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FRANKLIN FINANCIAL SERVICES CORP /PA/ - Quarter Report: 2016 June (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

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

For the quarterly period ended June  30, 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 4,302,395 outstanding shares of the Registrant’s common stock as of July 31, 2016.

 


 

INDEX



               



 

 

Part I - FINANCIAL INFORMATION

 



 

 

Item 1

Financial Statements

 



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

1



Consolidated Statements of Income for the Three and Six Months ended June  30, 2016 

2



and 2015 (unaudited)

 



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

3



June  30, 2016 and 2015 (unaudited)

 



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

4



ended June 30, 2016 and 2015 (unaudited)

 



Consolidated Statements of Cash Flows for the Six Months ended June  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

53

Item 4

Controls and Procedures

53



 

 

Part II - OTHER INFORMATION 

 



 

 

Item 1

Legal Proceedings

54

Item 1A

Risk Factors

54

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

54

Item 3

Defaults Upon Senior Securities

54

Item 4

Mine Safety Disclosures

54

Item 5

Other Information

54

Item 6

Exhibits

54

SIGNATURE PAGE

56

EXHIBITS

 







 

 


 

Part I FINANCIAL INFORMATION

Item 1 Financial Statements

Consolidated Balance Sheets







 

 

 

 

 



 

 

 

 

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

June 30

 

December 31



2016

 

2015

Assets

 

 

 

 

 

Cash and due from banks

$

15,668 

 

$

20,664 

Interest-bearing deposits in other banks

 

25,381 

 

 

18,502 

Total cash and cash equivalents

 

41,049 

 

 

39,166 

Investment securities available for sale, at fair value

 

163,557 

 

 

159,473 

Restricted stock

 

436 

 

 

782 

Loans held for sale

 

487 

 

 

461 

Loans

 

826,656 

 

 

782,016 

Allowance for loan losses

 

(10,318)

 

 

(10,086)

Net Loans

 

816,338 

 

 

771,930 

Premises and equipment, net

 

14,414 

 

 

14,759 

Bank owned life insurance

 

22,196 

 

 

22,364 

Goodwill

 

9,016 

 

 

9,016 

Other real estate owned

 

6,194 

 

 

6,451 

Deferred tax asset, net

 

3,947 

 

 

4,758 

Other assets

 

6,412 

 

 

6,135 

Total assets

$

1,084,046 

 

$

1,035,295 



 

 

 

 

 

Liabilities

 

 

 

 

 

Deposits

 

 

 

 

 

Noninterest-bearing checking

$

162,515 

 

$

152,095 

Money management, savings and interest checking

 

722,413 

 

 

680,686 

Time

 

80,626 

 

 

85,731 

Total Deposits

 

965,554 

 

 

918,512 

Other liabilities

 

2,544 

 

 

5,407 

Total liabilities

 

968,098 

 

 

923,919 



 

 

 

 

 

Shareholders' equity

 

 

 

 

 

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

 

 

 

 

 

4,685,049 shares issued and 4,301,648 shares outstanding at June 30, 2016 and

 

 

 

 

 

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

 

4,685 

 

 

4,659 

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

 

 

 

 

 

shares issued and outstanding

 

 -

 

 

 -

Additional paid-in capital

 

39,454 

 

 

38,778 

Retained earnings

 

81,090 

 

 

78,517 

Accumulated other comprehensive loss

 

(2,356)

 

 

(3,722)

Treasury stock, 383,401 shares at June 30, 2016 and 383,440 shares at

 

 

 

 

 

December 31, 2015, at cost

 

(6,925)

 

 

(6,856)

Total shareholders' equity

 

115,948 

 

 

111,376 

Total liabilities and shareholders' equity

$

1,084,046 

 

$

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 Six Months Ended

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

June 30

 

June 30



2016

 

2015

 

2016

 

2015

Interest income

 

 

 

 

 

 

 

 

 

 

 

Loans, including fees:

$

7,964 

 

$

7,477 

 

$

16,053 

 

$

14,853 

Interest and dividends on investments:

 

 

 

 

 

 

 

 

 

 

 

Taxable interest

 

584 

 

 

613 

 

 

1,160 

 

 

1,248 

Tax exempt interest

 

357 

 

 

408 

 

 

723 

 

 

817 

Dividend income

 

 

 

 

 

10 

 

 

60 

Deposits and obligations of other banks

 

79 

 

 

72 

 

 

141 

 

 

127 

Total interest income

 

8,988 

 

 

8,578 

 

 

18,087 

 

 

17,105 



 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

548 

 

 

619 

 

 

1,091 

 

 

1,260 

Short-term borrowings

 

 -

 

 

 -

 

 

 

 

 -

Total interest expense

 

548 

 

 

619 

 

 

1,093 

 

 

1,260 

Net interest income

 

8,440 

 

 

7,959 

 

 

16,994 

 

 

15,845 

Provision for loan losses

 

1,875 

 

 

310 

 

 

2,175 

 

 

635 

Net interest income after provision for loan losses

 

6,565 

 

 

7,649 

 

 

14,819 

 

 

15,210 



 

 

 

 

 

 

 

 

 

 

 

Noninterest income

 

 

 

 

 

 

 

 

 

 

 

Investment and trust services fees

 

1,218 

 

 

1,388 

 

 

2,472 

 

 

2,651 

Loan service charges

 

189 

 

 

314 

 

 

415 

 

 

496 

Deposit service charges and fees

 

602 

 

 

586 

 

 

1,180 

 

 

1,077 

Other service charges and fees

 

313 

 

 

311 

 

 

616 

 

 

607 

Debit card income

 

375 

 

 

356 

 

 

722 

 

 

675 

Increase in cash surrender value of life insurance

 

132 

 

 

140 

 

 

267 

 

 

279 

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

 

(2)

 

 

 -

 

 

(10)

 

 

32 

OTTI losses on debt securities

 

 -

 

 

 -

 

 

(20)

 

 

(20)

Gain on conversion of investment security

 

 -

 

 

 -

 

 

 -

 

 

728 

Securities gains, net

 

 

 

 

 

 

 

Other

 

27 

 

 

13 

 

 

164 

 

 

237 

Total noninterest income

 

2,856 

 

 

3,116 

 

 

5,809 

 

 

6,770 



 

 

 

 

 

 

 

 

 

 

 

Noninterest expense

 

 

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

4,346 

 

 

4,203 

 

 

8,716 

 

 

8,286 

Occupancy, net

 

553 

 

 

556 

 

 

1,152 

 

 

1,172 

Furniture and equipment

 

218 

 

 

239 

 

 

434 

 

 

470 

Advertising

 

262 

 

 

283 

 

 

543 

 

 

471 

Legal and professional

 

394 

 

 

203 

 

 

691 

 

 

499 

Data processing

 

504 

 

 

556 

 

 

1,001 

 

 

1,023 

Pennsylvania bank shares tax

 

260 

 

 

206 

 

 

496 

 

 

402 

Intangible amortization

 

 -

 

 

90 

 

 

 -

 

 

181 

FDIC insurance

 

169 

 

 

160 

 

 

326 

 

 

308 

ATM/debit card processing

 

200 

 

 

186 

 

 

428 

 

 

373 

Foreclosed real estate

 

13 

 

 

 

 

76 

 

 

19 

Telecommunications

 

90 

 

 

118 

 

 

209 

 

 

235 

Other

 

721 

 

 

852 

 

 

1,453 

 

 

1,711 

Total noninterest expense

 

7,730 

 

 

7,659 

 

 

15,525 

 

 

15,150 

Income before federal income tax expense

 

1,691 

 

 

3,106 

 

 

5,103 

 

 

6,830 

Federal income tax expense

 

130 

 

 

632 

 

 

815 

 

 

1,472 

Net income

$

1,561 

 

$

2,474 

 

$

4,288 

 

$

5,358 



 

 

 

 

 

 

 

 

 

 

 

Per share

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

$

0.36 

 

$

0.58 

 

$

1.00 

 

$

1.27 

Diluted earnings per share

$

0.36 

 

$

0.58 

 

$

1.00 

 

$

1.26 

Cash dividends declared

$

0.21 

 

$

0.19 

 

$

0.40 

 

$

0.36 

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 Six Months Ended



 

June 30

 

June 30

(Dollars in thousands) (unaudited)

 

2016

 

2015

 

2016

 

2015

Net Income

 

$

1,561 

 

$

2,474 

 

$

4,288 

 

$

5,358 



 

 

 

 

 

 

 

 

 

 

 

 

Securities:

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gains arising during the period

 

 

1,006 

 

 

(1,239)

 

 

2,051 

 

 

(536)

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

 

 

(2)

 

 

(8)

 

 

17 

 

 

(716)

Net unrealized gains (losses)

 

 

1,004 

 

 

(1,247)

 

 

2,068 

 

 

(1,252)

Tax effect

 

 

(340)

 

 

424 

 

 

(702)

 

 

426 

Net of tax amount

 

 

664 

 

 

(823)

 

 

1,366 

 

 

(826)



 

 

 

 

 

 

 

 

 

 

 

 

Derivatives:

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gains arising during the period

 

 

 -

 

 

32 

 

 

 -

 

 

31 

Reclassification adjustment for losses included in net income (2)

 

 

 -

 

 

64 

 

 

 -

 

 

160 

Net unrealized gains

 

 

 -

 

 

96 

 

 

 -

 

 

191 

Tax effect

 

 

 -

 

 

(32)

 

 

 -

 

 

(65)

Net of tax amount

 

 

 -

 

 

64 

 

 

 -

 

 

126 



 

 

 

 

 

 

 

 

 

 

 

 

Total other comprehensive income (loss)

 

 

664 

 

 

(759)

 

 

1,366 

 

 

(700)

Total Comprehensive Income

 

$

2,225 

 

$

1,715 

 

$

5,654 

 

$

4,658 



 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

Reclassification adjustment / Statement line item

 

Tax  expense (benefit)

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

 

$

 

$

 

$

(6)

 

$

243 

(2) Derivatives / interest expense on deposits

 

 

 -

 

 

(22)

 

 

 -

 

 

(54)



 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 









3

 


 







Consolidated Statements of Changes in Shareholders' Equity

For the Six Months Ended June 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

 

-

 

 

-

 

 

5,358 

 

 

-

 

 

-

 

 

5,358 

Other comprehensive loss

 

-

 

 

-

 

 

-

 

 

(700)

 

 

-

 

 

(700)

Cash dividends declared, $.36 per share

 

-

 

 

-

 

 

(1,522)

 

 

-

 

 

-

 

 

(1,522)

Treasury shares issued under employer stock option plans, 4,518 shares

 

-

 

 

 

 

-

 

 

-

 

 

81 

 

 

86 

Common stock issued under dividend reinvestment plan, 18,507 shares

 

18 

 

 

417 

 

 

-

 

 

-

 

 

-

 

 

435 

Balance at June 30, 2015

$

4,625 

 

$

37,926 

 

$

75,288 

 

$

(3,800)

 

$

(6,861)

 

$

107,178 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2015

$

4,659 

 

$

38,778 

 

$

78,517 

 

$

(3,722)

 

$

(6,856)

 

$

111,376 

Net income

 

-

 

 

-

 

 

4,288 

 

 

-

 

 

-

 

 

4,288 

Other comprehensive income

 

-

 

 

-

 

 

-

 

 

1,366 

 

 

-

 

 

1,366 

Cash dividends declared, $.40 per share

 

-

 

 

-

 

 

(1,715)

 

 

-

 

 

-

 

 

(1,715)

Acquisition of 15,521 shares of treasury stock

 

-

 

 

-

 

 

-

 

 

-

 

 

(350)

 

 

(350)

Treasury shares issued under employer stock purchase plan, 188 shares

 

-

 

 

 

 

-

 

 

-

 

 

278 

 

 

279 

Treasury shares issued under dividend reinvestment plan, 15,372 shares

 

-

 

 

82 

 

 

-

 

 

-

 

 

 

 

85 

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

 

25 

 

 

527 

 

 

-

 

 

-

 

 

-

 

 

552 

Common stock issued under incentive stock option plan, 500 shares

 

 

 

 

 

-

 

 

-

 

 

-

 

 

Stock option compensation expense

 

-

 

 

58 

 

 

-

 

 

-

 

 

-

 

 

58 

Balance at June 30, 2016

$

4,685 

 

$

39,454 

 

$

81,090 

 

$

(2,356)

 

$

(6,925)

 

$

115,948 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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















4

 


 

Consolidated Statements of Cash Flows





 

 

 

 

 



 

 

 

 

 



Six Months Ended June 30



2016

 

2015

(Dollars in thousands) (unaudited)

 

 

 

 

 

Cash flows from operating activities

 

 

 

 

 

Net income

$

4,288 

 

$

5,358 

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

 

 

 

 

 

Depreciation and amortization

 

666 

 

 

675 

Net amortization of loans and investment securities

 

794 

 

 

796 

Amortization and net change in mortgage servicing rights valuation

 

27 

 

 

Amortization of intangibles

 

 -

 

 

181 

Provision for loan losses

 

2,175 

 

 

635 

Gain on sales of securities

 

(3)

 

 

(8)

Impairment write-down on securities recognized in earnings

 

20 

 

 

20 

Gain on conversion of investment security

 

 -

 

 

(728)

Loans originated for sale

 

(4,963)

 

 

(3,812)

Proceeds from sale of loans

 

4,937 

 

 

2,446 

Write-down of other real estate owned

 

46 

 

 

 -

Write-down on premises and equipment

 

 -

 

 

60 

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

 

10 

 

 

(32)

Increase in cash surrender value of life insurance

 

(267)

 

 

(279)

Stock option compensation

 

58 

 

 

 -

(Increase) decrease in other assets

 

(504)

 

 

1,380 

(Decrease) in other liabilities

 

(2,588)

 

 

(2,195)

Net cash provided by operating activities

 

4,696 

 

 

4,506 



 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

Proceeds from sales and calls of investment securities available for sale

 

1,765 

 

 

1,381 

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

 

11,929 

 

 

14,132 

Purchase of investment securities available for sale

 

(16,605)

 

 

(21,689)

Net decrease (increase) in restricted stock

 

346 

 

 

(1)

Net increase in loans

 

(46,522)

 

 

(7,256)

Capital expenditures

 

(288)

 

 

(190)

Proceeds from surrender of life insurance policy

 

436 

 

 

 -

Proceeds from sale of other real estate

 

224 

 

 

129 

Net cash used in investing activities

 

(48,715)

 

 

(13,494)



 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

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

 

52,147 

 

 

41,406 

Net decrease in time deposits

 

(5,105)

 

 

(6,528)

Net decrease in repurchase agreements

 

 -

 

 

(9,079)

Dividends paid

 

(1,715)

 

 

(1,522)

Common stock issued under stock option plans

 

288 

 

 

86 

Common stock issued under dividend reinvestment plan

 

637 

 

 

435 

Purchase of treasury stock

 

(350)

 

 

 -

Net cash provided by financing activities

 

45,902 

 

 

24,798 



 

 

 

 

 

Increase in cash and cash equivalents

 

1,883 

 

 

15,810 

Cash and cash equivalents as of January 1

 

39,166 

 

 

48,593 

Cash and cash equivalents as of June 30

$

41,049 

 

$

64,403 



 

 

 

 

 

Supplemental Disclosures of Cash Flow Information

 

 

 

 

 

Cash paid during the year for:

 

 

 

 

 

Interest on deposits and other borrowed funds

$

1,097 

 

$

1,304 

Income taxes

$

2,100 

 

$

1,513 



 

 

 

 

 

Noncash Activities

 

 

 

 

 

Loans transferred to Other Real Estate

$

23 

 

$

449 



 

 

 

 

 

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 June  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 six month periods ended June 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 Six Months Ended



June 30

 

June 30

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

2016

 

2015

 

2016

 

2015

Weighted average shares outstanding (basic)

 

4,294 

 

 

4,234 

 

 

4,289 

 

 

4,228 

Impact of common stock equivalents

 

 

 

11 

 

 

 

 

Weighted average shares outstanding (diluted)

 

4,298 

 

 

4,245 

 

 

4,292 

 

 

4,236 

Anti-dilutive options excluded from calculation

 

43 

 

 

13 

 

 

44 

 

 

28 

Net income

$

1,561 

 

$

2,474 

 

$

4,288 

 

$

5,358 

Basic earnings per share

$

0.36 

 

$

0.58 

 

$

1.00 

 

$

1.27 

Diluted earnings per share

$

0.36 

 

$

0.58 

 

$

1.00 

 

$

1.26 





Note 2. Recent Accounting Pronouncements

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

6

 


 

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 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.





7

 


 

Note 3. Accumulated Other Comprehensive Loss

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







 

 

 

 

 



 

 

 

 

 



June 30

 

December 31,



2016

 

2015

(Dollars in thousands)

 

 

 

 

 

Net unrealized gains on securities

$

3,206 

 

$

1,138 

Tax effect

 

(1,089)

 

 

(387)

Net of tax amount

 

2,117 

 

 

751 



 

 

 

 

 

Accumulated pension adjustment

 

(6,777)

 

 

(6,777)

Tax effect

 

2,304 

 

 

2,304 

Net of tax amount

 

(4,473)

 

 

(4,473)



 

 

 

 

 

Total accumulated other comprehensive loss

$

(2,356)

 

$

(3,722)







Note 4. Guarantees

The Corporation does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit.  Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party.  Generally, all letters of credit, when issued, have expiration dates within one year.  The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers. The Bank generally holds collateral and/or personal guarantees supporting these commitments.  The Bank had $29.4 million and $25.9 million of standby letters of credit as of June 30, 2016 and December 31, 2015, respectively. Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payments required under the corresponding guarantees.  The amount of the liability as of June  30, 2016 and December 31, 2015 for guarantees under standby letters of credit issued was not material.





8

 


 

Note 5. Investments

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







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

June 30, 2016

 

cost

 

gains

 

losses

 

value

Equity securities

 

$

164 

 

$

76 

 

$

 -

 

$

240 

U.S. Government and Agency securities

 

 

13,104 

 

 

339 

 

 

(17)

 

 

13,426 

Municipal securities

 

 

68,430 

 

 

2,354 

 

 

(43)

 

 

70,741 

Trust preferred securities

 

 

5,968 

 

 

 -

 

 

(798)

 

 

5,170 

Agency mortgage-backed securities

 

 

71,448 

 

 

1,310 

 

 

(35)

 

 

72,723 

Private-label mortgage-backed securities

 

 

1,201 

 

 

27 

 

 

(5)

 

 

1,223 

Asset-backed securities

 

 

36 

 

 

 -

 

 

(2)

 

 

34 



 

$

160,351 

 

$

4,106 

 

$

(900)

 

$

163,557 









 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(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 June 30, 2016 and December 31, 2015, the fair value of investment securities pledged to secure public funds, trust balances, deposit and other obligations totaled $69.4 million and $79.6 million, respectively.

The amortized cost and estimated fair value of debt securities at June  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

$

2,618 

 

$

2,641 

Due after one year through five years

 

11,175 

 

 

11,516 

Due after five years through ten years

 

28,597 

 

 

29,698 

Due after ten years

 

45,148 

 

 

45,516 



 

87,538 

 

 

89,371 

Mortgage-backed securities

 

72,649 

 

 

73,946 



$

160,187 

 

$

163,317 



9

 


 

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





 

 

 

 

 

 

 

 

 

 

 



For the Three Months Ended

 

For the Six Months Ended



June 30

 

June 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 June 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 

 

$

832 

 

$

(134)

 

BB+

Wachovia Cap Trust II

 

1/15/2027

 

Single

 

Preferred Stock

 

 

279 

 

 

254 

 

 

(25)

 

BBB

Huntington Cap Trust

 

2/1/2027

 

Single

 

Preferred Stock

 

 

944 

 

 

795 

 

 

(149)

 

BB

Corestates Captl Tr II

 

2/15/2027

 

Single

 

Preferred Stock

 

 

941 

 

 

848 

 

 

(93)

 

BBB+

Huntington Cap Trust II

 

6/15/2028

 

Single

 

Preferred Stock

 

 

897 

 

 

767 

 

 

(130)

 

BB

Chase Cap VI JPM

 

8/1/2028

 

Single

 

Preferred Stock

 

 

965 

 

 

832 

 

 

(133)

 

BBB-

Fleet Cap Tr V

 

12/18/2028

 

Single

 

Preferred Stock

 

 

976 

 

 

842 

 

 

(134)

 

BB+



 

 

 

 

 

 

 

$

5,968 

 

$

5,170 

 

$

(798)

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



The following table provides additional detail about private label mortgage-backed securities as of June  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

 

$

322 

 

$

319 

 

$

(3)

 

ALT A

 

CCC

 

15.07 

 

$

 -

RALI 2005-QS2 A1

 

2/1/2005

 

 

176 

 

 

187 

 

 

11 

 

ALT A

 

CC

 

4.83 

 

 

10 

RALI 2006-QS4 A2

 

4/1/2006

 

 

425 

 

 

423 

 

 

(2)

 

ALT A

 

D

 

 -

 

 

323 

GSR 2006-5F 2A1

 

5/1/2006

 

 

53 

 

 

60 

 

 

 

Prime

 

D

 

 -

 

 

15 

RALI 2006-QS8 A1

 

7/28/2006

 

 

225 

 

 

234 

 

 

 

ALT A

 

D

 

 -

 

 

227 



 

 

 

$

1,201 

 

$

1,223 

 

$

22 

 

 

 

 

 

 

 

$

575 



Impairment:

The investment portfolio contained thirty-seven securities with $21.0 million of temporarily impaired fair value and $900 thousand in unrealized losses at June 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

10

 


 

conditions relating to specific issues.  The impairment identified on debt and equity securities and subject to assessment at June 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 June 30, 2016  and December 31, 2015:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



June 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

$

-

 

$

-

 

-

 

$

3,612 

 

$

(17)

 

10 

 

$

3,612 

 

$

(17)

 

10 

Municipal securities

 

 -

 

 

 -

 

 -

 

 

2,328 

 

 

(43)

 

 

 

2,328 

 

 

(43)

 

Trust preferred securities

 

 -

 

 

 -

 

 -

 

 

5,170 

 

 

(798)

 

 

 

5,170 

 

 

(798)

 

Agency mortgage-backed securities

 

3,218 

 

 

(2)

 

 

 

5,929 

 

 

(33)

 

11 

 

 

9,147 

 

 

(35)

 

14 

Private-label mortgage-backed securities

 

319 

 

 

(3)

 

 

 

423 

 

 

(2)

 

 

 

742 

 

 

(5)

 

Asset-backed securities

 

 -

 

 

 -

 

 -

 

 

 

 

(2)

 

 

 

 

 

(2)

 

Total temporarily impaired securities

$

3,537 

 

$

(5)

 

 

$

17,467 

 

$

(895)

 

33 

 

$

21,004 

 

$

(900)

 

37 









 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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 $43 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 $5.2 million and an unrealized loss of $798 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 June 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 are two PLMBS bonds showing a small unrealized loss of $5 thousand.  However, the PLMBS sector as a whole is showing an unrealized gain of $22 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 $20 thousand impairment charge during the first quarter of 2016 and has recorded

11

 


 

$575 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.

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







 

 

 

 

 



 

 

 

 

(Dollars in thousands)

Six Months Ended



2016

 

2015

Balance of cumulative credit-related OTTI at January 1

$

555 

 

$

535 

Additions for credit-related OTTI not previously recognized

 

20 

 

 

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 June 30

$

575 

 

$

555 



 

 

 

 

 



The Bank held $436 thousand of restricted stock at June 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 6. 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:



 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

Change

(Dollars in thousands)

June 30, 2016

 

December 31, 2015

 

 

Amount

 

%

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

Consumer first liens

$

101,113 

 

$

103,698 

 

$

(2,585)

 

(2.5)

Commercial first lien

 

62,424 

 

 

57,780 

 

 

4,644 

 

8.0 

Total first liens

 

163,537 

 

 

161,478 

 

 

2,059 

 

1.3 



 

 

 

 

 

 

 

 

 

 

Consumer junior liens and lines of credit

 

46,106 

 

 

44,996 

 

 

1,110 

 

2.5 

Commercial junior liens and lines of credit

 

5,908 

 

 

5,917 

 

 

(9)

 

(0.2)

Total junior liens and lines of credit

 

52,014 

 

 

50,913 

 

 

1,101 

 

2.2 

Total residential real estate 1-4 family

 

215,551 

 

 

212,391 

 

 

3,160 

 

1.5 



 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

 

 

 

 

 

 

 

 

Consumer

 

1,067 

 

 

545 

 

 

522 

 

95.8 

Commercial

 

7,253 

 

 

7,343 

 

 

(90)

 

(1.2)

Total residential real estate construction

 

8,320 

 

 

7,888 

 

 

432 

 

5.5 



 

 

 

 

 

 

 

 

 

 

Commercial real estate

 

371,786 

 

 

340,695 

 

 

31,091 

 

9.1 

Commercial

 

226,307 

 

 

215,942 

 

 

10,365 

 

4.8 

        Total commercial

 

598,093 

 

 

556,637 

 

 

41,456 

 

7.4 



 

 

 

 

 

 

 

 

 

 

Consumer

 

4,692 

 

 

5,100 

 

 

(408)

 

(8.0)



 

826,656 

 

 

782,016 

 

 

44,640 

 

5.7 

Less: Allowance for loan losses

 

(10,318)

 

 

(10,086)

 

 

(232)

 

2.3 

Net Loans

$

816,338 

 

$

771,930 

 

$

44,408 

 

5.8 



 

 

 

 

 

 

 

 

 

 

Included in the loan balances are the following:

 

 

 

 

 

 

 

 

 

 

Net unamortized deferred loan fees

$

225 

 

$

436 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

Loans pledged as collateral for borrowings and commitments from:

 

 

 

 

 

 

 

 

 

 

FHLB

$

583,567 

 

$

643,449 

 

 

 

 

 

Federal Reserve Bank

 

42,060 

 

 

45,111 

 

 

 

 

 



$

625,627 

 

$

688,560 

 

 

 

 

 





13

 


 

Note 7. 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 March 31, 2016

 

$

997 

 

$

316 

 

$

199 

 

$

6,181 

 

$

1,510 

 

$

99 

 

$

1,040 

 

$

10,342 

Charge-offs

 

 

(46)

 

 

 -

 

 

 -

 

 

(1,951)

 

 

(3)

 

 

(42)

 

 

 -

 

 

(2,042)

Recoveries

 

 

 

 

 -

 

 

 -

 

 

14 

 

 

106 

 

 

22 

 

 

 -

 

 

143 

Provision

 

 

71 

 

 

 

 

 

 

1,696 

 

 

(17)

 

 

18 

 

 

98 

 

 

1,875 

ALL at June 30, 2016

 

$

1,023 

 

$

319 

 

$

205 

 

$

5,940 

 

$

1,596 

 

$

97 

 

$

1,138 

 

$

10,318 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at December 31, 2015

 

$

989 

 

$

308 

 

$

194 

 

$

5,649 

 

$

1,519 

 

$

102 

 

$

1,325 

 

$

10,086 

Charge-offs

 

 

(49)

 

 

 -

 

 

 -

 

 

(1,954)

 

 

(66)

 

 

(84)

 

 

 -

 

 

(2,153)

Recoveries

 

 

33 

 

 

 -

 

 

 -

 

 

14 

 

 

121 

 

 

42 

 

 

 -

 

 

210 

Provision

 

 

50 

 

 

11 

 

 

11 

 

 

2,231 

 

 

22 

 

 

37 

 

 

(187)

 

 

2,175 

ALL at June 30, 2016

 

$

1,023 

 

$

319 

 

$

205 

 

$

5,940 

 

$

1,596 

 

$

97 

 

$

1,138 

 

$

10,318 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at March 31, 2015

 

$

1,016 

 

$

268 

 

$

249 

 

$

5,137 

 

$

1,353 

 

$

116 

 

$

1,071 

 

$

9,210 

Charge-offs

 

 

(43)

 

 

 -

 

 

(21)

 

 

 -

 

 

(17)

 

 

(26)

 

 

 -

 

 

(107)

Recoveries

 

 

 

 

 -

 

 

 -

 

 

14 

 

 

 

 

14 

 

 

 -

 

 

37 

Provision

 

 

40 

 

 

13 

 

 

(22)

 

 

28 

 

 

96 

 

 

 

 

147 

 

 

310 

ALL at June 30, 2015

 

$

1,014 

 

$

281 

 

$

206 

 

$

5,179 

 

$

1,440 

 

$

112 

 

$

1,218 

 

$

9,450 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at December 31, 2014

 

$

994 

 

$

271 

 

$

214 

 

$

4,978 

 

$

1,515 

 

$

127 

 

$

1,012 

 

$

9,111 

Charge-offs

 

 

(43)

 

 

 -

 

 

(21)

 

 

 -

 

 

(218)

 

 

(78)

 

 

 -

 

 

(360)

Recoveries

 

 

 

 

 -

 

 

 -

 

 

14 

 

 

14 

 

 

33 

 

 

 -

 

 

64 

Provision

 

 

60 

 

 

10 

 

 

13 

 

 

187 

 

 

129 

 

 

30 

 

 

206 

 

 

635 

ALL at June 30, 2015

 

$

1,014 

 

$

281 

 

$

206 

 

$

5,179 

 

$

1,440 

 

$

112 

 

$

1,218 

 

$

9,450 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 June 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



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for ALL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

396 

 

$

52 

 

$

491 

 

$

17,082 

 

$

 -

 

$

 -

 

$

 -

 

$

18,021 

Collectively

 

 

163,141 

 

 

51,962 

 

 

7,829 

 

 

354,704 

 

 

226,307 

 

 

4,692 

 

 

 -

 

 

808,635 

Total

 

$

163,537 

 

$

52,014 

 

$

8,320 

 

$

371,786 

 

$

226,307 

 

$

4,692 

 

$

 -

 

$

826,656 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL established for loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

Collectively

 

 

1,023 

 

 

319 

 

 

205 

 

 

5,940 

 

 

1,596 

 

 

97 

 

 

1,138 

 

 

10,318 

ALL at June 30, 2016

 

$

1,023 

 

$

319 

 

$

205 

 

$

5,940 

 

$

1,596 

 

$

97 

 

$

1,138 

 

$

10,318 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 June  30, 2016 and December 31, 2015:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Impaired Loans



 

With No Allowance

 

With Allowance

(Dollars in thousands)

 

 

 

 

Unpaid

 

 

 

 

 

Unpaid

 

 

 



 

Recorded

 

Principal

 

Recorded

 

Principal

 

Related

June 30, 2016

 

Investment

 

Balance

 

Investment

 

Balance

 

Allowance

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

921 

 

$

996 

 

$

 -

 

$

 -

 

$

 -

Junior liens and lines of credit

 

 

63 

 

 

75 

 

 

 -

 

 

 -

 

 

 -

Total

 

 

984 

 

 

1,071 

 

 

 -

 

 

 -

 

 

 -

 Residential real estate - construction

 

 

491 

 

 

540 

 

 

 -

 

 

 -

 

 

 -

 Commercial real estate

 

 

17,357 

 

 

19,910 

 

 

 -

 

 

 -

 

 

 -

 Commercial

 

 

25 

 

 

37 

 

 

 -

 

 

 -

 

 

 -

Total

 

$

18,857 

 

$

21,558 

 

$

 -

 

$

 -

 

$

 -







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 six months ended June  30, 2016 and 2015:





 

 

 

 

 

 

 

 

 

 

 



Three Months Ended

 

Six Months Ended



June 30, 2016

 

June 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

$

926 

 

$

 

$

998 

 

$

12 

Junior liens and lines of credit

 

63 

 

 

 -

 

 

67 

 

 

 -

Total

 

989 

 

 

 

 

1,065 

 

 

12 

 Residential real estate - construction

 

494 

 

 

 -

 

 

498 

 

 

 -

 Commercial real estate

 

19,345 

 

 

117 

 

 

19,555 

 

 

239 

 Commercial

 

34 

 

 

 -

 

 

39 

 

 

 -

Total

$

20,862 

 

$

123 

 

$

21,157 

 

$

251 



 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



Three Months Ended

 

Six Months Ended



June 30, 2015

 

June 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

$

1,618 

 

$

 

$

1,723 

 

$

16 

Junior liens and lines of credit

 

117 

 

 

 -

 

 

131 

 

 

 -

Total

 

1,735 

 

 

 

 

1,854 

 

 

16 

 Residential real estate - construction

 

516 

 

 

 -

 

 

723 

 

 

 -

 Commercial real estate

 

21,756 

 

 

174 

 

 

21,971 

 

 

327 

 Commercial

 

361 

 

 

 -

 

 

1,012 

 

 

 -

Total

$

24,368 

 

$

183 

 

$

25,560 

 

$

343 



 

 

 

 

 

 

 

 

 

 

 

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

June 30, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

162,601 

 

$

102 

 

$

393 

 

$

14 

 

$

509 

 

$

427 

 

$

163,537 

Junior liens and lines of credit

 

 

51,764 

 

 

154 

 

 

 -

 

 

33 

 

 

187 

 

 

63 

 

 

52,014 

Total

 

 

214,365 

 

 

256 

 

 

393 

 

 

47 

 

 

696 

 

 

490 

 

 

215,551 

Residential real estate - construction

 

 

7,652 

 

 

117 

 

 

 -

 

 

60 

 

 

177 

 

 

491 

 

 

8,320 

Commercial real estate

 

 

362,157 

 

 

2,415 

 

 

96 

 

 

306 

 

 

2,817 

 

 

6,812 

 

 

371,786 

Commercial

 

 

225,802 

 

 

381 

 

 

53 

 

 

46 

 

 

480 

 

 

25 

 

 

226,307 

Consumer

 

 

4,674 

 

 

18 

 

 

 -

 

 

 -

 

 

18 

 

 

 -

 

 

4,692 

Total

 

$

814,650 

 

$

3,187 

 

$

542 

 

$

459 

 

$

4,188 

 

$

7,818 

 

$

826,656 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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



 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

$

160,151 

 

$

2,003 

 

$

1,383 

 

$

 -

 

$

163,537 

Junior liens and lines of credit

 

51,796 

 

 

28 

 

 

190 

 

 

 -

 

 

52,014 

Total

 

211,947 

 

 

2,031 

 

 

1,573 

 

 

 -

 

 

215,551 

Residential real estate - construction

 

7,488 

 

 

 -

 

 

832 

 

 

 -

 

 

8,320 

Commercial real estate

 

352,191 

 

 

1,758 

 

 

17,837 

 

 

 -

 

 

371,786 

Commercial

 

223,082 

 

 

1,161 

 

 

2,064 

 

 

 -

 

 

226,307 

Consumer

 

4,692 

 

 

 -

 

 

 -

 

 

 -

 

 

4,692 

Total

$

799,400 

 

$

4,950 

 

$

22,306 

 

$

 -

 

$

826,656 









 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

June 30, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

$

491 

 

$

491 

 

$

 -

 

 -

 

$

 -

Residential real estate

 

 

 

645 

 

 

494 

 

 

151 

 

 -

 

 

 -

Commercial real estate

 

11 

 

 

12,351 

 

 

12,351 

 

 

 -

 

 -

 

 

 -

  Total

 

16 

 

$

13,487 

 

$

13,336 

 

$

151 

 

 -

 

$

 -



   

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 June  30, 2016:







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

New During Period



 

Number of

 

 

Pre-TDR

 

 

After-TDR

 

 

Recorded

 

 

Six Months Ended June 30, 2016

 

Contracts

 

 

Modification

 

 

Modification

 

 

Investment

 

Concession

Commercial real estate

 

 

$

525 

 

$

525 

 

$

515 

 

multiple



 

 

 

 

 

 

 

 

 

 

 

 

 

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



Note 8. OREO

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





 

 

 

 

 

 



 

June 30

(Dollars in thousands)

 

2016

 

2015

Balance at January 1

 

$

6,451 

 

$

3,666 

   Additions

 

 

23 

 

 

449 

   Proceeds from dispositions

 

 

(224)

 

 

(129)

   (Loss) gain on sales, net

 

 

(10)

 

 

32 

   Valuation adjustment

 

 

(46)

 

 

 -

Balance at June 30

 

$

6,194 

 

$

4,018 















20

 


 

Note 9. Pension

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





 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 



Three Months Ended June 30

 

Six Months Ended June 30

(Dollars in thousands)

2016

 

2015

 

2016

 

2015

Components of net periodic cost:

 

 

 

 

 

 

 

 

 

 

 

Service cost

$

83 

 

$

92 

 

$

164 

 

$

192 

Interest cost

 

180 

 

 

172 

 

 

360 

 

 

350 

Expected return on plan assets

 

(290)

 

 

(296)

 

 

(583)

 

 

(592)

Recognized net actuarial loss

 

120 

 

 

123 

 

 

231 

 

 

254 

Net period cost

$

93 

 

$

91 

 

$

172 

 

$

204 



The Bank expects its pension expense to increase to approximately $809 thousand in 2016 compared to $387 thousand in 2015, due to a pension settlement expense of approximately $450,000 that will be recorded during the second half of 2016.  No pension contributions were made or are expected to be made in 2016.

 







Note 10.  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 June 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:







 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



June 30, 2016



Carrying

 

Fair

 

 

 

 

 

 

 

(Dollars in thousands)

Amount

 

Value

 

Level 1

 

Level 2

 

Level 3



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

$

41,049 

 

$

41,049 

 

$

41,049 

 

$

 -

 

$

 -

Investment securities available for sale

 

163,557 

 

 

163,557 

 

 

240 

 

 

163,317 

 

 

 -

Restricted stock

 

436 

 

 

436 

 

 

 -

 

 

436 

 

 

 -

Loans held for sale

 

487 

 

 

487 

 

 

 -

 

 

487 

 

 

 -

Net loans

 

816,338 

 

 

824,266 

 

 

 -

 

 

 -

 

 

824,266 

Accrued interest receivable

 

3,151 

 

 

3,151 

 

 

 -

 

 

3,151 

 

 

 -



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

$

965,554 

 

$

965,439 

 

$

 -

 

$

965,439 

 

$

 -

Accrued interest payable

 

120 

 

 

120 

 

 

 -

 

 

120 

 

 

 -



 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



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 June 30, 2016 and December 31, 2015 are as follows:







 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands

Fair Value at June 30, 2016

Asset  Description

Level 1

 

Level 2

 

Level 3

 

Total

Equity securities

$

240 

 

$

 -

 

$

 -

 

$

240 

U.S. Government and Agency securities

 

 -

 

 

13,426 

 

 

 -

 

 

13,426 

Municipal securities

 

 -

 

 

70,741 

 

 

 -

 

 

70,741 

Trust Preferred Securities

 

 -

 

 

5,170 

 

 

 -

 

 

5,170 

Agency mortgage-backed securities

 

 -

 

 

72,723 

 

 

 -

 

 

72,723 

Private-label mortgage-backed securities

 

 -

 

 

1,223 

 

 

 -

 

 

1,223 

Asset-backed securities

 

 -

 

 

34 

 

 

 -

 

 

34 

Total assets

$

240 

 

$

163,317 

 

$

 -

 

$

163,557 



 

 

 

 

 

 

 

 

 

 

 







 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

(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 June 30, 2016 and December 31, 2015 are as follows:







 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

 

 

 

 



Fair Value at June 30, 2016

Asset  Description

Level 1

 

Level 2

 

Level 3

 

Total

Impaired loans (1)

$

 -

 

$

 -

 

$

3,363 

 

$

3,363 

Other real estate owned (1)

 

 -

 

 

 -

 

 

225 

 

 

225 

Total assets

$

 -

 

$

 -

 

$

3,588 

 

$

3,588 







 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

(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 June 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 June 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 June 30, 2016



 

 

 

 

 

 

 

 

Range

Asset  Description

 

 

Fair Value

 

Valuation Technique

 

Unobservable Input

 

(Weighted Average)

Impaired loans (1)

 

$

3,363 

 

Appraisal

 

Appraisal Adjustments (2)

 

100% (100%)



 

 

 

 

 

 

Cost to sell

 

8%  (8%)



 

 

 

 

 

 

 

 

 

Other real estate owned (1)

 

 

225 

 

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.

 

 

(2) Qualitative adjustments are discounts specific to each asset and are made as needed.

 

 













25

 


 

Note 11.  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 Three and Six Months Ended June  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

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

Three months ended:

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2016

$

 -

 

Interest Expense

 

$

 -

 

Other income (expense)

 

$

 -

June 30, 2015

$

64 

 

Interest Expense

 

$

(64)

 

Other income (expense)

 

$

 -



 

 

 

 

 

 

 

 

 

 

 

 

Six months ended:

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2016

$

 -

 

Interest Expense

 

$

 -

 

Other income (expense)

 

$

 -

June 30, 2015

$

126 

 

Interest Expense

 

$

(160)

 

Other income (expense)

 

$

 -



Interest Rate Swap Agreements (“Swap Agreements”)

As of June  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 12. 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

26

 


 

increasing the minimum capital ratios by 2.5%.  As of June  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 June  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)

 

June 30, 2016

 

December 31, 2015

 

Minimum

 

Minimum



 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

14.64% 

 

14.77% 

 

5.125% 

 

N/A

Farmers & Merchants Trust Company

 

14.59% 

 

14.76% 

 

5.125% 

 

6.50% 



 

 

 

 

 

 

 

 

Tier 1 Risk-based Capital Ratio (2)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

14.64% 

 

14.77% 

 

6.625% 

 

N/A

Farmers & Merchants Trust Company

 

14.59% 

 

14.76% 

 

6.625% 

 

8.00% 



 

 

 

 

 

 

 

 

Total Risk-based Capital Ratio (3)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

15.90% 

 

16.03% 

 

8.625% 

 

N/A

Farmers & Merchants Trust Company

 

15.85% 

 

16.02% 

 

8.625% 

 

10.00% 



 

 

 

 

 

 

 

 

Tier 1 Leverage Ratio (4)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

10.20% 

 

10.38% 

 

4.000% 

 

N/A

Farmers & Merchants Trust Company

 

10.17% 

 

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 13. 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 Six Months Ended June  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 June  30, 2016, total assets were $1.084 billion, an increase of $48.8 million from December 31, 2015. Net loans increased to $816.3 million and total deposits increased to $965.6 million.  The Corporation reported net income for the first six months of 2016 of $4.3 million.  This is a 20.0%  decrease versus net income of $5.4 million for the same period in 2015.  Net income for 2016 was negatively affected by a provision for loan loss expense that was $1.5 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 half of 2016 increased slightly, by  $21 thousand year-over-year. Interest income increased $982 thousand,  while interest expense decreased by  $167 thousand, resulting in a $1.1 million increase in net interest income. The provision for loan losses was $2.2 million for the first six months of 2016, $1.5 million more than in 2015.  Noninterest income decreased $961 thousand, while noninterest expense increased $375 thousand. Income tax expense decreased from $1.5 million in 2015 to $815 thousand in 2016. The effective tax rate decreased from 21.6% in 2015 to 16.0% in 2016. Diluted earnings per share decreased to $1.00 in 2016 from $1.26 in 2015.  

28

 


 

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







 

 

 

 

 

 

 

 

 



 

June 30

 

December 31,

 

June 30



 

2016

 

2015

 

2015

(Dollars in thousands, except per share)

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

Balance Sheet Highlights

 

 

 

 

 

 

 

 

 

Total assets

 

$

1,084,046 

 

$

1,035,295 

 

$

1,028,539 

Investment securities

 

 

163,557 

 

 

159,473 

 

 

176,424 

Loans, net

 

 

816,338 

 

 

771,930 

 

 

723,762 

Deposits

 

 

965,554 

 

 

918,512 

 

 

916,059 

Shareholders' equity

 

 

115,948 

 

 

111,376 

 

 

107,178 



 

 

 

 

 

 

 

 

 

Summary of Operations

 

 

 

 

 

 

 

 

 

Interest income

 

$

18,087 

 

$

34,615 

 

$

17,105 

Interest expense

 

 

1,093 

 

 

2,371 

 

 

1,260 

Net interest income

 

 

16,994 

 

 

32,244 

 

 

15,845 

Provision for loan losses

 

 

2,175 

 

 

1,285 

 

 

635 

Net interest income after provision for loan losses

 

 

14,819 

 

 

30,959 

 

 

15,210 

Noninterest income

 

 

5,809 

 

 

12,652 

 

 

6,770 

Noninterest expense

 

 

15,525 

 

 

31,136 

 

 

15,150 

Income before income taxes

 

 

5,103 

 

 

12,475 

 

 

6,830 

Income tax

 

 

815 

 

 

2,271 

 

 

1,472 

Net income

 

$

4,288 

 

$

10,204 

 

$

5,358 



 

 

 

 

 

 

 

 

 

Performance Measurements

 

 

 

 

 

 

 

 

 

Return on average assets*

 

 

0.80% 

 

 

1.00% 

 

 

1.07% 

Return on average equity*

 

 

7.56% 

 

 

9.52% 

 

 

10.28% 

Return on average tangible assets (1)*

 

 

0.81% 

 

 

1.02% 

 

 

1.09% 

Return on average tangible equity (1)*

 

 

8.21% 

 

 

10.52% 

 

 

11.40% 

Efficiency ratio (1)

 

 

65.04% 

 

 

67.39% 

 

 

66.11% 

Net interest margin*

 

 

3.63% 

 

 

3.59% 

 

 

3.60% 

Current dividend yield*

 

 

3.54% 

 

 

3.23% 

 

 

3.10% 

Dividend payout ratio

 

 

40.00% 

 

 

30.76% 

 

 

28.41% 



 

 

 

 

 

 

 

 

 

Shareholders' Value (per common share)

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

$

1.00 

 

$

2.40 

 

$

1.26 

Basic earnings per share

 

 

1.00 

 

 

2.40 

 

 

1.27 

Regular cash dividends paid

 

 

0.40 

 

 

0.74 

 

 

0.36 

Book value

 

 

26.95 

 

 

26.05 

 

 

25.27 

Tangible book value (1)

 

 

24.86 

 

 

23.94 

 

 

23.15 

Market value

 

 

23.73 

 

 

23.50 

 

 

24.55 

Market value/book value ratio

 

 

88.05% 

 

 

90.21% 

 

 

97.15% 

Price/earnings multiple*

 

 

11.87 

 

 

9.79 

 

 

9.74 



 

 

 

 

 

 

 

 

 

Safety and Soundness

 

 

 

 

 

 

 

 

 

Risk-based capital ratio (Total)

 

 

15.90% 

 

 

16.03% 

 

 

15.73% 

Leverage ratio (Tier 1)

 

 

10.20% 

 

 

10.38% 

 

 

10.17% 

Common equity ratio (Tier 1)

 

 

14.64% 

 

 

14.77% 

 

 

14.48% 

Nonperforming loans/gross loans

 

 

1.00% 

 

 

0.73% 

 

 

1.30% 

Nonperforming assets/total assets

 

 

1.33% 

 

 

1.18% 

 

 

1.32% 

Allowance for loan losses as a % of loans

 

 

1.25% 

 

 

1.29% 

 

 

1.29% 

Net charge-offs/average loans*

 

 

0.48% 

 

 

0.04% 

 

 

0.08% 

 

 

 

 

 

 

 

 

 

 

Trust assets under management (fair value)

 

$

606,334 

 

$

586,664 

 

$

598,085 







*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)

 

 

Six months ended

 

 

 

 

 

Six months ended



 

 

June 30, 2016

 

 

December 31, 2015

 

 

June 30, 2015

Return on Average Tangible Assets (non-GAAP)

 

 

 

 

 

 

 

 

 

Net income

 

$

4,288 

 

$

10,204 

 

$

5,358 

Plus intangible amortization (net of tax)

 

 

 -

 

 

119 

 

 

119 

Net income (non-GAAP)

 

 

4,288 

 

 

10,323 

 

 

5,477 



 

 

 

 

 

 

 

 

 

Average assets

 

 

1,066,183 

 

 

1,021,275 

 

 

1,011,516 

Less average intangible assets

 

 

(9,016)

 

 

(9,066)

 

 

(9,116)

Average assets (non-GAAP)

 

 

1,057,167 

 

 

1,012,209 

 

 

1,002,400 



 

 

 

 

 

 

 

 

 

 Return on average tangible assets (non-GAAP)

 

 

0.81% 

 

 

1.02% 

 

 

1.09% 



 

 

 

 

 

 

 

 

 

Return on Tangible Equity (non-GAAP)

 

 

 

 

 

 

 

 

 

Net income

 

$

4,288 

 

$

10,204 

 

$

5,358 

Plus intangible amortization (net of tax)

 

 

 -

 

 

119 

 

 

119 

Net income (non-GAAP)

 

 

4,288 

 

 

10,323 

 

 

5,477 



 

 

 

 

 

 

 

 

 

Average shareholders' equity

 

 

113,452 

 

 

107,175 

 

 

105,171 

Less average intangible assets

 

 

(9,016)

 

 

(9,066)

 

 

(9,116)

Average shareholders' equity (non-GAAP)

 

 

104,436 

 

 

98,109 

 

 

96,055 



 

 

 

 

 

 

 

 

 

 Return on average tangible equity (non-GAAP)

 

 

8.21% 

 

 

10.52% 

 

 

11.40% 



 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Shareholders' equity

 

$

115,948 

 

$

111,376 

 

$

107,178 

Less intangible assets

 

 

(9,016)

 

 

(9,016)

 

 

(9,016)

Shareholders' equity (non-GAAP)

 

 

106,932 

 

 

102,360 

 

 

98,162 



 

 

 

 

 

 

 

 

 

Shares outstanding (in thousands)

 

 

4,302 

 

 

4,276 

 

 

4,241 



 

 

 

 

 

 

 

 

 

 Tangible book value (non-GAAP)

 

 

24.86 

 

 

23.94 

 

 

23.15 



 

 

 

 

 

 

 

 

 

Efficiency Ratio

 

 

 

 

 

 

 

 

 

Noninterest expense

 

$

15,525 

 

$

31,136 

 

$

15,150 



 

 

 

 

 

 

 

 

 

Net interest income plus noninterest income

 

 

22,803 

 

 

44,896 

 

 

22,615 

Plus tax equivalent adjustment to net interest income

 

 

1,051 

 

 

2,023 

 

 

1,016 

Less net securities gains (losses), and OTTI

 

 

(17)

 

 

716 

 

 

716 

Net interest income plus noninterest income

 

 

23,871 

 

 

46,203 

 

 

22,915 



 

 

 

 

 

 

 

 

 

 Efficiency ratio

 

 

65.04% 

 

 

67.39% 

 

 

66.11% 





30

 


 

Comparison of the three months ended June  30, 2016 to the three months ended June  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 for the second quarter of 2016 increased $489 thousand quarter over quarter.  Average interest-earning assets increased $53.7 million from 2015,  while the yield on these assets decreased to 3.78% in 2016 from 3.80% in 2015.  The average balance of investment securities decreased $17.1 million while average loans increased $84.5 million quarter over quarter.  Average commercial loans increased $81.2 million and average consumer and home equity loans increased $7.0 million.  These increases were partially offset by a decrease of $3.6 million in the average balance of mortgage loans.



Interest expense was $548 thousand for the second quarter, a decrease of $71 thousand from the 2015 total of $619 thousand.  Average interest-bearing deposits increased $29.5 million to $799.6 million for the second quarter of 2016 from an average balance of $770.1 million in the same period in 2015.  The average cost of these deposits decreased from 0.32% in 2015 to  0.28% in 2016



Tax equivalent net interest income increased $489 thousand to $9.0 million in the second quarter of 2016 compared to $8.5 million in the same period in 2015.  Changes in the balance sheet contributed $732 thousand to this increase, but this was reduced by $243 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 June 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

$

38,400 

 

$

79 

 

0.83% 

 

$

52,114 

 

$

72 

 

0.55% 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

108,168 

 

 

588 

 

2.19% 

 

 

121,383 

 

 

621 

 

2.05% 

Tax Exempt

 

51,679 

 

 

535 

 

4.14% 

 

 

55,611 

 

 

613 

 

4.41% 

               Investments

 

159,847 

 

 

1,123 

 

2.83% 

 

 

176,994 

 

 

1,234 

 

2.80% 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, industrial and agricultural

 

660,177 

 

 

6,725 

 

4.03% 

 

 

578,985 

 

 

6,134 

 

4.22% 

Residential mortgage

 

76,832 

 

 

768 

 

4.00% 

 

 

80,474 

 

 

829 

 

4.14% 

Home equity loans and lines

 

71,413 

 

 

756 

 

4.26% 

 

 

63,650 

 

 

745 

 

4.69% 

Consumer

 

5,715 

 

 

60 

 

4.22% 

 

 

6,490 

 

 

79 

 

4.88% 

Loans

 

814,137 

 

 

8,309 

 

4.05% 

 

 

729,599 

 

 

7,787 

 

4.25% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest-earning assets

 

1,012,384 

 

$

9,511 

 

3.78% 

 

 

958,707 

 

$

9,093 

 

3.80% 

Other assets

 

67,771 

 

 

 

 

 

 

 

66,770 

 

 

 

 

 

Total assets

$

1,080,155 

 

 

 

 

 

 

$

1,025,477 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking

$

253,299 

 

$

81 

 

0.13% 

 

$

227,943 

 

 

67 

 

0.12% 

Money Management

 

390,985 

 

 

333 

 

0.34% 

 

 

382,738 

 

 

387 

 

0.41% 

Savings

 

73,323 

 

 

14 

 

0.08% 

 

 

65,738 

 

 

12 

 

0.07% 

Time

 

81,957 

 

 

120 

 

0.59% 

 

 

93,687 

 

 

153 

 

0.66% 

Total interest-bearing deposits

 

799,564 

 

 

548 

 

0.28% 

 

 

770,106 

 

 

619 

 

0.32% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other borrowings

 

 

 

-

 

0.58% 

 

 

-

 

 

-

 

-

Total interest-bearing liabilities

 

799,570 

 

 

548 

 

0.28% 

 

 

770,106 

 

 

619 

 

0.32% 

Noninterest-bearing deposits

 

161,209 

 

 

 

 

 

 

 

142,621 

 

 

 

 

 

Other liabilities

 

5,003 

 

 

 

 

 

 

 

6,751 

 

 

 

 

 

Shareholders' equity

 

114,373 

 

 

 

 

 

 

 

105,999 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,080,155 

 

 

 

 

 

 

$

1,025,477 

 

 

 

 

 

T/E net interest income/Net interest margin

 

 

 

 

8,963 

 

3.56% 

 

 

 

 

 

8,474 

 

3.55% 

Tax equivalent adjustment

 

 

 

 

(523)

 

 

 

 

 

 

 

(515)

 

 

Net interest income

 

 

 

$

8,440 

 

 

 

 

 

 

$

7,959 

 

 



32

 


 

Provision for Loan Losses

The increase in the provision expense was due to a higher level of charge-offs and growth in the loan portfolio compared to $310 thousand in 2015.  Provision expense for the second quarter was $1.9 million.  For more information refer to the Loan Quality and Allowance for Loan Losses discussion in the Financial Condition section.



Noninterest Income

For the second quarter of 2016, noninterest income decreased $260 thousand from the same period in 2015.  Investment and trust service fees decreased due to a decline in estate fees and investment commissions from 2015 to 2016.  Loan service charges decreased due to a large prepayment penalty in the second quarter of 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 the second quarter of 2016, compared to the same period in 2015.      



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





 

 

 

 

 

 

 

 

 

 



For the Three Months Ended

 

 

 

 

 



June 30

 

Change

(Dollars in thousands)

2016

 

2015

 

Amount

 

%

Noninterest Income

 

 

 

 

 

 

 

 

 

 

Investment and trust services fees

$

1,218 

 

$

1,388 

 

$

(170)

 

(12.2)

Loan service charges

 

189 

 

 

314 

 

 

(125)

 

(39.8)

Deposit service charges and fees

 

602 

 

 

586 

 

 

16 

 

2.7 

Other service charges and fees

 

313 

 

 

311 

 

 

 

0.6 

Debit card income

 

375 

 

 

356 

 

 

19 

 

5.3 

Increase in cash surrender value of life insurance

 

132 

 

 

140 

 

 

(8)

 

(5.7)

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

 

(2)

 

 

 -

 

 

(2)

 

N/A

Securities gains, net

 

 

 

 

 

(6)

 

(75.0)

Other

 

27 

 

 

13 

 

 

14 

 

107.7 

Total noninterest income

$

2,856 

 

$

3,116 

 

$

(260)

 

(8.3)



33

 


 



Noninterest Expense

Noninterest expense for the second quarter of 2016 increased $71 thousand compared to the same period in 2015.  The increase in salaries and benefits was primarily due to a $150 thousand increase in salary expense due to merit increasesLegal 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.  Data processing expenses decreased due to timing of invoices due to a change in vendors.     Other expenses decreased due to several one-time expenses the Bank took in the second quarter of 2015 related to branch assets taken out of service.



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







 

 

 

 

 

 

 

 

 

 



For the Three Months Ended

 

 

 

 

 

(Dollars in thousands)

June 30

 

Change

Noninterest Expense

2016

 

2015

 

Amount

 

%

Salaries and benefits

$

4,346 

 

$

4,203 

 

$

143 

 

3.4 

Net occupancy expense

 

553 

 

 

556 

 

 

(3)

 

(0.5)

Furniture and equipment expense

 

218 

 

 

239 

 

 

(21)

 

(8.8)

Advertising

 

262 

 

 

283 

 

 

(21)

 

(7.4)

Legal and professional fees

 

394 

 

 

203 

 

 

191 

 

94.1 

Data processing

 

504 

 

 

556 

 

 

(52)

 

(9.4)

Pennsylvania bank shares tax

 

260 

 

 

206 

 

 

54 

 

26.2 

Intangible amortization

 

 -

 

 

90 

 

 

(90)

 

(100.0)

FDIC insurance

 

169 

 

 

160 

 

 

 

5.6 

ATM/debit card processing

 

200 

 

 

186 

 

 

14 

 

7.5 

Foreclosed real estate

 

13 

 

 

 

 

 

85.7 

Telecommunications

 

90 

 

 

118 

 

 

(28)

 

(23.7)

Other

 

721 

 

 

852 

 

 

(131)

 

(15.4)

Total noninterest expense

$

7,730 

 

$

7,659 

 

$

71 

 

0.9 



Provision for Income Taxes

For the second quarter of 2016, the Corporation recorded a Federal income tax expense of $130 thousand compared to $632 thousand for the same quarter in 2015. The effective tax rate was 7.7% for the second quarter of 2016 compared to 20.3% for the same period in 2015The decrease was due to a reduction in pretax income, due to increased provision expense and nonrecurring items 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 six months ended June  30, 2016 to the six months ended June  30, 2015:

Net Interest Income

Tax equivalent net interest income for the first half of 2016 increased $1.2 million year over year.  Average interest-earning assets increased $54.5 million from 2015,  while the yield on these assets decreased slightly to 3.85% in 2016 from 3.87% in 2015.  The average balance of investment securities decreased $17.5 million while average loans increased $80.0 million year over year.  Average commercial loans increased $76.6 million and average consumer and home equity loans increased $6.5 million.  These increases were partially offset by a decrease of $3.2 million in the average balance of mortgage loans.



Interest expense was $1.1 million for the first half of 2016, a decrease of $167 thousand from the 2015 total of $1.3 million.  Average interest-bearing deposits increased $31.8 million to $791.2 million for 2016 from an average balance of $759.4 million in 2015.  The average cost of these deposits decreased from 0.33% in 2015 to  0.28% in 2016



34

 


 

Tax equivalent net interest income increased $1.2 million to $18.0 million in 2016 compared to $16.9 million in 2015.  Changes in the balance sheet contributed $1.4 million to this increase, but this was reduced by $210 thousand due to lower rates.



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 Six Months Ended June 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 

 

$

141 

 

0.82% 

 

$

42,577 

 

$

127 

 

0.60% 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

106,962 

 

 

1,170 

 

2.20% 

 

 

120,988 

 

 

1,308 

 

2.18% 

Tax Exempt

 

51,571 

 

 

1,085 

 

4.21% 

 

 

55,083 

 

 

1,225 

 

4.45% 

               Investments

 

158,533 

 

 

2,255 

 

2.86% 

 

 

176,071 

 

 

2,533 

 

2.90% 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, industrial and agricultural

 

651,542 

 

 

13,548 

 

4.11% 

 

 

574,924 

 

 

12,147 

 

4.22% 

Residential mortgage

 

77,727 

 

 

1,555 

 

4.00% 

 

 

80,902 

 

 

1,653 

 

4.10% 

Home equity loans and lines

 

71,166 

 

 

1,511 

 

4.27% 

 

 

63,778 

 

 

1,496 

 

4.73% 

Consumer

 

5,635 

 

 

128 

 

4.57% 

 

 

6,478 

 

 

165 

 

5.14% 

Loans

 

806,070 

 

 

16,742 

 

4.12% 

 

 

726,082 

 

 

15,461 

 

4.25% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest-earning assets

 

999,242 

 

$

19,138 

 

3.85% 

 

 

944,730 

 

$

18,121 

 

3.87% 

Other assets

 

66,941 

 

 

 

 

 

 

 

66,786 

 

 

 

 

 

Total assets

$

1,066,183 

 

 

 

 

 

 

$

1,011,516 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking

$

245,539 

 

$

153 

 

0.13% 

 

$

216,313 

 

 

120 

 

0.11% 

Money Management

 

390,626 

 

 

666 

 

0.34% 

 

 

383,423 

 

 

803 

 

0.42% 

Savings

 

71,637 

 

 

27 

 

0.08% 

 

 

64,487 

 

 

24 

 

0.08% 

Time

 

83,415 

 

 

245 

 

0.59% 

 

 

95,180 

 

 

313 

 

0.66% 

Total interest-bearing deposits

 

791,217 

 

 

1,091 

 

0.28% 

 

 

759,403 

 

 

1,260 

 

0.33% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities sold under agreements to repurchase

 

 -

 

 

 -

 

 -

 

 

50 

 

 

 -

 

0.15% 

Other borrowings

 

791 

 

 

 

0.60% 

 

 

12 

 

 

 -

 

0.30% 

Total interest-bearing liabilities

 

792,008 

 

 

1,093 

 

0.28% 

 

 

759,465 

 

 

1,260 

 

0.33% 

Noninterest-bearing deposits

 

155,456 

 

 

 

 

 

 

 

139,399 

 

 

 

 

 

Other liabilities

 

5,267 

 

 

 

 

 

 

 

7,481 

 

 

 

 

 

Shareholders' equity

 

113,452 

 

 

 

 

 

 

 

105,171 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,066,183 

 

 

 

 

 

 

$

1,011,516 

 

 

 

 

 

T/E net interest income/Net interest margin

 

 

 

 

18,045 

 

3.63% 

 

 

 

 

 

16,861 

 

3.60% 

Tax equivalent adjustment

 

 

 

 

(1,051)

 

 

 

 

 

 

 

(1,016)

 

 

Net interest income

 

 

 

$

16,994 

 

 

 

 

 

 

$

15,845 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



35

 


 

Provision for Loan Losses

The increase in the provision expense was due to a higher level of charge-offs and growth in the loan portfolio compared to $635 thousand in 2015.  Provision expense for the first six months of 2016 was $2.2 million.  For more information refer to the Loan Quality and Allowance for Loan Losses discussion in the Financial Condition section.



Noninterest Income

For the first half of 2016, noninterest income decreased $961 thousand 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 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, two properties held as other real estate owned were sold at a 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.      



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









 

 

 

 

 

 

 

 

 

 



For the Six Months Ended

 

 

 

 

 



June 30

 

Change

(Dollars in thousands)

2016

 

2015

 

Amount

 

%

Noninterest Income

 

 

 

 

 

 

 

 

 

 

Investment and trust services fees

$

2,472 

 

$

2,651 

 

$

(179)

 

(6.8)

Loan service charges

 

415 

 

 

496 

 

 

(81)

 

(16.3)

Deposit service charges and fees

 

1,180 

 

 

1,077 

 

 

103 

 

9.6 

Other service charges and fees

 

616 

 

 

607 

 

 

 

1.5 

Debit card income

 

722 

 

 

675 

 

 

47 

 

7.0 

Increase in cash surrender value of life insurance

 

267 

 

 

279 

 

 

(12)

 

(4.3)

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

 

(10)

 

 

32 

 

 

(42)

 

(131.3)

OTTI losses on debt securities

 

(20)

 

 

(20)

 

 

 -

 

 -

Gain on conversion of investment security

 

 -

 

 

728 

 

 

(728)

 

(100.0)

Securities gains, net

 

 

 

 

 

(5)

 

(62.5)

Other

 

164 

 

 

237 

 

 

(73)

 

(30.8)

Total noninterest income

$

5,809 

 

$

6,770 

 

$

(961)

 

(14.2)



 

 

 

 

 

 

 

 

 

 



36

 


 



Noninterest Expense

Noninterest expense for the first half of 2016 increased $375 thousand compared to the same period in 2015.  The increase in salaries and benefits was primarily due to a $288 thousand increase in salary expense due to merit increases and $58 thousand for stock option expense, compared to none in 2015Net occupancy expense decreased compared to prior year due to less expenses for snow removal in 2016.  Advertising expense increased due to customer acquisition promotions.  Legal 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 increased in 2016, due to a $46 thousand write-down on one property.  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 six months ended June  30, 2016 and 2015:







 

 

 

 

 

 

 

 

 

 



For the Six Months Ended

 

 

 

 

 

(Dollars in thousands)

June 30

 

Change

Noninterest Expense

2016

 

2015

 

Amount

 

%

Salaries and benefits

$

8,716 

 

$

8,286 

 

$

430 

 

5.2 

Net occupancy expense

 

1,152 

 

 

1,172 

 

 

(20)

 

(1.7)

Furniture and equipment expense

 

434 

 

 

470 

 

 

(36)

 

(7.7)

Advertising

 

543 

 

 

471 

 

 

72 

 

15.3 

Legal and professional fees

 

691 

 

 

499 

 

 

192 

 

38.5 

Data processing

 

1,001 

 

 

1,023 

 

 

(22)

 

(2.2)

Pennsylvania bank shares tax

 

496 

 

 

402 

 

 

94 

 

23.4 

Intangible amortization

 

 -

 

 

181 

 

 

(181)

 

(100.0)

FDIC insurance

 

326 

 

 

308 

 

 

18 

 

5.8 

ATM/debit card processing

 

428 

 

 

373 

 

 

55 

 

14.7 

Foreclosed real estate

 

76 

 

 

19 

 

 

57 

 

300.0 

Telecommunications

 

209 

 

 

235 

 

 

(26)

 

(11.1)

Other

 

1,453 

 

 

1,711 

 

 

(258)

 

(15.1)

Total noninterest expense

$

15,525 

 

$

15,150 

 

$

375 

 

2.5 



 

 

 

 

 

 

 

 

 

 

Provision for Income Taxes

For the first half of 2016, the Corporation recorded a Federal income tax expense of $815 thousand compared to $1.5 million for the same period in 2015. The effective tax rate was 16.0% for the first half of 2016 compared to 21.6% for the same period in 2015The decrease was due to a reduction in pretax income, due to increased provision expense and nonrecurring items 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 June 30, 2016, assets totaled $1.084 billion, an increase of $48.8 million from the 2015 year-end balance of $1.035 billion. Investment securities increased $4.1 million, while net loans increased $44.4 million (5.6%). Deposits increased  $47.0 million (5.1%) for the first six months of 2016 due to increases in every deposit category except time deposits. Shareholders’ equity increased $4.6 million during the first six months as retained earnings increased $2.6 million, accumulated other comprehensive loss decreased  $1.4 million and the Corporation’s Dividend Reinvestment Plan (DRIP) added an additional $637 thousand in new capital.

37

 


 

Cash and Cash Equivalents:

Cash and cash equivalents totaled $41.0 million at June 30, 2016,  an increase of approximately $2 million from the prior year-end balance of $39.2 million.  Interest-bearing deposits are held primarily at the Federal Reserve ($4.6 million) and in short-term bank owned certificates of deposit ($20.6 million).



Investment Securities:    

The investment portfolio has increased $2.0 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 43% and 44% of the portfolio fair value, respectively. The Bank invested $16.6 million during the first half of 2016 with the purchases spread between, U.S. Agency mortgage-backed securities and municipal securities.  The average life of the portfolio was 3.81 years. 

The investment portfolio had a net unrealized gain of $3.2 million at June 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 $158.5 million with a yield of 2.86% for the first half of 2016. This compares to an average of $176.1 million and a yield of 2.90% 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 30 states) and is comprised primarily of general obligation bonds (74%).  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 15 issuers in the state of Texas with a fair value of $9.2 million. The average rating of the municipal portfolio from Moody’s is Aa2. It contains $67.8 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.

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



 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

June 30, 2016

 

cost

 

gains

 

losses

 

value

Equity securities

 

$

164 

 

$

76 

 

$

 -

 

$

240 

U.S. Government and Agency securities

 

 

13,104 

 

 

339 

 

 

(17)

 

 

13,426 

Municipal securities

 

 

68,430 

 

 

2,354 

 

 

(43)

 

 

70,741 

Trust preferred securities

 

 

5,968 

 

 

 -

 

 

(798)

 

 

5,170 

Agency mortgage-backed securities

 

 

71,448 

 

 

1,310 

 

 

(35)

 

 

72,723 

Private-label mortgage-backed securities

 

 

1,201 

 

 

27 

 

 

(5)

 

 

1,223 

Asset-backed securities

 

 

36 

 

 

 -

 

 

(2)

 

 

34 



 

$

160,351 

 

$

4,106 

 

$

(900)

 

$

163,557 





 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(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 

38

 


 

The following table provides additional detail about the Bank’s trust preferred securities as of June 30, 2016:  





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(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 

 

$

832 

 

$

(134)

 

BB+

Wachovia Cap Trust II

 

1/15/2027

 

Single

 

Preferred Stock

 

 

279 

 

 

254 

 

 

(25)

 

BBB

Huntington Cap Trust

 

2/1/2027

 

Single

 

Preferred Stock

 

 

944 

 

 

795 

 

 

(149)

 

BB

Corestates Captl Tr II

 

2/15/2027

 

Single

 

Preferred Stock

 

 

941 

 

 

848 

 

 

(93)

 

BBB+

Huntington Cap Trust II

 

6/15/2028

 

Single

 

Preferred Stock

 

 

897 

 

 

767 

 

 

(130)

 

BB

Chase Cap VI JPM

 

8/1/2028

 

Single

 

Preferred Stock

 

 

965 

 

 

832 

 

 

(133)

 

BBB-

Fleet Cap Tr V

 

12/18/2028

 

Single

 

Preferred Stock

 

 

976 

 

 

842 

 

 

(134)

 

BB+



 

 

 

 

 

 

 

$

5,968 

 

$

5,170 

 

$

(798)

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(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

 

$

322 

 

$

319 

 

$

(3)

 

ALT A

 

CCC

 

15.07 

 

$

 -

RALI 2005-QS2 A1

 

2/1/2005

 

 

176 

 

 

187 

 

 

11 

 

ALT A

 

CC

 

4.83 

 

 

10 

RALI 2006-QS4 A2

 

4/1/2006

 

 

425 

 

 

423 

 

 

(2)

 

ALT A

 

D

 

 -

 

 

323 

GSR 2006-5F 2A1

 

5/1/2006

 

 

53 

 

 

60 

 

 

 

Prime

 

D

 

 -

 

 

15 

RALI 2006-QS8 A1

 

7/28/2006

 

 

225 

 

 

234 

 

 

 

ALT A

 

D

 

 -

 

 

227 



 

 

 

$

1,201 

 

$

1,223 

 

$

22 

 

 

 

 

 

 

 

$

575 



The investment portfolio contained thirty-seven securities with $21.0 million of temporarily impaired fair value and $900 thousand in unrealized losses at June 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 June 30, 2016, was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted.

39

 


 

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 June 30, 2016 and December 31, 2015:



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



June 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

$

 -

 

$

 -

 

 -

 

$

3,612 

 

$

(17)

 

10 

 

$

3,612 

 

$

(17)

 

10 

Municipal securities

 

 -

 

 

 -

 

 -

 

 

2,328 

 

 

(43)

 

 

 

2,328 

 

 

(43)

 

Trust preferred securities

 

 -

 

 

 -

 

 -

 

 

5,170 

 

 

(798)

 

 

 

5,170 

 

 

(798)

 

Agency mortgage-backed securities

 

3,218 

 

 

(2)

 

 

 

5,929 

 

 

(33)

 

11 

 

 

9,147 

 

 

(35)

 

14 

Private-label mortgage-backed securities

 

319 

 

 

(3)

 

 

 

423 

 

 

(2)

 

 

 

742 

 

 

(5)

 

Asset-backed securities

 

 -

 

 

 -

 

 -

 

 

 

 

(2)

 

 

 

 

 

(2)

 

Total temporarily impaired securities

$

3,537 

 

$

(5)

 

 

$

17,467 

 

$

(895)

 

33 

 

$

21,004 

 

$

(900)

 

37 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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 $43 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 $5.2 million and an unrealized loss of $798 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 June 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 are two PLMBS bonds showing a small unrealized loss of $5 thousand.  However, the PLMBS sector as a whole is showing an unrealized gain of $22 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 $20 thousand impairment charge during the first quarter of 2016 and has recorded $575 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.

The Bank held $436 thousand of restricted stock at June 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

40

 


 

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 six months of 2016, the Bank originated $5.0 million in mortgages, including approximately $5.0 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 ($7.3 million), while loans for individuals to construct personal residences totaled $1.1 million thousand at June 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 June 30, 2016, the Bank had $5.1 million in residential real estate construction loans funded with an interest reserve and capitalized $56 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 $371.8 million from $340.7 million at the end of 2015, an increase of $31.1 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 ($54.3 million), hotels and motels ($49.7 million), land development ($39.7 million), apartment units ($36.4 million), and auto dealerships ($31.9 million). 

Commercial (C&I):  This category includes commercial, industrial, farm, agricultural, and municipal loans.  C&I loans increased $10.4 million to $226.3 million at June 30, 2016, compared to $215.9 million at the end of 2015.    The largest sectors (by industry) in the commercial loan category are: retail trade ($24.7 million), construction ($16.5 million) and health care ($15.2 million).  At June 30, 2016, the Bank had $114.6 million in municipal loans. The Bank is very active in its market in pursuing commercial lending opportunities, but supplements 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. These loans usually represent an opportunity to participate in larger credits that are not available in market, with the benefit of lower origination and servicing costs.  For the first six months of 2016, the Bank purchased $10.3 million of loan participations and commitments.  At June  30, 2016, the Bank held $132.2 million in purchased loan participations in its portfolio.    

Consumer loans decreased $408 thousand due primarily to regular payments and maturities.  The Bank believes the consumer portfolio will continue to run-down, as consumers are unwilling to increase their debt. The majority of the Bank’s consumer loans, approximately $3.0 million, are personal lines of credit.

41

 


 

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



 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

Change

(Dollars in thousands)

June 30, 2016

 

December 31, 2015

 

 

Amount

 

%

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

Consumer first liens

$

101,113 

 

$

103,698 

 

$

(2,585)

 

(2.5)

Commercial first lien

 

62,424 

 

 

57,780 

 

 

4,644 

 

8.0 

Total first liens

 

163,537 

 

 

161,478 

 

 

2,059 

 

1.3 



 

 

 

 

 

 

 

 

 

 

Consumer junior liens and lines of credit

 

46,106 

 

 

44,996 

 

 

1,110 

 

2.5 

Commercial junior liens and lines of credit

 

5,908 

 

 

5,917 

 

 

(9)

 

(0.2)

Total junior liens and lines of credit

 

52,014 

 

 

50,913 

 

 

1,101 

 

2.2 

Total residential real estate 1-4 family

 

215,551 

 

 

212,391 

 

 

3,160 

 

1.5 



 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

 

 

 

 

 

 

 

 

Consumer

 

1,067 

 

 

545 

 

 

522 

 

95.8 

Commercial

 

7,253 

 

 

7,343 

 

 

(90)

 

(1.2)

Total residential real estate construction

 

8,320 

 

 

7,888 

 

 

432 

 

5.5 



 

 

 

 

 

 

 

 

 

 

Commercial real estate

 

371,786 

 

 

340,695 

 

 

31,091 

 

9.1 

Commercial

 

226,307 

 

 

215,942 

 

 

10,365 

 

4.8 

        Total commercial

 

598,093 

 

 

556,637 

 

 

41,456 

 

7.4 



 

 

 

 

 

 

 

 

 

 

Consumer

 

4,692 

 

 

5,100 

 

 

(408)

 

(8.0)



 

826,656 

 

 

782,016 

 

 

44,640 

 

5.7 

Less: Allowance for loan losses

 

(10,318)

 

 

(10,086)

 

 

(232)

 

2.3 

Net Loans

$

816,338 

 

$

771,930 

 

$

44,408 

 

5.8 



 

 

 

 

 

 

 

 

 

 

Included in the loan balances are the following:

 

 

 

 

 

 

 

 

 

 

Net unamortized deferred loan fees

$

225 

 

$

436 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

Loans pledged as collateral for borrowings and commitments from:

 

 

 

 

 

 

 

 

 

 

FHLB

$

583,567 

 

$

643,449 

 

 

 

 

 

Federal Reserve Bank

 

42,060 

 

 

45,111 

 

 

 

 

 



$

625,627 

 

$

688,560 

 

 

 

 

 

42

 


 

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 $27.3 million at quarter end and includes both performing and nonperforming loans.  It is comprised of $5.0 million rated 6 and $22.3 million rated 7. The Bank has no loans rated 8-doubtful or 9-loss. The watch totaled $31.6 million at March 31, 2016 and $27.9 million at the prior year-end. While essentially unchanged since year-end, the watch list at June 30, 2016 is $4.3 million less than reported at March 31, 2016 ($31.6 million).  The quarter-to-quarter reduction is due primarily to a charge-off of $1.9 million (see the Allowance for Loan Losses discussion) and a pay down of $1.5 million on a commercial line-of-credit.  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 a lower loan-to-value limit, than the supervisory limits.  At June 30, 2016, the Bank had loans of $30.6 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 7 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).

43

 


 

Loan quality, as measured by the balance of nonperforming loans, has declined from year-end. The increase in nonaccrual loans occurred in the commercial real estate category due to one loan (Credit 4 on the Significant Nonaccrual Loan table) for $3.4 million transferred to nonaccrual in 2016.  The following table presents a summary of nonperforming assets:



 

 

 

 

 



 

 

 

 

 



 

 

 

 

 

(Dollars in thousands)

June 30, 2016

 

December 31, 2015



 

 

 

 

 

Nonaccrual loans

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

First liens

$

427 

 

$

806 

Junior liens and lines of credit

 

63 

 

 

105 

Total

 

490 

 

 

911 

Residential real estate - construction

 

491 

 

 

502 

Commercial real estate

 

6,812 

 

 

3,681 

Commercial

 

25 

 

 

276 

Total nonaccrual loans

 

7,818 

 

 

5,370 



 

 

 

 

 

Loans past due 90 days or more and not included above

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

First liens

 

14 

 

 

214 

Junior liens and lines of credit

 

33 

 

 

 -

Total

 

47 

 

 

214 

Residential real estate - construction

 

60 

 

 

 -

Commercial real estate

 

306 

 

 

152 

Commercial

 

46 

 

 

 -

Consumer

 

 -

 

 

Total loans past due 90 days or more and still accruing

 

459 

 

 

368 



 

 

 

 

 

Total nonperforming loans

 

8,277 

 

 

5,738 



 

 

 

 

 

Other real estate owned

 

6,194 

 

 

6,451 

Total nonperforming assets

$

14,471 

 

$

12,189 



 

 

 

 

 



 

 

 

 

 

Nonperforming loans to total gross loans

 

1.00% 

 

 

0.73% 

Nonperforming assets to total assets

 

1.33% 

 

 

1.18% 

Allowance for loan losses to nonperforming loans

 

124.66% 

 

 

175.78% 



44

 


 

The following table identifies the most significant loans in nonaccrual status. These four nonaccrual loans account for 88% 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 June 30, 2016 totaled $19.0 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 - Commercial real estate

 

515 

 

 

 -

 

Aug-11

 

Y

 

1st lien on commercial and residential properties and 70 acres of farmland

 

PA

 

Nov-15

$

944 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit 2 - Residential real estate

 

1,782 

 

 

 -

 

Mar-12

 

Y

 

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

 

PA

 

Jan-16

$

3,810 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit 3 - Commercial real estate

 

1,201 

 

 

 -

 

Dec-14

 

N

 

Hotel and entertainment complex

 

PA

 

Apr-16

$

4,000 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit 4 - Commercial real estate

 

3,363 

 

 

 -

 

Mar-16

 

N

 

Hotel

 

PA

 

Apr-16

$

3,656 



$

6,861 

 

$

 -

 

 

 

 

 

 

 

 

 

 

 

 



(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 was restructured (TDR) into a new loan at the end of the first quarter of 2016. It will remain as nonaccrual for at least 6 months to ensure compliance with the modified terms. Credit 2 is a TDR that is performing in accordance with the modified terms. Credit 3 is a hotel and entertainment complex being operated as part of an estate liquidation and is currently listed for sale.  Credit 4 is a hotel that was transferred to nonaccrual at March 31, 2016. This loan is a participated loan and the Bank is not the lead bank. As part of the loan work-out, the borrower has entered into a forbearance agreement that requires the sale of the property. The Bank recorded a $1.9 million charge-off on this credit during the second quarter of 2016 (see the Allowance for Loan Losses Discussion).

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 $18.9 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 7 in the accompanying financial statements for information on TDR loans in the portfolio.

45

 


 

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





 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 



 

June 30, 2016

(Dollars in thousands)

 

Nonaccrual

 

Accruing

 

Total



 

Non-TDR

 

TDR

 

TDR

 

Impaired

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

276 

 

$

151 

 

$

494 

 

$

921 

Junior liens and lines of credit

 

 

63 

 

 

 -

 

 

 -

 

 

63 

Total

 

 

339 

 

 

151 

 

 

494 

 

 

984 

Residential real estate - construction

 

 

 -

 

 

491 

 

 

 -

 

 

491 

Commercial real estate

 

 

5,006 

 

 

1,806 

 

 

10,545 

 

 

17,357 

Commercial

 

 

25 

 

 

 -

 

 

 -

 

 

25 

Total

 

$

5,370 

 

$

2,448 

 

$

11,039 

 

$

18,857 



 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

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 June 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 June 30, 2016, impaired loans totaled $18.9 million compared to $16.8 million at year-end 2015. Credit four in the significant nonaccrual table was identified as impaired during the first quarter of 2016 and is primarily responsible for the increase in impaired loans since 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 7 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

46

 


 

slowly improving economy.   As credit quality improved the Bank began to see lower charge-offs.  The Bank believes that 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 ($8.5 million) at June 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 $1.1 million compared to $1.3 million at 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.

47

 


 

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 June  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



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for ALL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

396 

 

$

52 

 

$

491 

 

$

17,082 

 

$

 -

 

$

 -

 

$

 -

 

$

18,021 

Collectively

 

 

163,141 

 

 

51,962 

 

 

7,829 

 

 

354,704 

 

 

226,307 

 

 

4,692 

 

 

 -

 

 

808,635 

Total

 

$

163,537 

 

$

52,014 

 

$

8,320 

 

$

371,786 

 

$

226,307 

 

$

4,692 

 

$

 -

 

$

826,656 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL established for loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

Collectively

 

 

1,023 

 

 

319 

 

 

205 

 

 

5,940 

 

 

1,596 

 

 

97 

 

 

1,138 

 

 

10,318 

ALL at June 30, 2016

 

$

1,023 

 

$

319 

 

$

205 

 

$

5,940 

 

$

1,596 

 

$

97 

 

$

1,138 

 

$

10,318 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 six months of 2016, the Bank recorded $2.2 million for the loan loss provision expense compared to $635 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 $1.9 million for the six months of 2016.

In the second quarter of 2016, the Bank recorded a charge-off of $1.9 million on a commercial real estate loan (Credit 4 of the Significant Nonaccrual Loan table).  The loan represents the Bank’s portion of a participated loan transaction. The Bank is not the lead lender. The 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 negotiated a forbearance agreement with the borrower that requires 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 the charge-off on this credit. The Bank does not know when the property will be sold or at what price. It is possible that that an additional charge-off may be required. 

48

 


 

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 March 31, 2016

 

$

997 

 

$

316 

 

$

199 

 

$

6,181 

 

$

1,510 

 

$

99 

 

$

1,040 

 

$

10,342 

Charge-offs

 

 

(46)

 

 

 -

 

 

 -

 

 

(1,951)

 

 

(3)

 

 

(42)

 

 

 -

 

 

(2,042)

Recoveries

 

 

 

 

 -

 

 

 -

 

 

14 

 

 

106 

 

 

22 

 

 

 -

 

 

143 

Provision

 

 

71 

 

 

 

 

 

 

1,696 

 

 

(17)

 

 

18 

 

 

98 

 

 

1,875 

ALL at June 30, 2016

 

$

1,023 

 

$

319 

 

$

205 

 

$

5,940 

 

$

1,596 

 

$

97 

 

$

1,138 

 

$

10,318 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at December 31, 2015

 

$

989 

 

$

308 

 

$

194 

 

$

5,649 

 

$

1,519 

 

$

102 

 

$

1,325 

 

$

10,086 

Charge-offs

 

 

(49)

 

 

 -

 

 

 -

 

 

(1,954)

 

 

(66)

 

 

(84)

 

 

 -

 

 

(2,153)

Recoveries

 

 

33 

 

 

 -

 

 

 -

 

 

14 

 

 

121 

 

 

42 

 

 

 -

 

 

210 

Provision

 

 

50 

 

 

11 

 

 

11 

 

 

2,231 

 

 

22 

 

 

37 

 

 

(187)

 

 

2,175 

ALL at June 30, 2016

 

$

1,023 

 

$

319 

 

$

205 

 

$

5,940 

 

$

1,596 

 

$

97 

 

$

1,138 

 

$

10,318 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 







 

 

 

 

 

 

 

 



Six months ended

 

Year ended

 

Six months ended



June 30, 2016

 

December 31, 2015

 

June 30, 2015

Net loans charged-off as a percentage of average gross loans

 

0.48% 

 

 

0.04% 

 

 

0.08% 

Net loans charged-off as a percentage of the provision for loan losses

 

0.89% 

 

 

24.12% 

 

 

46.61% 

Allowance as a percentage of loans

 

1.25% 

 

 

1.29% 

 

 

1.29% 

Net charge-offs

$

1,943 

 

$

310 

 

$

296 



Other Real Estate Owned:

The Bank holds $6.2 million of other real estate owned (OREO), comprised of six 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 two properties for a loss of $10 thousand, recorded a write down of $46 thousand on one property and incurred expense of $76 thousand to hold and maintain OREO. Note 8 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:









 

 

 

 

 

 

June 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 June 30, 2016, the Bank had $315 thousand of residential properties in the process of foreclosure compared to $218 thousand at the end of 2015.

49

 


 

Deposits: 

Total deposits increased $47.0 million during the first six months of 2016 to $965.6 million. Non-interest bearing deposits increased $10.4 million, while savings and interest-bearing checking increased $41.7 million and time deposits decreased $5.1 million. The increase in non-interest bearing checking accounts occurred primarily in small business checking accounts ($9.4 million).  Interest bearing checking increased by $21.1 million, primarily from commercial deposits.  The Bank’s Money Management product increased $16.0 million, primarily from commercial deposits.    Retail time deposits decreased since year-end, as customers moved funds to more liquid accounts.  As of June  30, 2016, the Bank had $3.3 million in CDARS reciprocal time deposits included in brokered time deposits.  



 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

Change

(Dollars in thousands)

June 30, 2016

 

December 31, 2015

 

 

Amount

 

%

Noninterest-bearing checking

$

162,515 

 

$

152,095 

 

$

10,420 

 

6.9 



 

 

 

 

 

 

 

 

 

 

Interest-bearing checking

 

253,256 

 

 

232,181 

 

 

21,075 

 

9.1 

Money management

 

395,293 

 

 

379,331 

 

 

15,962 

 

4.2 

Savings

 

73,864 

 

 

69,174 

 

 

4,690 

 

6.8 

Total interest-bearing checking and savings

 

722,413 

 

 

680,686 

 

 

41,727 

 

6.1 



 

 

 

 

 

 

 

 

 

 

Retail time deposits

 

77,359 

 

 

82,468 

 

 

(5,109)

 

(6.2)

Brokered time deposits

 

3,267 

 

 

3,263 

 

 

 

0.1 

Total time deposits

 

80,626 

 

 

85,731 

 

 

(5,105)

 

(6.0)

Total deposits

$

965,554 

 

$

918,512 

 

$

47,042 

 

5.1 



 

 

 

 

 

 

 

 

 

 

Overdrawn deposit accounts reclassified as loans

$

185 

 

$

128 

 

 

 

 

 



Borrowings:

The Corporation had no borrowings at June 30, 2016

Shareholders’ Equity:

Total shareholders’ equity increased $4.6 million to $115.9 million at June  30, 2016, compared to $111.4 million at the end of 2015.  The increase in retained earnings from the Corporation’s net income of $4.3 million was partially offset by the cash dividend of $1.7 million. The Corporation’s dividend payout ratio is 40.0% for the first six months of 2016 compared to 28.4% 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 $0.40 per share, compared to $0.36 for the same period in 2015,  an 11.1% increase.  For the second quarter of 2016, the Corporation paid a $0.21 per share dividend, compared to $0.19 paid in the second quarter of 2015.  On July 28, 2016 the Board of Directors declared a $0.21 per share regular quarterly dividend for the third quarter of 2016, which will be paid on August 24, 2016.

In addition, the Corporation considers how dividend decisions may affect the Dividend Reinvestment Plan (DRIP), which has raised $637 thousand in new capital this year with 40,602 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 April 2016, the Corporation repurchased 15,521 shares of its common stock for $350 thousand.

50

 


 

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 June 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 June  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)

 

June 30, 2016

 

December 31, 2015

 

Minimum

 

Minimum



 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

14.64% 

 

14.77% 

 

5.125% 

 

N/A

Farmers & Merchants Trust Company

 

14.59% 

 

14.76% 

 

5.125% 

 

6.50% 



 

 

 

 

 

 

 

 

Tier 1 Risk-based Capital Ratio (2)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

14.64% 

 

14.77% 

 

6.625% 

 

N/A

Farmers & Merchants Trust Company

 

14.59% 

 

14.76% 

 

6.625% 

 

8.00% 



 

 

 

 

 

 

 

 

Total Risk-based Capital Ratio (3)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

15.90% 

 

16.03% 

 

8.625% 

 

N/A

Farmers & Merchants Trust Company

 

15.85% 

 

16.02% 

 

8.625% 

 

10.00% 



 

 

 

 

 

 

 

 

Tier 1 Leverage Ratio (4)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

10.20% 

 

10.38% 

 

4.000% 

 

N/A

Farmers & Merchants Trust Company

 

10.17% 

 

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 4.2% in Cumberland County to high of 6.4% 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 or business and Management believes that the Bank’s primary market area continues to be well suited for growth as the recession eases.

51

 


 

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

Economic Data





 

 

 

 



 

 

 

 



 

 



 

June 30, 2016

 

December 31, 2015

Unemployment Rate (seasonally adjusted)

 

 

 

 

Market area range (1)

 

4.2% - 6.4%

 

3.5 - 5.5%

Pennsylvania

 

5.5% 

 

5.0% 

United States

 

4.9% 

 

5.0% 



 

 

 

 

Housing Price Index - year over year change

 

 

 

 

PA, nonmetropolitan statistical area

 

-0.2%

 

2.0% 

United States

 

5.4% 

 

5.6% 



 

 

 

 

Franklin County Building Permits - year over year change

 

 

 

 

Residential, estimated

 

-11.3%

 

-15.6%

Multifamily, estimated

 

43.8% 

 

-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 June 30, 2016, the Bank had approximately $69.4 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 June  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  June  30, 2016, the Bank had an excess borrowing capacity at FHLB of $272.9 million, which includes the amount available on the line of credit.  The Bank has established credit at the Federal Reserve Discount Window and as of quarter-end had the ability to borrow approximately $23 million. 



52

 


 

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 $309.0 million and $291.4 million, respectively, at June  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 six months ended June  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 June  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 June  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. 

53

 


 



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.  However, in management’s opinion, there are no proceedings pending to which the Corporation is a party or to which our property is subject, which, if determined adversely to the Corporation, would be material in relation to our shareholders’ equity or financial condition.  In addition, no material proceedings are pending or are known to be threatened or contemplated against us by governmental authorities or other parties.

Item 1A. Risk Factors 

There were no material changes in the Corporation’s risk factors during the six months ended June  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 June 30, 2016, 15,521 shares have been purchased under this plan.  The following table reports stock repurchases made during the second quarter 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 



 

15,521 

 

$

22.55 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



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)

54

 


 

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





 

 



 

 

          August 8, 2016

 

/s/ Timothy G. Henry



 

Timothy G. Henry



 

Chief Executive Office and President



 

(Principal Executive Officer)



 

 

August 8, 2016

 

/s/ Mark R. Hollar



 

Mark R. Hollar



 

Treasurer and Chief Financial Officer



 

(Principal Financial and Accounting Officer)



55