and rates paid on liabilities, deposit sensitivity, size and composition of the balance sheet. The assumptions are based on what management believes at that time to be the most likely interest rate environment. Earnings at risk is the change in net interest income from a base case scenario under various scenarios of rate shock increases and decreases in the interest rate earnings simulation model.

The table below presents an analysis of the changes in net interest income and net present value of the balance sheet resulting from various increases or decreases in the level of interest rates, such as two percentage points (200 basis points) in the level of interest rates. The calculated estimates of change in net interest income and net present value of the balance sheet are compared to current limits approved by ALCO and the Board of Directors. The earnings simulation model projects net interest income would decrease 16.34%, 31.71%, and 45.79% in the 100, 200 and 300 basis point increasing rate scenarios presented. In addition, the earnings simulation model projects net interest income would increase 8.25%, 18.72%, and 28.35% in the 100, 200 and 300 basis point decreasing rate scenarios presented. All of the forecasts in the increasing rate scenarios presented are outside of the Company’s policy guidelines with the 100 basis point immediate increase scenario at (16.34)%, the 200 basis point immediate increase scenario at (31.71)% and the 300 basis point immediate increase scenario at (45.79)% vs. the policy limits of (15.00)%, (20.00)%, and (25.00)%, respectively.

The analysis and model used to quantify the sensitivity of net interest income becomes less reliable in a decreasing rate scenario given the current interest rate environment with federal funds trading in the 500-525 basis point range and many deposit accounts still lagging at markedly lower rates. Results of the decreasing basis point declining scenarios are affected by the fact that many of the Company’s interest-bearing liabilities are at rates below 1% and therefore likely may not decline 100 or more basis points. However, the Company’s interest-sensitive assets are able to decline by these amounts. For the three months ended June 30, 2023, the cost of interest-bearing liabilities averaged 2.52%, and the yield on interest-earning assets, on a fully taxable equivalent basis, averaged 4.46%.

Net Present Value Estimation

The net present value measures economic value at risk and is used for helping to determine levels of risk at a point in time present in the balance sheet that might not be taken into account in the earnings simulation model. The net present value of the balance sheet is defined as the discounted present value of asset cash flows minus the discounted present value of liability cash flows. At June 30, 2023, net present value is projected to decrease 4.07%, 10.93%, and 19.31% in the 100, 200, and 300 basis point immediate increase scenarios, respectively. Additionally, the 100, 200 and

60

300 basis point immediate decreases in rates are estimated to affect net present value with a decrease of 1.12%, 9.50%, and 26.89%, respectively. All scenarios presented are within the Company’s policy limits.

The computation of the effects of hypothetical interest rate changes are based on many assumptions. They should not be relied upon solely as being indicative of actual results, since the computations do not account for actions management could undertake in response to changes in interest rates.

Effect of Change in Interest Rates

    

Projected Change

 

Effect on Net Interest Income

1-Year Net Interest Income Simulation Projection

 

  

+300 bp Shock vs. Stable Rate

 

(45.79)

%

+200 bp Shock vs. Stable Rate

 

(31.71)

%

+100 bp Shock vs. Stable Rate

 

(16.34)

%

Flat rate

 

  

‒100 bp Shock vs. Stable Rate

 

8.25

%

‒200 bp Shock vs. Stable Rate

 

18.72

%

‒300 bp Shock vs. Stable Rate

28.35

%

Effect on Net Present Value of Balance Sheet

 

  

Static Net Present Value Change

 

  

+300 bp Shock vs. Stable Rate

 

(19.31)

%

+200 bp Shock vs. Stable Rate

 

(10.93)

%

+100 bp Shock vs. Stable Rate

 

(4.07)

%

Flat rate

 

  

‒100 bp Shock vs. Stable Rate

 

(1.12)

%

‒200 bp Shock vs. Stable Rate

 

(9.50)

%

‒300 bp Shock vs. Stable Rate

 

(26.89)

%

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

Information with respect to quantitative and qualitative disclosures about market risk is included in the information under Management’s Discussion and Analysis in Item 2.

Item 4.  Controls and Procedures

a)

Evaluation of Disclosure Controls and Procedures. First Keystone Corporation maintains disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Based upon their evaluation of those disclosure controls and procedures performed as of the end of the period covered by this report, the Chief Executive Officer and Chief Financial Officer of the Company concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2023.

b)

Changes in internal control over financial reporting. There were no other changes in the Company’s internal control over financial reporting during the fiscal quarter ended June 30, 2023, that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

61

PART II - OTHER INFORMATION

Item 1.  Legal Proceedings

Although the Company is subject to various claims and legal actions that occur from time to time in the ordinary course of business, the Company is not party to any pending legal proceedings that management believes could have a material adverse effect on its business, results of operations, financial condition or cash flows.

Item 1A. Risk Factors

Recent negative developments affecting the banking industry, including recent bank failures or concerns regarding liquidity, have eroded customer confidence in the banking system and may have a material adverse effect on the Corporation.

During March and April 2023 three significant bank failures occurred (Silicon Valley Bank, Signature Bank, and First Republic Bank). This was and continues to be accompanied by financial instability at certain additional banks. These bank failures and bank instabilities have created and may continue to create market and other risks, for all financial institutions and banks, including the Corporation. These risks include, but are not limited to:

Market risk and loss of confidence in the financial services sector, and/or specific banks;
Deterioration of securities and loan portfolios;
Deposit volatility and reductions with higher volumes and occurring over shorter periods of time;
Increased liquidity demand and utilization of sources of liquidity; and
Interest rate volatility and abrupt, sudden and greater than usual rate changes.

These factors individually, or in any combination, could materially and adversely affect:

Financial condition;
Operations and results thereof; and
Stock price.

In addition, the previously mentioned bank failures and instabilities may result in an increase of FDIC deposit insurance premiums and/or result in special FDIC deposit insurance assessments, which also may adversely affect the Corporation’s financial condition, operations, results thereof or stock price. The Corporation cannot predict the impact, timing or duration of such events.

Other than the item listed above, there have been no material changes to the risk factors disclosed in Item 1A “Risk Factors” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2022.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

Period

(a)
Total Number of Shares Purchased

(b)
Average Price Paid per Share

(c)
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs

(d)
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs

April 1 - April 30, 2023

120,000

May 1 - May 31, 2023

120,000

June 1 - June 30, 2023

120,000

Total

120,000

62

Item 3.  Defaults Upon Senior Securities

None.

Item 4.  Mine Safety Disclosures

Not applicable.

Item 5.  Other Information

None.

63

Item 6.  Exhibits and Reports on Form 8-K

(a)

Exhibits required by Item 601 Regulation S-K

Exhibit Number

    

Description of Exhibit

3.1

Articles of Incorporation, as amended (Incorporated by reference to Exhibit 3.1 to the Registrant’s Report on Form 8-K dated August 28, 2018).

3.2

By-Laws, as amended and restated (Incorporated by reference to Exhibit 3.2 to the Registrant’s Report on Form 8-K dated January 26, 2021).

10.1(a)

Supplemental Employee Retirement Plan – J. Gerald Bazewicz (Incorporated by reference to Exhibit 10 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2013).*

10.1(b)

Supplemental Employee Retirement Plan – David R. Saracino (Incorporated by reference to Exhibit 10 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2013).*

10.1(d)

Supplemental Employee Retirement Plan – Elaine Woodland (Incorporated by reference to Exhibit 10 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2013).*

10.2

Management Incentive Compensation Plan (Incorporated by reference to Exhibit 10 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2018).*

14

First Keystone Corporation Directors and Senior Management Code of Ethics (Incorporated by reference to Exhibit 99.1 to Registrant’s Report on Form 8-K dated August 27, 2013).

31.1

Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.**

31.2

Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.**

32.1

Section 1350 Certification of Chief Executive Officer.**

32.2

Section 1350 Certification of Chief Financial Officer.**

101.INS

Inline XBRL Instance Document.**

101.SCH

Inline XBRL Taxonomy Extension Schema Document.**

101.CAL

Inline XBRL Taxonomy Extension Calculation Linkbase Document.**

101.DEF

Inline XBRL Taxonomy Extension Definition Linkbase Document.**

101.LAB

Inline XBRL Taxonomy Extension Label Linkbase Document.**

101.PRE

Inline XBRL Taxonomy Extension Presentation Linkbase Document.**

104

Cover Page Interactive Data File (Formatted as Inline XBRL and Contained in Exhibit 101)

*   Denotes a compensatory plan.

** Filed herewith.

The Company will provide a copy of any exhibit upon receipt of a written request for the particular exhibit or exhibits desired. All requests should be addressed to the Company’s principal executive offices.

64

FIRST KEYSTONE CORPORATION

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly cause this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

FIRST KEYSTONE CORPORATION

 

Registrant

 

 

 

 

August 9, 2023

/s/ Elaine A. Woodland

 

Elaine A. Woodland

 

President and Chief Executive Officer

 

(Principal Executive Officer)

 

 

 

 

 

 

August 9, 2023

/s/ Diane C.A. Rosler

 

Diane C.A. Rosler

 

Senior Vice President and Chief Financial Officer

 

(Principal Financial Officer)

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