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FRANKLIN FINANCIAL SERVICES CORP /PA/ - Quarter Report: 2016 September (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 September 30, 2016

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 0-12126

FRANKLIN FINANCIAL SERVICES CORPORATION

(Exact name of registrant as specified in its charter)



 

PENNSYLVANIA

25-1440803

(State or other jurisdiction of incorporation or organization) 

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







 

20 South Main Street, Chambersburg

PA 17201-0819

(Address of principal executive offices)

(Zip Code)



(717) 264-6116

(Registrant's telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

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, or a smaller reporting company.   See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer        Accelerated filer          Non-accelerated filer        Smaller reporting company 



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



There were 4,299,317 outstanding shares of the Registrant’s common stock as of October 31, 2016.

 


 

INDEX



               



 

 

Part I - FINANCIAL INFORMATION

 



 

 

Item 1

Financial Statements

 



Consolidated Balance Sheets as of September  30, 2016 and December 31, 2015 (unaudited)

1



Consolidated Statements of Income for the Three and Nine Months ended September  30, 2016 

2



and 2015 (unaudited)

 



Consolidated Statements of Comprehensive Income for the Three and Nine Months ended

3



September  30, 2016 and 2015 (unaudited)

 



Consolidated Statements of Changes in Shareholders’ Equity for the Nine Months

4



ended September 30, 2016 and 2015 (unaudited)

 



Consolidated Statements of Cash Flows for the Nine Months ended September  30, 2016 

5



and 2015 (unaudited)

 



Notes to Consolidated Financial Statements (unaudited)

6



 

 

Item 2

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

28

Item 3

Quantitative and Qualitative Disclosures about Market Risk

52

Item 4

Controls and Procedures

52



 

 

Part II - OTHER INFORMATION 

 



 

 

Item 1

Legal Proceedings

53

Item 1A

Risk Factors

53

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

53

Item 3

Defaults Upon Senior Securities

53

Item 4

Mine Safety Disclosures

53

Item 5

Other Information

53

Item 6

Exhibits

53

SIGNATURE PAGE

54

EXHIBITS

 







 

 


 

Part I FINANCIAL INFORMATION

Item 1 Financial Statements

Consolidated Balance Sheets







 

 

 

 

 



 

 

 

 

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

September 30

 

December 31



2016

 

2015

Assets

 

 

 

 

 

Cash and due from banks

$

16,770 

 

$

20,664 

Interest-bearing deposits in other banks

 

23,824 

 

 

18,502 

Total cash and cash equivalents

 

40,594 

 

 

39,166 

Investment securities available for sale, at fair value

 

155,345 

 

 

159,473 

Restricted stock

 

1,118 

 

 

782 

Loans held for sale

 

367 

 

 

461 

Loans

 

858,576 

 

 

782,016 

Allowance for loan losses

 

(10,685)

 

 

(10,086)

Net Loans

 

847,891 

 

 

771,930 

Premises and equipment, net

 

14,322 

 

 

14,759 

Bank owned life insurance

 

22,327 

 

 

22,364 

Goodwill

 

9,016 

 

 

9,016 

Other real estate owned

 

5,872 

 

 

6,451 

Deferred tax asset, net

 

4,044 

 

 

4,758 

Other assets

 

6,224 

 

 

6,135 

Total assets

$

1,107,120 

 

$

1,035,295 



 

 

 

 

 

Liabilities

 

 

 

 

 

Deposits

 

 

 

 

 

Noninterest-bearing checking

$

174,390 

 

$

152,095 

Money management, savings and interest checking

 

726,845 

 

 

680,686 

Time

 

77,317 

 

 

85,731 

Total Deposits

 

978,552 

 

 

918,512 

Short-term borrowings

 

8,530 

 

 

 -

Other liabilities

 

3,159 

 

 

5,407 

Total liabilities

 

990,241 

 

 

923,919 



 

 

 

 

 

Shareholders' equity

 

 

 

 

 

Common stock, $1 par value per share,15,000,000 shares authorized with

 

 

 

 

 

4,688,149 shares issued and 4,299,223 shares outstanding at September 30, 2016 and

 

 

 

 

 

4,659,319 shares issued and 4,275,879 shares outstanding at December 31, 2015

 

4,688 

 

 

4,659 

Capital stock without par value, 5,000,000 shares authorized with no

 

 

 

 

 

shares issued and outstanding

 

 -

 

 

 -

Additional paid-in capital

 

39,584 

 

 

38,778 

Retained earnings

 

82,262 

 

 

78,517 

Accumulated other comprehensive loss

 

(2,547)

 

 

(3,722)

Treasury stock, 388,926 shares at September 30, 2016 and 383,440 shares at

 

 

 

 

 

December 31, 2015, at cost

 

(7,108)

 

 

(6,856)

Total shareholders' equity

 

116,879 

 

 

111,376 

Total liabilities and shareholders' equity

$

1,107,120 

 

$

1,035,295 



 

 

 

 

 

The accompanying notes are an integral part of these unaudited financial statements.

 

 

 

 

 



















1

 


 

Consolidated Statements of Income





 

 

 

 

 

 

 

 

 

 

 



For the Three Months Ended

 

For the Nine Months Ended

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

September 30

 

September 30



2016

 

2015

 

2016

 

2015

Interest income

 

 

 

 

 

 

 

 

 

 

 

Loans, including fees

$

8,343 

 

$

7,665 

 

$

24,394 

 

$

22,518 

Interest and dividends on investments:

 

 

 

 

 

 

 

 

 

 

 

Taxable interest

 

569 

 

 

584 

 

 

1,729 

 

 

1,832 

Tax exempt interest

 

355 

 

 

402 

 

 

1,079 

 

 

1,218 

Dividend income

 

 

 

 

 

12 

 

 

63 

Deposits and obligations of other banks

 

79 

 

 

66 

 

 

220 

 

 

192 

Total interest income

 

9,348 

 

 

8,720 

 

 

27,434 

 

 

25,823 



 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

559 

 

 

554 

 

 

1,650 

 

 

1,813 

Short-term borrowings

 

 

 

 

 

 

 

Total interest expense

 

563 

 

 

555 

 

 

1,656 

 

 

1,814 

Net interest income

 

8,785 

 

 

8,165 

 

 

25,778 

 

 

24,009 

Provision for loan losses

 

1,150 

 

 

400 

 

 

3,325 

 

 

1,035 

Net interest income after provision for loan losses

 

7,635 

 

 

7,765 

 

 

22,453 

 

 

22,974 



 

 

 

 

 

 

 

 

 

 

 

Noninterest income

 

 

 

 

 

 

 

 

 

 

 

Investment and trust services fees

 

1,211 

 

 

1,154 

 

 

3,683 

 

 

3,805 

Loan service charges

 

102 

 

 

288 

 

 

518 

 

 

784 

Deposit service charges and fees

 

635 

 

 

623 

 

 

1,815 

 

 

1,700 

Other service charges and fees

 

325 

 

 

309 

 

 

941 

 

 

916 

Debit card income

 

373 

 

 

346 

 

 

1,095 

 

 

1,021 

Increase in cash surrender value of life insurance

 

131 

 

 

137 

 

 

399 

 

 

416 

Net (loss) gain on sale of other real estate owned

 

(20)

 

 

 -

 

 

(31)

 

 

32 

OTTI losses on debt securities

 

(10)

 

 

 -

 

 

(30)

 

 

(20)

Gain on conversion of investment security

 

 -

 

 

 -

 

 

 -

 

 

728 

Securities gains, net

 

 -

 

 

 -

 

 

 

 

Other

 

56 

 

 

126 

 

 

219 

 

 

363 

Total noninterest income

 

2,803 

 

 

2,983 

 

 

8,613 

 

 

9,753 



 

 

 

 

 

 

 

 

 

 

 

Noninterest expense

 

 

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

4,566 

 

 

4,214 

 

 

13,282 

 

 

12,500 

Occupancy, net

 

556 

 

 

535 

 

 

1,708 

 

 

1,706 

Furniture and equipment

 

221 

 

 

232 

 

 

655 

 

 

702 

Advertising

 

296 

 

 

336 

 

 

839 

 

 

807 

Legal and professional

 

423 

 

 

311 

 

 

1,114 

 

 

811 

Data processing

 

539 

 

 

524 

 

 

1,540 

 

 

1,547 

Pennsylvania bank shares tax

 

203 

 

 

206 

 

 

699 

 

 

608 

Intangible amortization

 

 -

 

 

 -

 

 

 -

 

 

181 

FDIC insurance

 

188 

 

 

170 

 

 

514 

 

 

479 

ATM/debit card processing

 

214 

 

 

193 

 

 

642 

 

 

566 

Foreclosed real estate

 

18 

 

 

322 

 

 

93 

 

 

341 

Telecommunications

 

91 

 

 

145 

 

 

300 

 

 

379 

Other

 

665 

 

 

675 

 

 

2,119 

 

 

2,385 

Total noninterest expense

 

7,980 

 

 

7,863 

 

 

23,505 

 

 

23,012 

Income before federal income tax expense

 

2,458 

 

 

2,885 

 

 

7,561 

 

 

9,715 

Federal income tax expense

 

383 

 

 

306 

 

 

1,198 

 

 

1,778 

Net income

$

2,075 

 

$

2,579 

 

$

6,363 

 

$

7,937 



 

 

 

 

 

 

 

 

 

 

 

Per share

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

$

0.48 

 

$

0.61 

 

$

1.48 

 

$

1.87 

Diluted earnings per share

$

0.48 

 

$

0.61 

 

$

1.48 

 

$

1.87 

Cash dividends declared

$

0.21 

 

$

0.19 

 

$

0.61 

 

$

0.55 

The accompanying notes are an integral part of these unaudited financial statements.







2

 


 







Consolidated Statements of Comprehensive Income





 

 

 

 

 

 

 

 

 

 

 

 



 

For the Three Months Ended

 

For the Nine Months Ended



 

September 30

 

September 30

(Dollars in thousands) (unaudited)

 

2016

 

2015

 

2016

 

2015

Net Income

 

$

2,075 

 

$

2,579 

 

$

6,363 

 

$

7,937 



 

 

 

 

 

 

 

 

 

 

 

 

Securities:

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized (losses) gains arising during the period

 

 

(524)

 

 

1,097 

 

 

1,528 

 

 

561 

Reclassification adjustment for losses (gains) included in net income (1)

 

 

10 

 

 

 -

 

 

26 

 

 

(716)

Net unrealized (losses) gains

 

 

(514)

 

 

1,097 

 

 

1,554 

 

 

(155)

Tax effect

 

 

174 

 

 

(373)

 

 

(528)

 

 

53 

Net of tax amount

 

 

(340)

 

 

724 

 

 

1,026 

 

 

(102)



 

 

 

 

 

 

 

 

 

 

 

 

Derivatives:

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gains arising during the period

 

 

 -

 

 

 -

 

 

 -

 

 

31 

Reclassification adjustment for losses included in net income (2)

 

 

 -

 

 

 -

 

 

 -

 

 

160 

Net unrealized gains

 

 

 -

 

 

 -

 

 

 -

 

 

191 

Tax effect

 

 

 -

 

 

 -

 

 

 -

 

 

(65)

Net of tax amount

 

 

 -

 

 

 -

 

 

 -

 

 

126 



 

 

 

 

 

 

 

 

 

 

 

 

Pension:

 

 

 

 

 

 

 

 

 

 

 

 

Change in plan assets and benefit obligations

 

 

 -

 

 

 -

 

 

 -

 

 

 -

Reclassification adjustment for losses included in net income (3)

 

 

225 

 

 

 -

 

 

225 

 

 

 -

Net unrealized losses

 

 

225 

 

 

 -

 

 

225 

 

 

 -

Tax effect

 

 

(76)

 

 

 -

 

 

(76)

 

 

 -

Net of tax amount

 

 

149 

 

 

 -

 

 

149 

 

 

 -



 

 

 

 

 

 

 

 

 

 

 

 

Total other comprehensive (loss) income

 

 

(191)

 

 

724 

 

 

1,175 

 

 

24 

Total Comprehensive Income

 

$

1,884 

 

$

3,303 

 

$

7,538 

 

$

7,961 



 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

Reclassification adjustment / Statement line item

 

Tax  expense (benefit)

(1) Securities / gain on conversion & securities (gains) losses,

 

 

 

 

 

 

 

 

 

 

 

 

   including OTTI losses, net

 

$

(3)

 

$

 -

 

$

(9)

 

$

243 

(2) Derivatives / interest expense on deposits

 

 

 -

 

 

 -

 

 

 -

 

 

(54)

(3) Pension / Salary & Benefits

 

 

(77)

 

 

 -

 

 

(77)

 

 

 -



 

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these unaudited financial statements.

 

 

 

 

 

 

 

 

 















3

 


 







Consolidated Statements of Changes in Shareholders' Equity

For the Nine Months Ended September 30, 2016 and 2015:









 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 



 

 

 

Additional

 

 

 

 

Other

 

 

 

 

 

 



Common

 

Paid-in

 

Retained

 

Comprehensive

 

Treasury

 

 

 

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

Stock

 

Capital

 

Earnings

 

Loss

 

Stock

 

Total

Balance at December 31, 2014

$

4,607 

 

$

37,504 

 

$

71,452 

 

$

(3,100)

 

$

(6,942)

 

$

103,521 

Net income

 

 -

 

 

 -

 

 

7,937 

 

 

 -

 

 

 -

 

 

7,937 

Other comprehensive income

 

 -

 

 

 -

 

 

 -

 

 

24 

 

 

 -

 

 

24 

Cash dividends declared, $.55 per share

 

 -

 

 

 -

 

 

(2,330)

 

 

 -

 

 

 -

 

 

(2,330)

Treasury shares issued under stock option plans, 4,794 shares

 

 -

 

 

 

 

 -

 

 

 -

 

 

86 

 

 

92 

Common stock issued under dividend reinvestment plan, 36,608 shares

 

36 

 

 

833 

 

 

 -

 

 

 -

 

 

 -

 

 

869 

Balance at September 30, 2015

$

4,643 

 

$

38,343 

 

$

77,059 

 

$

(3,076)

 

$

(6,856)

 

$

110,113 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2015

$

4,659 

 

$

38,778 

 

$

78,517 

 

$

(3,722)

 

$

(6,856)

 

$

111,376 

Net income

 

 -

 

 

 -

 

 

6,363 

 

 

 -

 

 

 -

 

 

6,363 

Other comprehensive income

 

 -

 

 

 -

 

 

 -

 

 

1,175 

 

 

 -

 

 

1,175 

Cash dividends declared, $.61 per share

 

 -

 

 

 -

 

 

(2,618)

 

 

 -

 

 

 -

 

 

(2,618)

Acquisition of 30,196 shares of treasury stock

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

(700)

 

 

(700)

Treasury shares issued under employer stock purchase plan, 539 shares

 

 -

 

 

 

 

 -

 

 

 -

 

 

10 

 

 

12 

Treasury shares issued under dividend reinvestment plan, 24,171 shares

 

 -

 

 

134 

 

 

 -

 

 

 -

 

 

438 

 

 

572 

Common stock issued under dividend reinvestment plan, 25,230 shares

 

25 

 

 

527 

 

 

 -

 

 

 -

 

 

 -

 

 

552 

Common stock issued under incentive stock option plan, 3,600 shares

 

 

 

55 

 

 

 -

 

 

 -

 

 

 -

 

 

59 

Stock option compensation expense

 

 -

 

 

88 

 

 

 -

 

 

 -

 

 

 -

 

 

88 

Balance at September 30, 2016

$

4,688 

 

$

39,584 

 

$

82,262 

 

$

(2,547)

 

$

(7,108)

 

$

116,879 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these unaudited financial statements.



















4

 


 

Consolidated Statements of Cash Flows





 

 

 

 

 



 

 

 

 

 



Nine Months Ended September 30



2016

 

2015

(Dollars in thousands) (unaudited)

 

 

 

 

 

Cash flows from operating activities

 

 

 

 

 

Net income

$

6,363 

 

$

7,937 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

1,002 

 

 

999 

Net amortization of loans and investment securities

 

1,218 

 

 

1,248 

Amortization and net change in mortgage servicing rights valuation

 

41 

 

 

20 

Amortization of intangibles

 

 -

 

 

181 

Provision for loan losses

 

3,325 

 

 

1,035 

Gain on sales of securities

 

(4)

 

 

(8)

Impairment write-down on securities recognized in earnings

 

30 

 

 

20 

Gain on conversion of investment security

 

 -

 

 

(728)

Loans originated for sale

 

(6,598)

 

 

(6,193)

Proceeds from sale of loans

 

6,692 

 

 

6,206 

Write-down of other real estate owned

 

46 

 

 

250 

Write-down on premises and equipment

 

 -

 

 

60 

Net loss (gain) on sale or disposal of other real estate/other repossessed assets

 

31 

 

 

(32)

Increase in cash surrender value of life insurance

 

(399)

 

 

(416)

Gain from surrender of life insurance policy

 

 -

 

 

(103)

Stock option compensation

 

88 

 

 

 -

Decrease in other assets

 

154 

 

 

1,877 

Decrease in other liabilities

 

(2,247)

 

 

(2,497)

Net cash provided by operating activities

 

9,742 

 

 

9,856 



 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

Proceeds from sales and calls of investment securities available for sale

 

1,925 

 

 

1,381 

Proceeds from maturities and pay-downs of securities available for sale

 

18,984 

 

 

21,607 

Purchase of investment securities available for sale

 

(16,605)

 

 

(21,689)

Net increase in restricted stock

 

(336)

 

 

(417)

Net increase in loans

 

(79,275)

 

 

(47,110)

Capital expenditures

 

(515)

 

 

(765)

Proceeds from surrender of life insurance policy

 

436 

 

 

 -

Proceeds from sale of other real estate

 

625 

 

 

129 

Net cash used in investing activities

 

(74,761)

 

 

(46,864)



 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

Net increase in demand deposits, interest-bearing checking, and savings accounts

 

68,454 

 

 

45,360 

Net decrease in time deposits

 

(8,414)

 

 

(9,094)

Net decrease in repurchase agreements

 

 -

 

 

(9,079)

Net increase in short-term borrowings

 

8,530 

 

 

3,500 

Dividends paid

 

(2,618)

 

 

(2,330)

Common stock issued under stock option plans

 

71 

 

 

92 

Common stock issued under dividend reinvestment plan

 

1,124 

 

 

869 

Purchase of treasury stock

 

(700)

 

 

 -

Net cash provided by financing activities

 

66,447 

 

 

29,318 



 

 

 

 

 

Increase (decrease) in cash and cash equivalents

 

1,428 

 

 

(7,690)

Cash and cash equivalents as of January 1

 

39,166 

 

 

48,593 

Cash and cash equivalents as of September 30

$

40,594 

 

$

40,903 



 

 

 

 

 

Supplemental Disclosures of Cash Flow Information

 

 

 

 

 

Cash paid during the year for:

 

 

 

 

 

Interest on deposits and other borrowed funds

$

1,643 

 

$

1,826 

Income taxes

$

2,100 

 

$

2,514 



 

 

 

 

 

Noncash Activities

 

 

 

 

 

Loans transferred to Other Real Estate

$

123 

 

$

3,488 



 

 

 

 

 

The accompanying notes are an integral part of these unaudited financial statements.

 

 

 

 

 



5

 


 













FRANKLIN FINANCIAL SERVICES CORPORATION and SUBSIDIARIES

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 1 - Basis of Presentation

The consolidated financial statements include the accounts of Franklin Financial Services Corporation (the Corporation), and its wholly-owned subsidiaries, Farmers and Merchants Trust Company of Chambersburg (the Bank) and Franklin Future Fund Inc.  Farmers and Merchants Trust Company of Chambersburg is a commercial bank that has one wholly-owned subsidiary, Franklin Financial Properties Corp.  Franklin Financial Properties Corp. holds real estate assets that are leased by the Bank. Franklin Future Fund Inc. is a non-bank investment company. The activities of non-bank entities are not significant to the consolidated totals.  All significant intercompany transactions and account balances have been eliminated.

In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the consolidated financial position, results of operations, and cash flows as of September  30, 2016, and for all other periods presented have been made.

Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted.  It is suggested that these consolidated financial statements be read in conjunction with the audited consolidated financial statements and notes thereto included in the Corporation’s 2015 Annual Report on Form 10-K.  The consolidated results of operations for the three and nine month periods ended September 30, 2016 are not necessarily indicative of the operating results for the full year.  Management has evaluated subsequent events for potential recognition and/or disclosure through the date these consolidated financial statements were issued.

The consolidated balance sheet at December 31, 2015 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete consolidated financial statements.

For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, interest-bearing deposits in other banks and federal funds sold.  Generally, federal funds are purchased and sold for one-day periods. 

Earnings per share are computed based on the weighted average number of shares outstanding during each period end.  A reconciliation of the weighted average shares outstanding used to calculate basic earnings per share and diluted earnings per share follows:







 

 

 

 

 

 

 

 

 

 

 



For the Three Months Ended

 

For the Nine Months Ended



September 30

 

September 30

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

2016

 

2015

 

2016

 

2015

Weighted average shares outstanding (basic)

 

4,307 

 

 

4,252 

 

 

4,295 

 

 

4,236 

Impact of common stock equivalents

 

 

 

 

 

 

 

Weighted average shares outstanding (diluted)

 

4,314 

 

 

4,257 

 

 

4,298 

 

 

4,243 

Anti-dilutive options excluded from calculation

 

 

 

26 

 

 

37 

 

 

27 

Net income

$

2,075 

 

$

2,579 

 

$

6,363 

 

$

7,937 

Basic earnings per share

$

0.48 

 

$

0.61 

 

$

1.48 

 

$

1.87 

Diluted earnings per share

$

0.48 

 

$

0.61 

 

$

1.48 

 

$

1.87 









Note 2. Recent Accounting Pronouncements

Statements of Cash Flow (Topic 320).  In August 2016, the FASB issued ASU 2016-15, “Classification of Certain Cash Receipts and Cash Payments (Topic 320).”  ASU 2016-15 clarifies how certain cash receipts and cash payments are presented and classified in the statement of cash flows.  The amendments are intended to reduce diversity in practice.  The ASU contains additional guidance clarifying when an entity should separate cash receipts and cash payments and classify them into more than one class of cash flows (including when reasonable judgement is required to estimate and allocate cash flows) versus when an entity should classify the aggregate amount into one class of cash flows on the basis of predominance.  The amendments are effective fiscal years, and interim periods within those fiscal years, beginning after

6

 


 

December 15, 2017.  The Corporation is currently evaluating the impact of the pending adoption of the amended standard on its consolidated financial statements.



Financial Instruments – Credit Losses (Topic 326). In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.”  ASU 2016-13 requires credit losses on most financial assets measured at amortized cost and certain other instruments to be measured using an expected credit loss model (referred to as the current expected credit loss (CECL) model).  Under this model, entities will estimate credit losses over the entire contractual term of the instrument (considering estimated prepayments, but not expected extensions or modifications unless reasonable expectation of a troubled debt restructuring exists) from the date of initial recognition of that instrument.  The ASU replaces the current accounting model for purchased credit impaired loans and debt securities.  The allowance for credit losses for purchased financial assets with a more-than insignificant amount of credit deterioration since origination (“PCD assets”), should be determined in a similar manner to other financial assets measured on an amortized cost basis.  However, upon initial recognition, the allowance for credit losses is added to the purchase price (“gross up approach”) to determine the initial amortized cost basis.  The subsequent account for PCD financial assets is the same expected loss model described above.  The ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years.  Early adoption is permitted as of the fiscal year beginning after December 15, 2018, including interim periods within those fiscal years.  The Corporation is currently evaluating the impact of the pending adoption of the new standard on its consolidated financial statements.



Revenue from Contracts with Customers (Topic 606). The amendments in this Update (ASU 2014-09) establish a comprehensive revenue recognition standard for virtually all industries under U.S. GAAP, including those that previously followed industry-specific guidance such as the real estate, construction and software industries. The revenue standard’s core principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. To accomplish this objective, the standard requires five basic steps: (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The ASU is effective for public entities for annual periods beginning after December 15, 2016, including interim periods therein. Three basic transition methods are available – full retrospective, retrospective with certain practical expedients, and a cumulative effect approach. Under the third alternative, an entity would apply the new revenue standard only to contracts that are incomplete under legacy U.S. GAAP at the date of initial application (e.g. January 1, 2017) and recognize the cumulative effect of the new standard as an adjustment to the opening balance of retained earnings. That is, prior years would not be restated and additional disclosures would be required to enable users of the financial statements to understand the impact of adopting the new standard in the current year compared to prior years that are presented under legacy U.S. GAAP. Early adoption is prohibited under U.S. GAAP. The Corporation does not believe ASU 2014-09 will have a material effect on its financial statements. 



Financial Instruments – Overall (Topic 825-10). In January 2016, the FASB issued ASU 2016-01, “Financial Instruments – Overall (Topic 825-10): “Recognition and Measurement of Financial Assets and Financial Liabilities.” ASU 2016-01 amends the guidance on the classification and measurement of financial instruments.  Some of the amendments in ASU 2016-01 include the following: 1) requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; 2) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; 3) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; and 4) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value; among others.  For public business entities, the amendments of ASU 2016-01 are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.  The Corporation does not believe ASU 2016-01 will have a material effect on its financial statements.

Leases (Topic 842). In February 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-02, Leases.  From the lessee’s perspective, the new standard established a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months.  Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income

7

 


 

statement for a lessees.  From the lessor’s perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating.  A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee.  If risks and rewards are conveyed without the transfer of control, the lease is treated as financing.  If the lessor doesn’t convey risks and rewards or control, an operating lease results.

The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.  A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available.  A modified retrospective transition approach is required for lessors for sales-type, direct financing, and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available.  The Corporation is currently evaluating the impact of the pending adoption of the new standard on its consolidated financial statements.   





Note 3. Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive losses included in shareholders' equity are as follows:







 

 

 

 

 



 

 

 

 

 



September 30

 

December 31,



2016

 

2015

(Dollars in thousands)

 

 

 

 

 

Net unrealized gains on securities

$

2,692 

 

$

1,138 

Tax effect

 

(915)

 

 

(387)

Net of tax amount

 

1,777 

 

 

751 



 

 

 

 

 

Accumulated pension adjustment

 

(6,552)

 

 

(6,777)

Tax effect

 

2,228 

 

 

2,304 

Net of tax amount

 

(4,324)

 

 

(4,473)



 

 

 

 

 

Total accumulated other comprehensive loss

$

(2,547)

 

$

(3,722)











8

 


 

Note 4. Investments

The amortized cost and estimated fair value of investment securities available for sale as of September  30, 2016 and December 31, 2015 are as follows:







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

September 30, 2016

 

cost

 

gains

 

losses

 

value

Equity securities

 

$

164 

 

$

86 

 

$

 -

 

$

250 

U.S. Government and Agency securities

 

 

12,728 

 

 

292 

 

 

(21)

 

 

12,999 

Municipal securities

 

 

66,248 

 

 

1,924 

 

 

(92)

 

 

68,080 

Trust preferred securities

 

 

5,973 

 

 

 -

 

 

(555)

 

 

5,418 

Agency mortgage-backed securities

 

 

66,369 

 

 

1,089 

 

 

(79)

 

 

67,379 

Private-label mortgage-backed securities

 

 

1,137 

 

 

57 

 

 

(7)

 

 

1,187 

Asset-backed securities

 

 

34 

 

 

 -

 

 

(2)

 

 

32 



 

$

152,653 

 

$

3,448 

 

$

(756)

 

$

155,345 









 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

December 31, 2015

 

cost

 

gains

 

losses

 

value

Equity securities

 

$

164 

 

$

69 

 

$

 -

 

$

233 

U.S. Government and Agency securities

 

 

13,705 

 

 

164 

 

 

(33)

 

 

13,836 

Municipal securities

 

 

67,851 

 

 

1,555 

 

 

(218)

 

 

69,188 

Trust preferred securities

 

 

5,958 

 

 

 -

 

 

(669)

 

 

5,289 

Agency mortgage-backed securities

 

 

69,284 

 

 

621 

 

 

(386)

 

 

69,519 

Private-label mortgage-backed securities

 

 

1,335 

 

 

39 

 

 

(2)

 

 

1,372 

Asset-backed securities

 

 

38 

 

 

 -

 

 

(2)

 

 

36 



 

$

158,335 

 

$

2,448 

 

$

(1,310)

 

$

159,473 



At September 30, 2016 and December 31, 2015, the fair value of investment securities pledged to secure public funds, trust balances, deposit and other obligations totaled $86.0 million and $79.6 million, respectively.

The amortized cost and estimated fair value of debt securities at September  30, 2016, by contractual maturity are shown below. Actual maturities may differ from contractual maturities because of prepayment or call options embedded in the securities.



 

 

 

 

 



 

 

 

 

 



 

 

 

 



 

 

 

(Dollars in thousands)

Amortized cost

 

Fair value

Due in one year or less

$

2,073 

 

$

2,094 

Due after one year through five years

 

11,896 

 

 

12,218 

Due after five years through ten years

 

28,278 

 

 

29,158 

Due after ten years

 

42,736 

 

 

43,059 



 

84,983 

 

 

86,529 

Mortgage-backed securities

 

67,506 

 

 

68,566 



$

152,489 

 

$

155,095 



9

 


 

The composition of the net realized securities gains for the three and nine months ended are as follows:





 

 

 

 

 

 

 

 

 

 

 



For the Three Months Ended

 

For the Nine Months Ended



September 30

 

September 30

(Dollars in thousands)

2016

 

2015

 

2016

 

2015

Gross gains realized

$

 -

 

$

 -

 

$

 

$

Gross losses realized

 

 -

 

 

 -

 

 

 -

 

 

 -

Conversion gain

 

 -

 

 

 -

 

 

 -

 

 

728 

Net gains realized

$

 -

 

$

 -

 

$

 

$

736 



 

 

 

 

 

 

 

 

 

 

 



The following table provides additional detail about trust preferred securities as of September 30, 2016:

Trust Preferred Securities





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deal Name

 

Maturity

 

Single Issuer or Pooled

 

Class

 

Amortized Cost

 

Fair Value

 

Gross Unrealized Gain (Loss)

 

Lowest Credit Rating Assigned



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BankAmerica Cap III

 

1/15/2027

 

Single

 

Preferred Stock

 

$

966 

 

$

868 

 

$

(98)

 

BB+

Wachovia Cap Trust II

 

1/15/2027

 

Single

 

Preferred Stock

 

 

279 

 

 

263 

 

 

(16)

 

BBB

Huntington Cap Trust

 

2/1/2027

 

Single

 

Preferred Stock

 

 

945 

 

 

842 

 

 

(103)

 

BB

Corestates Captl Tr II

 

2/15/2027

 

Single

 

Preferred Stock

 

 

942 

 

 

883 

 

 

(59)

 

BBB+

Huntington Cap Trust II

 

6/15/2028

 

Single

 

Preferred Stock

 

 

899 

 

 

815 

 

 

(84)

 

BB

Chase Cap VI JPM

 

8/1/2028

 

Single

 

Preferred Stock

 

 

965 

 

 

877 

 

 

(88)

 

BBB-

Fleet Cap Tr V

 

12/18/2028

 

Single

 

Preferred Stock

 

 

977 

 

 

870 

 

 

(107)

 

BB+



 

 

 

 

 

 

 

$

5,973 

 

$

5,418 

 

$

(555)

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



The following table provides additional detail about private label mortgage-backed securities as of September  30, 2016:

Private Label Mortgage Backed Securities





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

Gross 

 

 

 

 

 

 

 

Cumulative



 

Origination

 

Amortized

 

Fair

 

Unrealized

 

Collateral

 

Lowest Credit

 

Credit

 

OTTI

Description

 

Date

 

Cost

 

Value

 

Gain (Loss)

 

Type

 

Rating Assigned

 

Support %

 

Charges

MALT 2004-6 7A1

 

6/1/2004

 

$

317 

 

$

310 

 

$

(7)

 

ALT A

 

CCC

 

15.01 

 

$

 -

RALI 2005-QS2 A1

 

2/1/2005

 

 

168 

 

 

181 

 

 

13 

 

ALT A

 

CC

 

4.56 

 

 

10 

RALI 2006-QS4 A2

 

4/1/2006

 

 

400 

 

 

417 

 

 

17 

 

ALT A

 

D

 

 -

 

 

323 

GSR 2006-5F 2A1

 

5/1/2006

 

 

45 

 

 

53 

 

 

 

Prime

 

D

 

 -

 

 

15 

RALI 2006-QS8 A1

 

7/28/2006

 

 

207 

 

 

226 

 

 

19 

 

ALT A

 

D

 

 -

 

 

237 



 

 

 

$

1,137 

 

$

1,187 

 

$

50 

 

 

 

 

 

 

 

$

585 



Impairment:

The investment portfolio contained fifty securities with $29.0 million of temporarily impaired fair value and $756 thousand in unrealized losses at September 30, 2016. The total unrealized loss position has improved from a $1.3 million unrealized loss at year-end 2015. 

For securities with an unrealized loss, Management applies a systematic methodology in order to perform an assessment of the potential for other-than-temporary impairment.  In the case of debt securities, investments considered for other-than-temporary impairment: (1) had a specified maturity or repricing date; (2) were generally expected to be redeemed at par, and (3) were expected to achieve a recovery in market value within a reasonable period of time. In addition, the Bank considers whether it intends to sell these securities or whether it will be forced to sell these securities before the earlier of amortized cost recovery or maturity. Equity securities are assessed for other-than-temporary

10

 


 

impairment based on the length of time of impairment, dollar amount of the impairment and general market and financial conditions relating to specific issues.  The impairment identified on debt and equity securities and subject to assessment at September 30, 2016, was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted.

The following table reflects temporary impairment in the investment portfolio (excluding restricted stock), aggregated by investment category, length of time that individual securities have been in a continuous unrealized loss position and the number of securities in each category as of September 30, 2016  and December 31, 2015:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



September 30, 2016

 

 



Less than 12 months

 

12 months or more

 

Total



Fair

 

Unrealized

 

 

 

Fair

 

Unrealized

 

 

 

Fair

 

Unrealized

 

 

(Dollars in thousands)

Value

 

Losses

 

Count

 

Value

 

Losses

 

Count

 

Value

 

Losses

 

Count



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government and Agency securities

$

-

 

$

-

 

-

 

$

3,486 

 

$

(21)

 

10 

 

$

3,486 

 

$

(21)

 

10 

Municipal securities

 

2,657 

 

 

(7)

 

 

 

2,275 

 

 

(85)

 

 

 

4,932 

 

 

(92)

 

Trust preferred securities

 

 -

 

 

 -

 

 -

 

 

5,418 

 

 

(555)

 

 

 

5,418 

 

 

(555)

 

Agency mortgage-backed securities

 

8,900 

 

 

(35)

 

12 

 

 

5,998 

 

 

(44)

 

11 

 

 

14,898 

 

 

(79)

 

23 

Private-label mortgage-backed securities

 

310 

 

 

(7)

 

 

 

 -

 

 

 -

 

 -

 

 

310 

 

 

(7)

 

Asset-backed securities

 

 -

 

 

 -

 

 -

 

 

 

 

(2)

 

 

 

 

 

(2)

 

Total temporarily impaired securities

$

11,867 

 

$

(49)

 

18 

 

$

17,181 

 

$

(707)

 

32 

 

$

29,048 

 

$

(756)

 

50 









 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



December 31, 2015



Less than 12 months

 

12 months or more

 

Total



Fair

 

Unrealized

 

 

 

Fair

 

Unrealized

 

 

 

Fair

 

Unrealized

 

 

(Dollars in thousands)

Value

 

Losses

 

Count

 

Value

 

Losses

 

Count

 

Value

 

Losses

 

Count



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government and Agency securities

$

479 

 

$

(1)

 

 

$

4,364 

 

$

(32)

 

10 

 

$

4,843 

 

$

(33)

 

13 

Municipal securities

 

5,806 

 

 

(35)

 

 

 

4,785 

 

 

(183)

 

 

 

10,591 

 

 

(218)

 

15 

Trust preferred securities

 

 -

 

 

 -

 

 -

 

 

5,289 

 

 

(669)

 

 

 

5,289 

 

 

(669)

 

Agency mortgage-backed securities

 

18,977 

 

 

(215)

 

29 

 

 

7,394 

 

 

(171)

 

13 

 

 

26,371 

 

 

(386)

 

42 

Private-label mortgage-backed securities

 

 -

 

 

 -

 

 -

 

 

246 

 

 

(2)

 

 

 

246 

 

 

(2)

 

Asset-backed securities

 

 -

 

 

 -

 

 -

 

 

 

 

(2)

 

 

 

 

 

(2)

 

Total temporarily impaired securities

$

25,262 

 

$

(251)

 

40 

 

$

22,083 

 

$

(1,059)

 

39 

 

$

47,345 

 

$

(1,310)

 

79 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



The unrealized loss in the municipal bond portfolio decreased to $92 thousand from $218 thousand at December 31, 2015 as market prices improved during the quarter.  There are three securities in this portfolio with an unrealized loss and the loss in this portfolio is deemed to be non-credit related and no other-than-temporary impairment charges have been recorded.

The trust preferred portfolio contains seven securities with a fair value of $5.4 million and an unrealized loss of $555 thousand The trust-preferred securities held by the Bank are single entity issues, not pooled trust preferred securities.  Therefore, the impairment review of these securities is based only on the issuer and the security cannot be impaired by the performance of other issuers as if it was a pooled trust-preferred bond. All of the Bank’s trust preferred securities are single issue, variable rate notes with long maturities (2027 – 2028).  None of these bonds have suspended or missed a dividend payment. At September 30, 2016, the Bank believes it will be able to collect all interest and principal due on these bonds and no other-than-temporary-impairment charges were recorded. 

There is one PLMBS bond showing a small unrealized loss of $7 thousand.  However, the PLMBS sector as a whole is showing a net unrealized gain of $50 thousand at quarter end.  This is primarily a result of the cumulative OTTI charges recorded on this portfolio.  Due to the nature of these bonds, they are evaluated closely. These bonds were all rated AAA at time of purchase, but have since experienced rating declines. Some have experienced increased delinquencies and defaults, while others have seen the credit support increase as the bonds paid-down. The Bank monitors the performance of the PLMBS investments on a regular basis and reviews delinquencies, default rates, credit support levels and various cash flow stress test scenarios. In determining the credit related loss, Management considers all principal past due 60 days or more as a loss. If additional principal moves beyond 60 days past due, it will also be considered a loss.  The Bank recorded a $30 thousand impairment charge during the first nine months of 2016 and has recorded $585 thousand of

11

 


 

cumulative impairment charges on this portfolio. Management continues to monitor these securities and it is possible that additional write-downs may occur if current loss trends continue.

The following table represents the cumulative credit losses on debt securities recognized in earnings as of September  30:







 

 

 

 

 



 

 

 

 

(Dollars in thousands)

Nine Months Ended



2016

 

2015

Balance of cumulative credit-related OTTI at January 1

$

555 

 

$

535 

Additions for credit-related OTTI not previously recognized

 

30 

 

 

20 

Additional increases for credit-related OTTI previously recognized when there is no intent to sell

 

 

 

 

 

   and no requirement to sell before recovery of amortized cost basis

 

 -

 

 

 -

Decreases for previously recognized credit-related OTTI because there was an intent to sell

 

 -

 

 

 -

Reduction for increases in cash flows expected to be collected

 

 -

 

 

 -

Balance of credit-related OTTI at September 30

$

585 

 

$

555 



 

 

 

 

 



The Bank held $1.1 million of restricted stock at September 30, 2016.  Except for $30 thousand, this investment represents stock in FHLB Pittsburgh. The Bank is required to hold this stock to be a member of FHLB and it is carried at cost of $100 per share. The level of FHLB stock held is determined by FHLB and is comprised of a minimum membership amount plus a variable activity amount. FHLB stock is evaluated for impairment primarily based on an assessment of the ultimate recoverability of its cost. As a government sponsored entity, FHLB has the ability to raise funding through the U.S. Treasury that can be used to support its operations.  There is not a public market for FHLB stock and the benefits of FHLB membership (e.g., liquidity and low cost funding) add value to the stock beyond purely financial measures. Management intends to remain a member of the FHLB and believes that it will be able to fully recover the cost basis of this investment.    





Note 5. Loans

The Bank reports its loan portfolio based on the primary collateral of the loan. It further classifies these loans by the primary purpose, either consumer or commercial. The Bank’s residential real estate loans include long-term loans to individuals and businesses secured by mortgages on the borrower’s real property and include home equity loans.  Construction loans are made to finance the purchase of land and the construction of residential and commercial buildings thereon, and are secured by mortgages on real estate.  Commercial real estate loans include construction, owner and non-owner occupied properties and farm real estate.  Commercial loans are made to businesses of various sizes for a variety of purposes including property, plant and equipment, working capital and loans to government municipalities.  Commercial lending is concentrated in the Bank’s primary market, but also includes purchased loan participations. Consumer loans are comprised of installment loans and unsecured personal lines of credit. 



12

 


 

A summary of loans outstanding, by class, at the end of the reporting periods is as follows:



 

 

 

 

 



 

 

 

 

 

(Dollars in thousands)

September 30, 2016

 

December 31, 2015

Residential Real Estate 1-4 Family

 

 

 

 

 

Consumer first liens

$

99,571 

 

$

103,698 

Commercial first lien

 

63,515 

 

 

57,780 

Total first liens

 

163,086 

 

 

161,478 



 

 

 

 

 

Consumer junior liens and lines of credit

 

46,688 

 

 

44,996 

Commercial junior liens and lines of credit

 

5,837 

 

 

5,917 

Total junior liens and lines of credit

 

52,525 

 

 

50,913 

Total residential real estate 1-4 family

 

215,611 

 

 

212,391 



 

 

 

 

 

Residential real estate - construction

 

 

 

 

 

Consumer

 

1,589 

 

 

545 

Commercial

 

7,067 

 

 

7,343 

Total residential real estate construction

 

8,656 

 

 

7,888 



 

 

 

 

 

Commercial real estate

 

375,316 

 

 

340,695 

Commercial

 

254,274 

 

 

215,942 

        Total commercial

 

629,590 

 

 

556,637 



 

 

 

 

 

Consumer

 

4,719 

 

 

5,100 



 

858,576 

 

 

782,016 

Less: Allowance for loan losses

 

(10,685)

 

 

(10,086)

Net Loans

$

847,891 

 

$

771,930 



 

 

 

 

 

Included in the loan balances are the following:

 

 

 

 

 

Net unamortized deferred loan costs

$

149 

 

$

436 



 

 

 

 

 

Loans pledged as collateral for borrowings and commitments from:

 

 

 

 

 

FHLB

$

692,043 

 

$

643,449 

Federal Reserve Bank

 

41,806 

 

 

45,111 



$

733,849 

 

$

688,560 









13

 


 

Note 6. Loan Quality

The following table presents, by class, the activity in the Allowance for Loan Losses (ALL) for the periods ended:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

Junior Liens &

 

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

First Liens

 

Lines of Credit

 

Construction

 

Real Estate

 

Commercial

 

Consumer

 

Unallocated

 

Total



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at June 30, 2016

 

$

1,023 

 

$

319 

 

$

205 

 

$

5,940 

 

$

1,596 

 

$

97 

 

$

1,138 

 

$

10,318 

Charge-offs

 

 

 -

 

 

 -

 

 

 -

 

 

(776)

 

 

 -

 

 

(42)

 

 

 -

 

 

(818)

Recoveries

 

 

 

 

 -

 

 

 -

 

 

 

 

 

 

22 

 

 

 -

 

 

35 

Provision

 

 

(3)

 

 

 

 

 

 

876 

 

 

132 

 

 

21 

 

 

115 

 

 

1,150 

ALL at September 30, 2016

 

$

1,021 

 

$

320 

 

$

213 

 

$

6,045 

 

$

1,735 

 

$

98 

 

$

1,253 

 

$

10,685 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at December 31, 2015

 

$

989 

 

$

308 

 

$

194 

 

$

5,649 

 

$

1,519 

 

$

102 

 

$

1,325 

 

$

10,086 

Charge-offs

 

 

(49)

 

 

 -

 

 

 -

 

 

(2,730)

 

 

(66)

 

 

(126)

 

 

 -

 

 

(2,971)

Recoveries

 

 

34 

 

 

 -

 

 

 -

 

 

18 

 

 

129 

 

 

64 

 

 

 -

 

 

245 

Provision

 

 

47 

 

 

12 

 

 

19 

 

 

3,108 

 

 

153 

 

 

58 

 

 

(72)

 

 

3,325 

ALL at September 30, 2016

 

$

1,021 

 

$

320 

 

$

213 

 

$

6,045 

 

$

1,735 

 

$

98 

 

$

1,253 

 

$

10,685 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at June 30, 2015

 

$

1,014 

 

$

281 

 

$

207 

 

$

5,179 

 

$

1,442 

 

$

110 

 

$

1,217 

 

$

9,450 

Charge-offs

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

(47)

 

 

(75)

 

 

 -

 

 

(122)

Recoveries

 

 

 

 

 -

 

 

18 

 

 

 -

 

 

102 

 

 

24 

 

 

 -

 

 

145 

Provision

 

 

(16)

 

 

18 

 

 

(27)

 

 

389 

 

 

32 

 

 

45 

 

 

(41)

 

 

400 

ALL at September 30, 2015

 

$

999 

 

$

299 

 

$

198 

 

$

5,568 

 

$

1,529 

 

$

104 

 

$

1,176 

 

$

9,873 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at December 31, 2014

 

$

994 

 

$

271 

 

$

214 

 

$

4,978 

 

$

1,515 

 

$

127 

 

$

1,012 

 

$

9,111 

Charge-offs

 

 

(43)

 

 

(21)

 

 

 -

 

 

 -

 

 

(263)

 

 

(155)

 

 

 -

 

 

(482)

Recoveries

 

 

 

 

 -

 

 

18 

 

 

14 

 

 

116 

 

 

57 

 

 

 -

 

 

209 

Provision

 

 

44 

 

 

49 

 

 

(34)

 

 

576 

 

 

161 

 

 

75 

 

 

164 

 

 

1,035 

ALL at September 30, 2015

 

$

999 

 

$

299 

 

$

198 

 

$

5,568 

 

$

1,529 

 

$

104 

 

$

1,176 

 

$

9,873 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

14

 


 

The following table presents, by class, loans that were evaluated for the ALL under the specific reserve (individually) and those that were evaluated under the general reserve (collectively) and the amount of the ALL established in each class as of September 30, 2016 and December 31, 2015:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

Junior Liens &

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

First Liens

 

Lines of Credit

 

Construction

 

Real Estate

 

Commercial

 

Consumer

 

Unallocated

 

Total



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for ALL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

632 

 

$

52 

 

$

545 

 

$

13,815 

 

$

 -

 

$

 -

 

$

 -

 

$

15,044 

Collectively

 

 

162,454 

 

 

52,473 

 

 

8,111 

 

 

361,501 

 

 

254,274 

 

 

4,719 

 

 

 -

 

 

843,532 

Total

 

$

163,086 

 

$

52,525 

 

$

8,656 

 

$

375,316 

 

$

254,274 

 

$

4,719 

 

$

 -

 

$

858,576 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL established for loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

Collectively

 

 

1,021 

 

 

320 

 

 

213 

 

 

6,045 

 

 

1,735 

 

 

98 

 

 

1,253 

 

 

10,685 

ALL at September 30, 2016

 

$

1,021 

 

$

320 

 

$

213 

 

$

6,045 

 

$

1,735 

 

$

98 

 

$

1,253 

 

$

10,685 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for ALL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

930 

 

$

51 

 

$

502 

 

$

14,309 

 

$

230 

 

$

 -

 

$

 -

 

$

16,022 

Collectively

 

 

160,548 

 

 

50,862 

 

 

7,386 

 

 

326,386 

 

 

215,712 

 

 

5,100 

 

 

 -

 

 

765,994 

Total

 

$

161,478 

 

$

50,913 

 

$

7,888 

 

$

340,695 

 

$

215,942 

 

$

5,100 

 

$

 -

 

$

782,016 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL established for loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 

$

 -

 

$

 -

 

$

Collectively

 

 

989 

 

 

308 

 

 

194 

 

 

5,649 

 

 

1,510 

 

 

102 

 

 

1,325 

 

 

10,077 

ALL at December 31, 2015

 

$

989 

 

$

308 

 

$

194 

 

$

5,649 

 

$

1,519 

 

$

102 

 

$

1,325 

 

$

10,086 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

15

 


 

The following table shows additional information about those loans considered to be impaired at September  30, 2016 and December 31, 2015:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Impaired Loans



 

With No Allowance

 

With Allowance

(Dollars in thousands)

 

 

 

 

Unpaid

 

 

 

 

 

Unpaid

 

 

 



 

Recorded

 

Principal

 

Recorded

 

Principal

 

Related

September 30, 2016

 

Investment

 

Balance

 

Investment

 

Balance

 

Allowance

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

1,189 

 

$

1,263 

 

$

 -

 

$

 -

 

$

 -

Junior liens and lines of credit

 

 

96 

 

 

107 

 

 

 -

 

 

 -

 

 

 -

Total

 

 

1,285 

 

 

1,370 

 

 

 -

 

 

 -

 

 

 -

 Residential real estate - construction

 

 

545 

 

 

597 

 

 

 -

 

 

 -

 

 

 -

 Commercial real estate

 

 

13,815 

 

 

14,372 

 

 

 -

 

 

 -

 

 

 -

 Commercial

 

 

24 

 

 

35 

 

 

 -

 

 

 -

 

 

 -

Total

 

$

15,669 

 

$

16,374 

 

$

 -

 

$

 -

 

$

 -







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

1,523 

 

$

1,725 

 

$

 -

 

$

 -

 

$

 -

Junior liens and lines of credit

 

 

105 

 

 

133 

 

 

 -

 

 

 -

 

 

 -

Total

 

 

1,628 

 

 

1,858 

 

 

 -

 

 

 -

 

 

 -

 Residential real estate - construction

 

 

502 

 

 

546 

 

 

 -

 

 

 -

 

 

 -

 Commercial real estate

 

 

14,431 

 

 

15,007 

 

 

 

 

 

 -

 

 

 -

 Commercial

 

 

267 

 

 

330 

 

 

 

 

10 

 

 

Total

 

$

16,828 

 

$

17,741 

 

$

 

$

10 

 

$



16

 


 

The following table shows the average of impaired loans and related interest income for the three and nine months ended September  30, 2016 and 2015:





 

 

 

 

 

 

 

 

 

 

 



Three Months Ended

 

Nine Months Ended



September 30, 2016

 

September 30, 2016



Average

 

Interest

 

Average

 

Interest

(Dollars in thousands)

Recorded

 

Income

 

Recorded

 

Income



Investment

 

Recognized

 

Investment

 

Recognized

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

First liens

$

1,196 

 

$

10 

 

$

1,262 

 

$

30 

Junior liens and lines of credit

 

96 

 

 

 -

 

 

90 

 

 

 -

Total

 

1,292 

 

 

10 

 

 

1,352 

 

 

30 

 Residential real estate - construction

 

548 

 

 

 -

 

 

554 

 

 

 -

 Commercial real estate

 

13,889 

 

 

118 

 

 

17,871 

 

 

478 

 Commercial

 

25 

 

 

 -

 

 

34 

 

 

 -

Total

$

15,754 

 

$

128 

 

$

19,811 

 

$

508 



 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



Three Months Ended

 

Nine Months Ended



September 30, 2015

 

September 30, 2015



Average

 

Interest

 

Average

 

Interest

(Dollars in thousands)

Recorded

 

Income

 

Recorded

 

Income



Investment

 

Recognized

 

Investment

 

Recognized

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

First liens

$

1,600 

 

$

 

$

2,474 

 

$

26 

Junior liens and lines of credit

 

181 

 

 

 

 

157 

 

 

Total

 

1,781 

 

 

11 

 

 

2,631 

 

 

30 

 Residential real estate - construction

 

510 

 

 

 -

 

 

651 

 

 

 -

 Commercial real estate

 

14,836 

 

 

126 

 

 

21,774 

 

 

452 

 Commercial

 

380 

 

 

 -

 

 

1,181 

 

 

 -

Total

$

17,507 

 

$

137 

 

$

26,237 

 

$

482 



 

 

 

 

 

 

 

 

 

 

 

17

 


 



The following table presents the aging of payments of the loan portfolio:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Loans Past Due and Still Accruing

 

 

 

 

Total



 

Current

 

30-59 Days

 

60-89 Days

 

90 Days+

 

Total

 

Non-Accrual

 

Loans

September 30, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

162,334 

 

$

239 

 

$

53 

 

$

38 

 

$

330 

 

$

422 

 

$

163,086 

Junior liens and lines of credit

 

 

52,304 

 

 

62 

 

 

 

 

61 

 

 

125 

 

 

96 

 

 

52,525 

Total

 

 

214,638 

 

 

301 

 

 

55 

 

 

99 

 

 

455 

 

 

518 

 

 

215,611 

Residential real estate - construction

 

 

8,111 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

545 

 

 

8,656 

Commercial real estate

 

 

369,833 

 

 

200 

 

 

559 

 

 

568 

 

 

1,327 

 

 

4,156 

 

 

375,316 

Commercial

 

 

253,919 

 

 

300 

 

 

 

 

26 

 

 

331 

 

 

24 

 

 

254,274 

Consumer

 

 

4,699 

 

 

10 

 

 

10 

 

 

 -

 

 

20 

 

 

 -

 

 

4,719 

Total

 

$

851,200 

 

$

811 

 

$

629 

 

$

693 

 

$

2,133 

 

$

5,243 

 

$

858,576 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

159,998 

 

$

44 

 

$

416 

 

$

214 

 

$

674 

 

$

806 

 

$

161,478 

Junior liens and lines of credit

 

 

50,541 

 

 

217 

 

 

50 

 

 

 -

 

 

267 

 

 

105 

 

 

50,913 

Total

 

 

210,539 

 

 

261 

 

 

466 

 

 

214 

 

 

941 

 

 

911 

 

 

212,391 

Residential real estate - construction

 

 

7,209 

 

 

177 

 

 

 -

 

 

 -

 

 

177 

 

 

502 

 

 

7,888 

Commercial real estate

 

 

330,953 

 

 

5,713 

 

 

196 

 

 

152 

 

 

6,061 

 

 

3,681 

 

 

340,695 

Commercial

 

 

215,449 

 

 

210 

 

 

 

 

 

 

217 

 

 

276 

 

 

215,942 

Consumer

 

 

5,041 

 

 

55 

 

 

 

 

 -

 

 

59 

 

 

 -

 

 

5,100 

Total

 

$

769,191 

 

$

6,416 

 

$

671 

 

$

368 

 

$

7,455 

 

$

5,370 

 

$

782,016 

18

 


 

The following table reports the internal credit rating for the loan portfolio.  Consumer purpose loans (mortgage, home equity and installment) are assigned a rating of either pass or substandard.  Substandard consumer loans are comprised of loans 90 days or more past due and still accruing, and nonaccrual loans.  Commercial purpose loans may be assigned any rating in accordance with the Bank’s internal risk rating system.



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



Pass

 

Special Mention

 

Substandard

 

Doubtful

 

 

 

(Dollars in thousands)

(1-5)

 

(6)

 

(7)

 

(8)

 

Total



 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

$

159,758 

 

$

1,942 

 

$

1,386 

 

$

 -

 

$

163,086 

Junior liens and lines of credit

 

52,308 

 

 

28 

 

 

189 

 

 

 -

 

 

52,525 

Total

 

212,066 

 

 

1,970 

 

 

1,575 

 

 

 -

 

 

215,611 

Residential real estate - construction

 

7,833 

 

 

 -

 

 

823 

 

 

 -

 

 

8,656 

Commercial real estate

 

360,788 

 

 

359 

 

 

14,169 

 

 

 -

 

 

375,316 

Commercial

 

250,118 

 

 

2,058 

 

 

2,098 

 

 

 -

 

 

254,274 

Consumer

 

4,719 

 

 

 -

 

 

 -

 

 

 -

 

 

4,719 

Total

$

835,524 

 

$

4,387 

 

$

18,665 

 

$

 -

 

$

858,576 









 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

$

157,514 

 

$

2,122 

 

$

1,842 

 

$

 -

 

$

161,478 

Junior liens and lines of credit

 

50,685 

 

 

28 

 

 

200 

 

 

 -

 

 

50,913 

Total

 

208,199 

 

 

2,150 

 

 

2,042 

 

 

 -

 

 

212,391 

Residential real estate - construction

 

7,386 

 

 

 -

 

 

502 

 

 

 -

 

 

7,888 

Commercial real estate

 

319,985 

 

 

6,175 

 

 

14,535 

 

 

 -

 

 

340,695 

Commercial

 

213,492 

 

 

1,978 

 

 

472 

 

 

 -

 

 

215,942 

Consumer

 

5,100 

 

 

 -

 

 

 -

 

 

 -

 

 

5,100 

Total

$

754,162 

 

$

10,303 

 

$

17,551 

 

$

 -

 

$

782,016 

19

 


 

The following table presents information on the Bank’s Troubled Debt Restructuring (TDR) loans:



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

Troubled Debt Restructurings



 

 

 

 

 

 

 

 

 

 

 

 

That Have Defaulted on



 

 

 

 

 

 

 

 

 

Modified Terms in the

(Dollars in thousands)

 

Troubled Debt Restructurings

 

Last Twelve Months



 

Number of

 

Recorded

 

 

 

 

 

 

 

Number of

 

Recorded



 

Contracts

 

Investment

 

Performing*

 

Nonperforming*

 

Contracts

 

Investment

September 30, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

$

486 

 

$

486 

 

$

 -

 

 -

 

$

 -

Residential real estate

 

 

 

879 

 

 

728 

 

 

151 

 

 -

 

 

 -

Commercial real estate

 

11 

 

 

12,211 

 

 

10,930 

 

 

1,281 

 

 

 

1,281 

  Total

 

17 

 

$

13,576 

 

$

12,144 

 

$

1,432 

 

 

$

1,281 



   

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

$

502 

 

$

502 

 

$

 -

 

 -

 

$

 -

Residential real estate

 

 

 

654 

 

 

503 

 

 

151 

 

 -

 

 

 -

Commercial real estate

 

10 

 

 

12,125 

 

 

12,125 

 

 

 -

 

 -

 

 

 -

  Total

 

15 

 

$

13,281 

 

$

13,130 

 

$

151 

 

 -

 

$

 -



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

*The performing status is determined by the loan’s compliance with the modified terms.



The following table reports new TDR loans during 2016, concession granted and the recorded investment as of September  30, 2016:







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

New During Period



 

Number of

 

 

Pre-TDR

 

 

After-TDR

 

 

Recorded

 

 

Nine Months Ended September 30, 2016

 

Contracts

 

 

Modification

 

 

Modification

 

 

Investment

 

Concession

Commercial real estate

 

 

$

525 

 

$

525 

 

$

515 

 

multiple

Residential real estate

 

 

 

238 

 

 

238 

 

 

238 

 

maturity

  Total

 

 

$

763 

 

$

763 

 

$

753 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

There were no new TDR loans made in the first nine months of 2015.



Note 7. OREO

Changes in other real estate owned during the nine months ended September 30, 2016 and 2015 were as follows:





 

 

 

 

 

 



 

September 30

(Dollars in thousands)

 

2016

 

2015

Balance at January 1

 

$

6,451 

 

$

3,666 

   Additions

 

 

123 

 

 

3,488 

   Proceeds from dispositions

 

 

(625)

 

 

(129)

   (Loss) gain on sales, net

 

 

(31)

 

 

32 

   Valuation adjustment

 

 

(46)

 

 

(250)

Balance at September 30

 

$

5,872 

 

$

6,807 

















20

 


 

Note 8. Pension

The components of pension expense for the periods presented are as follows:





 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 



Three Months Ended September 30

 

Nine Months Ended September 30

(Dollars in thousands)

2016

 

2015

 

2016

 

2015

Components of net periodic cost:

 

 

 

 

 

 

 

 

 

 

 

Service cost

$

83 

 

$

92 

 

$

247 

 

$

284 

Interest cost

 

180 

 

 

172 

 

 

540 

 

 

522 

Expected return on plan assets

 

(290)

 

 

(296)

 

 

(873)

 

 

(888)

Settlement expense

 

225 

 

 

 -

 

 

225 

 

 

 -

Recognized net actuarial loss

 

120 

 

 

123 

 

 

351 

 

 

377 

Net period cost

$

318 

 

$

91 

 

$

490 

 

$

295 



The Bank expects its pension expense to increase to approximately $922 thousand in 2016 compared to $387 thousand in 2015. This increase is due to a pension settlement expense of approximately $564 thousand that will be recorded during the second half of 2016, as a result of lump sum distributionsNo pension contributions were made or are expected to be made in 2016.

 







Note 9.  Fair Value Measurements and Fair Values of Financial Instruments

Management uses its best judgment in estimating the fair value of the Corporation’s financial instruments; however, there are inherent weaknesses in any estimation technique.  Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Corporation could have realized in a sales transaction on the dates indicated.  The estimated fair value amounts have been measured as of their respective period-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates.  As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates maybe different than the amounts reported at each year-end.

FASB ASC Topic 820, “Financial Instruments”, requires disclosure of the fair value of financial assets and liabilities, including those financial assets and liabilities that are not measured and reported at fair value on a recurring and nonrecurring basis. The Corporation does not report any nonfinancial assets at fair value. FASB ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value.  The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).  The three levels of the fair value hierarchy under FASB ASC Topic 820 are as follows:

Level 1: Valuation is based on unadjusted, quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2:  Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.  There may be substantial differences in the assumptions used for securities within the same level.  For example, prices for U.S. Agency securities have fewer assumptions and are closer to level 1 valuations than the private label mortgage backed securities that require more assumptions and are closer to level 3 valuations.

Level 3: Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Corporation’s assumptions regarding what market participants would assume when pricing a financial instrument. 

An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The following methods and assumptions were used to estimate the fair values of the Corporation’s financial instruments at September 30, 2016 and December 31, 2015.

Cash and Cash Equivalents:  For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

Investment securities:  The fair value of investment securities is determined in accordance with the methods described under FASB ASC Topic 820 as discussed below.

21

 


 

Restricted stock:  The carrying value of restricted stock approximates its fair value based on redemption provisions for the restricted stock.

Loans held for sale: The fair value of loans held for sale is determined by the price set between the Bank and the purchaser prior to origination. These loans are usually sold at par.

Net loans (including impaired loans)The fair value of fixed-rate loans is estimated for each major type of loan (e.g. real estate, commercial, industrial and agricultural and consumer) by discounting the future cash flows associated with such loans using rates currently offered for loans with similar terms to borrowers of comparable credit quality.  The model considers scheduled principal maturities, repricing characteristics, prepayment assumptions and interest cash flows.  The discount rates used are estimated based upon consideration of a number of factors including the treasury yield curve, expense and service charge factors. For variable rate loans that reprice frequently and have no significant change in credit quality, carrying values approximate the fair value.

Accrued Interest Receivable:  The carrying amount is a reasonable estimate of fair value.

Deposits and Short-term borrowingsThe fair value of demand deposits, savings accounts, and money market deposits is the amount payable on demand at the reporting date.  The fair value of fixed-rate certificates of deposit is estimated by discounting the future cash flows using rates approximating those currently offered for certificates of deposit with similar remaining maturities.  For short-term borrowings, the carrying value approximates a reasonable estimate of the fair value.

Accrued interest payable:  The carrying amount is a reasonable estimate of fair value.

The following information regarding the fair value of the Corporation’s financial instruments should not be interpreted as an estimate of the fair value of the entire Corporation since a fair value calculation is only provided for a limited portion of the Corporation’s assets and liabilities.  Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Corporation’s disclosures and those of other companies may not be meaningful. 

22

 


 

The fair value of the Corporation's financial instruments are as follows:







 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



September 30, 2016



Carrying

 

Fair

 

 

 

 

 

 

 

(Dollars in thousands)

Amount

 

Value

 

Level 1

 

Level 2

 

Level 3



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

$

40,594 

 

$

40,594 

 

$

40,594 

 

$

 -

 

$

 -

Investment securities available for sale

 

155,345 

 

 

155,345 

 

 

250 

 

 

155,095 

 

 

 -

Restricted stock

 

1,118 

 

 

1,118 

 

 

 -

 

 

1,118 

 

 

 -

Loans held for sale

 

367 

 

 

367 

 

 

 -

 

 

367 

 

 

 -

Net loans

 

847,891 

 

 

858,095 

 

 

 -

 

 

 -

 

 

858,095 

Accrued interest receivable

 

3,105 

 

 

3,105 

 

 

 -

 

 

3,105 

 

 

 -



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

$

978,552 

 

$

978,487 

 

$

 -

 

$

978,487 

 

$

 -

Accrued interest payable

 

137 

 

 

137 

 

 

 -

 

 

137 

 

 

 -



 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



December 31, 2015



Carrying

 

Fair

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

Amount

 

Value

 

Level 1

 

Level 2

 

Level 3



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

$

39,166 

 

$

39,166 

 

$

39,166 

 

$

 -

 

$

 -

Investment securities available for sale

 

159,473 

 

 

159,473 

 

 

233 

 

 

159,240 

 

 

 -

Restricted stock

 

782 

 

 

782 

 

 

 -

 

 

782 

 

 

 -

Loans held for sale

 

461 

 

 

461 

 

 

 -

 

 

461 

 

 

 -

Net loans

 

771,930 

 

 

779,742 

 

 

 -

 

 

 -

 

 

779,742 

Accrued interest receivable

 

3,164 

 

 

3,164 

 

 

 -

 

 

3,164 

 

 

 -



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

$

918,512 

 

$

918,401 

 

$

 -

 

$

918,401 

 

$

 -

Accrued interest payable

 

124 

 

 

124 

 

 

 -

 

 

124 

 

 

 -



 

 

 

 

 

 

 

 

 

 

 

 

 

 

23

 


 

Recurring Fair Value Measurements

For financial assets and liabilities measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2016 and December 31, 2015 are as follows:







 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands

Fair Value at September 30, 2016

Asset  Description

Level 1

 

Level 2

 

Level 3

 

Total

Equity securities

$

250 

 

$

 -

 

$

 -

 

$

250 

U.S. Government and Agency securities

 

 -

 

 

12,999 

 

 

 -

 

 

12,999 

Municipal securities

 

 -

 

 

68,080 

 

 

 -

 

 

68,080 

Trust Preferred Securities

 

 -

 

 

5,418 

 

 

 -

 

 

5,418 

Agency mortgage-backed securities

 

 -

 

 

67,379 

 

 

 -

 

 

67,379 

Private-label mortgage-backed securities

 

 -

 

 

1,187 

 

 

 -

 

 

1,187 

Asset-backed securities

 

 -

 

 

32 

 

 

 -

 

 

32 

Total assets

$

250 

 

$

155,095 

 

$

 -

 

$

155,345 



 

 

 

 

 

 

 

 

 

 

 







 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

Fair Value at December 31, 2015

Asset  Description

Level 1

 

Level 2

 

Level 3

 

Total

Equity securities

$

233 

 

$

 -

 

$

 -

 

$

233 

U.S. Government and Agency securities

 

 -

 

 

13,836 

 

 

 -

 

 

13,836 

Municipal securities

 

 -

 

 

69,188 

 

 

 -

 

 

69,188 

Trust Preferred Securities

 

 -

 

 

5,289 

 

 

 -

 

 

5,289 

Agency mortgage-backed securities

 

 -

 

 

69,519 

 

 

 -

 

 

69,519 

Private-label mortgage-backed securities

 

 -

 

 

1,372 

 

 

 -

 

 

1,372 

Asset-backed securities

 

 -

 

 

36 

 

 

 -

 

 

36 

Total assets

$

233 

 

$

159,240 

 

$

 -

 

$

159,473 



 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

The Corporation used the following methods and significant assumptions to estimate the fair values for financial assets measured at fair value on a recurring basis.

Investment securities:  Level 1 securities represent equity securities that are valued using quoted market prices from nationally recognized markets. Level 2 securities represent debt securities that are valued using a mathematical model based upon the specific characteristics of a security in relationship to quoted prices for similar securities.    

24

 


 

Nonrecurring Fair Value Measurements

For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2016 and December 31, 2015 are as follows:







 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

 

 

 

 



Fair Value at September 30, 2016

Asset  Description

Level 1

 

Level 2

 

Level 3

 

Total

Other real estate owned (1)

 

 -

 

 

 -

 

 

325 

 

 

325 

Total assets

$

 -

 

$

 -

 

$

325 

 

$

325 







 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

Fair Value at December 31, 2015

Asset  Description

Level 1

 

Level 2

 

Level 3

 

Total

Premises held-for-sale (1)

$

 -

 

$

 -

 

$

225 

 

$

225 

Other real estate owned (1)

 

 -

 

 

 -

 

 

6,128 

 

 

6,128 

Total assets

$

 -

 

$

 -

 

$

6,353 

 

$

6,353 

(1)

Includes assets directly charged-down to fair value during the year-to-date period.

The Corporation used the following methods and significant assumptions to estimate the fair values for financial assets measured at fair value on a nonrecurring basis.

Impaired loans: Impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral.  Collateral values are estimated using Level 3 inputs based on customized discounting criteria.

Premises held-for-sale: The fair value of premises held for sale, upon initial recognition, is estimated using Level 3 inputs within the fair value hierarchy. 

Other real estate: The fair value of other real estate, upon initial recognition, is estimated using Level 2 inputs within the fair value hierarchy based on observable market data and Level 3 inputs based on customized discounting criteria.  In connection with the measurement and initial recognition of the foregoing assets, the Corporation recognizes charge-offs through the allowance for loan losses.  Subsequent charge-offs are recognized as an expense.

The Corporation did not record any liabilities at fair value for which measurement of the fair value was made on a nonrecurring basis at September 30, 2016. For financial assets and liabilities measured at fair value on a recurring basis, there were no transfers of financial assets or liabilities between Level 1 and Level 2 during the period ending September 30, 2016.

The following table presents additional quantitative information about Level 3 assets measured at fair value on a nonrecurring basis:





 

 

 

 

 

 

 

 

 



 

 

Quantitative Information about Level 3 Fair Value Measurements

(Dollars in Thousands)

 

 

at September 30, 2016



 

 

 

 

 

 

 

 

Range

Asset  Description

 

 

Fair Value

 

Valuation Technique

 

Unobservable Input

 

(Weighted Average)



 

 

 

 

 

 

 

 

 

Other real estate owned (1)

 

 

325 

 

Appraisal

 

Cost to sell

 

8%  (8%)



 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 



 

 

at December 31, 2015

Premises held-for-sale (1)

 

$

225 

 

Appraisal

 

 -

 

 -

Other real estate owned (1)

 

 

6,128 

 

Appraisal

 

Cost to sell

 

8%  (8%)



 

 

 

 

 

 

 

 

 

(1) Includes assets directly charged-down to fair value during the year-to-date period.

 

 

















25

 


 

Note 10.  Financial Derivatives

The Board of Directors has given Management authorization to enter into derivative activity including interest rate swaps, caps and floors, forward-rate agreements, options and futures contracts in order to hedge interest rate risk.  The Bank is exposed to credit risk equal to the positive fair value of a derivative instrument, if any, as a positive fair value indicates that the counterparty to the agreement is financially liable to the Bank.  To limit this risk, counterparties must have an investment grade long-term debt rating and individual counterparty credit exposure is limited by Board approved parameters.  The final swap transaction matured in 2015.

The Effect of Derivative Instruments on the Statement of Income for the Nine Months Ended September  30, 2016 and 2015 follows:





 

 

 

 

 

 

 

 

 

 

 

 

Derivatives in ASC Topic 815 Cash Flow Hedging Relationships

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

Amount of Gain



 

 

 

 

 

 

 

 

Location of

 

or (Loss)



 

 

 

 

 

 

 

 

Gain or (Loss)

 

Recognized in



 

 

 

 

 

 

 

 

Recognized in

 

Income on



 

 

 

Location of

 

Amount of Gain

 

Income on

 

Derivatives



Amount of Gain

 

Gain or (Loss)

 

or (Loss)

 

Derivative (Ineffective

 

(Ineffective Portion



or (Loss)

 

Reclassified from

 

Reclassified from

 

Portion and Amount

 

and Amount



Recognized in OCI

 

Accumulated OCI

 

Accumulated OCI

 

Excluded from

 

Excluded from



net of tax on Derivative

 

into Income

 

into Income

 

Effectiveness

 

Effectiveness

Date / Type

(Effective Portion)

 

(Effective Portion)

 

(Effective Portion)

 

Testing)

 

Testing)

Interest rate contracts

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

Nine months ended:

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2016

$

 -

 

Interest Expense

 

$

 -

 

Other income (expense)

 

$

 -

September 30, 2015

$

126 

 

Interest Expense

 

$

(160)

 

Other income (expense)

 

$

 -



 

 

 

 

 

 

 

 

 

 

 

 

There was no expense for the Swap in third quarter of 2015 or 2016, as the Swap matured in May, 2015.

 

 

 



Interest Rate Swap Agreements (“Swap Agreements”)

As of September  30, 2016, the Bank had no swap agreements outstanding. The Bank had entered into interest rate swap agreements as part of its asset/liability management program.  The swap agreements were free-standing derivatives and were recorded at fair value in the Corporation’s consolidated statements of condition.  The Bank was party to master netting arrangements with its financial institution counterparties; however, the Bank did not offset assets and liabilities under these arrangements for financial statement presentation purposes.  The master netting arrangements provided for a single net settlement of all swap agreements, as well as collateral, in the event of default on, or termination of, any one contract.  Collateral, in the form of marketable securities, was posted by the counterparty with net liability positions in accordance with contract thresholds. 







Note 11. Capital Ratios

Capital adequacy is currently defined by regulatory agencies through the use of several minimum required ratios.  In July 2013, Federal banking regulators approved the final rules from the Basel Committee on Banking Supervision for the regulation of capital requirements for bank holding companies and U.S banks, generally referred to as “Basel III.” The Basel III standards were effective for the Corporation and the Bank, effective January 1, 2015 (subject to a phase-in period for certain provisions).  Basel III imposes significantly higher capital requirements and more restrictive leverage and liquidity ratios than those previously in place.  The capital ratios to be considered “well capitalized” under Basel III are: (1) Common Equity Tier 1(CET1) of 6.5%, (2) Tier 1 Leverage of 5%, (3)Tier 1 Risk-Based Capital of 8%, and (4) Total Risk-Based Capital of 10%.  The CET1 ratio is a new capital ratio under Basel III and the Tier 1 risk-based capital ratio of 8% has been increased from 6%. The rules also include changes in the risk weights of certain assets to better reflect credit and other risk exposures. In addition, a capital conservation buffer will be phased-in beginning January 1, 2016 at 0.625%, increasing each year until fully implemented in 2019 at 2.5% above the minimum capital ratios required to avoid any capital distribution restrictions. The capital conservation buffer will be applicable to all of the capital ratios except for the Tier1 Leverage ratio. When fully implemented, the capital conservation buffer will have the effect of increasing the minimum capital ratios by 2.5%.  As of September  30, 2016, the Bank was “well capitalized’ under the

26

 


 

Basel III requirements and believes it would be “well capitalized” on a fully-phased in basis had such a requirement been in effect.

   The following table summarizes regulatory capital information as of September  30, 2016 and December 31, 2015 (restated) for the Corporation and the BankThe adequately capitalized minimum ratios, except for the Tier 1 Leverage Ratio, include the 0.625% Capital Conservation buffer effective for 2016.





 

 

 

 

 

 

 

 



 

 

 

 

 

Regulatory Ratios



 

 

 

 

 

Adequately

 

Well



 

 

 

 

 

Capitalized

 

Capitalized

(Dollars in thousands)

 

September 30, 2016

 

December 31, 2015

 

Minimum

 

Minimum



 

 

 

 

 

 

 

 

Common Equity Tier 1 Risk-based Capital Ratio (1)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

14.60% 

 

14.77% 

 

5.125% 

 

N/A

Farmers & Merchants Trust Company

 

14.53% 

 

14.76% 

 

5.125% 

 

6.50% 



 

 

 

 

 

 

 

 

Tier 1 Risk-based Capital Ratio (2)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

14.60% 

 

14.77% 

 

6.625% 

 

N/A

Farmers & Merchants Trust Company

 

14.53% 

 

14.76% 

 

6.625% 

 

8.00% 



 

 

 

 

 

 

 

 

Total Risk-based Capital Ratio (3)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

15.86% 

 

16.03% 

 

8.625% 

 

N/A

Farmers & Merchants Trust Company

 

15.79% 

 

16.02% 

 

8.625% 

 

10.00% 



 

 

 

 

 

 

 

 

Tier 1 Leverage Ratio (4)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

10.07% 

 

10.38% 

 

4.000% 

 

N/A

Farmers & Merchants Trust Company

 

10.03% 

 

10.37% 

 

4.000% 

 

5.00% 



 

 

 

 

 

 

 

 

(1) Common equity Tier 1 capital/ total risk-weighted assets (2) Tier 1 capital / total risk-weighted assets

(3) Total risk-based capital / total risk-weighted assets, (4) Tier 1 capital / average quarterly assets

















31Note 12. Reclassification

Certain prior period amounts may have been reclassified to conform to the current year presentation.  Such reclassifications did not affect the Corporation’s financial position or results of operations.

27

 


 

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

For the Three and Nine Months Ended September 30, 2016 and 2015



Forward Looking Statements



Certain statements appearing herein which are not historical in nature are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  Such forward-looking statements refer to a future period or periods, reflecting management’s current views as to likely future developments, and use words such as “may,” “will,” “expect,” “believe,” “estimate,” “anticipate,” or similar terms.  Because forward-looking statements involve certain risks, uncertainties and other factors over which the Corporation has no direct control, actual results could differ materially from those contemplated in such statements.  These factors include (but are not limited to) the following: general economic conditions, changes in interest rates, changes in the Corporation’s cost of funds, changes in government monetary policy, changes in government regulation and taxation of financial institutions, changes in the rate of inflation, changes in technology, the intensification of competition within the Corporation’s market area, and other similar factors.



Critical Accounting Policies



Management has identified critical accounting policies for the Corporation.  These policies are particularly sensitive, requiring significant judgements, estimates and assumptions to be made by Management. There were no changes to the critical accounting policies disclosed in the 2015 Annual Report on Form 10-K in regards to application or related judgments and estimates used.  Please refer to Item 7 of the Corporation’s 2015 Annual Report on Form 10-K for a more detailed disclosure of the critical accounting policies.



Results of Operations



Year-to-Date Summary

At September  30, 2016, total assets were $1.107 billion, an increase of $71.8 million from December 31, 2015. Net loans increased to $847.9 million and total deposits increased to $978.6 million.  The Corporation reported net income for the first nine months of 2016 of $6.4 million.  This is a 19.8%  decrease versus net income of $7.9 million for the same period in 2015.  Net income for 2016 was negatively affected by a provision for loan loss expense that was $2.3 million more than 2015, while 2015 was enhanced by two nonrecurring events that increased noninterest income by $899 thousand.  Despite the nonrecurring events in 2015, total revenue (interest income and noninterest income) for the first nine months of 2016 increased by  $471 thousand year-over-year. Interest income increased $1.6 million,  while interest expense decreased by  $158 thousand, resulting in a $1.8 million increase in net interest income. The provision for loan losses was $3.3 million for the first nine months of 2016, $2.3 million more than in 2015, as a result of loan growth and one large loan charge-off.  Noninterest income decreased $1.1 million due to the nonrecurring events in 2015, while noninterest expense increased $493 thousand. Income tax expense decreased from $1.8 million in 2015 to $1.2 million in 2016. The effective tax rate decreased from 18.3% in 2015 to 15.8% in 2016. Diluted earnings per share decreased to $1.48 in 2016 from $1.87 in 2015.  

28

 


 

Key performance ratios as of, or for the nine months ended September 30, 2016 and 2015 and the year ended December 31, 2015 are listed below:







 

 

 

 

 

 

 

 

 



 

September 30

 

December 31

 

September 30



 

2016

 

2015

 

2015

(Dollars in thousands, except per share)

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

Balance Sheet Highlights

 

 

 

 

 

 

 

 

 

Total assets

 

$

1,107,120 

 

$

1,035,295 

 

$

1,036,323 

Investment securities

 

 

155,345 

 

 

159,473 

 

 

169,516 

Loans, net

 

 

847,891 

 

 

771,930 

 

 

760,802 

Deposits

 

 

978,552 

 

 

918,512 

 

 

917,447 

Shareholders' equity

 

 

116,879 

 

 

111,376 

 

 

110,113 



 

 

 

 

 

 

 

 

 

Summary of Operations

 

 

 

 

 

 

 

 

 

Interest income

 

$

27,434 

 

$

34,615 

 

$

25,823 

Interest expense

 

 

1,656 

 

 

2,371 

 

 

1,814 

Net interest income

 

 

25,778 

 

 

32,244 

 

 

24,009 

Provision for loan losses

 

 

3,325 

 

 

1,285 

 

 

1,035 

Net interest income after provision for loan losses

 

 

22,453 

 

 

30,959 

 

 

22,974 

Noninterest income

 

 

8,613 

 

 

12,652 

 

 

9,753 

Noninterest expense

 

 

23,505 

 

 

31,136 

 

 

23,012 

Income before income taxes

 

 

7,561 

 

 

12,475 

 

 

9,715 

Income tax

 

 

1,198 

 

 

2,271 

 

 

1,778 

Net income

 

$

6,363 

 

$

10,204 

 

$

7,937 



 

 

 

 

 

 

 

 

 

Performance Measurements

 

 

 

 

 

 

 

 

 

Return on average assets*

 

 

0.79% 

 

 

1.00% 

 

 

1.04% 

Return on average equity*

 

 

7.42% 

 

 

9.52% 

 

 

10.00% 

Return on average tangible assets (1)*

 

 

0.79% 

 

 

1.02% 

 

 

1.06% 

Return on average tangible equity (1)*

 

 

8.05% 

 

 

10.52% 

 

 

11.07% 

Efficiency ratio (1)

 

 

65.21% 

 

 

67.39% 

 

 

66.59% 

Net interest margin

 

 

3.61% 

 

 

3.59% 

 

 

3.59% 

Current dividend yield*

 

 

3.46% 

 

 

3.23% 

 

 

3.32% 

Dividend payout ratio

 

 

41.14% 

 

 

30.76% 

 

 

29.36% 



 

 

 

 

 

 

 

 

 

Shareholders' Value (per common share)

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

$

1.48 

 

$

2.40 

 

$

1.87 

Basic earnings per share

 

 

1.48 

 

 

2.40 

 

 

1.87 

Regular cash dividends paid

 

 

0.61 

 

 

0.74 

 

 

0.55 

Book value

 

 

27.19 

 

 

26.05 

 

 

25.85 

Tangible book value (1)

 

 

25.09 

 

 

23.94 

 

 

23.73 

Market value

 

 

24.31 

 

 

23.50 

 

 

22.90 

Market value/book value ratio

 

 

89.41% 

 

 

90.21% 

 

 

88.59% 

Market value/tangible book value ratio

 

 

96.89% 

 

 

98.16% 

 

 

96.50% 

Price/earnings multiple*

 

 

12.34 

 

 

9.79 

 

 

9.20 



 

 

 

 

 

 

 

 

 

Safety and Soundness

 

 

 

 

 

 

 

 

 

Risk-based capital ratio (Total)

 

 

15.86% 

 

 

16.03% 

 

 

15.69% 

Leverage ratio (Tier 1)

 

 

10.07% 

 

 

10.38% 

 

 

10.33% 

Common equity ratio (Tier 1)

 

 

14.60% 

 

 

14.77% 

 

 

14.44% 

Nonperforming loans/gross loans

 

 

0.69% 

 

 

0.73% 

 

 

0.80% 

Nonperforming assets/total assets

 

 

1.07% 

 

 

1.18% 

 

 

1.25% 

Allowance for loan losses as a % of loans

 

 

1.24% 

 

 

1.29% 

 

 

1.28% 

Net charge-offs/average loans*

 

 

0.44% 

 

 

0.04% 

 

 

0.05% 

 

 

 

 

 

 

 

 

 

 

Trust assets under management (fair value)

 

$

617,289 

 

$

586,664 

 

$

569,484 











*Annualized

(1)

See the section titled “GAAP versus Non-GAAP Presentation” that follows.

29

 


 

GAAP versus non-GAAP PresentationsThe Corporation supplements its traditional GAAP measurements with certain non-GAAP measurements to evaluate its performance and to eliminate the effect of intangible assets.  By eliminating intangible assets, the Corporation believes it presents a measurement that is comparable to companies that have no intangible assets or to companies that have eliminated intangible assets in similar calculations. However, not all companies may use the same calculation method for each measurement. The non-GAAP measurements are not intended to be used as a substitute for the related GAAP measurements. The following table shows the calculation of the non-GAAP measurements.





 

 

 

 

 

 

 

 

 

(Dollars in thousands, except per share)

 

 

Nine months ended

 

 

 

 

 

Nine months ended



 

 

September 30, 2016

 

 

December 31, 2015

 

 

September 30, 2015

Return on Average Tangible Assets (non-GAAP)

 

 

 

 

 

 

 

 

 

Net income

 

$

6,363 

 

$

10,204 

 

$

7,937 

Plus intangible amortization (net of tax)

 

 

 -

 

 

119 

 

 

119 

Net income (non-GAAP)

 

 

6,363 

 

 

10,323 

 

 

8,056 



 

 

 

 

 

 

 

 

 

Average assets

 

 

1,079,250 

 

 

1,021,275 

 

 

1,017,853 

Less average intangible assets

 

 

(9,016)

 

 

(9,066)

 

 

(9,116)

Average assets (non-GAAP)

 

 

1,070,234 

 

 

1,012,209 

 

 

1,008,737 



 

 

 

 

 

 

 

 

 

 Return on average tangible assets (non-GAAP)

 

 

0.79% 

 

 

1.02% 

 

 

1.06% 



 

 

 

 

 

 

 

 

 

Return on Tangible Equity (non-GAAP)

 

 

 

 

 

 

 

 

 

Net income

 

$

6,363 

 

$

10,204 

 

$

7,937 

Plus intangible amortization (net of tax)

 

 

 -

 

 

119 

 

 

119 

Net income (non-GAAP)

 

 

6,363 

 

 

10,323 

 

 

8,056 



 

 

 

 

 

 

 

 

 

Average shareholders' equity

 

 

114,363 

 

 

107,175 

 

 

106,109 

Less average intangible assets

 

 

(9,016)

 

 

(9,066)

 

 

(9,116)

Average shareholders' equity (non-GAAP)

 

 

105,347 

 

 

98,109 

 

 

96,993 



 

 

 

 

 

 

 

 

 

 Return on average tangible equity (non-GAAP)

 

 

8.05% 

 

 

10.52% 

 

 

11.07% 



 

 

 

 

 

 

 

 

 

Tangible Book Value (per share) (non-GAAP)

 

 

 

 

 

 

 

 

 

Shareholders' equity

 

$

116,879 

 

$

111,376 

 

$

110,113 

Less intangible assets

 

 

(9,016)

 

 

(9,016)

 

 

(9,016)

Shareholders' equity (non-GAAP)

 

 

107,863 

 

 

102,360 

 

 

101,097 



 

 

 

 

 

 

 

 

 

Shares outstanding (in thousands)

 

 

4,299 

 

 

4,276 

 

 

4,260 



 

 

 

 

 

 

 

 

 

 Tangible book value (non-GAAP)

 

 

25.09 

 

 

23.94 

 

 

23.73 



 

 

 

 

 

 

 

 

 

Efficiency Ratio

 

 

 

 

 

 

 

 

 

Noninterest expense

 

$

23,505 

 

$

31,136 

 

$

23,012 



 

 

 

 

 

 

 

 

 

Net interest income plus noninterest income

 

 

34,391 

 

 

44,896 

 

 

33,762 

Plus tax equivalent adjustment to net interest income

 

 

1,626 

 

 

2,023 

 

 

1,512 

Less net securities gains (losses), and OTTI

 

 

(26)

 

 

716 

 

 

716 

Net interest income plus noninterest income

 

 

36,043 

 

 

46,203 

 

 

34,558 



 

 

 

 

 

 

 

 

 

 Efficiency ratio

 

 

65.21% 

 

 

67.39% 

 

 

66.59% 





30

 


 

Comparison of the three months ended September  30, 2016 to the three months ended September  30, 2015:

Net Interest Income

The most important source of the Corporation’s earnings is net interest income, which is defined as the difference between income on interest-earning assets and the expense of interest-bearing liabilities supporting those assets.  Principal categories of interest-earning assets are loans and securities, while deposits, short-term borrowings and long-term debt are the principal categories of interest-bearing liabilities.  Demand deposits enhance net interest income because they are noninterest-bearing deposits. For the purpose of this discussion, balance sheet items refer to the average balance for the year and net interest income is adjusted to a fully taxable-equivalent basis.  This tax-equivalent adjustment facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Corporation’s 34% Federal statutory rate. 



Tax equivalent net interest income increased $699 thousand to $9.4 million in the third quarter of 2016 compared to $8.7 million in the same period in 2015.  Balance sheet volume contributed $853 thousand to this increase, but was reduced by $154 thousand due to lower rates.    

31

 


 

The following table presents average balances, tax-equivalent (T/E) interest income, and yields earned or rates paid on the assets or liabilities.  All nontaxable interest income has been adjusted to a tax-equivalent basis using a tax rate of 34%. 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



For the Three Months Ended September 30,



2016

 

2015



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



Average

 

Income or

 

Average

 

Average

 

Income or

 

Average

(Dollars in thousands)

balance

 

expense

 

yield/rate

 

balance

 

expense

 

yield/rate



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing obligations of other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

banks and federal funds sold

$

32,055 

 

$

79 

 

0.98% 

 

$

37,098 

 

$

66 

 

0.71% 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

107,998 

 

 

571 

 

2.10% 

 

 

118,218 

 

 

587 

 

1.97% 

Tax Exempt

 

52,444 

 

 

533 

 

4.07% 

 

 

55,388 

 

 

603 

 

4.36% 

               Investments

 

160,442 

 

 

1,104 

 

2.74% 

 

 

173,606 

 

 

1,190 

 

2.72% 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, industrial and agricultural

 

691,245 

 

 

7,135 

 

4.04% 

 

 

599,337 

 

 

6,316 

 

4.13% 

Residential mortgage

 

76,776 

 

 

763 

 

3.98% 

 

 

81,182 

 

 

819 

 

4.02% 

Home equity loans and lines

 

71,990 

 

 

777 

 

4.29% 

 

 

66,023 

 

 

731 

 

4.39% 

Consumer

 

4,785 

 

 

64 

 

5.32% 

 

 

5,759 

 

 

93 

 

6.41% 

Loans

 

844,796 

 

 

8,739 

 

4.06% 

 

 

752,301 

 

 

7,959 

 

4.16% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest-earning assets

 

1,037,293 

 

$

9,922 

 

3.81% 

 

 

963,005 

 

$

9,215 

 

3.80% 

Other assets

 

67,808 

 

 

 

 

 

 

 

67,315 

 

 

 

 

 

Total assets

$

1,105,101 

 

 

 

 

 

 

$

1,030,320 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking

$

259,986 

 

$

87 

 

0.13% 

 

$

226,846 

 

 

69 

 

0.12% 

Money Management

 

394,866 

 

 

341 

 

0.34% 

 

 

382,202 

 

 

327 

 

0.34% 

Savings

 

73,814 

 

 

14 

 

0.08% 

 

 

67,664 

 

 

12 

 

0.07% 

Time

 

79,084 

 

 

117 

 

0.59% 

 

 

91,060 

 

 

146 

 

0.64% 

Total interest-bearing deposits

 

807,750 

 

 

559 

 

0.28% 

 

 

767,772 

 

 

554 

 

0.29% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other borrowings

 

3,190 

 

 

 

0.54% 

 

 

1,452 

 

 

 

0.35% 

Total interest-bearing liabilities

 

810,940 

 

 

563 

 

0.28% 

 

 

769,224 

 

 

555 

 

0.29% 

Noninterest-bearing deposits

 

174,131 

 

 

 

 

 

 

 

147,325 

 

 

 

 

 

Other liabilities

 

3,860 

 

 

 

 

 

 

 

5,819 

 

 

 

 

 

Shareholders' equity

 

116,170 

 

 

 

 

 

 

 

107,952 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,105,101 

 

 

 

 

 

 

$

1,030,320 

 

 

 

 

 

T/E net interest income/Net interest margin

 

 

 

 

9,359 

 

3.59% 

 

 

 

 

 

8,660 

 

3.57% 

Tax equivalent adjustment

 

 

 

 

(574)

 

 

 

 

 

 

 

(495)

 

 

Net interest income

 

 

 

$

8,785 

 

 

 

 

 

 

$

8,165 

 

 



32

 


 

Provision for Loan Losses

Provision expense for the third quarter was $1.1 million, compared to $400 thousand in 2015.    The increase in the provision expense was due to a higher level of charge-offs and growth in the loan portfolio.    For more information refer to the Loan Quality and Allowance for Loan Losses discussion in the Financial Condition section.



Noninterest Income

For the third quarter of 2016, noninterest income decreased $180 thousand from the same period in 2015.  Investment and trust service fees increased due to an increase in recurring fee income in 2016.  Loan service charges decreased due to higher volume of prepayment penalties during the third quarter of 2015.  The change in debit card income was due to increased usage by customers in the third quarter of 2016, compared to the same period in 2015. The loss on the sale of other real estate owned was from the sale of three properties in 2016 compared to none in 2015. The Corporation recorded an other than temporary impairment (OTTI) charge in 2016 a none in 2015.  Other income was higher in 2015, due to a $103 thousand gain from the proceeds of a bank owned life insurance policy. 

       

The following table presents a comparison of noninterest income for the three months ended September 30, 2016 and 2015.





 

 

 

 

 

 

 

 

 

 



For the Three Months Ended

 

 

 

 

 



September 30

 

Change

(Dollars in thousands)

2016

 

2015

 

Amount

 

%

Noninterest Income

 

 

 

 

 

 

 

 

 

 

Investment and trust services fees

$

1,211 

 

$

1,154 

 

$

57 

 

4.9 

Loan service charges

 

102 

 

 

288 

 

 

(186)

 

(64.6)

Deposit service charges and fees

 

635 

 

 

623 

 

 

12 

 

1.9 

Other service charges and fees

 

325 

 

 

309 

 

 

16 

 

5.2 

Debit card income

 

373 

 

 

346 

 

 

27 

 

7.8 

Increase in cash surrender value of life insurance

 

131 

 

 

137 

 

 

(6)

 

(4.4)

Net (loss) gain on sale of other real estate owned

 

(20)

 

 

 -

 

 

(20)

 

N/A

OTTI losses on debt securities

 

(10)

 

 

 -

 

 

(10)

 

N/A

Other

 

56 

 

 

126 

 

 

(70)

 

(55.6)

Total noninterest income

$

2,803 

 

$

2,983 

 

$

(180)

 

(6.0)



33

 


 



Noninterest Expense

Noninterest expense for the third quarter of 2016 increased $117 thousand compared to the same period in 2015.  The increase in salaries and benefits was primarily due to a $147 thousand increase in salary expense due to merit increases and increased staffing levels and a $227 thousand increase in pension expense due to pension settlement expenses compared to the same period in 2015Legal and professional fees increased due to fees associated with a lawsuit brought against the Corporation in 2015.  This lawsuit was more thoroughly described on a Form 8-K that was filed on July 29, 2016.  It is expected that the Corporation will incur additional legal expenses until this lawsuit is resolved. Foreclosed real estate expense decreased due to $250 thousand write down on other real estate owned (OREO) property in 2015.     



The following table presents a comparison of noninterest expense for the three months ended September  30, 2016 and 2015:



 

 

 

 

 

 

 

 

 

 



For the Three Months Ended

 

 

 

 

 

(Dollars in thousands)

September 30

 

Change

Noninterest Expense

2016

 

2015

 

Amount

 

%

Salaries and benefits

$

4,566 

 

$

4,214 

 

$

352 

 

8.4 

Net occupancy expense

 

556 

 

 

535 

 

 

21 

 

3.9 

Furniture and equipment expense

 

221 

 

 

232 

 

 

(11)

 

(4.7)

Advertising

 

296 

 

 

336 

 

 

(40)

 

(11.9)

Legal and professional fees

 

423 

 

 

311 

 

 

112 

 

36.0 

Data processing

 

539 

 

 

524 

 

 

15 

 

2.9 

Pennsylvania bank shares tax

 

203 

 

 

206 

 

 

(3)

 

(1.5)

FDIC insurance

 

188 

 

 

170 

 

 

18 

 

10.6 

ATM/debit card processing

 

214 

 

 

193 

 

 

21 

 

10.9 

Foreclosed real estate

 

18 

 

 

322 

 

 

(304)

 

(94.4)

Telecommunications

 

91 

 

 

145 

 

 

(54)

 

(37.2)

Other

 

665 

 

 

675 

 

 

(10)

 

(1.5)

Total noninterest expense

$

7,980 

 

$

7,863 

 

$

117 

 

1.5 



Provision for Income Taxes

For the third quarter of 2016, the Corporation recorded a Federal income tax expense of $383 thousand compared to $306 thousand for the same quarter in 2015. The effective tax rate was 15.6% for the third quarter of 2016 compared to 10.6% for the same period in 2015The increase was due to a reduction in pretax income in 2016 from increased provision expense. In addition, the 2015 rate was lower than normal due to the reversal of $250 thousand of the valuation allowance on the deferred tax asset due to the large security gain on the conversion of Integrity Bancshares.  Without this reversal, the effective tax rate would have been 19.3% in 2015. The variances from the federal statutory rate are generally due to tax-exempt income from investments, loans and bank-owned life insurance. All taxable income for the Corporation is taxed at a rate of 34%.



Comparison of the nine months ended September  30, 2016 to the nine months ended September  30, 2015:

Net Interest Income



Tax equivalent net interest income increased $1.9 million to $27.4 million in 2016 compared to $25.5 million in 2015.  Balance sheet volume contributed $2.3 million to this increase, but this was reduced by $369 thousand due to lower rates.  See the Financial Condition discussion for changes in the composition of the balance sheet.



llowing table presents average balances, tax-equivalent (T/E) interest income, and yields earned or rates paid on the assets or liabilities.  All nontaxable interest income has been adjusted to a tax-equivalent basis using a tax rate of 34%. 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

34

 


 





For the Nine Months Ended September 30,



2016

 

2015



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



Average

 

Income or

 

Average

 

Average

 

Income or

 

Average

(Dollars in thousands)

balance

 

expense

 

yield/rate

 

balance

 

expense

 

yield/rate



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing obligations of other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

banks and federal funds sold

$

34,639 

 

$

220 

 

0.85% 

 

$

40,730 

 

$

192 

 

0.63% 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

107,310 

 

 

1,741 

 

2.17% 

 

 

120,054 

 

 

1,895 

 

2.11% 

Tax Exempt

 

51,864 

 

 

1,618 

 

4.16% 

 

 

55,186 

 

 

1,828 

 

4.42% 

               Investments

 

159,174 

 

 

3,359 

 

2.82% 

 

 

175,240 

 

 

3,723 

 

2.84% 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, industrial and agricultural

 

665,302 

 

 

20,683 

 

4.09% 

 

 

583,151 

 

 

18,463 

 

4.18% 

Residential mortgage

 

77,467 

 

 

2,318 

 

3.99% 

 

 

80,996 

 

 

2,479 

 

4.07% 

Home equity loans and lines

 

71,443 

 

 

2,288 

 

4.28% 

 

 

64,534 

 

 

2,185 

 

4.53% 

Consumer

 

4,861 

 

 

192 

 

5.28% 

 

 

6,237 

 

 

293 

 

6.28% 

Loans

 

819,073 

 

 

25,481 

 

4.10% 

 

 

734,918 

 

 

23,420 

 

4.22% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest-earning assets

 

1,012,886 

 

$

29,060 

 

3.83% 

 

 

950,888 

 

$

27,335 

 

3.84% 

Other assets

 

66,364 

 

 

 

 

 

 

 

66,965 

 

 

 

 

 

Total assets

$

1,079,250 

 

 

 

 

 

 

$

1,017,853 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking

$

250,390 

 

$

239 

 

0.13% 

 

$

219,863 

 

 

189 

 

0.11% 

Money Management

 

392,050 

 

 

1,007 

 

0.34% 

 

 

383,011 

 

 

1,128 

 

0.39% 

Savings

 

72,368 

 

 

41 

 

0.08% 

 

 

65,558 

 

 

36 

 

0.07% 

Time

 

81,960 

 

 

363 

 

0.59% 

 

 

93,791 

 

 

460 

 

0.66% 

Total interest-bearing deposits

 

796,768 

 

 

1,650 

 

0.28% 

 

 

762,223 

 

 

1,813 

 

0.32% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities sold under agreements to repurchase

 

 -

 

 

 -

 

 -

 

 

33 

 

 

 -

 

0.15% 

Other borrowings

 

1,597 

 

 

 

0.56% 

 

 

497 

 

 

 

0.35% 

Total interest-bearing liabilities

 

798,365 

 

 

1,656 

 

0.28% 

 

 

762,753 

 

 

1,814 

 

0.32% 

Noninterest-bearing deposits

 

161,727 

 

 

 

 

 

 

 

142,070 

 

 

 

 

 

Other liabilities

 

4,795 

 

 

 

 

 

 

 

6,921 

 

 

 

 

 

Shareholders' equity

 

114,363 

 

 

 

 

 

 

 

106,109 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,079,250 

 

 

 

 

 

 

$

1,017,853 

 

 

 

 

 

T/E net interest income/Net interest margin

 

 

 

 

27,404 

 

3.61% 

 

 

 

 

 

25,521 

 

3.59% 

Tax equivalent adjustment

 

 

 

 

(1,626)

 

 

 

 

 

 

 

(1,512)

 

 

Net interest income

 

 

 

$

25,778 

 

 

 

 

 

 

$

24,009 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



Provision for Loan Losses

Provision expense for the first nine months of 2016 was $3.3 million, compared to $1.0 million in 2015. The increase in the provision expense was due to a higher level of charge-offs and growth in the loan portfolio compared.    For more information refer to the Loan Quality and Allowance for Loan Losses discussion in the Financial Condition section.



Noninterest Income

For the first nine months of 2016, noninterest income decreased $1.1 million from the same period in 2015.  Investment and trust service fees decreased due to a decline in estate fees and insurance commissions from 2015 to 2016.  Loan service charges decreased due to less loan prepayment fees in 2016, compared to 2015.  Deposit service charges increased due to increased enrollment and use of the Bank’s overdraft programThe change in debit card income was due to increased usage by customers in 2016.  During 2016, five properties held as other real estate owned were sold with a total net loss, compared to one property sold at a gain in 2015.  The Corporation recorded a nonrecurring gain on the conversion of an investment security in 2015.  Other income in 2015 included a $171 thousand gain from an investment the Corporation owned in an offshore insurance company that liquidated and paid out the investors.      

35

 


 



The following table presents a comparison of noninterest income for the nine months ended September 30, 2016 and 2015.









 

 

 

 

 

 

 

 

 

 



For the Nine Months Ended

 

 

 

 

 



September 30

 

Change

(Dollars in thousands)

2016

 

2015

 

Amount

 

%

Noninterest Income

 

 

 

 

 

 

 

 

 

 

Investment and trust services fees

$

3,683 

 

$

3,805 

 

$

(122)

 

(3.2)

Loan service charges

 

518 

 

 

784 

 

 

(266)

 

(33.9)

Deposit service charges and fees

 

1,815 

 

 

1,700 

 

 

115 

 

6.8 

Other service charges and fees

 

941 

 

 

916 

 

 

25 

 

2.7 

Debit card income

 

1,095 

 

 

1,021 

 

 

74 

 

7.2 

Increase in cash surrender value of life insurance

 

399 

 

 

416 

 

 

(17)

 

(4.1)

Net (loss) gain on sale of other real estate owned

 

(31)

 

 

32 

 

 

(63)

 

(196.9)

OTTI losses on debt securities

 

(30)

 

 

(20)

 

 

(10)

 

50.0 

Gain on conversion of investment security

 

 -

 

 

728 

 

 

(728)

 

(100.0)

Securities gains, net

 

 

 

 

 

(4)

 

(50.0)

Other

 

219 

 

 

363 

 

 

(144)

 

(39.7)

Total noninterest income

$

8,613 

 

$

9,753 

 

$

(1,140)

 

(11.7)



 

 

 

 

 

 

 

 

 

 

Noninterest Expense

Noninterest expense for the first nine months of 2016 increased $493 thousand compared to the same period in 2015.  The increase in salaries and benefits was primarily due to a $436 thousand increase in salary expense due to merit increases and increased staffing levels, a $194 thousand increase in pension expense due to pension settlement expenses and $88 thousand for stock option compensationLegal and professional fees increased due to fees associated with a lawsuit brought against the Corporation in 2015.  This lawsuit was more thoroughly described on a Form 8-K that was filed on July 29, 2016.  It is expected that the Corporation will incur additional legal expenses until this lawsuit is resolved. The shares tax increase was due to growth in the Bank’s balance sheet and shareholders’ equity that resulted in a higher premium. Intangible amortization expense decreased as the core deposit intangible was fully amortized as of June 2015.  ATM/Debit card processing increased due to the purchase of EMV debit card inventory.    Foreclosed real estate expense decreased in 2016, due to a $250 thousand write-down on one property in 2015.  Other expense decreased due to a one-time expense taken in 2015 to fund a deferred director’s compensation plan and several one-time expenses the Bank took in 2015 related to branch assets taken out of service.



The following table presents a comparison of noninterest expense for the nine months ended September  30, 2016 and 2015:





 

 

 

 

 

 

 

 

 

 



For the Nine Months Ended

 

 

 

 

 

(Dollars in thousands)

September 30

 

Change

Noninterest Expense

2016

 

2015

 

Amount

 

%

Salaries and benefits

$

13,282 

 

$

12,500 

 

$

782 

 

6.3 

Net occupancy expense

 

1,708 

 

 

1,706 

 

 

 

0.1 

Furniture and equipment expense

 

655 

 

 

702 

 

 

(47)

 

(6.7)

Advertising

 

839 

 

 

807 

 

 

32 

 

4.0 

Legal and professional fees

 

1,114 

 

 

811 

 

 

303 

 

37.4 

Data processing

 

1,540 

 

 

1,547 

 

 

(7)

 

(0.5)

Pennsylvania bank shares tax

 

699 

 

 

608 

 

 

91 

 

15.0 

Intangible amortization

 

 -

 

 

181 

 

 

(181)

 

(100.0)

FDIC insurance

 

514 

 

 

479 

 

 

35 

 

7.3 

ATM/debit card processing

 

642 

 

 

566 

 

 

76 

 

13.4 

Foreclosed real estate

 

93 

 

 

341 

 

 

(248)

 

(72.7)

Telecommunications

 

300 

 

 

379 

 

 

(79)

 

(20.8)

Other

 

2,119 

 

 

2,385 

 

 

(266)

 

(11.2)

Total noninterest expense

$

23,505 

 

$

23,012 

 

$

493 

 

2.1 



 

 

 

 

 

 

 

 

 

 

36

 


 

Provision for Income Taxes

For the first nine months of 2016, the Corporation recorded a Federal income tax expense of $1.2 million compared to $1.8 million for the same period in 2015. The effective tax rate was 15.8% for the first nine months of 2016 compared to 18.3% for the same period in 2015The decrease in 2016 was due to a reduction in pretax income from increased provision expense. In addition, the 2015 rate was lower than normal due to the reversal of $250 thousand of the valuation allowance on the deferred tax asset, due to the large security gain on the conversion of Integrity Bancshares, established in prior years on other than temporary impairment charges in the equity portfolio.  Without this reversal, the effective tax rate would have been 20.9% in 2015.   The variances from the federal statutory rate are generally due to tax-exempt income from investments, loans and bank-owned life insurance. All taxable income for the Corporation is taxed at a rate of 34%.



Financial Condition

Summary:

At September 30, 2016, assets totaled $1.107 billion, an increase of $71.8 million from the 2015 year-end balance of $1.035 billion. Investment securities decreased $4.1 million, while net loans increased $76.0 million (9.8%) due to growth in the commercial loan portfolio. Deposits increased  $60.0 million (6.5%) during the first nine months of 2016 due to increases in every deposit category except time deposits. Shareholders’ equity increased $5.5 million during the first nine months as retained earnings increased $3.7 million, accumulated other comprehensive loss decreased  $1.2 million and the Corporation’s Dividend Reinvestment Plan (DRIP) added an additional $1.1 million in new capital.

Cash and Cash Equivalents:

Cash and cash equivalents totaled $40.6 million at September 30, 2016,  an increase of $1.4 million from the prior year-end balance of $39.2 million.  Interest-bearing deposits are held primarily at the Federal Reserve ($1.1 million) and in short-term bank owned certificates of deposit ($22.6 million).



Investment Securities:    

The investment portfolio has decreased $5.7 million on a cost basis, since year-end 2015. The composition of the portfolio has remained consistent with municipal securities and U.S. Agency mortgage-backed securities comprising the greatest portion of the portfolio at approximately 44% and 43% of the portfolio fair value, respectively. The Bank invested $16.6 million during the first nine months of 2016 with the purchases spread between, U.S. Agency mortgage-backed securities and municipal securities.  The average life of the portfolio was 3.74 years. 

The investment portfolio had a net unrealized gain of $2.7 million at September 30, 2016 compared to $1.1 million at the prior year-end. The increase in the unrealized gain is due primarily to the decline in intermediate and long term interest rates.  The portfolio averaged $159.2 million with a yield of 2.82% for the first nine months of 2016. This compares to an average of $175.2 million and a yield of 2.84% for the same period in 2015. 

The Bank holds only one equity security, a Pennsylvania community bank. The municipal bond portfolio is well diversified geographically (issuers from within 28 states) and is comprised primarily of general obligation bonds (75%).  Many municipal bonds have credit enhancements in the form of private bond insurance or other credit support. The largest geographic municipal bond exposure is to 16 issuers in the state of Pennsylvania with a fair value of $9.0 million and 14 issuers in the state of Texas with a fair value of $8.7 million. The average rating of the municipal portfolio from Moody’s is Aa2. It contains $68.1 million of bonds rated A3 or higher and one bond of $600 thousand that is not rated by Moody’s rating agency.  No municipal bonds are rated below investment grade.

The holdings of trust preferred investments and private-label mortgage-backed securities (PLMBS) are unchanged since year-end and are detailed in separate tables.

37

 


 

The amortized cost and estimated fair value of investment securities available for sale as of September 30, 2016 and December 31, 2015 is as follows:



 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

September 30, 2016

 

cost

 

gains

 

losses

 

value

Equity securities

 

$

164 

 

$

86 

 

$

 -

 

$

250 

U.S. Government and Agency securities

 

 

12,728 

 

 

292 

 

 

(21)

 

 

12,999 

Municipal securities

 

 

66,248 

 

 

1,924 

 

 

(92)

 

 

68,080 

Trust preferred securities

 

 

5,973 

 

 

 -

 

 

(555)

 

 

5,418 

Agency mortgage-backed securities

 

 

66,369 

 

 

1,089 

 

 

(79)

 

 

67,379 

Private-label mortgage-backed securities

 

 

1,137 

 

 

57 

 

 

(7)

 

 

1,187 

Asset-backed securities

 

 

34 

 

 

 -

 

 

(2)

 

 

32 



 

$

152,653 

 

$

3,448 

 

$

(756)

 

$

155,345 







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

December 31, 2015

 

cost

 

gains

 

losses

 

value

Equity securities

 

$

164 

 

$

69 

 

$

 -

 

$

233 

U.S. Government and Agency securities

 

 

13,705 

 

 

164 

 

 

(33)

 

 

13,836 

Municipal securities

 

 

67,851 

 

 

1,555 

 

 

(218)

 

 

69,188 

Trust preferred securities

 

 

5,958 

 

 

 -

 

 

(669)

 

 

5,289 

Agency mortgage-backed securities

 

 

69,284 

 

 

621 

 

 

(386)

 

 

69,519 

Private-label mortgage-backed securities

 

 

1,335 

 

 

39 

 

 

(2)

 

 

1,372 

Asset-backed securities

 

 

38 

 

 

 -

 

 

(2)

 

 

36 



 

$

158,335 

 

$

2,448 

 

$

(1,310)

 

$

159,473 



The investment portfolio contained fifty securities with $29.0 million of temporarily impaired fair value and $756 thousand in unrealized losses at September 30, 2016. The total unrealized loss position has improved from a $1.3 million unrealized loss at year-end 2015. 

For securities with an unrealized loss, Management applies a systematic methodology in order to perform an assessment of the potential for other-than-temporary impairment.  In the case of debt securities, investments considered for other-than-temporary impairment: (1) had a specified maturity or repricing date; (2) were generally expected to be redeemed at par, and (3) were expected to achieve a recovery in market value within a reasonable period of time. In addition, the Bank considers whether it intends to sell these securities or whether it will be forced to sell these securities before the earlier of amortized cost recovery or maturity. Equity securities are assessed for other-than-temporary impairment based on the length of time of impairment, dollar amount of the impairment and general market and financial conditions relating to specific issues.  The impairment identified on debt and equity securities and subject to assessment at September 30, 2016, was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted.

38

 


 

The following table reflects temporary impairment in the investment portfolio (excluding restricted stock), aggregated by investment category, length of time that individual securities have been in a continuous unrealized loss position and the number of securities in each category as of September 30, 2016 and December 31, 2015:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



September 30, 2016

 

 



Less than 12 months

 

12 months or more

 

Total



Fair

 

Unrealized

 

 

 

Fair

 

Unrealized

 

 

 

Fair

 

Unrealized

 

 

(Dollars in thousands)

Value

 

Losses

 

Count

 

Value

 

Losses

 

Count

 

Value

 

Losses

 

Count



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government and Agency securities

$

 -

 

$

 -

 

 -

 

$

3,486 

 

$

(21)

 

10 

 

$

3,486 

 

$

(21)

 

10 

Municipal securities

 

2,657 

 

 

(7)

 

 

 

2,275 

 

 

(85)

 

 

 

4,932 

 

 

(92)

 

Trust preferred securities

 

 -

 

 

 -

 

 -

 

 

5,418 

 

 

(555)

 

 

 

5,418 

 

 

(555)

 

Agency mortgage-backed securities

 

8,900 

 

 

(35)

 

12 

 

 

5,998 

 

 

(44)

 

11 

 

 

14,898 

 

 

(79)

 

23 

Private-label mortgage-backed securities

 

310 

 

 

(7)

 

 

 

 -

 

 

 -

 

 -

 

 

310 

 

 

(7)

 

Asset-backed securities

 

 -

 

 

 -

 

 -

 

 

 

 

(2)

 

 

 

 

 

(2)

 

Total temporarily impaired securities

$

11,867 

 

$

(49)

 

18 

 

$

17,181 

 

$

(707)

 

32 

 

$

29,048 

 

$

(756)

 

50 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



December 31, 2015



Less than 12 months

 

12 months or more

 

Total



Fair

 

Unrealized

 

 

 

Fair

 

Unrealized

 

 

 

Fair

 

Unrealized

 

 

(Dollars in thousands)

Value

 

Losses

 

Count

 

Value

 

Losses

 

Count

 

Value

 

Losses

 

Count



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government and Agency securities

$

479 

 

$

(1)

 

 

$

4,364 

 

$

(32)

 

10 

 

$

4,843 

 

$

(33)

 

13 

Municipal securities

 

5,806 

 

 

(35)

 

 

 

4,785 

 

 

(183)

 

 

 

10,591 

 

 

(218)

 

15 

Trust preferred securities

 

 -

 

 

 -

 

 -

 

 

5,289 

 

 

(669)

 

 

 

5,289 

 

 

(669)

 

Agency mortgage-backed securities

 

18,977 

 

 

(215)

 

29 

 

 

7,394 

 

 

(171)

 

13 

 

 

26,371 

 

 

(386)

 

42 

Private-label mortgage-backed securities

 

 -

 

 

 -

 

 -

 

 

246 

 

 

(2)

 

 

 

246 

 

 

(2)

 

Asset-backed securities

 

 -

 

 

 -

 

 -

 

 

 

 

(2)

 

 

 

 

 

(2)

 

Total temporarily impaired securities

$

25,262 

 

$

(251)

 

40 

 

$

22,083 

 

$

(1,059)

 

39 

 

$

47,345 

 

$

(1,310)

 

79 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



The unrealized loss in the municipal bond portfolio decreased to $92 thousand from $218 thousand at December 31, 2015 as market prices improved during the quarter.  There are three securities in this portfolio with an unrealized loss and the loss in this portfolio is deemed to be non-credit related and no other-than-temporary impairment charges have been recorded.

The trust preferred portfolio contains seven securities with a fair value of $5.4 million and an unrealized loss of $555 thousand The trust-preferred securities held by the Bank are single entity issues, not pooled trust preferred securities.  Therefore, the impairment review of these securities is based only on the issuer and the security cannot be impaired by the performance of other issuers as if it was a pooled trust-preferred bond. All of the Bank’s trust preferred securities are single issue, variable rate notes with long maturities (2027 – 2028).  None of these bonds have suspended or missed a dividend payment. At September 30, 2016, the Bank believes it will be able to collect all interest and principal due on these bonds and no other-than-temporary-impairment charges were recorded. 

There is one PLMBS bond showing a small unrealized loss of $7 thousand.  However, the PLMBS sector as a whole is showing an unrealized gain of $50 thousand at quarter end.  This is primarily a result of the cumulative OTTI charges recorded on this portfolio.  Due to the nature of these bonds, they are evaluated closely. These bonds were all rated AAA at time of purchase, but have since experienced rating declines. Some have experienced increased delinquencies and defaults, while others have seen the credit support increase as the bonds paid-down. The Bank monitors the performance of the PLMBS investments on a regular basis and reviews delinquencies, default rates, credit support levels and various cash flow stress test scenarios. In determining the credit related loss, Management considers all principal past due 60 days or more as a loss. If additional principal moves beyond 60 days past due, it will also be considered a loss.  The Bank recorded a $30 thousand impairment charge during the first nine months of 2016 and has recorded $585 thousand of cumulative impairment charges on this portfolio. Management continues to monitor these securities and it is possible that additional write-downs may occur if current loss trends continue.

39

 


 

The Bank held $1.1 million of restricted stock at September 30, 2016.  Except for $30 thousand, this investment represents stock in FHLB Pittsburgh. The Bank is required to hold this stock to be a member of FHLB and it is carried at cost of $100 per share. The level of FHLB stock held is determined by FHLB and is comprised of a minimum membership amount plus a variable activity amount. FHLB stock is evaluated for impairment primarily based on an assessment of the ultimate recoverability of its cost. As a government sponsored entity, FHLB has the ability to raise funding through the U.S. Treasury that can be used to support its operations.  There is not a public market for FHLB stock and the benefits of FHLB membership (e.g., liquidity and low cost funding) add value to the stock beyond purely financial measures. Management intends to remain a member of the FHLB and believes that it will be able to fully recover the cost basis of this investment.



 Loans:    

Residential real estate:  This category is comprised of consumer purpose loans secured by residential real estate and to a lesser extent, commercial purpose loans secured by residential real estate.  The consumer purpose category represents traditional residential mortgage loans and home equity products (primarily junior liens and lines of credit). Commercial purpose loans in this category represent loans made for various business needs, but are secured with residential real estate. In addition to the real estate collateral, it is possible that additional security is provided by personal guarantees or UCC filings. These loans are underwritten as commercial loans and are not originated to be sold.

Total residential real estate loans increased $3.2 million over 2015, primarily in the commercial first lien and consumer junior liens and lines of credit categories due to a home equity special promotion in 2015 and 2016.  For the first nine months of 2016, the Bank originated $10.2 million in mortgages, including approximately $6.6 million for a fee through a third party brokerage agreement. The Bank does not originate or hold any loans that would be considered sub-prime or Alt-A, and does not generally originate mortgages outside of its primary market area.

Residential real estate construction:  The largest component of this category represents loans to residential real estate developers ($7.1 million), while loans for individuals to construct personal residences totaled $1.6 million at September 30, 2016.  The Bank’s exposure to residential construction loans is concentrated primarily in south central Pennsylvania.

Real estate construction loans, including residential real estate and land development loans, occasionally provide an interest reserve in order to assist the developer during the development stage when minimal cash flow is generated. All real estate construction loans are underwritten in the same manner, regardless of the use of an interest reserve. At September 30, 2016, the Bank had $7.3 million in residential real estate construction loans funded with an interest reserve and capitalized $93 thousand of interest from these reserves on active projects.  Real estate construction loans are monitored on a regular basis by either an independent third party inspector or the assigned loan officer depending on loan amount or complexity of the project. This monitoring process includes at a minimum, the submission of invoices and AIA documents of costs incurred by the borrower, on-site inspections, and a signature by the assigned loan officer for disbursement of funds.    

Commercial real estate (CRE): This category includes commercial, industrial, farm and agricultural loans, where real estate serves as the primary collateral for the loans. Total commercial real estate loans increased to $375.3 million from $340.7 million at the end of 2015, an increase of $34.6 million.  The increases were primarily in commercial construction and multi-family units. The largest sectors (by collateral) in the commercial real estate category are: office buildings ($57.7 million), hotels and motels ($45.7 million), land development ($42.9 million), apartment units ($37.3 million), and auto dealerships ($32.8 million). 

Commercial (C&I):  This category includes commercial, industrial, farm, agricultural, and municipal loans.  C&I loans increased $38.3 million to $254.3 million at September 30, 2016, compared to $215.9 million at the end of 2015, primarily in the municipal loan portfolio. The largest sectors (by industry) in the commercial loan category are: retail trade ($25.3 million), manufacturing ($15.8 million) and health care ($15.6 million).  At September 30, 2016, the Bank had $137.8 million in municipal loans. The Bank is very active in its market in pursuing commercial lending opportunities, but has historically supplemented in-market growth with purchased loan participations, when appropriate. The Bank purchases commercial loan participations in an effort to increase its commercial lending and diversify its loan mix, both geographically and by industry sector.  Purchased loans are originated primarily within the south central Pennsylvania market and are purchased from only a few select counter parties. For the first nine months of 2016, the Bank purchased $12.2 million of loan participations and commitments.  At September  30, 2016, the Bank held $132.0 million in purchased loan participations in its portfolio.    

Consumer loans decreased $381 thousand due primarily to regular payments and maturities. The majority of the Bank’s consumer loans, approximately $3.0 million, are personal lines of credit. The Bank believes the consumer portfolio will continue to decline.  



40

 


 

The following table presents a summary of loans outstanding, by primary collateral as of:





 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

Change

(Dollars in thousands)

September 30, 2016

 

December 31, 2015

 

 

Amount

 

%

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

Consumer first liens

$

99,571 

 

$

103,698 

 

$

(4,127)

 

(4.0)

Commercial first lien

 

63,515 

 

 

57,780 

 

 

5,735 

 

9.9 

Total first liens

 

163,086 

 

 

161,478 

 

 

1,608 

 

1.0 



 

 

 

 

 

 

 

 

 

 

Consumer junior liens and lines of credit

 

46,688 

 

 

44,996 

 

 

1,692 

 

3.8 

Commercial junior liens and lines of credit

 

5,837 

 

 

5,917 

 

 

(80)

 

(1.4)

Total junior liens and lines of credit

 

52,525 

 

 

50,913 

 

 

1,612 

 

3.2 

Total residential real estate 1-4 family

 

215,611 

 

 

212,391 

 

 

3,220 

 

1.5 



 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

 

 

 

 

 

 

 

 

Consumer

 

1,589 

 

 

545 

 

 

1,044 

 

191.6 

Commercial

 

7,067 

 

 

7,343 

 

 

(276)

 

(3.8)

Total residential real estate construction

 

8,656 

 

 

7,888 

 

 

768 

 

9.7 



 

 

 

 

 

 

 

 

 

 

Commercial real estate

 

375,316 

 

 

340,695 

 

 

34,621 

 

10.2 

Commercial

 

254,274 

 

 

215,942 

 

 

38,332 

 

17.8 

        Total commercial

 

629,590 

 

 

556,637 

 

 

72,953 

 

13.1 



 

 

 

 

 

 

 

 

 

 

Consumer

 

4,719 

 

 

5,100 

 

 

(381)

 

(7.5)



 

858,576 

 

 

782,016 

 

 

76,560 

 

9.8 

Less: Allowance for loan losses

 

(10,685)

 

 

(10,086)

 

 

(599)

 

5.9 

Net Loans

$

847,891 

 

$

771,930 

 

$

75,961 

 

9.8 



 

 

 

 

 

 

 

 

 

 

Loan Quality: 

Management utilizes a risk rating scale ranging from 1 (Prime) to 9 (Loss) to evaluate loan quality. This risk rating scale is used primarily for commercial purpose loans. Consumer purpose loans are identified as either a pass or substandard rating. Substandard consumer loans are loans that are 90 days or more past due and still accruing.  Loans rated 1 – 4 are considered pass credits. Loans that are rated 5 are pass credits, but have been identified as credits that are likely to warrant additional attention and monitoring. Loans rated 6 (Special Mention) or worse begin to receive enhanced monitoring and reporting by the Bank. Loans rated 7 (Substandard) or 8 (Doubtful) exhibit the greatest financial weakness and present the greatest possible risk of loss to the Bank. Nonaccrual loans are rated no better than 7.   The following factors represent some of the factors used in determining the risk rating of a borrower: cash flow, debt coverage, liquidity, management, and collateral. Risk ratings, for pass credits, are generally reviewed annually for term debt and at renewal for revolving or renewing debt. The Bank monitors loan quality by reviewing four measurements: (1) loans rated 6 or worse (collectively “watch list”), (2) delinquent loans, (3) other real estate owned (OREO), and (4) net-charge-offs. Management compares trends in these measurements with the Bank’s internally established targets, as well as its national peer group.

Watch list loans exhibit financial weaknesses that increase the potential risk of default or loss to the Bank. However, inclusion on the watch list, does not by itself, mean a loss is certain. The watch list totaled $23.1 million at quarter end and includes both performing and nonperforming loans.  It is comprised of $4.4 million rated 6 and $18.7 million rated 7. The Bank has no loans rated 8-doubtful or 9-loss. The watch list totaled $27.3 million at June 30, 2016 and $27.9 million at the prior year-end. The decrease in the watch list from year-end, and the prior quarter  is due primarily to a $5.6 million credit (year-end balance) that was partially charged-off in 2016 and sold during the third quarter of 2016 (see the Allowance for Loan Losses discussion).  The credit composition of the portfolio, by primary collateral is shown in Note 7 of the accompanying financial statements. The Bank’s Loan Management Committee reviews these loans and risk ratings on a quarterly basis in order to proactively identify and manage problem loans. In addition, a committee meets monthly to discuss possible workout strategies for OREO and all credits rated 7 or worse. Management also tracks other commercial loan risk measurements including high loan to value loans, concentrations, participations and policy exceptions and reports these to the Credit Risk Oversight Committee of the Board of Directors. The Bank also uses a third-party consultant to assist with internal loan review with a goal of reviewing 60% of commercial loans each year. The FDIC defines certain supervisory loan-to-value lending limits.  The Bank’s internal loan–to-value limits are all equal to, or have

41

 


 

a lower loan-to-value limit, than the supervisory limits.  At September 30, 2016, the Bank had loans of $18.5 million that exceeded the supervisory limit.

Delinquent loans are a result of borrowers’ cash flow and/or alternative sources of cash being insufficient to repay loans.  The Bank’s likelihood of collateral liquidation to repay the loans becomes more probable the further behind a borrower falls, particularly when loans reach 90 days or more past due. Management monitors the performance status of loans by the use of an aging report. The aging report can provide an early indicator of loans that may become severely delinquent and possibly result in a loss to the Bank.  See Note 6 in the accompanying financial statements for a note that presents the aging of payments in the loan portfolio.

Nonaccruing loans generally represent Management’s determination that the borrower will be unable to repay the loan in accordance with its contractual terms and that collateral liquidation may or may not fully repay both interest and principal. It is the Bank’s policy to evaluate the probable collectability of principal and interest due under terms of loan contracts for all loans 90-days or more, nonaccrual loans, or impaired loans. Further, it is the Bank’s policy to discontinue accruing interest on loans that are not adequately secured and in the process of collection.  Upon determination of nonaccrual status, the Bank subtracts any current year accrued and unpaid interest from its income, and any prior year accrued and unpaid interest from the allowance for loan losses.  Management continually monitors the status of nonperforming loans, the value of any collateral and potential of risk of loss.  Nonaccrual loans are rated no better than 7 (Substandard).

42

 


 

Loan quality, as measured by the balance of nonperforming loans, has declined from year-end.  The following table presents a summary of nonperforming assets:



 

 

 

 

 



 

 

 

 

 



 

 

 

 

 

(Dollars in thousands)

September 30, 2016

 

December 31, 2015



 

 

 

 

 

Nonaccrual loans

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

First liens

$

422 

 

$

806 

Junior liens and lines of credit

 

96 

 

 

105 

Total

 

518 

 

 

911 

Residential real estate - construction

 

545 

 

 

502 

Commercial real estate

 

4,156 

 

 

3,681 

Commercial

 

24 

 

 

276 

Total nonaccrual loans

 

5,243 

 

 

5,370 



 

 

 

 

 

Loans past due 90 days or more and not included above

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

First liens

 

38 

 

 

214 

Junior liens and lines of credit

 

61 

 

 

 -

Total

 

99 

 

 

214 

Residential real estate - construction

 

 -

 

 

 -

Commercial real estate

 

568 

 

 

152 

Commercial

 

26 

 

 

 -

Consumer

 

 -

 

 

Total loans past due 90 days or more and still accruing

 

693 

 

 

368 



 

 

 

 

 

Total nonperforming loans

 

5,936 

 

 

5,738 



 

 

 

 

 

Other real estate owned

 

5,872 

 

 

6,451 

Total nonperforming assets

$

11,808 

 

$

12,189 



 

 

 

 

 



 

 

 

 

 

Nonperforming loans to total gross loans

 

0.69% 

 

 

0.73% 

Nonperforming assets to total assets

 

1.07% 

 

 

1.18% 

Allowance for loan losses to nonperforming loans

 

180.00% 

 

 

175.78% 



43

 


 

The following table identifies the most significant loans in nonaccrual status. These three nonaccrual loans account for 80% of the total nonaccrual balance. The table also indicates those significant nonaccrual loans that are classified as troubled debt restructurings (TDR). A TDR loan is maintained on nonaccrual status until a satisfactory repayment history is established.  All loans on the watch list that are not on nonaccrual or past due 90 days more are considered potential problem loans. Potential problem loans at September 30, 2016 totaled $17.1 million compared to $22.1 million at year-end 2015.



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

ALL

 

Nonaccrual

 

TDR

 

 

 

 

 

Last

(Dollars in thousands)

 

Balance

 

 

Reserve

 

Date

 

Status

 

Collateral

 

Location

 

Appraisal(1)



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit 1 - Residential real estate

 

1,755 

 

 

 -

 

Mar-12

 

Y

 

1st and 2nd liens on commercial real estate, residential real estate and business assets

 

PA

 

Jan-16

$

3,810 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit 2 - Commercial real estate

 

1,138 

 

 

 -

 

Dec-14

 

N

 

Hotel and entertainment complex

 

PA

 

Apr-16

$

4,200 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit 3 - Agricultural

 

1,281 

 

 

 -

 

Sep-16

 

Y

 

1st lien on farmland

 

PA

 

Jul-14

$

2,391 



$

4,174 

 

$

 -

 

 

 

 

 

 

 

 

 

 

 

 



(1) Appraisal value, as reported, does not reflect the pay-off of any senior liens or the cost to liquidate the collateral, but does reflect only the Bank’s share of the collateral if it is a participated loan.

Credit 1 is a TDR that is performing in accordance with the modified terms. Credit 2 is a hotel and entertainment complex being operated as part of an estate liquidation and is currently listed for sale. Credit 3is a new nonaccrual loan as a result of a TDR default.

In addition to monitoring nonaccrual loans, the Bank also closely monitors impaired loans and troubled debt restructurings (TDR).  A loan is considered to be impaired when, based on current information and events, it is probable that the Bank will be unable to collect all interest and principal payments due according to the originally contracted terms of the loan agreement.  Nonaccrual loans and TDR loans are always considered impaired. For impaired commercial loans with balances less than $250 thousand and all consumer purpose loans, a specific reserve analysis is not performed and these loans are added to the general allocation pool. In accordance with financial accounting standards, TDR loans are always considered impaired until they are paid off.  However, an impaired TDR loan can be a performing loan. Impaired loans totaled $15.7 million at quarter-end compared to $16.8 million at year-end 2015.

A loan is considered a troubled debt restructuring (TDR) if the creditor (the Bank), for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. These concessions may include lowering the rate, extending the maturity, reamortization of the payment, or a combination of multiple concessions.   The Bank reviews all loans rated 6 or worse when it is providing a loan restructure, modification or new credit facility to determine if the action is a TDR.  If a TDR loan is placed on nonaccrual status, it remains on nonaccrual status for at least six months to ensure performance. All TDR loans are in compliance with their modified terms. See Note 6 in the accompanying financial statements for information on TDR loans in the portfolio.

44

 


 

The following table shows the composition of impaired loans as of:





 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 



 

September 30, 2016

(Dollars in thousands)

 

Nonaccrual

 

Accruing

 

Total



 

Non-TDR

 

TDR

 

TDR

 

Impaired

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

271 

 

$

151 

 

$

728 

 

$

1,150 

Junior liens and lines of credit

 

 

96 

 

 

 -

 

 

 -

 

 

96 

Total

 

 

367 

 

 

151 

 

 

728 

 

 

1,246 

Residential real estate - construction

 

 

59 

 

 

486 

 

 

 -

 

 

545 

Commercial real estate

 

 

1,604 

 

 

2,551 

 

 

9,660 

 

 

13,815 

Commercial

 

 

24 

 

 

 -

 

 

 -

 

 

24 

Total

 

$

2,054 

 

$

3,188 

 

$

10,388 

 

$

15,630 



 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

Allowance for Loan Losses: 

Management performs a quarterly evaluation of the adequacy of the allowance for loan losses (ALL). The ALL is determined by segmenting the loan portfolio based on the loan’s collateral. The Bank further classifies the portfolio based on the primary purpose of the loan, either consumer or commercial.  When calculating the ALL, consideration is given to a variety of factors in establishing this estimate including, but not limited to, current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, historical charge-offs, the adequacy of the underlying collateral (if collateral dependent) and other relevant factors. The Bank begins enhanced monitoring of all loans rated 6 (OAEM) or worse, and obtains a new appraisal or asset valuation for any loan rated 7 (substandard) or worse. Management, at its discretion, may determine that additional adjustments to the appraisal or valuation are required.  Valuation adjustments will be made as necessary based on factors, including, but not limited to: the economy, deferred maintenance, industry, type of property/equipment, age of the appraisal, etc. and the knowledge Management has about a particular situation. In addition, the cost to sell or liquidate the collateral is also estimated and deducted from the valuation in order to determine the net realizable value to the Bank. When determining the allowance for loan losses, certain factors involved in the evaluation are inherently subjective and require material estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans. Management monitors the adequacy of the allowance for loan losses on an ongoing basis and reports its adequacy quarterly to the Credit Risk Oversight Committee of the Board of Directors.  Management believes that the allowance for loan losses at September 30, 2016 is adequate.

The analysis for determining the ALL is consistent with guidance set forth in generally accepted accounting principles (GAAP) and the Interagency Policy Statement on the Allowance for Loan and Lease Losses. The analysis has two components, specific and general allocations. The specific component addresses specific reserves established for impaired loans. A loan is considered to be impaired when, based on current information and events, it is probable that the Bank will be unable to collect all interest and principal payments due according to the originally contracted terms of the loan agreement.  Collateral values discounted for market conditions and selling costs are used to establish specific allocations for impaired loans. It is possible that as a result of the credit analysis, a specific reserve is not required for an impaired loan. For impaired commercial loans with balances less than $250 thousand and all consumer purpose loans, a specific reserve analysis is not performed and these loans are added to the general allocation pool. At September 30, 2016, impaired loans totaled $15.7 million compared to $16.8 million at year-end 2015.  The Bank does not have a specific reserve established for any of its impaired loans. At year-end 2015, the Bank had one impaired loan with a specific reserve of $9 thousand that paid-off during the first quarter of 2016. Note 6 in the accompanying financial statements provide additional information about the ALL established for impaired loans.

The general allocation component addresses the reserves established for pools of homogenous loans. The general component includes a quantitative and qualitative analysis. When calculating the general allocation, the Bank segregates its loan portfolio into the following sectors based primarily on the type of supporting collateral:  residential real estate, commercial, industrial or agricultural real estate; commercial and industrial (C&I non-real estate), and consumer.  The residential real estate sector is further segregated by first lien loans, junior liens and home equity products, and residential real estate construction. The quantitative analysis uses the Bank’s twenty quarter rolling historical loan loss experience adjusted for factors derived from current economic and market conditions that have been determined to have an effect on the probability and magnitude of a loss. Prior to 2015, the Bank was using an eight quarter rolling history for the quantitative analysis. The change to a longer historical period is based upon improving charge-offs and a more stable and slowly improving economy.   As credit quality improved the Bank began to see lower charge-offs.  The Bank believes that

45

 


 

an eight quarter historical period presented the loss history during a very favorable period and it may not accurately reflect historical trends.  It believes that a twenty quarter period covers a longer economic cycle and more accurately reflects its loss history and therefore is a more appropriate factor for calculating the general reserve in the current environment.  The historical loss experience factor for the general allocation was 1.02% of gross loans ($8.8 million) at September 30, 2016 compared to 1.07% and $8.4 million at the prior year-end.  Included in the general loan loss reserve is an unallocated reserve of $1.3 million, unchanged from December 31, 2015.

The qualitative analysis utilizes a risk matrix that incorporates qualitative and environmental factors such as: loan volume, management, loan review process, credit concentrations, competition, and legal and regulatory issues. These factors are each risk rated from minimal to high risk and in total can add up to a maximum qualitative factor of 37.5 basis points. At quarter-end, this factor was 22.5 basis points compared to 21.5 at year-end 2015.  These factors are determined on the basis of Management’s observation, judgment and experience. 

Real estate appraisals and collateral valuations are an important part of the Bank’s process for determining potential loss on collateral dependent loans and thereby have a direct effect on the determination of loan reserves, charge-offs and the calculation of the allowance for loan losses.  As long as the loan remains a performing loan, no further updates to appraisals are required. If a loan or relationship migrates to risk rating of 7 or worse, an evaluation for impairment status is made based on the current information available at the time of downgrade and a new appraisal or collateral valuation is obtained.

In determining the allowance for loan losses, Management, at its discretion, may determine that additional adjustments to the fair value obtained from an appraisal or collateral valuation are required. Adjustments will be made as necessary based on factors, including, but not limited to the economy, deferred maintenance, industry, type of property or equipment etc., and the knowledge Management has about a particular situation. In addition, the cost to sell or liquidate the collateral is also estimated and deducted from the valuation in order to determine the net realizable value to the Bank. If an appraisal is not available, Management may make its best estimate of the real value of the collateral or use last known market value and apply appropriate discounts.  If an adjustment is made to the collateral valuation, this will be documented with appropriate support and reported to the Loan Management Committee.

46

 


 

The following table shows the loans that were evaluated for the allowance for loan losses under a specific reserve (individually) and those that were evaluated under a general reserve (collectively), and the amount of the allowance established in each loan class as of September 30, 2016 and December 31, 2015:



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

Junior Liens &

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

First Liens

 

Lines of Credit

 

Construction

 

Real Estate

 

Commercial

 

Consumer

 

Unallocated

 

Total



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for ALL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

632 

 

$

52 

 

$

545 

 

$

13,815 

 

$

 -

 

$

 -

 

$

 -

 

$

15,044 

Collectively

 

 

162,454 

 

 

52,473 

 

 

8,111 

 

 

361,501 

 

 

254,274 

 

 

4,719 

 

 

 -

 

 

843,532 

Total

 

$

163,086 

 

$

52,525 

 

$

8,656 

 

$

375,316 

 

$

254,274 

 

$

4,719 

 

$

 -

 

$

858,576 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL established for loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

Collectively

 

 

1,021 

 

 

320 

 

 

213 

 

 

6,045 

 

 

1,735 

 

 

98 

 

 

1,253 

 

 

10,685 

ALL at September 30, 2016

 

$

1,021 

 

$

320 

 

$

213 

 

$

6,045 

 

$

1,735 

 

$

98 

 

$

1,253 

 

$

10,685 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for ALL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

930 

 

$

51 

 

$

502 

 

$

14,309 

 

$

230 

 

$

 -

 

$

 -

 

$

16,022 

Collectively

 

 

160,548 

 

 

50,862 

 

 

7,386 

 

 

326,386 

 

 

215,712 

 

 

5,100 

 

 

 -

 

 

765,994 

Total

 

$

161,478 

 

$

50,913 

 

$

7,888 

 

$

340,695 

 

$

215,942 

 

$

5,100 

 

$

 -

 

$

782,016 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL established for loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 

$

 -

 

$

 -

 

$

Collectively

 

 

989 

 

 

308 

 

 

194 

 

 

5,649 

 

 

1,510 

 

 

102 

 

 

1,325 

 

 

10,077 

ALL at December 31, 2015

 

$

989 

 

$

308 

 

$

194 

 

$

5,649 

 

$

1,519 

 

$

102 

 

$

1,325 

 

$

10,086 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

During the first nine months of 2016, the Bank recorded $3.3 million for the loan loss provision expense compared to $1.0 thousand during the prior year.  Charged-off loans usually result from: (1) a borrower being legally relieved of loan repayment responsibility through bankruptcy, (2) insufficient collateral sale proceeds to repay a loan; or (3) the borrower and/or guarantor does not own other assets that, if sold, would generate sufficient sale proceeds to repay a loan. The Bank recorded net loan charge-offs of $2.7 million for the first nine months of 2016.

At December 31, 2015, Special Mention loans included a $5.4 million commercial real estate loan. The loan represented the Bank’s portion of a participated loan transaction where the Bank was not the lead lenderThe Bank placed the loan on nonaccrual at March 31, 2016 with a specific loan loss reserve of $74 thousand. The reserve was determined using a September 2015 property appraisal obtained by the lead bank that showed a collateral value in excess of $19.0 million. Based on its ownership percentage, the Bank discounted the appraised value by 30% plus costs, to calculate its specific loan loss reserve. The bank group subsequently negotiated a forbearance agreement with the borrower that required the sale of the property.  A specialty broker was engaged by the lead bank to provide an opinion of value and to sell the property. The broker’s opinion of value was less than half the September 2015 appraised value. Due to the significant decline in value since the 2015 appraisal, the Bank raised questions about the broker’s valuation with the bank group.   Despite objections raised by the Bank, the lead bank listed the property at a price consistent with the broker’s valuation.  This decision resulted in a $1.9 million charge-off on this credit during the second quarter of 2016.  During the third quarter of 2016, the bank group agreed to sell the loan and this decision resulted in an additional $759 thousand charge-off.  Overall, the total charge-off on this credit, $2.7 million, accounted for 91% of the total gross charge-offs of $3.0 million in 2016. 

47

 


 

The following table presents an analysis of the allowance for loan losses for the periods ended:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

Junior Liens &

 

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

First Liens

 

Lines of Credit

 

Construction

 

Real Estate

 

Commercial

 

Consumer

 

Unallocated

 

Total



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at June 30, 2016

 

$

1,023 

 

$

319 

 

$

205 

 

$

5,940 

 

$

1,596 

 

$

97 

 

$

1,138 

 

$

10,318 

Charge-offs

 

 

 -

 

 

 -

 

 

 -

 

 

(776)

 

 

 -

 

 

(42)

 

 

 -

 

 

(818)

Recoveries

 

 

 

 

 -

 

 

 -

 

 

 

 

 

 

22 

 

 

 -

 

 

35 

Provision

 

 

(3)

 

 

 

 

 

 

876 

 

 

132 

 

 

21 

 

 

115 

 

 

1,150 

ALL at September 30, 2016

 

$

1,021 

 

$

320 

 

$

213 

 

$

6,045 

 

$

1,735 

 

$

98 

 

$

1,253 

 

$

10,685 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at December 31, 2015

 

$

989 

 

$

308 

 

$

194 

 

$

5,649 

 

$

1,519 

 

$

102 

 

$

1,325 

 

$

10,086 

Charge-offs

 

 

(49)

 

 

 -

 

 

 -

 

 

(2,730)

 

 

(66)

 

 

(126)

 

 

 -

 

 

(2,971)

Recoveries

 

 

34 

 

 

 -

 

 

 -

 

 

18 

 

 

129 

 

 

64 

 

 

 -

 

 

245 

Provision

 

 

47 

 

 

12 

 

 

19 

 

 

3,108 

 

 

153 

 

 

58 

 

 

(72)

 

 

3,325 

ALL at September 30, 2016

 

$

1,021 

 

$

320 

 

$

213 

 

$

6,045 

 

$

1,735 

 

$

98 

 

$

1,253 

 

$

10,685 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 







Other Real Estate Owned: 

The Bank holds $5.8 million of other real estate owned (OREO), comprised of four properties compared to $6.5 million and seven properties at December 31, 2015.  The most significant OREO holdings are listed in the table below. Property 1 was part of a participated loan and the workout is being handled by the lead bank.  In early May 2016, an agreement of sale was executed.  The agreement allows for a lengthy due diligence and approval process prior to settlement.  Therefore, the final outcome is not certain.  Property 2 was part of a participated loan and the workout is being handled by the lead bank.  During 2016, the Bank sold five properties for a loss of $31 thousand, recorded a write down of $46 thousand on one property and incurred expense of $47 thousand to hold and maintain OREO. Note 7 of the accompanying financial statements provides additional information on activity in OREO.

The following table provides additional information on significant other real estate owned properties:









 

 

 

 

 

 

September 30, 2016



 

 

 

 

 

 

(Dollars in thousands)

Date

 

 

 

 

 



Acquired

 

Balance

 

Collateral

Location



 

 

 

 

 

 

Property 1

2012

 

2,508 

 

1st, 2nd, and 3rd liens residential development land - four tracts with 196 acres

PA



 

 

 

 

 

 

Property 2

2015

 

3,039 

 

1st lien on 90 acres undeveloped commercial real estate

PA



 

$

5,547 

 

 

 



 

 

 

 

 

 

At September 30, 2016, the Bank had $349 thousand of residential properties in the process of foreclosure compared to $218 thousand at the end of 2015.

48

 


 

Deposits: 

Total deposits increased $60.0 million during the first nine months of 2016 to $978.6 million. Non-interest bearing deposits increased $22.3 million, while savings and interest-bearing checking increased $46.2 million and time deposits decreased $8.4 million. The increase in non-interest bearing checking accounts occurred primarily in state/municipal accounts ($11.4 million) and small business checking accounts ($10.6 million).  Interest bearing checking increased by $13.1 million, primarily from commercial deposits.  The Bank’s Money Management product increased $26.9 million, primarily from state/municipal deposits.    Retail time deposits decreased since year-end, as customers moved funds to more liquid accounts.  As of September  30, 2016, the Bank had $3.3 million in CDARS reciprocal time deposits included in brokered time deposits.  



 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

Change

(Dollars in thousands)

September 30, 2016

 

December 31, 2015

 

 

Amount

 

%

Noninterest-bearing checking

$

174,390 

 

$

152,095 

 

$

22,295 

 

14.7 



 

 

 

 

 

 

 

 

 

 

Interest-bearing checking

 

245,310 

 

 

232,181 

 

 

13,129 

 

5.7 

Money management

 

406,262 

 

 

379,331 

 

 

26,931 

 

7.1 

Savings

 

75,273 

 

 

69,174 

 

 

6,099 

 

8.8 

Total interest-bearing checking and savings

 

726,845 

 

 

680,686 

 

 

46,159 

 

6.8 



 

 

 

 

 

 

 

 

 

 

Retail time deposits

 

74,049 

 

 

82,468 

 

 

(8,419)

 

(10.2)

Brokered time deposits

 

3,268 

 

 

3,263 

 

 

 

0.2 

Total time deposits

 

77,317 

 

 

85,731 

 

 

(8,414)

 

(9.8)

Total deposits

$

978,552 

 

$

918,512 

 

$

60,040 

 

6.5 



 

 

 

 

 

 

 

 

 

 

Overdrawn deposit accounts reclassified as loans

$

133 

 

$

128 

 

 

 

 

 



Borrowings:

The Corporation had short-term borrowings of $8.5 million at September 30, 2016 and no borrowings at September 30, 2015. 

Shareholders’ Equity:

Total shareholders’ equity increased $5.5 million to $116.9 million at September  30, 2016, compared to $111.4 million at the end of 2015.  The increase in retained earnings from the Corporation’s net income of $6.4 million was partially offset by the cash dividend of $2.6 million. The Corporation’s dividend payout ratio is 41.1% for the first nine months of 2016 compared to 29.4% in 2015.  

As part of its quarterly dividend decision, the Corporation considers current and future income projections, dividend yield, payout ratio, and current and future capital ratios. Year-to-date, the Corporation paid dividends of $0.61 per share, compared to $0.55 for the same period in 2015,  a 10.9% increase.  For the third quarter of 2016, the Corporation paid a $0.21 per share dividend, compared to $0.19 paid in the third quarter of 2015.  On October 13, 2016 the Board of Directors declared a $0.21 per share regular quarterly dividend for the fourth quarter of 2016, which will be paid on November 23, 2016.

In addition, the Corporation considers how dividend decisions may affect the Dividend Reinvestment Plan (DRIP), which has raised $1.1 million in new capital this year with 49,401 new shares purchased.  On April 14, 2016, the Board of Directors approved a stock repurchase program that authorizes the repurchase of up to $350,000 in shares of common stock during each calendar quarter through March 31, 2017. In 2016, the Corporation repurchased 30,196 shares of its common stock for $700 thousand.

49

 


 

In July 2013, Federal banking regulators approved the final rules from the Basel Committee on Banking Supervision for the regulation of capital requirements for bank holding companies and U.S banks, generally referred to as “Basel III.” The Basel III standards were effective for the Corporation and the Bank, effective January 1, 2015 (subject to a phase-in period for certain provisions).  Basel III imposes significantly higher capital requirements and more restrictive leverage and liquidity ratios than those previously in place.  The capital ratios to be considered “well capitalized” under Basel III are: (1) Common Equity Tier 1(CET1) of 6.5%, (2) Tier 1 Leverage of 5%, (3)Tier 1 Risk-Based Capital of 8%, and (4) Total Risk-Based Capital of 10%.  The CET1 ratio is a new capital ratio under Basel III and the Tier 1 risk-based capital ratio of 8% has been increased from 6%. The rules also include changes in the risk weights of certain assets to better reflect credit and other risk exposures. In addition, a capital conservation buffer will be phased-in beginning January 1, 2016 at 0.625%, increasing each year until fully implemented in 2019 at 2.5% above the minimum capital ratios required to avoid any capital distribution restrictions. The capital conservation buffer will be applicable to all of the capital ratios except for the Tier1 Leverage ratio. When fully implemented, the capital conservation buffer will have the effect of increasing the minimum capital ratios by 2.5%.  As of September 30, 2016, the Bank was “well capitalized’ under the Basel III requirements and believes it would be “well capitalized” on a fully-phased in basis had such a requirement been in effect.

The following table summarizes regulatory capital information as of September  30, 2016 and December 31, 2015 (restated) for the Corporation and the BankThe adequately capitalized minimum ratios, except for the Tier 1 Leverage Ratio, include the 0.625% Capital Conservation buffer effective for 2016.





 

 

 

 

 

 

 

 



 

 

 

 

 

Regulatory Ratios



 

 

 

 

 

Adequately

 

Well



 

 

 

 

 

Capitalized

 

Capitalized

(Dollars in thousands)

 

September 30, 2016

 

December 31, 2015

 

Minimum

 

Minimum



 

 

 

 

 

 

 

 

Common Equity Tier 1 Risk-based Capital Ratio (1)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

14.60% 

 

14.77% 

 

5.125% 

 

N/A

Farmers & Merchants Trust Company

 

14.53% 

 

14.76% 

 

5.125% 

 

6.50% 



 

 

 

 

 

 

 

 

Tier 1 Risk-based Capital Ratio (2)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

14.60% 

 

14.77% 

 

6.625% 

 

N/A

Farmers & Merchants Trust Company

 

14.53% 

 

14.76% 

 

6.625% 

 

8.00% 



 

 

 

 

 

 

 

 

Total Risk-based Capital Ratio (3)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

15.86% 

 

16.03% 

 

8.625% 

 

N/A

Farmers & Merchants Trust Company

 

15.79% 

 

16.02% 

 

8.625% 

 

10.00% 



 

 

 

 

 

 

 

 

Tier 1 Leverage Ratio (4)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

10.07% 

 

10.38% 

 

4.000% 

 

N/A

Farmers & Merchants Trust Company

 

10.03% 

 

10.37% 

 

4.000% 

 

5.00% 



 

 

 

 

 

 

 

 

(1) Common equity Tier 1 capital/ total risk-weighted assets (2) Tier 1 capital / total risk-weighted assets

(3) Total risk-based capital / total risk-weighted assets, (4) Tier 1 capital / average quarterly assets



Economy 

The Corporation’s primary market area includes Franklin, Fulton, Cumberland and Huntingdon County, PA.  This area is diverse in demographic and economic makeup.  County populations range from a low of approximately 15,000 in Fulton County to over 238,000 in Cumberland County. Unemployment in the Bank’s market area has remained virtually unchanged over the past year and ranges from a low of 4.7% in Cumberland County to high of 7.1% in Huntingdon County.  The market area has a diverse economic base and local industries include warehousing, truck & rail shipping centers, light and heavy manufacturers, health-care, higher education institutions, farming and agriculture, and a varied service sector.  The Corporation’s primary market area is located in south central Pennsylvania and provides easy access to the major metropolitan markets on the east coast via trucking and rail transportation. Because of this, warehousing and distribution companies continue to find the area attractive. The local economy is not overly dependent on any one industry

50

 


 

or business and Management believes that the Bank’s primary market area continues to be well suited for growth as the recession eases.

The following provides selected economic data for the Bank’s primary market:

Economic Data





 

 

 

 



 

 

 

 



 

 



 

September 30, 2016

 

December 31, 2015

Unemployment Rate (seasonally adjusted)

 

 

 

 

Market area range (1)

 

4.7% - 7.1%

 

3.5 - 5.5%

Pennsylvania

 

5.2% 

 

5.0% 

United States

 

4.9% 

 

5.0% 



 

 

 

 

Housing Price Index - year over year change

 

 

 

 

PA, nonmetropolitan statistical area

 

2.7% 

 

2.0% 

United States

 

5.6% 

 

5.6% 



 

 

 

 

Franklin County Building Permits - year over year change

 

 

 

 

Residential, estimated

 

7.4% 

 

-15.6%

Multifamily, estimated

 

10.5% 

 

-65.0%



 

 

 

 

(1) Franklin, Cumberland, Fulton and Huntingdon Counties

 

 

 



Unlike many companies, the assets and liabilities of the Corporation are financial in nature. As such, interest rates and changes in interest rates may have a more significant effect on the Corporation’s financial results than on other types of industries. Because of this, the Corporation watches the actions of the Federal Reserve Open Market Committee (FOMC) as it makes decisions about interest rate changes. The FOMC continues to hold short-term rates at historic lows.  It continues to monitor employment and inflation data as it considers the timing of an increase in the Fed Funds rate. 

Liquidity

The Corporation must meet the financial needs of the customers that it serves, while providing a satisfactory return on the shareholders’ investment.  In order to accomplish this, the Corporation must maintain sufficient liquidity in order to respond quickly to the changing level of funds required for both loan and deposit activity.  The goal of liquidity management is to meet the ongoing cash flow requirements of depositors who want to withdraw funds and of borrowers who request loan disbursements. The Bank regularly reviews it liquidity position by measuring its projected net cash flows (in and out) at a 30 and 90-day interval.  The Bank stresses this measurement by assuming a level of deposit out-flows that have not historically been realized. In addition to this forecast, other funding sources are reviewed as a method to provide emergency funding if necessary.  The objective of this measurement is to identify the amount of cash that could be raised quickly without the need to liquidate assets.  The Bank also stresses its liquidity position utilizing different longer-term scenarios.  The varying degrees of stress create pressure on deposit flows in its local market, reduce access to wholesale funding and limit access of funds available through brokered deposit channels. In addition to stressing cash flow, specific liquidity risk indicators are monitored to help identify risk areas.  This analysis will help identify and quantify the potential cash surplus/deficit over a variety of time horizons to ensure the Bank has adequate funding resources.  Assumptions used for liquidity stress testing are subjective.  Should an evolving liquidity situation or business cycle present new data, potential assumption changes will be considered.  The Bank believes it can meet all anticipated liquidity demands.

Historically, the Corporation has satisfied its liquidity needs from earnings, repayment of loans and amortizing investment securities, maturing investment securities, loan` sales, deposit growth and its ability to access existing lines of credit.  All investment securities are classified as available for sale; therefore, securities that are not pledged as collateral for borrowings are an additional source of readily available liquidity, either by selling the security or, more preferably, to provide collateral for additional borrowing. At September 30, 2016, the Bank had approximately $86.0 million (fair value) in its investment portfolio pledged as collateral for deposits.  Another source of available liquidity for the Bank is a line of credit with the FHLB.  At September  30, 2016, the Bank had approximately $130 million available on this line of credit and $6.0 million of unsecured lines of credit at a correspondent bank. At  September 30, 2016, the Bank had an excess borrowing capacity at FHLB of $266.7 million, which includes the amount available on the line of credit.  The Bank has

51

 


 

established credit at the Federal Reserve Discount Window and as of quarter-end had the ability to borrow approximately $23 million. 



Off Balance Sheet Commitments

The Corporation’s financial statements do not reflect various commitments that are made in the normal course of business, which may involve some liquidity risk.  These commitments consist mainly of unfunded loans and letters of credit made under the same standards as on-balance sheet instruments.  Because these instruments have fixed maturity dates, and because many of them will expire without being drawn upon, they do not generally present any significant liquidity risk to the Corporation.  Unused commitments and standby letters of credit totaled $299.1 million and $291.4 million, respectively, at September  30, 2016 and December 31, 2015.

The Corporation has entered into various contractual obligations to make future payments.  These obligations include time deposits, long-term debt, operating leases, deferred compensation and pension payments.  These amounts have not changed materially from those reported in the Corporation’s 2015 Annual Report on Form 10-K.

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

There were no material changes in the Corporation’s exposure to market risk during the nine months ended September  30, 2016. For more information on market risk refer to the Corporation’s 2015 Annual Report on Form 10-K.



Item 4.  Controls and Procedures

Evaluation of Controls and Procedures

The Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon the evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer concluded that as of September  30, 2016, the Corporation’s disclosure controls and procedures are effective. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in the Corporation’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. There were no changes in the Corporation’s internal control over financial reporting during the quarterly period ended September  30, 2016, that have materially affected, or are reasonably likely to materially affect, the internal control over financial reporting.

The management of the Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. The Corporation’s internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

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

52

 


 



Part II – OTHER INFORMATION

Item 1.     Legal Proceedings

The nature of the Corporation’s business generates a certain amount of litigation involving matters arising in the ordinary course of business, including the matter disclosed in our Form 8-K filed July 29, 2016.  In management’s opinion, we do not anticipate, at the present time, that the ultimate aggregate liability, if any, arising out of such litigation will have a material adverse effect on our financial position.  We cannot now determine, however, whether or not any claims asserted against us, including the disclosed matter, will have a material adverse effect on our results of operations in any future reporting period, which will depend on, among other things, the amount of loss resulting from the claim and the amount of income otherwise reported for the reporting period. In addition, no material proceedings are pending or are known to be threatened or contemplated against us by governmental authorities.

Item 1A. Risk Factors 

There were no material changes in the Corporation’s risk factors during the nine months ended September 30, 2016. For more information, refer to the Corporation’s 2015 Annual Report on Form 10-K.

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

The Board of Directors approved a stock repurchase plan on April 14, 2016 that authorizes the repurchase of up to $350,000 in shares of common stock during each calendar quarter through March 31, 2017. 

As of September 30, 2016, 30,196 shares have been purchased under this plan.  The following table reports stock repurchases made during the 2016 and total shares repurchased under this plan:





 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands, except per share)

 

 

Weighted

 

 

Dollar Amount of

 

 

Dollar Amount of



 

 

 

 

Average

 

 

Shares Purchased

 

 

Shares that May



 

Number of

 

 

Price Paid

 

 

as Part of Publically

 

 

Yet Be Purchased

Period

 

Shares Purchased

 

 

per Share

 

 

Announced Program

 

 

Under Program



 

 

 

 

 

 

 

 

 

 

 

April 2016

 

15,521 

 

$

22.55 

 

$

350 

 

$

1,050 

August 2016

 

14,675 

 

 

23.80 

 

 

350 

 

 

700 



 

30,196 

 

$

23.16 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



Item 3.   Defaults by the Company on its Senior Securities

None

Item 4.   Mine Safety Disclosures

Not Applicable

Item 5.   Other Information

None

Item 6.   Exhibits 

Exhibits

3.1   Articles of Incorporation of the Corporation.  (Filed as Exhibit 3.1 to Annual Report on Form 10-K for the year ended December 31, 2015 and incorporated herein by reference.)

3.2   Bylaws of the Corporation. (Filed as Exhibit 99 to Current Report on Form 8-K filed on December 20, 2014 and incorporated herein by reference.)

31.1 Rule 13a – 14(a)/15d-14(a) Certifications – Principal Executive Officer

31.2 Rule 13a – 14(a)/15d-14(a) Certifications – Principal Financial Officer

32.1 Section 1350 Certifications – Principal Executive Officer

32.2 Section 1350 Certifications – Principal Financial Officer

101 Interactive Data File (XBRL)

53

 


 

FRANKLIN FINANCIAL SERVICES CORPORATION

and SUBSIDIARIES



SIGNATURES



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



Franklin Financial Services Corporation





 

 



 

 

      November 7, 2016

 

/s/ Timothy G. Henry



 

Timothy G. Henry



 

Chief Executive Office and President



 

(Principal Executive Officer)



 

 

November 7, 2016

 

/s/ Mark R. Hollar



 

Mark R. Hollar



 

Treasurer and Chief Financial Officer



 

(Principal Financial and Accounting Officer)



54