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FRANKLIN FINANCIAL SERVICES CORP /PA/ - Annual Report: 2017 (Form 10-K)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-K

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

For the fiscal year ended December 31, 2017

  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)

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

NONE

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

Common Stock,  par value $1.00 per share

(Title of class)

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

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

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

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

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

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





 

 

 

Large accelerated filer

Accelerated filer 

Non-accelerated filer

Smaller reporting company



 

 

Emerging growth company



If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  

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

The aggregate market value of the 4,050,683 shares of the Registrant's common stock held by nonaffiliates of the Registrant as of June 30, 2017 based on the price of such shares was $129,621,856.

There were 4,364,433 outstanding shares of the Registrant's common stock as of February 28, 2018.



DOCUMENTS INCORPORATED BY REFERENCE

Article I. Portions of the definitive annual proxy statement to be filed, pursuant to Reg. 14A within 120 days after December 31, 2017, are incorporated into Part III.

 

 


 

 

FRANKLIN FINANCIAL SERVICES CORPORATION

FORM 10-K

INDEX



 

 

Part I

 

Page

Item 1.

Business

3

Item 1A.

Risk Factors

7

Item 1B.

Unresolved Staff Comments

10

Item 2.

Properties

10

Item 3.

Legal Proceedings

10

Item 4.

Mine Safety Disclosures

11

Part II

 

 

Item 5. 

Market for Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

11

Item 6.

Selected Financial Data

15

Item 7.

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

16

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

41

Item 8.

Financial Statements and Supplementary Data

44

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

85

Item 9A.

Controls and Procedures

85

Item 9B.

Other Information

87

Part III

 

 

Item 10.

Directors, Executive Officer and Corporate Governance

87

Item 11.

Executive Compensation

87

Item 12.

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

87

Item 13.

Certain Relationships and Related Transaction, and Director Independence

87

Item 14.

Principal Accountant Fees and Services

88

Part IV

 

 

Item 15.

Exhibits, Financial Statement Schedules

88

Signatures

 

89

Index of Exhibits

 

90







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Part I



Item 1. Business



General

Franklin Financial Services Corporation (the “Corporation”) was organized as a Pennsylvania business corporation on June 1, 1983 and is a registered bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHCA”).  On January 16, 1984, pursuant to a plan of reorganization approved by the shareholders of Farmers and Merchants Trust Company of Chambersburg (“F&M Trust” or “the Bank”) and the appropriate regulatory agencies, the Corporation acquired all the shares of F&M Trust and issued its own shares to former F&M Trust shareholders on a share-for-share basis.



The Corporation’s common stock is thinly traded in the over-the-counter market.  The Corporation’s stock is listed under the symbol “FRAF” (www.otcmarkets.com/stock/FRAF/quote) on the OTCQX Market Tier of the OTC Markets. The Corporation’s internet address is www.franklinfin.com.  Electronic copies of the Corporation’s 2017 Annual Report on Form 10-K are available free of charge by visiting the “Investor Information” section of www.franklinfin.com.  Electronic copies of quarterly reports on Form 10-Q and current reports on Form 8-K are also available at this internet address.  These reports are posted as soon as reasonably practicable after they are electronically filed with the Securities and Exchange Commission (SEC).



The Corporation conducts substantially all of its business through its direct banking subsidiary, F&M Trust, which is wholly owned. F&M Trust, established in 1906, is a full-service, Pennsylvania-chartered commercial bank and trust company, which is not a member of the Federal Reserve System. F&M Trust operates twenty-two community banking offices in Franklin, Cumberland, Fulton and Huntingdon Counties, Pennsylvania. The Bank engages in general commercial, retail banking and trust services normally associated with community banks and its deposits are insured (up to applicable limits) by the Federal Deposit Insurance Corporation (the “FDIC”). F&M Trust offers a wide variety of banking services to businesses, individuals, and governmental entities.  These services include, but are not necessarily limited to, accepting and maintaining checking, savings, and time deposit accounts, providing investment and trust services, making loans and providing safe deposit facilities. Franklin Future Fund Inc., a direct subsidiary of the Corporation, is a non-bank investment company that makes venture capital investments, limited to 5% or less of the outstanding shares of any class of voting securities of any company, within the Corporation’s primary market area. Franklin Financial Properties Corp. is a “qualified real estate subsidiary,” a wholly owned subsidiary of F&M Trust, and was established to hold real estate assets used by F&M Trust in its banking operations.



F&M Trust is not dependent upon a single customer or a few customers for a material part of its business.  Thus, the loss of any customer or identifiable group of customers would not materially affect the business of the Corporation or the Bank in an adverse manner.  Also, none of the Bank’s business is seasonal.  The Bank’s lending activities consist primarily of commercial real estate, construction and land development, agricultural, commercial and industrial loans, installment and revolving loans to consumers and residential mortgage loans.  Secured and unsecured commercial and industrial loans, including accounts receivable and inventory financing, and commercial equipment financing, are made to small and medium-sized businesses, individuals, governmental entities, and non-profit organizations. 



The Bank classifies loans in this report by the type of collateral, primarily residential or commercial and agricultural real estate. Loans secured by residential real estate loans may be further broken down into consumer or commercial purposes. Consumer purpose residential real estate loans represent traditional residential mortgages and home equity products. Both of these products are underwritten in generally the same manner; however, home equity products may present greater risk since many of these loans are secured by a second lien position where the Bank may or may not hold the first lien position. Commercial purpose residential real estate loans represent loans made to businesses, but are secured by residential real estate.  These loans are underwritten as commercial loans and the repayment ability may be dependent on the business operation, despite the residential collateral. In addition to the real estate collateral, it is possible that personal guarantees or UCC filings on business assets provide additional security.  In certain situations, the Bank acquires properties through foreclosure on delinquent loans.  The Bank initially records these properties at the estimated fair value less cost to sell with subsequent adjustments to fair value recorded as needed.



Commercial and agricultural real estate loans are secured by properties such as hotels, office buildings, apartment buildings, retail sites, and farmland or agricultural related properties. These loans are highly dependent on the business operations for repayment. Compared to residential real estate, this collateral may be more difficult to sell in the event of a delinquency.



Construction loans are made to finance the purchase of land and the construction of residential and commercial buildings, and are secured by mortgages on real estate.  These loans are primarily comprised of loans to consumers to build a home, and loans to contractors and developers to construct residential properties for resale or rental. Construction loans present various risks that include, but are not limited to:  schedule delays, cost overruns, changes in economic conditions during the construction period, and the inability to sell or rent the property upon completion.



Commercial loans are made to businesses and government municipalities of various sizes for a variety of purposes including operations, property, plant and equipment, and working capital. These loans are highly dependent on the business operations for

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repayment and are generally secured by business assets and personal guarantees. As such, this collateral may be more difficult to sell in the event of a delinquency.  Commercial lending, including commercial real estate, is concentrated in the Bank’s primary market, but also includes purchased loan participations originated primarily in south-central Pennsylvania. 



Consumer loans are comprised of unsecured personal lines of credit and installment loans.  While some of these loans are secured, the collateral behind the loans is often comprised of assets that lose value quickly (e.g. automobiles) and if repossessed, may not fully satisfy the loan in the event of default. Repayment of these loans is highly dependent on the borrowers’ financial condition that can be affected by economic factors beyond their control and personal circumstances.



F&M Trust’s Investment and Trust Services Department offers all of the personal and corporate trust services normally associated with community bank trust departments including: estate planning and administration, corporate and personal trust fund management, pension, profit sharing and other employee benefit funds management, and custodial services.  F&M Trust through licensed members of its Investment and Trust Services Department sells mutual funds, annuities and selected insurance products.



Competition



The Corporation and its banking subsidiary operate in a highly competitive environment. The principal market of F&M Trust is in south central Pennsylvania, primarily the counties of Franklin, Cumberland, Fulton and Huntingdon. There are 24 competing commercial banks that have offices within the Corporation’s primary market area. These banks range from large regional banks to independent community banks.  In addition, credit unions, savings and loan associations, mortgage banks, brokerage firms and other on-line competitors compete within the market.



The following table shows the Bank’s market share in its primary market as reported on the June 30, 2017 FDIC Summary of Deposits Report:







 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 



 

F&M Trust

 

 

 

 

 

County

 

# of Locations

 

 

Deposits

 

Market Deposits

 

Market Share

Franklin

 

12 

 

$

687,688 

 

$

2,140,858 

 

32% 

Cumberland

 

 

 

230,960 

 

 

6,775,750 

 

3% 

Fulton

 

 

 

73,119 

 

 

209,071 

 

35% 

Huntingdon

 

 

 

15,906 

 

 

605,093 

 

3% 



 

22 

 

$

1,007,673 

 

$

9,730,772 

 

10% 





Because of increasing competition, profit margins in the traditional banking business of lending and gathering deposits have been flat and many nonbanking institutions offer services similar to those offered by the Bank. Some competitors may have access to resources (e.g., financial and technological) sooner than they are available to the Bank, or that may be unavailable to the Bank, thereby creating a competitive disadvantage for the Bank in terms of product, service pricing and delivery.  The Bank utilizes various strategies including its long history of local customer service and convenience as part of a relationship management culture, a wide variety of products and services and, to a lesser extent, the pricing of loans and deposits, to compete.  F&M Trust is the largest financial institution headquartered in Franklin County and had total assets of approximately $1.2 billion on December 31, 2017.



Staff



As of December 31, 2017, the Corporation and its banking subsidiary had 255 full-time equivalent employees.  The officers of the Corporation are employees of the Bank.  The Bank offers a 401(k) plan, employee stock purchase plan and incentive compensation plans and employees are also provided with group life and health insurance.  Management considers employee relations to be excellent.



Supervision and Regulation



Various requirements and restrictions under the laws of the United States and under Pennsylvania law affect the Corporation and its subsidiaries.



General



The Corporation is registered as a bank holding company and is subject to supervision and regulation by the Board of Governors of the Federal Reserve System under the Bank Holding Act of 1956, as amended.  The Corporation has also made an effective election to be treated as a "financial holding company."  Financial holding companies are bank holding companies that meet certain minimum

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capital and other standards and are therefore entitled to engage in financially related activities on an expedited basis as further discussed below.  Bank holding companies are required to file periodic reports with and are subject to examination by the Federal Reserve.  The Federal Reserve has issued regulations under the Bank Holding Company Act that require a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks.  As a result, the Federal Reserve, pursuant to such regulations, may require the Corporation to stand ready to use its resources to provide adequate capital funds to its Bank subsidiary during periods of financial stress or adversity. In addition to the impact of regulation, commercial banks are affected significantly by the actions of the Federal Reserve Board as it attempts to control the money supply and credit availability in order to influence the economy.



The Bank Holding Company Act prohibits the Corporation from acquiring direct or indirect control of more than 5% of the outstanding shares of any class of voting stock, or substantially all of the assets of any bank, or from merging or consolidating with another bank holding company, without prior approval of the Federal Reserve Board.  Additionally, the Bank Holding Company Act prohibits the Corporation from engaging in or from acquiring ownership or control of more than 5% of the outstanding shares of any class of voting stock of any company engaged in a non‑banking business, unless such business is determined by the Federal Reserve Board to be so closely related to banking as to be a proper incident thereto.  Federal law and Pennsylvania law also require persons or entities desiring to acquire certain levels of share ownership (generally, 10% or more, or 5% or more for another bank holding company) of the Corporation to first obtain prior approval from the Federal Reserve and the Pennsylvania Department of Banking and Securities. 



As a Pennsylvania bank holding company for purposes of the Pennsylvania Banking Code, the Corporation is also subject to regulation and examination by the Pennsylvania Department of Banking and Securities.



The Bank is a state chartered bank that is not a member of the Federal Reserve System, and its deposits are insured (up to applicable limits) by the Federal Deposit Insurance Corporation (FDIC).  Accordingly, the Bank's primary federal regulator is the FDIC, and the Bank is subject to extensive regulation and examination by the FDIC and the Pennsylvania Department of Banking and Securities.  The Bank is also subject to requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon, and limitations on the types of investments that may be made and the types of services that may be offered.  The Bank is subject to extensive regulation and reporting requirements in a variety of areas, including helping to prevent money laundering, to preserve financial privacy, and to properly report late payments, defaults, and denials of loan applications. 



Community Reinvestment Act



The Community Reinvestment Act (CRA) requires the Bank to help meet the credit needs of the entire community where the Bank operates, including low and moderate-income neighborhoods.  The Bank's rating under the Community Reinvestment Act, assigned by the FDIC pursuant to an examination of the Bank, is important in determining whether the bank may receive approval for, or utilize certain streamlined procedures in applications to engage in new activities.  The Bank’s present CRA rating is “satisfactory.”  Various consumer laws and regulations also affect the operations of the Bank.    



Capital Adequacy Guidelines



The Corporation, as a bank holding company, is required to comply with the capital adequacy standards established by Federal Reserve Board.  The Bank is required to comply with capital adequacy standards established by the FDIC. In addition, the Pennsylvania Department of Banking and Securities also requires state chartered banks to maintain minimum capital ratios, defined substantially the same as the federal regulations.



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 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 is phased-in beginning at 0.625% for 2016, 1.25% for 2017, 1.875% for 2018 and 2.50% for 2019 and thereafter. The capital conservation buffer is applicable to all of the capital ratios except for the Tier1 Leverage ratio. The capital conservation buffer is equal to the lowest value of the three applicable capital ratios less the regulatory minimum for each respective capital measurement.   The Bank’s capital conservation buffer at December 31, 2017 was 7.19% (total risk-based capital 15.19% less 8.00%)  compared to the 2017 regulatory buffer of 1.25%. Compliance with the capital conservation buffer is required in order to avoid limitations on certain capital distributions, especially dividends.  As of December 31, 2017, 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 requirements been in effect.  The minimum capital ratios (shown as “adequately capitalized”) and the “well capitalized” capital ratios are reported in Note 2 of the accompanying financial statements. 

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Prompt Corrective Action Rules



The federal banking agencies have regulations defining the levels at which an insured institution would be considered "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized."  The applicable federal bank regulator for a depository institution could, under certain circumstances, reclassify a "well‑capitalized" institution as "adequately capitalized" or require an "adequately capitalized" or "undercapitalized" institution to comply with supervisory actions as if it were in the next lower category.  Such a reclassification could be made if the regulatory agency determines that the institution is in an unsafe or unsound condition (which could include unsatisfactory examination ratings).  At December 31, 2017, the Bank satisfied the criteria to be classified as "well capitalized" within the meaning of applicable regulations.



Regulatory Restrictions on Dividends



Dividend payments by the Bank to the Corporation are subject to the Pennsylvania Banking Code, the Federal Deposit Insurance Act, and the regulations of the FDIC.  Under the Banking Code, no dividends may be paid except from "accumulated net earnings" (generally, retained earnings).  The Federal Reserve and the FDIC have formal and informal policies which provide that insured banks and bank holding companies should generally pay dividends only out of current operating earnings, with some exceptions.  The Prompt Corrective Action Rules and the Basel III rules, described above, may further limit the ability of banks to pay dividends or make capital distributions if regulatory capital requirements are not met. There are currently no restrictions on the payments of dividends by either the Bank or the Corporation.



Volker Rule



In December 2013, Federal banking regulators issued rules for complying with the Volker Rule provision of the Dodd-Frank Act. The Bank does not engage in, or expect to engage in, any transactions that are considered “covered activities” as defined by the Volker Rule. Therefore, the Bank does not have any compliance obligations under the Volker Rule.



Consumer Laws and Regulations



The Consumer Financial Protection Bureau (“CFPB”) was created under the Dodd-Frank Act to centralize responsibility for consumer financial protection with broad rulemaking, supervision, and enforcement authority for a wide range of consumer protection laws that would apply to all banks and thrifts, including the Equal Credit Opportunity Act, Truth in Lending Act (“TILA”), Real Estate Settlement Procedures Act (“RESPA”), Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act, and certain other statues. Violations of consumer protection laws may result in litigation and liability from consumers and regulators.   It is likely that future CFPB rulemaking action will affect the Bank.  Banks with total assets less than $10 billion are not subject to examination by the CFPB.  However, the CFPB can require any bank to submit reports it deems necessary to fulfill its mission and it can request to be part of any bank examination.



Ability to Repay / Qualified Mortgages



In July 2013, the Consumer Finance Protection Bureau adopted the final rules that implement the Ability to Repay (ATR) / Qualified Mortgages (QM) provisions of the Dodd-Frank Act. Regulators believe that the ATR/QM rules will prevent many of the loose underwriting practices that contributed to the mortgage crisis in 2008.  The ATR/QM rule applies to almost all closed-end consumer credit transactions secured by a dwelling. The ATR rule provides eight specific factors that must be considered during the underwriting process. QMs generally have three types of requirements: restrictions on loan features, points and fees, and underwriting criteria.  A QM is presumed to comply with the ATR requirements. The ATR/QM rule was effective January 10, 2014. 



Commercial Real Estate Guidance



In December 2015, the federal banking agencies released a “Statement on Prudent Risk Management for Commercial Real Estate Lending” (the “CRE Statement”).  The agencies stated that financial institutions should review their policies and practices related to CRE lending and should maintain risk management practices and capital levels commensurate with the level and nature of their CRE concentration risk, including maintaining underwriting discipline and exercising prudent risk management practices that identify, measure, monitor and manage the risks arising from their CRE lending activity.  Financial institutions were directed to review the interagency guidance on “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” issued in 2006 providing that a financial institution is potentially exposed to significant CRE concentration risk, and should employ enhanced risk management practices where (1) total CRE loans represent 300% or more of total capital, and (2) the outstanding balance the CRE loan portfolio has increased by 50% or more during the prior 36 months.  The agencies state in the CRE statement that they will focus on those financial institutions that have recently experienced, or whose lending strategy plans for, substantial growth in CRE lending activity, or that operate in markets or loan segments with increasing growth or risk fundamentals.



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Pennsylvania Regulation and Supervision



In December 2012, the “Banking Law Modernization Package” became effective.  The law permits banks to disclose formal enforcement actions initiated by the Pennsylvania Department of Banking and Securities, clarifies that the Department has examination and enforcement authority over subsidiaries as well as affiliates of regulated banks, and bolsters the Department’s enforcement authority over its regulated institutions by clarifying its ability to remove directors, officers and employees from institutions for violations of laws or orders or for any unsafe or unsound practice or breach of fiduciary duty.  The Department also may assess civil money penalties of up to $25,000 per violation.



FDIC Insurance



The Bank is a member of the Deposit Insurance Fund (DIF), which is administered by the FDIC. The FDIC insures deposit accounts at the Bank, generally up to a maximum of $250,000 for each separately insured depositor. The FDIC charges a premium to depository institutions for deposit insurance. This rate is based on the risk category of the institution and the total premium is based on average total assets less average tangible equity.  As of December 31, 2017, the Bank was considered well capitalized and its assessment rate was approximately 3 basis points of the assessment base.



Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. We do not currently know of any practice, condition or violation that might lead to termination of our deposit insurance.



In addition to the FDIC assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the Federal Deposit Insurance Corporation, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2019. The Bank’s FICO assessment was approximately $52 thousand in 2017 and was included in FDIC insurance expense.



New Legislation



Congress is often considering new financial industry legislation, and the federal banking agencies routinely propose new regulations.  The Corporation cannot predict how any new legislation, or new rules adopted by the federal banking agencies, may affect its business in the future. 



Tax Reform



On December 22, 2017 the Tax Cuts and Jobs Act (the Act) was signed into law.  This comprehensive tax legislation provides for significant changes to the U.S. Internal Revenue Code of 1986, as amended, that impact corporate taxation such as the reduction in the federal corporate income tax rate from 35% to 21% effective January 1, 2018.  The Act repeals the corporate alternative minimum tax, provides for earlier recognition of certain revenue, accelerates expensing of investments in tangible property and limits several deductions such as FDIC premiums, certain executive compensation and meals and entertainment expenses.  We are currently assessing the overall impact of the Act on the future expected federal income tax obligations of the Corporation and our customers.  While we expect that our future federal income tax liabilities will benefit overall from the provisions in the Act, we also expect that certain aspects of our business may change over time as to the investments we may make, how the Act may affect our customers, and how, in response, we may offer and deliver our products and services.



Selected Statistical Information



Certain statistical information is included in this report as part of Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Item 1A. Risk Factors



The following is a summary of the primary risks associated with the Corporation’s business, financial condition and results of operations, and common stock.



Risk Factors Relating to the Corporation



Real estate related loans are a significant portion of our loan portfolio.



The Bank offers a variety of loan products, including residential mortgage, consumer, construction and commercial loans.  The Bank requires real estate as collateral for many of its loans. At December 31, 2017, approximately 68% ($647.1 million) of its loans

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were secured by real estate.  Loans secured by real estate and the percent of the loan portfolio are reported in Table 16.  These real estate loans are located primarily in the Bank’s market area of south central Pennsylvania.  Real estate values tend to follow changes in general economic cycles. If a loan becomes delinquent as the result of an economic downturn and the Bank becomes dependent on the real estate collateral as a source of repayment, it is likely that the value of the real estate collateral has also declined.  A decline in real estate values means it is possible that the real estate collateral may be insufficient to cover the outstanding balance of a delinquent or foreclosed loan, resulting in a loss to the Bank. In addition, the real estate collateral is concentrated in a small market area of south central Pennsylvania. Localized events such as plant closures or layoffs may affect real estate prices and collateral values and could have a more negative affect on the Bank as compared to other competitors with a more geographically diverse portfolio.   As the Bank grows, it is expected that real estate secured loans will continue to comprise a significant part of its balance sheet. Risk of loan default is unavoidable in the banking industry, and Management tries to limit exposure to this risk by carefully monitoring the amount of loans in specific industries and by exercising prudent lending practices and securing appropriate collateral.  However, this risk cannot be eliminated and substantial credit losses could result in reduced earnings or losses.



Commercial loans are a significant portion of our loan portfolio.



The Bank continues to grow its commercial loan portfolio.  Commercial purpose loans account for 84% ($795 million) of the total loan portfolio.  These loans are made to businesses for a variety of commercial purposes and may include fixed and variable rate loans, term loans, and lines of credit. Commercial purpose loans may be secured by real estate, business assets and equipment, personal guarantees, or non-real estate collateral.  Commercial purpose loans secured by real estate were $469.1 million at December 31, 2017 and account for 63% of the total commercial loan portfolio.   These loans contain all the risks associated with real estate lending as discussed above. In addition, commercial real estate collateral may be more difficult to liquidate for repayment purposes than residential real estate. The repayment of commercial loans is highly dependent upon the success of the business activity and as such maybe more susceptible to risk of loss during a downturn in the economy. Because the Bank’s commercial loan portfolio is concentrated in south-central Pennsylvania, the ability to repay these loans could be affected by deterioration of the economy in this region.  As commercial lending continues to be the primary drive of loan growth, these new loans may present additional risk due to a lack of repayment history with the Bank.  The Bank attempts to mitigate these risks through its underwriting and loan review process; however, this risk cannot be eliminated and substantial credit losses could result in reduced earnings or losses.  

   

The allowance for loan losses may prove to be insufficient to absorb inherent losses in our loan portfolio.



The Bank maintains an allowance for loan losses that Management believes is appropriate to provide for any inherent losses in the loan portfolio.  The amount of the allowance is determined through a periodic review and consideration of several factors, including an ongoing review of the quality, size and diversity of our loan portfolio; evaluation of nonperforming loans; historical loan loss experience; and the amount and quality of collateral, including guarantees, securing the loan.



Although Management believes the loan loss allowance is adequate to absorb inherent losses in the loan portfolio, such losses cannot be predicted and the allowance may not be adequate.  Excessive loan losses could have a material adverse effect on the Bank’s financial condition and results of operations.



The Bank’s lending limit is smaller than many of our competitors, which affects the size of the loans it can offer customers.



The Bank’s lending limit is approximately $18.5 million.  Accordingly, the size of the loans that can be offered to customers is less than the size of loans that many of our competitors, with larger lending limits, can offer.  This limit affects the Bank’s ability to seek relationships with larger businesses in its market area.  Loan amounts in excess of the lending limits can be accommodated through the sale of participations in such loans to other banks.  However, there can be no assurance that the Bank will be successful in attracting or maintaining customers seeking larger loans or that it will be able to engage in participation of such loans or on terms favorable to the Bank.



There is strong competition in the Bank’s primary market areas and its geographic diversification is limited.



The Bank encounters strong competition from other financial institutions in its primary market area, which consists of Franklin, Cumberland, Fulton and Huntingdon Counties, Pennsylvania.  In addition, established financial institutions not already operating in the Bank’s primary market area may open branches there at future dates or can compete in the market via the Internet.  In the conduct of certain aspects of banking business, the Bank also competes with savings institutions, credit unions, mortgage banking companies, consumer finance companies, insurance companies and other institutions, some of which are not subject to the same degree of regulation or restrictions as are imposed upon the Bank.  Many of these competitors have substantially greater resources and lending limits and can offer services that the Bank does not provide.  In addition, many of these competitors have numerous branch offices located throughout their extended market areas that provide them with a competitive advantage.  No assurance can be given that such competition will not have an adverse effect on the Bank’s financial condition and results of operations.



8


 

 

Changes in interest rates could have an adverse impact upon our results of operations.



The Bank’s profitability is in part a function of the spread between interest rates earned on investments, loans and other interest-earning assets and the interest rates paid on deposits and other interest-bearing liabilities. Interest rates are highly sensitive to many factors that are beyond the Bank’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System. Changes in monetary policy, including changes in interest rates, will influence not only the interest received on loans and investment securities and the amount of interest we pay on deposits and borrowings, but will also affect the Bank’s ability to originate loans and obtain deposits and the value of our investment portfolio.  If the rate of interest paid on deposits and other borrowings increases more than the rate of interest earned on loans and other investments, the Bank’s net interest income, and therefore earnings, could be adversely affected.  Likewise, the Bank currently has a very low cost of funds that it may be unable to maintain in a raising rate environment.  Earnings could also be adversely affected if the rates on loans and other investments fall more quickly than those on deposits and other borrowings.  While Management takes measures to guard against interest rate risk, there can be no assurance that such measures will be effective in minimizing the exposure to interest rate risk



Our operational or security systems may experience interruption or breach in security, including cyber-attacks.



We rely heavily on communications and information systems to conduct our business.  These systems include both our internal network and data systems, as well as those of third party vendors.  Any failure, interruption or breach in security or these systems, including a cyber-attack, could result in the disclosure or misuse of confidential or proprietary information.   Cyber security risks for financial institutions have significantly increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties, including foreign state actors.  Financial services institutions have been subject to, and are likely to continue to be the target of, cyber-attacks, including computer viruses, malicious or destructive code, phishing attacks, denial of service or information or other security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of confidential, proprietary and other information of the institution, its employees or customers or of third parties, or otherwise materially disrupt network access or business operations.  Cyber threats could result in unauthorized access, loss or destruction of customer data, unavailability, degradation or denial of service, introduction of computer viruses and other adverse events, causing the Corporation to incur additional costs (such as repairing systems or adding new personnel or protection technologies). Cyber threats may also subject the Corporation to regulatory investigations, litigation or enforcement, require the payment of regulatory fines or penalties or undertaking costly remediation efforts.  While we have systems, policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed.  The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of client business, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our business, financial condition and results of operations.



A large component of fee income is dependent on stock market values.



Fee income from the Bank’s Investment and Trust Services Department comprises a large percentage of total noninterest income.  Fee income from Investment and Trust Services is comprised primarily of asset management fees as measured by the market value of assets under management.  As such, the market values are directly related to stock market values.  Therefore, any significant change in the value of assets under management due to stock market fluctuations could greatly affect fee income.



A large component of fee income is dependent on two deposit services.



Fee income from the Bank’s debit card is a significant contributor of fee income.  As technology changes and consumer payment preferences change it is possible that debit card income does not continue to grow or may decline. The Bank’s overdraft protection program has also been a significant contributor of fee income. It is possible that the usage of this product slows or that regulatory changes effect the fees that can be charged for such services.



A large percentage of certificates of deposit have short-term maturities.



Sixty-five percent ($49.3 million) of the Bank’s certificates of deposit are scheduled to mature within one year. If the Bank is unable to retain these deposits, it may require the Bank to access other sources of liquidity that may carry a higher cost.



Liquidity contingency funding is highly concentrated. 



The Bank is a member of the Federal Home Loan Bank of Pittsburgh (FHLB). Access to funding through the FHLB is the largest component of the Bank’s liquidity stress testing and contingency funding plans. The ability to access funding from FHLB may be critical if a funding need arises. However, there can be no assurance that the FHLB will be able to provide funding when needed, nor can there be assurance that the FHLB will provide funds to the Bank if its financial condition deteriorates. The inability to access

9


 

 

FHLB funding, through a restriction on credit or the failure of the FHLB, could have a materially adverse effect on the Bank’s liquidity management.





Our business and financial results could be impacted materially by adverse results in legal proceedings.



The nature of the Corporation’s business generates a certain amount of litigation involving matters arising in the ordinary course of business (and, in some cases, from the activities of companies we have acquired).  These legal proceedings, whether founded or unfounded, could result in reputation damage and have an adverse effect on our financial condition and results of operation if they are not resolved in a manner favorable to the Corporation.  Although we establish legal accruals for legal proceedings when information related to the loss contingencies represented by these matters indicates that both a loss is probable and that the amount of the loss can be reasonably estimated, we do not have accruals for all legal proceedings where we face a risk of loss.  In addition, due to the inherent subjectivity of the assessments and unpredictability of outcomes of legal proceedings, any amounts that may be accrued or included in estimates of possible losses or ranges of possible losses may not represent the actual loss to the Corporation.  We discuss these matters further in Part I Item 3 Legal Proceedings and in Note 18 Commitments and Contingencies in the Notes to Consolidated Financial Statements in Part II Item 8 of this Report.



Risk Factors Relating to the Common Stock



There is a limited trading market for the Corporation’s common stock.



There is currently only a limited public market for the Corporation’s common stock.  It is quoted on the OTCQX Market Tier of the OTC Markets under the symbol “FRAF” (www.otcmarkets.com/stock/FRAF/quote). Because it is thinly traded, you may not be able to resell your shares of common stock for a price that is equal to the price that you paid for your shares. 



The Bank's ability to pay dividends to the Corporation is subject to regulatory limitations that may affect the Corporation’s ability to pay dividends to its shareholders.



As a holding company, the Corporation is a separate legal entity from the Bank and does not have significant operations of its own. It currently depends upon the Bank's cash and liquidity to pay dividends to its shareholders.  The Corporation cannot assure you that in the future the Bank will have the capacity to pay dividends to the Corporation. Various statutes and regulations limit the availability of dividends from the Bank. It is possible; depending upon the Bank's financial condition and other factors, that the Bank’s regulators could assert that payment of dividends by the Bank to the Corporation would constitute an unsafe or unsound practice.  In the event that the Bank is unable to pay dividends to the Corporation, the Corporation may not be able to pay dividends to its shareholders.

 

Item 1B. Unresolved Staff Comments



None

 

Item 2.  Properties



The Corporation’s headquarters is located in the main office of F&M Trust at 20 South Main Street, Chambersburg, Pennsylvania.  This location also houses a community banking office as well as operational support services for the Bank. The Corporation owns or leases thirty-seven properties in Franklin, Cumberland, Fulton and Huntingdon Counties, Pennsylvania, for banking operations, as described below:







 

 

 

 

Property

 

Owned

 

Leased

Community Banking Facilities

 

16 

 

Remote ATM Sites

 

 

Other Properties

 

 



Included in Other Properties are two properties used for operational support services for the Bank, a drive-up location, one office that was closed as part of a branch consolidation in January 2015 and one other property leased for future use. The office closed in 2015 and was sold on February 28, 2018.

 

Item 3.  Legal Proceedings



The nature of the Corporation’s business generates a certain amount of lititation involving matters arising in the ordinary course of business including, without limitation, the Kalan et al. v. Farmers and Merchants Trust Company of Chambersburg, et al. (Case No. 2:15-CV-01435-WB) case filed in the United States District Court for the Eastern District of Pennsylvania and described in our current reports on Form 8-K filed July 29, 2016, July 28, 2017, November 3, 2017 and January 2, 2018.

10


 

 



The Kalan case was brought by the named plaintiffs as a putative class action on behalf of certain employee health and welfare benefit plans whose assets are held by trusts known as the Regional Employers Assurance League Voluntary Employee’s Beneficiary Association and the Single Employer Welfare Benefit Plan, and the participants and beneficiaries of those plans.  The plaintiffs allege that F&M Trust, as successor by merger to Community Trust Company, which F&M Trust acquired in 2008, and in its own capacity, served as trustee of the trusts and failed to perform its fiduciary duties in accordance with the prudent man standard of care, knowingly participated in and facilitated misconduct by its co-fiduciaries, and failed to take reasonable steps to prevent or remedy any fiduciary breaches of its co-fiduciaries. The plaintiffs purport to state claims against F&M Trust under the Employee Retirement Income Security Act (ERISA), the Racketeer Influenced and Corrupt Organizations Act (RICO), common law breach of fiduciary duties, and equitable restitution and disgorgement, and seek recovery of damages allegedly totaling at least $40 million, along with reasonable attorney’s fees and other relief.  F&M Trust denies any and all wrongdoing and liability and has vigorously defended against the plaintiffs’ claims.



As described in our current report on Form 8-K filed January 2, 2018, F&M Trust entered into a Class Action Settlement Term Sheet on December 29, 2017 with the named plaintiffs and certain of the other remaining defendants in the Kalan case following a mediation of the case held pursuant to a stipulation for selection of a Mediator submitted jointly by the parties and approved by the Court.  The Term Sheet provides for F&M Trust to make a settlement payment of $10 million in full and final settlement of all claims that the named plaintiffs and members of the Settlement Class (as defined by the Term Sheet) have brought or could have brought against F&M Trust.  The Term Sheet further provides that the parties will enter into a definitive settlement agreement that is to provide for a general release of all claims by all parties to the case.  The terms of the settlement will be subject to preliminary and final approval by the court.



The Corporation has accrued the $10 million settlement payment as an expense for the year ended December 31, 2017.



In management’s opinion, there are no other proceedings pending to which the Corporation is a party or to which its property is subject which, if determined adversely to the Corporation, would be material.  No material proceedings are pending or are known to be threatened or contemplated against us by any governmental authorities.

 

Item 4.  Mine Safety Disclosures



Not Applicable 



Part II



Item 5.  Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities



Market and Dividend Information



The Corporation’s common stock is traded in the over-the-counter market.  It is quoted on the OTCQX Market Tier of the OTC Markets under the symbol “FRAF” (www.otcmarkets.com/stock/FRAF/quote). The range of high and low prices is shown in the following table for the years 2017 and 2016, as well as cash dividends declared for those periods.  The closing price of Franklin Financial Services Corporation common stock recorded from an actual transaction on December 31, 2017 was $37.36.  The Corporation had 1,756 shareholders of record as of December 31, 2017.





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Market and Dividend Information



 

2017

 

2016



 

 

 

 

 

 

 

Dividends

 

 

 

 

 

 

 

Dividends

(Dollars per share)

 

High

 

Low

 

Declared

 

High

 

Low

 

Declared

First quarter

 

$

31.00 

 

$

28.60 

 

$

0.21 

 

$

23.50 

 

$

20.11 

 

$

0.19 

Second quarter

 

 

33.00 

 

 

30.10 

 

 

0.24 

 

 

24.00 

 

 

21.62 

 

 

0.21 

Third quarter

 

 

35.25 

 

 

31.25 

 

 

0.24 

 

 

24.60 

 

 

23.35 

 

 

0.21 

Fourth quarter

 

 

38.50 

 

 

34.95 

 

 

0.24 

 

 

29.00 

 

 

24.35 

 

 

0.21 



 

 

 

 

 

 

 

$

0.93 

 

 

 

 

 

 

 

$

0.82 

 

Restrictions on the Payment of Dividends



For limitations on the Corporation’s ability to pay dividends, see “Supervision and Regulation – Regulatory Restrictions on Dividends” in Item 1 above.



11


 

 

Securities Authorized for Issuance under Equity Compensation Plans



The information related to equity compensation plans is incorporated by reference to the materials set forth under the heading “Executive Compensation – Compensation Tables” in the Corporation’s Proxy Statement for the 2018 Annual Meeting of Shareholders.



Common Stock Repurchases



The Board of Directors, from time to time, authorizes the repurchase of the Corporation’s $1.00 par value common stock. The repurchased shares will be held as Treasury shares available for issuance in connection with future stock dividends and stock splits, employee benefit plans, executive compensation plans, the Dividend Reinvestment Plan and other appropriate corporate purposes. 



12


 

 

The following table shows stock repurchase activity under approved plans:







 

 

 

 

 

 

 

 



 

 

 

 

 

Shares Repurchased

Plan Date

 

Authorized

 

Expiration

 

2017

 

2016

4/18/2016

 

$350,000 in shares per calendar quarter

 

3/31/2017

 

 -

 

34,048 

10/12/2017

 

100,000 shares

 

9/30/2018

 

 -

 

N/A



Performance Graph



The following graph compares the cumulative total return to shareholders of Franklin Financial with selected market indices and a bank peer group, consisting of Mid-Atlantic Banks with assets between $1 billion - $2 billion as of September 30, 2017; for the five year period ended December 31, 2017, in each case assuming an initial investment of $100 on December 31, 2012 and the reinvestment of all dividends. Information is provided by S&P Global Market Intelligence.











 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Period Ending

Index

12/31/12

 

12/31/13

 

12/31/14

 

12/31/15

 

12/31/16

 

12/31/17

Franklin Financial Services Corporation

$

100.00 

 

$

127.44 

 

$

169.89 

 

$

187.25 

 

$

235.97 

 

$

317.11 

NASDAQ Composite

$

100.00 

 

$

140.12 

 

$

160.78 

 

$

171.97 

 

$

187.22 

 

$

242.71 

SNL Mid-Atlantic Bank Index

$

100.00 

 

$

134.79 

 

$

146.85 

 

$

152.36 

 

$

193.66 

 

$

237.34 

Peer Group

$

100.00 

 

$

130.44 

 

$

136.13 

 

$

143.28 

 

$

184.81 

 

$

214.62 



13


 

 

Shareholders’ Information



Dividend Reinvestment Plan:



Franklin Financial Services Corporation offers a dividend reinvestment program whereby shareholders of the Corporation’s common stock may reinvest their dividend, or make optional cash payment, to purchase additional shares of the Corporation.  Beneficial owners of shares of the Corporation’s common stock may participate in the program by making appropriate arrangements through their bank, broker or other nominee. Information concerning this optional program is available by contacting the Corporate Secretary at 20 South Main Street, P.O. Box 6010, Chambersburg, PA 17201-6010, telephone 717-264-6116.



Dividend Direct Deposit Program:



Franklin Financial Services Corporation offers a dividend direct deposit program whereby shareholders of the Corporation’s common stock may choose to have their dividends deposited directly into the bank account of their choice on the dividend payment date.  Information concerning this optional program is available by contacting the Corporate Secretary at 20 South Main Street, P.O. Box 6010, Chambersburg, PA  17201-6010, telephone 717-264-6116.



Annual Meeting:



The Annual Shareholders’ Meeting will be held on Tuesday,  April 24, 2018, at the Orchard Restaurant & Banquet Facility, 1580 Orchard Drive, Chambersburg, PA.  The Business Meeting will begin at 9:00 a.m. with breakfast provided prior to the meeting.



Websites:



Franklin Financial Services Corporation:        www.franklinfin.com

Farmers & Merchants Trust Company:           www.fmtrustonline.com



Stock Information:



The Corporation’s common stock is traded in the over-the-counter market.  It is quoted on the OTCQX Market Tier of the OTC Markets under the symbol “FRAF” (www.otcmarkets.com/stock/FRAF/quote).



Registrar and Transfer Agent:





 

The registrar and transfer agent for Franklin Financial Services Corporation is:

Computershare



P.O. Box 30170



College Station, TX 77842-3170



1-800-368-5948

 

14


 

 

Item 6.  Selected Financial Data





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Summary of Selected Financial Data as of and for the Year Ended December 31



 

2017

 

2016

 

2015

 

2014

 

2013

(Dollars in thousands, except per share)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance Sheet Highlights

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

1,179,813 

 

$

1,127,443 

 

$

1,035,295 

 

$

1,001,448 

 

$

984,587 

Investment securities

 

 

127,336 

 

 

143,875 

 

 

159,473 

 

 

171,751 

 

 

159,674 

Loans, net

 

 

931,908 

 

 

882,798 

 

 

771,930 

 

 

717,420 

 

 

713,711 

Deposits

 

 

1,047,181 

 

 

982,120 

 

 

918,512 

 

 

881,181 

 

 

845,724 

Shareholders' equity

 

 

115,144 

 

 

116,493 

 

 

111,376 

 

 

103,521 

 

 

95,388 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Summary of Operations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

39,885 

 

$

36,979 

 

$

34,615 

 

$

34,794 

 

$

36,042 

Interest expense

 

 

2,491 

 

 

2,245 

 

 

2,371 

 

 

3,180 

 

 

4,378 

Net interest income

 

 

37,394 

 

 

34,734 

 

 

32,244 

 

 

31,614 

 

 

31,664 

Provision for loan losses

 

 

670 

 

 

3,775 

 

 

1,285 

 

 

764 

 

 

2,920 

Net interest income after provision for loan losses

 

 

36,724 

 

 

30,959 

 

 

30,959 

 

 

30,850 

 

 

28,744 

Noninterest income

 

 

12,189 

 

 

11,605 

 

 

12,652 

 

 

11,131 

 

 

10,033 

Noninterest expense

 

 

43,172 

 

 

33,175 

 

 

31,136 

 

 

31,573 

 

 

31,250 

Income before income taxes

 

 

5,741 

 

 

9,389 

 

 

12,475 

 

 

10,408 

 

 

7,527 

Federal income tax expense

 

 

3,565 

 

 

1,302 

 

 

2,271 

 

 

2,006 

 

 

1,295 

Net income

 

$

2,176 

 

$

8,087 

 

$

10,204 

 

$

8,402 

 

$

6,232 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Performance Measurements

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Return on average assets

 

 

0.19% 

 

 

0.74% 

 

 

1.00% 

 

 

0.83% 

 

 

0.61% 

Return on average equity

 

 

1.80% 

 

 

7.04% 

 

 

9.52% 

 

 

8.44% 

 

 

6.75% 

Return on average tangible assets (1)

 

 

0.19% 

 

 

0.75% 

 

 

1.02% 

 

 

0.87% 

 

 

0.64% 

Return on average tangible equity (1)

 

 

1.94% 

 

 

7.64% 

 

 

10.52% 

 

 

9.72% 

 

 

7.86% 

Efficiency ratio (1)

 

 

82.59% 

 

 

68.26% 

 

 

67.39% 

 

 

71.01% 

 

 

72.11% 

Net interest margin, fully tax equivalent

 

 

3.72% 

 

 

3.62% 

 

 

3.59% 

 

 

3.56% 

 

 

3.47% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders' Value (per common share)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

$

0.50 

 

$

1.88 

 

$

2.40 

 

$

2.00 

 

$

1.51 

Basic earnings per share

 

 

0.50 

 

 

1.88 

 

 

2.40 

 

 

2.10 

 

 

1.51 

Regular cash dividends paid

 

 

0.93 

 

 

0.82 

 

 

0.74 

 

 

0.68 

 

 

0.68 

Book value

 

 

26.44 

 

 

26.99 

 

 

26.05 

 

 

24.54 

 

 

22.88 

Tangible book value (1)

 

 

24.37 

 

 

24.90 

 

 

23.94 

 

 

22.36 

 

 

20.55 

Market value

 

 

37.36 

 

 

28.60 

 

 

23.50 

 

 

22.00 

 

 

17.10 

Market value/book value ratio

 

 

141.30% 

 

 

105.97% 

 

 

90.21% 

 

 

89.65% 

 

 

74.74% 

Price/earnings multiple

 

 

74.72 

 

 

15.21 

 

 

9.79 

 

 

11.00 

 

 

11.32 

Current dividend yield*

 

 

2.49% 

 

 

2.94% 

 

 

3.23% 

 

 

3.09% 

 

 

3.98% 

Dividend payout ratio

 

 

185.25% 

 

 

43.56% 

 

 

30.76% 

 

 

33.88% 

 

 

45.09% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Safety and Soundness

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Risk-based capital ratio (Total)

 

 

15.31% 

 

 

15.67% 

 

 

16.03% 

 

 

15.49% 

 

 

14.24% 

Leverage ratio (Tier 1)

 

 

9.73% 

 

 

10.11% 

 

 

10.38% 

 

 

9.69% 

 

 

9.14% 

Common equity ratio (Tier 1)

 

 

14.06% 

 

 

14.41% 

 

 

14.77% 

 

 

0.00% 

 

 

0.00% 

Nonperforming loans/gross loans

 

 

0.28% 

 

 

0.61% 

 

 

0.73% 

 

 

1.74% 

 

 

3.49% 

Nonperforming assets/total assets

 

 

0.45% 

 

 

0.92% 

 

 

1.18% 

 

 

1.63% 

 

 

3.04% 

Allowance for loan loss/loans

 

 

1.25% 

 

 

1.24% 

 

 

1.29% 

 

 

1.25% 

 

 

1.34% 

Net (recoveries) loans charged-off/average loans

 

 

-0.01%

 

 

0.33% 

 

 

0.04% 

 

 

0.19% 

 

 

49.00% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets under Management 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trust and Investment Services (fair value)

 

$

686,941 

 

$

622,630 

 

$

586,664 

 

$

605,796 

 

$

574,680 

Held at third-party brokers (fair value)

 

 

158,145 

 

 

142,676 

 

 

122,010 

 

 

132,700 

 

 

130,000 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

*Annualized

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1) See the section titled "GAAP versus Non-GAAP Presentation" that follows.

 

 

 

 

 

 

 

 

 

15


 

 

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations



Application of Critical Accounting Policies:



Disclosure of the Corporation’s significant accounting policies is included in Note 1 to the consolidated financial statements.  These policies are particularly sensitive requiring significant judgments, estimates and assumptions to be made by Management.  Senior management has discussed the development of such estimates, and related Management Discussion and Analysis disclosure, with the Audit Committee of the Board of Directors.



The following accounting policies are identified by management to be critical to the results of operations: Allowance for Loan Losses, Goodwill, Federal Income Taxes and Other-Than-Temporary-Impairment.



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 Efficiency Ratio measures the cost to generate one dollar of revenue. 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)

 

For the Year Ended December 31



 

2017

 

2016

 

2015

 

2014

 

2013

Return on Average Tangible Assets (non-GAAP)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

2,176 

 

$

8,087 

 

$

10,204 

 

$

8,402 

 

$

6,232 

Plus intangible amortization (net of tax)

 

 

 —

 

 

 —

 

 

119 

 

 

341 

 

 

281 

Net income (non-GAAP)

 

 

 —

 

 

 —

 

 

10,323 

 

 

8,743 

 

 

6,513 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average assets

 

 

1,139,703 

 

 

1,088,047 

 

 

1,021,275 

 

 

1,015,995 

 

 

1,029,895 

Less average intangible assets

 

 

(9,016)

 

 

(9,016)

 

 

(9,066)

 

 

(9,516)

 

 

(9,937)

Average assets (non-GAAP)

 

 

1,130,687 

 

 

1,079,031 

 

 

1,012,209 

 

 

1,006,479 

 

 

1,019,958 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 Return on average tangible assets (non-GAAP)

 

 

0.19% 

 

 

0.75% 

 

 

1.02% 

 

 

0.87% 

 

 

0.64% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Return on Average Tangible Equity (non-GAAP)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

2,176 

 

$

8,087 

 

$

10,204 

 

$

8,402 

 

$

6,232 

Plus intangible amortization (net of tax)

 

 

 —

 

 

 —

 

 

119 

 

 

341 

 

 

281 

Net income (non-GAAP)

 

 

 —

 

 

 —

 

 

10,323 

 

 

8,743 

 

 

6,513 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average shareholders' equity

 

 

120,993 

 

 

114,884 

 

 

107,175 

 

 

99,512 

 

 

92,786 

Less average intangible assets

 

 

(9,016)

 

 

(9,016)

 

 

(9,066)

 

 

(9,516)

 

 

(9,937)

Average shareholders' equity (non-GAAP)

 

 

111,977 

 

 

105,868 

 

 

98,109 

 

 

89,996 

 

 

82,849 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 Return on average tangible equity (non-GAAP)

 

 

1.94% 

 

 

7.64% 

 

 

10.52% 

 

 

9.72% 

 

 

7.86% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders' equity

 

$

115,144 

 

$

116,493 

 

$

111,376 

 

$

103,521 

 

$

95,388 

Less intangible assets

 

 

(9,016)

 

 

(9,016)

 

 

(9,016)

 

 

(9,197)

 

 

(9,714)

Shareholders' equity (non-GAAP)

 

 

106,128 

 

 

107,477 

 

 

102,360 

 

 

94,324 

 

 

85,674 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares outstanding (in thousands)

 

 

4,355 

 

 

4,317 

 

 

4,276 

 

 

4,218 

 

 

4,169 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 Tangible book value (non-GAAP)

 

 

24.37 

 

 

24.90 

 

 

23.94 

 

 

22.36 

 

 

20.55 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Efficiency Ratio (non-GAAP)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest expense

 

$

43,172 

 

$

33,175 

 

$

31,136 

 

$

31,573 

 

$

31,250 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income  

 

 

37,394 

 

 

34,734 

 

 

32,244 

 

 

31,614 

 

 

31,664 

Plus tax equivalent adjustment to net interest income

 

 

2,690 

 

 

2,246 

 

 

2,203 

 

 

1,978 

 

 

1,596 

Plus noninterest income, net of securities gains/losses & OTTI

 

 

12,186 

 

 

11,623 

 

 

11,756 

 

 

10,871 

 

 

10,075 

Total revenue

 

 

52,270 

 

 

48,603 

 

 

46,203 

 

 

44,463 

 

 

43,335 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 Efficiency ratio (non-GAAP)

 

 

82.59% 

 

 

68.26% 

 

 

67.39% 

 

 

71.01% 

 

 

72.11% 



16


 

 



Results of Operations:



Management’s Overview



The following discussion and analysis is intended to assist the reader in reviewing the financial information presented and should be read in conjunction with the consolidated financial statements and other financial data presented elsewhere herein.



Highlights of 2017 performance include:



Net income was $2.2 million for the year, down 73.1% from $8.1 million in 2017.

·

Net interest income increased $2.7 million and the net interest margin increased to 3.72%.

·

The provision for loan loss expense decreased $3.1 million as credit quality continued to improve.

·

Noninterest income increased by 5% driven by an increase in fees from Investment and Trust services.

·

Noninterest expense increased by $10 million, solely the result of a $10 million reserve for a legal settlement.

·

Federal income tax expense included a charge of $2.3 million for the revaluation of net deferred tax assets.



The balance sheet grew by more than $52.4 million, closing the year at $1.2 billion.

·

Loans grew by 5.6% to $943.7 million.

·

Deposits increased by $65.1 million to $1.0 billion.

Other key performance measurements are presented in Item 6, of this report.



A more detailed discussion of the areas that had the greatest effect on the reported results follows.     



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.  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.  The components of net interest income are detailed in Tables 1, 2 and 3.



2017 versus 2016



As shown on Table 1, tax equivalent net interest income increased 8.4% in 2017.  This increase of $3.1 million was driven by a $2.9 million increase in tax equivalent interest income.  A larger balance sheet contributed $2.6 million of the increase in tax equivalent interest income while the effect of rate changes added $739 thousand.  The yield on earning assets (Table 3) improved from 3.84% for 2016 to 3.96% for 2017, driven by an increase in the yield on the loan portfolio. The yield on most earning assets benefited from three rate increases by the Federal Reserve during 2017. Interest expense increased $246 thousand, approximately 11%, over 2016.    Rate changes on deposits were the primary contributor to the increase in interest expense.  Most of the increase in interest expense occurred in the Money Management product.    Table 2 shows the affect volume and rate had on the change in tax equivalent net interest income in 2017.



2016 versus 2015



Tax equivalent net interest income increased 7.9% in 2016.  This increase was driven by a 6.8% increase in interest income.  The yield on earning assets (Table 3) remained unchanged year-over-year at 3.84%.  The yield on most earning asset classes declined in 2016, except for the yield on interest bearing deposits which was boosted by short-term bank owned CDs.   Despite no change in the yield, average interest-earning assets increased $66.9 million over the 2015 average. The commercial loan portfolio was the growth leader in 2016 increasing more than $87 million in 2016.  Even though the Federal Reserve increased short-term interest rates in December 2015, portfolio yields declined in 2016. However, a larger earning asset base more than offset the lower yields and improved interest income by $2.7 million (Table 2). 



Interest expense declined slightly in 2016 and the cost of interest-bearing deposits fell by .03% from 2015. The cost of interest-bearing liabilities declined due to higher rate CDs maturing and an interest rate swap that matured in 2015 that pushed the cost of the money management product over the nominal rate.  Table 2 shows the affect volume and rate had on the change in tax equivalent net interest income in 2016.



17


 

 

Table 1. Net Interest Income







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

Change

 

 

 

 

Change

 

 

 

(Dollars in thousands)

 

2017

 

$

 

%

 

2016

 

$

 

%

 

2015

Interest income

 

$

39,885 

 

$

2,906 

 

7.9 

 

$

36,979 

 

$

2,364 

 

6.8 

 

$

34,615 

Interest expense

 

 

2,491 

 

 

246 

 

11.0 

 

 

2,245 

 

 

(126)

 

(5.3)

 

 

2,371 

Net interest income

 

 

37,394 

 

 

2,660 

 

7.7 

 

 

34,734 

 

 

2,490 

 

7.7 

 

 

32,244 

Tax equivalent adjustment

 

 

2,690 

 

 

444 

 

 

 

 

2,246 

 

 

223 

 

 

 

 

2,023 

Tax equivalent net interest income

 

$

40,084 

 

$

3,104 

 

8.4 

 

$

36,980 

 

$

2,713 

 

7.9 

 

$

34,267 



Table 2 identifies increases and decreases in tax equivalent net interest income to either changes in average volume or to changes in average rates for interest-earning assets and interest-bearing liabilities.  Numerous and simultaneous balance and rate changes occur during the year.  The amount of change that is not due solely to volume or rate is allocated proportionally to both.  All nontaxable interest income has been adjusted to a tax-equivalent basis, using a tax rate of 34%.



Table 2. Rate-Volume Analysis of Tax Equivalent Net Interest Income







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

2017 Compared to 2016

 

2016 Compared to 2015

Increase (Decrease) due to:

 

 Increase (Decrease) due to:

 

 Increase (Decrease) due to:

(Dollars in thousands)

 

Volume

 

Rate

 

Net

 

Volume

 

Rate

 

Net

Interest earned on:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing obligations in other banks

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and Federal funds sold

 

$

 —

 

$

114 

 

$

114 

 

$

(44)

 

$

84 

 

$

40 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

 

(310)

 

 

110 

 

 

(200)

 

 

(260)

 

 

66 

 

 

(194)

Nontaxable

 

 

(299)

 

 

(137)

 

 

(436)

 

 

(146)

 

 

(146)

 

 

(292)

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, industrial and agriculture

 

 

3,310 

 

 

456 

 

 

3,766 

 

 

3,612 

 

 

(413)

 

 

3,199 

Residential mortgage

 

 

(105)

 

 

 

 

(103)

 

 

(134)

 

 

(54)

 

 

(188)

Home equity loans and lines

 

 

22 

 

 

185 

 

 

207 

 

 

259 

 

 

(97)

 

 

162 

Consumer

 

 

(7)

 

 

 

 

 

 

(78)

 

 

(62)

 

 

(140)

Loans

 

 

3,220 

 

 

652 

 

 

3,872 

 

 

3,659 

 

 

(626)

 

 

3,033 

Total net change in interest income

 

 

2,611 

 

 

739 

 

 

3,350 

 

 

3,209 

 

 

(622)

 

 

2,587 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense on:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking

 

 

28 

 

 

15 

 

 

43 

 

 

37 

 

 

27 

 

 

64 

Money management

 

 

73 

 

 

99 

 

 

172 

 

 

44 

 

 

(144)

 

 

(100)

Savings

 

 

 

 

67 

 

 

72 

 

 

 

 

 

 

Time deposits

 

 

(39)

 

 

15 

 

 

(24)

 

 

(73)

 

 

(53)

 

 

(126)

Short-term borrowings

 

 

(26)

 

 

 

 

(17)

 

 

25 

 

 

 

 

29 

Total net change in interest expense

 

 

41 

 

 

204 

 

 

246 

 

 

38 

 

 

(164)

 

 

(126)

Change in tax equivalent net interest income

 

$

2,570 

 

$

535 

 

$

3,104 

 

$

3,171 

 

$

(458)

 

$

2,713 

 

18


 

 

The following table presents average balances, tax-equivalent (T/E) interest income and expense, 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%.



Table 3. Analysis of Net Interest Income







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



2017

 

2016

 

2015



Average

 

Income or

 

Average

 

Average

 

Income or

 

Average

 

Average

 

Income or

 

Average

(Dollars in thousands)

balance

 

expense

 

yield/rate

 

balance

 

expense

 

yield/rate

 

balance

 

expense

 

yield/rate



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing obligations of other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

banks and federal funds sold

$

30,818 

 

$

401 

 

1.30% 

 

$

30,833 

 

$

287 

 

0.93% 

 

$

36,732 

 

$

247 

 

0.67% 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

92,031 

 

 

2,088 

 

2.27% 

 

 

105,862 

 

 

2,288 

 

2.16% 

 

 

117,973 

 

 

2,482 

 

2.10% 

Tax Exempt

 

43,818 

 

 

1,682 

 

3.84% 

 

 

51,429 

 

 

2,118 

 

4.12% 

 

 

54,854 

 

 

2,410 

 

4.39% 

               Investments

 

135,849 

 

 

3,770 

 

2.78% 

 

 

157,291 

 

 

4,406 

 

2.80% 

 

 

172,827 

 

 

4,892 

 

2.83% 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, industrial and agricultural

 

757,969 

 

 

31,880 

 

4.21% 

 

 

679,114 

 

 

28,114 

 

4.14% 

 

 

592,010 

 

 

24,915 

 

4.21% 

Residential mortgage

 

74,697 

 

 

2,979 

 

3.99% 

 

 

77,331 

 

 

3,082 

 

3.99% 

 

 

80,679 

 

 

3,270 

 

4.05% 

Home equity loans and lines

 

72,158 

 

 

3,290 

 

4.56% 

 

 

71,660 

 

 

3,083 

 

4.30% 

 

 

65,687 

 

 

2,921 

 

4.45% 

Consumer

 

4,718 

 

 

255 

 

5.40% 

 

 

4,841 

 

 

253 

 

5.23% 

 

 

6,196 

 

 

393 

 

6.34% 

Loans

 

909,542 

 

 

38,404 

 

4.22% 

 

 

832,946 

 

 

34,532 

 

4.15% 

 

 

744,572 

 

 

31,499 

 

4.23% 

Total interest-earning assets

 

1,076,209 

 

$

42,575 

 

3.96% 

 

 

1,021,070 

 

$

39,225 

 

3.84% 

 

 

954,131 

 

$

36,638 

 

3.84% 

Other assets

 

63,494 

 

 

 

 

 

 

 

66,977 

 

 

 

 

 

 

 

67,144 

 

 

 

 

 

Total assets

$

1,139,703 

 

 

 

 

 

 

$

1,088,047 

 

 

 

 

 

 

$

1,021,275 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking

$

271,513 

 

$

363 

 

0.13% 

 

$

250,562 

 

$

320 

 

0.13% 

 

$

220,314 

 

$

256 

 

0.12% 

Money Management

 

416,926 

 

 

1,535 

 

0.37% 

 

 

396,267 

 

 

1,363 

 

0.34% 

 

 

384,499 

 

 

1,463 

 

0.38% 

Savings

 

78,310 

 

 

128 

 

0.16% 

 

 

72,724 

 

 

56 

 

0.08% 

 

 

66,134 

 

 

49 

 

0.07% 

Time

 

73,947 

 

 

449 

 

0.61% 

 

 

80,391 

 

 

473 

 

0.59% 

 

 

92,212 

 

 

599 

 

0.65% 

Total interest-bearing deposits

 

840,696 

 

 

2,475 

 

0.29% 

 

 

799,944 

 

 

2,212 

 

0.28% 

 

 

763,159 

 

 

2,367 

 

0.31% 

Securities sold under agreements

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

to repurchase

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 —

 

 

25 

 

 

 —

 

0.15% 

Other borrowings

 

1,894 

 

 

16 

 

0.83% 

 

 

5,258 

 

 

33 

 

0.63% 

 

 

923 

 

 

 

0.38% 

Total interest-bearing liabilities

 

842,590 

 

 

2,491 

 

0.30% 

 

 

805,202 

 

 

2,245 

 

0.28% 

 

 

764,082 

 

 

2,371 

 

0.31% 

Noninterest-bearing deposits

 

170,649 

 

 

 

 

 

 

 

163,258 

 

 

 

 

 

 

 

143,374 

 

 

 

 

 

Other liabilities

 

5,471 

 

 

 

 

 

 

 

4,703 

 

 

 

 

 

 

 

6,619 

 

 

 

 

 

Shareholders' equity

 

120,993 

 

 

 

 

 

 

 

114,884 

 

 

 

 

 

 

 

107,175 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,139,703 

 

 

 

 

 

 

$

1,088,047 

 

 

 

 

 

 

$

1,021,250 

 

 

 

 

 

T/E net interest income/Net interest margin

 

 

 

 

40,084 

 

3.72% 

 

 

 

 

 

36,980 

 

3.62% 

 

 

 

 

 

34,267 

 

3.59% 

Tax equivalent adjustment

 

 

 

 

(2,690)

 

 

 

 

 

 

 

(2,246)

 

 

 

 

 

 

 

(2,023)

 

 

Net interest income

 

 

 

$

37,394 

 

 

 

 

 

 

$

34,734 

 

 

 

 

 

 

$

32,244 

 

 



 

Provision for Loan Losses



The Bank charged-off loans of $137 thousand in 2017, while recording recoveries of previously charged-off loans of $184 thousand.  As a result, the Bank ended the year in a net recovery position of $47 thousand.  This compares to $2.8 million in net-charge-offs in 2016.  The 2016 charged-offs were inflated by one commercial real estate loan charge-off of $2.7 million. Without this charge-off, net charge-offs for 2016 would have been only $21 thousand.  For 2017, the provision for loan loss expense was $670 thousand and was added to the allowance for loan losses (ALL) primarily as the result of loan growth.  The ALL was $11.8 million at year-end 2017 (1.25% of total loans), compared to $11.1 million at year-end 2016 (1.24% of total loans). Management closely monitors the credit quality of the portfolio in order to ensure that an appropriate ALL is maintained. As part of this process, Management performs a comprehensive analysis of the loan portfolio considering delinquencies trends and events, current economic conditions, and other relevant factors to determine the adequacy of the allowance for loan losses and the provision for loan losses.  For more information, refer to the Loan Quality discussion and Tables 11  - 17.



19


 

 

Noninterest Income



The following table presents a comparison of noninterest income for the years ended December 31, 2017 and 2016:



Table 4. Noninterest Income

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



 

 

 

Change

(Dollars in thousands)

 

2017

 

2016

 

Amount

 

%

Noninterest Income

 

 

 

 

 

 

 

 

 

 

 

Investment and trust services fees

 

$

5,370 

 

$

4,969 

 

$

401 

 

8.1 

Loan service charges

 

 

831 

 

 

714 

 

 

117 

 

16.4 

Deposit service charges and fees

 

 

2,399 

 

 

2,468 

 

 

(69)

 

(2.8)

Other service charges and fees

 

 

1,327 

 

 

1,257 

 

 

70 

 

5.6 

Debit card income

 

 

1,543 

 

 

1,469 

 

 

74 

 

5.0 

Increase in cash surrender value of life insurance

 

 

521 

 

 

531 

 

 

(10)

 

(1.9)

Net loss on sale of other real estate owned

 

 

(26)

 

 

(31)

 

 

 

16.1 

OTTI losses on debt securities

 

 

 —

 

 

(40)

 

 

40 

 

100.0 

Securities gains, net

 

 

 

 

22 

 

 

(19)

 

(86.4)

Other

 

 

221 

 

 

246 

 

 

(25)

 

(10.2)

Total

 

$

12,189 

 

$

11,605 

 

$

584 

 

5.0 



2017 versus 2016



The most significant changes in noninterest income are discussed below:



Investment and Trust Service fees: These fees are comprised of asset management fees, estate administration and settlement fees, employee benefit plans, and commissions from the sale of insurance and investment products.  Asset management fees are recurring in nature and are affected by the fair value of assets under management at the time the fees are recognized.  Asset management fees totaled $4.8 million for 2017, an increase of $428 thousand over 2016.  The fair value of trust assets under management increased to $686.9 million at year-end, compared to $622.6 million at the end of 2016. By the nature of an estate settlement, these fees are considered nonrecurring.    Estate fees declined by $54 thousand to $243 thousand in 2017.  Commissions from the sale of insurance and investment products increased by $26 thousand over 2016. 



Loan service charges:  This category includes loan origination fees, offset by those fees that are deferred, as well as production fees for originating mortgages for sale in the secondary market, and any fees for loan services that are charged after origination, e.g.: late fees or debt protection. The primary cause of the increase was higher service charges from commercial loans and fees for mortgages originated through a third-party broker.

 

Deposit fees:  This category is comprised primarily of fees from overdrafts, an overdraft protection program, service charges, and account analysis fees.  The decrease in this category is due primarily to lower usage of the Bank’s overdraft protection program, resulting in $1.4 million of fees in 2017 compared to $1.5 million in 2016.  During the year, fee income from retail usage of this service decreased, but was partially offset by increased usage by commercial customers.  



Debit card income:  Debit card fees are comprised of both a retail and business card program. Retail fees increased by $45 thousand while business card fees increased $29 thousand, a 10% increase over the prior year.   The business debit card offers a cash back rewards program based on usage.

   

Other service charges and fees: The most significant items in this category include fees from the Bank’s merchant card program and ATM fees.  Merchant card fees increased $43 thousand while ATM fees increased $13 thousand.



Securities gains and losses, and OTTI charges:  The gains in 2017 were solely the result of called bonds.  In 2016, $40 thousand of other-than-temporary-impairment charges were recorded on three private-label mortgage-backed securities, while $18 thousand in security gains were the result of called bonds.



20


 

 

The following table presents a comparison of noninterest income for the years ended December 31, 2016 and 2015:



Table 4.1 Noninterest Income





 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 



 

 

 

Change

(Dollars in thousands)

 

2016

 

2015

 

Amount

 

%

Noninterest Income

 

 

 

 

 

 

 

 

 

 

 

Investment and trust services fees

 

$

4,969 

 

$

5,036 

 

$

(67)

 

(1.3)

Loan service charges

 

 

714 

 

 

1,002 

 

 

(288)

 

(28.7)

Deposit service charges and fees

 

 

2,468 

 

 

2,318 

 

 

150 

 

6.5 

Other service charges and fees

 

 

1,257 

 

 

1,239 

 

 

18 

 

1.5 

Debit card income

 

 

1,469 

 

 

1,368 

 

 

101 

 

7.4 

Increase in cash surrender value of life insurance

 

 

531 

 

 

551 

 

 

(20)

 

(3.6)

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

 

 

(31)

 

 

32 

 

 

(63)

 

(196.9)

OTTI losses on debt securities

 

 

(40)

 

 

(20)

 

 

(20)

 

(100.0)

Gain on conversion of investment security

 

 

 —

 

 

728 

 

 

(728)

 

100.0 

Securities gains, net

 

 

22 

 

 

 

 

14 

 

175.0 

Other

 

 

246 

 

 

390 

 

 

(144)

 

(36.9)

Total

 

$

11,605 

 

$

12,652 

 

$

(1,047)

 

(8.3)



2016 versus 2015



The most significant changes in noninterest income are discussed below:



Investment and Trust Service fees:  Asset management fees increased $176 thousand, while estate fees decreased $187 thousand over 2015. Commissions from the sale of insurance and investment products decreased by $56 thousand compared to the 2015 commissions. The fair value of trust assets under management increased to $622.6 million at year-end, compared to $586.7 million at the end of 2015.



Loan service charges:  The primary cause of the decrease in 2016 was lower service charges from commercial loans and a lower volume of consumer debt protection, as well as lower consumer loan originations.



Deposit fees:  During 2016, these fees increased $150 thousand compared to 2015.  The increase in this category is due primarily to increased enrollment in the Bank’s overdraft protection program, resulting in $1.5 million of fees in 2016 compared to $1.3 million in 2015.



Debit card income:   Debit card fees are comprised of both a retail and business card program and the increase in this category was driven primarily by higher retail usage. However, business card usage also increased, but not to the extent as did retail. 



Other real estate owned gains (losses), net:  The net loss was generated by the sale of five residential properties.



Other: The decrease in this category is the result of an investment the Corporation owned in an offshore insurance company that liquidated in 2015 and paid out the investors ($171 thousand).



Gain on conversion, securities gains and losses, and OTTI charges:  In 2016, other-than-temporary-impairment charges were recorded on three private-label mortgage-backed securities, while the security gains were the result of called bonds. In 2015, a gain on conversion of an investment security of $728 thousand was recorded when one bank equity stock owned by the Bank was acquired by another bank. The remaining security gains were generated by the sale of equity securities



21


 

 

Noninterest Expense



The following table presents a comparison of noninterest expense for the years ended December 31, 2017 and 2016:



Table 5. Noninterest Expense





 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

Change

Noninterest Expense

 

2017

 

2016

 

Amount

 

%

Salaries and benefits

 

$

18,871 

 

$

18,276 

 

$

595 

 

3.3 

Occupancy, furniture and equipment, net

 

 

3,152 

 

 

3,120 

 

 

32 

 

1.0 

Advertising

 

 

1,197 

 

 

1,155 

 

 

42 

 

3.6 

Legal and professional

 

 

1,813 

 

 

1,508 

 

 

305 

 

20.2 

Data processing

 

 

2,229 

 

 

2,093 

 

 

136 

 

6.5 

Pennsylvania bank shares tax

 

 

971 

 

 

902 

 

 

69 

 

7.6 

FDIC insurance

 

 

372 

 

 

580 

 

 

(208)

 

(35.9)

ATM/debit card processing

 

 

959 

 

 

855 

 

 

104 

 

12.2 

Foreclosed real estate

 

 

151 

 

 

1,333 

 

 

(1,182)

 

(88.7)

Telecommunications

 

 

418 

 

 

429 

 

 

(11)

 

(2.6)

Legal reserve

 

 

10,000 

 

 

 —

 

 

10,000 

 

 —

Other

 

 

3,039 

 

 

2,924 

 

 

115 

 

3.9 

Total

 

$

43,172 

 

$

33,175 

 

$

9,997 

 

30.1 

 

2017 versus 2016



The most significant changes in noninterest expense are discussed below:



Salaries and benefits:  This category is the largest noninterest expense category and these expenses increased by $595 thousand compared to the prior year.  During the year, salaries, 401(k) contributions and incentive compensation accounted for the largest increases.   Partially offsetting the increases were a reduction in pension expense of $463 thousand.  Pension expense in 2016 included a one-time pension settlement of $564 thousand. See Note 14 of the accompanying consolidated financial statements for additional information on benefit plans.



Net Occupancy:  This category includes all of the expense associated with the properties and facilities used for bank operations such as depreciation, leases, maintenance, utilities and real estate taxes. Building maintenance costs increased during 2017, but were partially offset by a decrease in depreciation expense.



Legal and professional fees:  This category consists of fees paid to outside legal counsel, consultants, and audit fees.  The increase was primarily from legal fees associated with a lawsuit brought against the Corporation that is described in Item 3, Legal Proceedings.    It is expected that the Corporation will incur additional legal expenses until this lawsuit is fully resolved. Internal and external audit fees increased by $10 thousand.



Data processing:  The largest cost in this category is the expense associated with the Bank’s core processing system and related services, and accounted for $1.2 million of the total data processing costs, unchanged from the prior year. An increase in software expense contributed $80 thousand to the total increase in this category.

 

FDIC insurance: This category consists of the total fees paid to the Federal Deposit Insurance Corporation. The expense for 2017 decreased compared to prior year as an improvement in the Bank’s credit quality reduced the assessment factor.  Also, in the third quarter of 2016, the FDIC lowered the assessment rate on banks with less than $10 billion in assets, as the surplus accumulated in its deposit insurance fund reached the required level and the Bank benefited from this change for the full year of 2017.



Foreclosed real estate: This category consists of expenses related to collecting loans and expenses to carry other real estate owned.  The decrease in 2017 was due primarily to a write down the value of one property by $1.2 million in 2016.



Legal Reserve: This expense represents the accrual for a legal settlement described in Item 3 Legal Proceedings.



22


 

 

The following table presents a comparison of noninterest expense for the years ended December 31, 2016 and 2015:



Table 5.1 Noninterest Expense







 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

Change

Noninterest Expense

 

2016

 

2015

 

Amount

 

%

Salaries and benefits

 

$

18,276 

 

$

17,186 

 

$

1,090 

 

6.3 

Occupancy, furniture and equipment, net

 

 

3,120 

 

 

3,164 

 

 

(44)

 

(1.4)

Advertising

 

 

1,155 

 

 

1,105 

 

 

50 

 

4.5 

Legal and professional

 

 

1,508 

 

 

1,093 

 

 

415 

 

38.0 

Data processing

 

 

2,093 

 

 

2,051 

 

 

42 

 

2.0 

Pennsylvania bank shares tax

 

 

902 

 

 

815 

 

 

87 

 

10.7 

FDIC insurance

 

 

580 

 

 

663 

 

 

(83)

 

(12.5)

ATM/debit card processing

 

 

855 

 

 

830 

 

 

25 

 

3.0 

Foreclosed real estate

 

 

1,333 

 

 

462 

 

 

871 

 

188.5 

Telecommunications

 

 

429 

 

 

555 

 

 

(126)

 

(22.7)

Other

 

 

2,924 

 

 

3,031 

 

 

(107)

 

(3.5)

Total

 

$

33,175 

 

$

30,955 

 

$

2,220 

 

7.2 



2016 versus 2015



Salaries and benefits: This category increased by $1.1 million compared to the prior year. Pension expense increased $535 thousand due to pension settlement expense, salary expense increased $489 thousand and health insurance expense increased $114 thousand. These increases were partially offset by a decrease of $112 thousand in 401(k) incentive plan. All other employee benefit expenses remained consistent with 2015 levels. 



Net Occupancy:   Depreciation expense increased slightly in 2016, but was offset by lower utility expenses and less third party maintenance expenses, due to increased in-house maintenance efforts.



Legal and professional fees:  This category increased $415 thousand from 2015.  The increase was primarily from legal fees associated with a lawsuit brought against the Corporation in 2015.  Internal and external audit fees increased by $93 thousand.



Data processing:  The Bank’s core processing system and related services, and accounted for $1.2 million of the total data processing costs in 2016 and $1.1 million in 2015.  The increase in 2016 was due to higher customer utilization of the Bank’s various electronic banking products.



FDIC insurance: The expense for 2016 decreased compared to prior year as an improvement in the Bank’s credit quality reduced the assessment factor.  Also, in the third quarter of 2016, the FDIC lowered the assessment rate on banks with less than $10 billion in assets, as the surplus accumulated in its deposit insurance fund reached the required level.



Foreclosed real estate: In 2016, the Bank wrote down the value of one property by $1.2 million.



Other:  Other noninterest expense decreased in 2016, as the Bank took one-time expenses in 2015 to fulfill the funding requirement of a deferred director’s benefit plan established thirty years ago ($70 thousand), and expenses related to branch assets taken out of service in 2015 ($60 thousand).



Provision for Income Taxes



The Corporation recorded a Federal income tax expense of $3.6 million in 2017 compared to $1.3 million in 2016 and $2.3 million in 2015. The effective tax rate for 2017, 2016, and 2015 was 62.1%, 13.9%, and 18.2%, respectively. In most years, the Corporation’s effective tax rate is lower than its statutory rate due to the effect of tax-exempt income from certain investment securities, loans, and bank owned life insurance. In 2017, income tax expense and the effective tax rate increased due to the write-down of net deferred tax assets as a result of the passage of the Tax Cuts and Jobs Act of 2017 (the Act) . The Act reduced the federal corporate income tax rate to 21%, effective January 1, 2018 from the Corporation’s statutory rate of 34% in prior periods.   With the passage of the Act, net deferred tax assets were required to be revalued using the new rate of 21%.  The Corporation recorded additional income tax expense of $2.3 million in 2017 as a result of the revaluation of net deferred tax assets. Excluding the effect of the write-down of net deferred tax assets, the effective tax rate for 2017 would have been 22.1%.  The Corporation has determined that the accounting for the Tax Cuts and Jobs Act is final as of December 31, 2017.



23


 

 

The income tax provision and effective tax rate were lower in 2016, due to lower pre-tax income as a result of an increase in the provision for loan loss expense, a $1.2 million write-down on an other-real-estate-owned property and more tax-free income in 2016.  During 2015, the Corporation reduced the deferred tax valuation allowance related to capital losses by $200 thousand primarily due to a gain on conversion and sale of equity securities. Without this reduction, the effective tax rate for 2015 would have been 19.8% compared to 19.3% in 2014. For a more comprehensive analysis of Federal income tax expense refer to Note 12 of the accompanying consolidated financial statements.

 

Financial Condition



One method of evaluating the Corporation’s condition is in terms of its sources and uses of funds.  Assets represent uses of funds while liabilities represent sources of funds.  At December 31, 2017, total assets increased 4.7% over the prior year to $1.2 billion from $1.1 billion at the end of 2016.



Interest Bearing Deposits in Other Banks:



This asset increased $17.4 million year-over-year, but the average balance for 2017 remained steady at approximately $31 million. At year-end, approximately $7 million was in the form of short-term certificates of deposit and $30.0 million was held in an interest-bearing account at the Federal Reserve.    



Investment Securities:



The investment portfolio serves as a mechanism to invest funds if funding sources out pace lending activity, to provide liquidity for lending and operations, and provide collateral for deposits and borrowings. The mix of securities and investing decisions are made as a component of balance sheet management. Debt securities include U.S. Government Agencies, U.S. Government Agency mortgage-backed securities, non-agency mortgage-backed securities, state and municipal government bonds, and trust preferred securities.  The equity portfolio consists of one community bank stock.  The average life of the portfolio is 3.5 years and $84.1 million (fair value) is pledged as collateral for deposits. The Bank has no investments in a single issuer that exceeds 10% of shareholders equity.  All securities are classified as available for sale and all investment balances refer to fair value, unless noted otherwise. The following table presents the amortized cost and estimated fair value of investment securities by type at December 31 for the past three years:



Table 6. Investment Securities at Amortized Cost and Estimated Fair Value







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



2017

 

2016

 

2015



Amortized

 

Fair

 

Amortized

 

Fair

 

Amortized

 

Fair

(Dollars in thousands)

Cost

 

value

 

Cost

 

value

 

Cost

 

value

Equity securities

$

164 

 

$

365 

 

$

164 

 

$

290 

 

$

164 

 

$

233 

U.S. Government and Agency securities

 

11,451 

 

 

11,472 

 

 

12,598 

 

 

12,720 

 

 

13,705 

 

 

13,836 

Municipal securities

 

57,374 

 

 

57,772 

 

 

62,763 

 

 

62,985 

 

 

67,851 

 

 

69,188 

Trust preferred securities

 

6,000 

 

 

5,817 

 

 

5,979 

 

 

5,461 

 

 

5,958 

 

 

5,289 

Agency mortgage-backed securities

 

51,307 

 

 

50,937 

 

 

61,305 

 

 

61,284 

 

 

69,284 

 

 

69,519 

Private-label mortgage-backed securities

 

858 

 

 

946 

 

 

1,053 

 

 

1,104 

 

 

1,335 

 

 

1,372 

Asset-backed securities

 

28 

 

 

27 

 

 

33 

 

 

31 

 

 

38 

 

 

36 

Total

$

127,182 

 

$

127,336 

 

$

143,895 

 

$

143,875 

 

$

158,335 

 

$

159,473 

 

24


 

 

The following table presents investment securities at December 31, 2017 by maturity, and the weighted average yield for each maturity presented.  The yields presented in this table are calculated using tax-equivalent interest and the amortized cost.



Table 7. Maturity Distribution of Investment Portfolio







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

After one year

 

After five years

 

After ten

 

 

 

 



One year or less

 

through five years

 

through ten years

 

years

 

Total



Fair

 

 

Fair

 

 

Fair

 

 

Fair

 

 

Fair

 

(Dollars in thousands)

Value

Yield

 

Value

Yield

 

Value

Yield

 

Value

Yield

 

Value

Yield

Available for Sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Agency securities

$

 —

 

$

4,948  2.08% 

 

$

2,784  2.53% 

 

$

3,740  1.85% 

 

$

11,472  2.12% 

Municipal securities

 

 —

 

 

8,972  3.27% 

 

 

27,930  3.48% 

 

 

20,870  3.60% 

 

 

57,772  3.49% 

Trust preferred securities

 

 —

 

 

 —

 

 

3,056  2.70% 

 

 

2,761  2.89% 

 

 

5,817  2.79% 

Agency mortgage-backed securities

 

80  2.04% 

 

 

3,267  2.35% 

 

 

7,453  2.54% 

 

 

40,137  2.46% 

 

 

50,937  2.46% 

Private-label mortgage-backed

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

securities

 

 —

 

 

 —

 

 

 —

 

 

946  5.16% 

 

 

946  5.16% 

Asset-backed securities

 

19  0.49% 

 

 

 —

 

 

 —

 

 

3.81% 

 

 

27  1.47% 

Total

$

99  1.74% 

 

$

17,187  2.75% 

 

$

41,223  3.19% 

 

$

68,462  2.83% 

 

$

126,971  2.93% 





Table 3 shows the three-year trend of average balances and yields on the investment portfolio. The average balances and year-over-year ending balances declined (Table 6), due primarily to cash-flow from called municipal and mortgage-backed securities not being reinvested into the portfolio. The yield on the portfolio declined slightly from 2.80% in 2016 to 2.78% in 2017.  U.S. Agency mortgage-backed securities and municipal bonds continue to comprise the largest sectors by fair value of the portfolio, approximately 85% in total. The Bank expects that the portfolio will continue to remain concentrated in these investment sectors. The portfolio produced $23.6 million in cash flows in 2017 while $8.6 million was invested into the portfolio during the year.   For the year, the Corporation recorded a gain of $3 thousand on three municipal calls.



Municipal Bonds:  The Bank’s municipal bond portfolio is well diversified geographically and is comprised of both tax-exempt (72% of the portfolio) and taxable (28% of the portfolio) municipal bonds.  General obligation bonds (74%) and revenue bonds (17%) comprise the largest portions of the portfolio. The portfolio holds 106 issues within 28 states. The largest dollar exposure is to issuers in the state of Texas (fair value of $8.4 million / 15 issuers) and Pennsylvania (fair value of $5.1 million / 8 issuers).  Thirty-eight percent of the portfolio has either private bond insurance or some other type of credit enhancement. When purchasing municipal bonds, the Bank looks primarily to the underlying credit of the issuer as a sign of credit quality and then to any credit enhancement. Approximately $56 million of the portfolio is rated “A” or higher by a nationally recognized rating agency and the weighted average rating of the portfolio is “Aa2”.  



Trust Preferred Bonds:  The holdings remain the same as at the prior year end, but the unrealized loss has declined from $518 thousand to $183 thousand year-over-year. The credit ratings for each bond are similar to the ratings one year prior. Trust preferred securities are typically issued by a subsidiary grantor trust of a bank holding company, which uses the proceeds of the equity issuance to purchase deeply subordinated debt issued by the bank holding company.  All of the Bank’s trust preferred securities are single issuer bonds.  See Note 4 of the accompanying financial statements for more information on the trust preferred securities.



Mortgage-backed Securities (MBS):  This sector holds $51.9 million or 41% of the total portfolio. The majority of this sector ($51.0 million) is comprised of U.S. Government Agency MBS. The Government MBS sector is comprised of mortgage backed securities and collateralized mortgage obligations, both fixed and variable rate. In addition, the Bank holds five private-label mortgage-backed securities (PLMBS) with a fair value of $946 thousand and an amortized cost of $858 thousand.  The Bank’s private-label mortgage-backed securities (PLMBS) portfolio is comprised primarily of Alt-A loans. Alt-A loans are first-lien residential mortgages that generally conform to traditional “prime” credit guidelines; however, loan factors such as the loan-to-value ratio, loan documentation, occupancy status or property type cause these loans not to qualify for standard underwriting programs.  The See Note 4 of the accompanying financial statements for more information on the mortgage-backed securities.



Impairment:  Table 8 reflects the temporary impairment in the investment portfolio, 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 December 31, 2017 and 2016.



The condition of the portfolio at year-end 2017, as measured by the dollar amount of temporarily impaired securities, is better than year-end 2016. The Agency Mortgage-backed sector recorded the largest unrealized loss and the greatest number of securities with an unrealized loss.



25


 

 

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 December 31, 2017, was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted.  The following table presents the temporary impairment in the security portfolio for the years presented:



Table 8. Temporary Impairment











 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



December 31, 2017



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

$

2,315 

 

$

(11)

 

 

$

3,528 

 

$

(32)

 

10 

 

$

5,843 

 

$

(43)

 

15 

Municipal securities

 

13,767 

 

 

(89)

 

22 

 

 

7,507 

 

 

(163)

 

14 

 

 

21,274 

 

 

(252)

 

36 

Trust preferred securities

 

1,216 

 

 

(12)

 

 

 

4,601 

 

 

(171)

 

 

 

5,817 

 

 

(183)

 

Agency mortgage-backed securities

 

16,287 

 

 

(129)

 

29 

 

 

20,563 

 

 

(438)

 

39 

 

 

36,850 

 

 

(567)

 

68 

Private-label mortgage-backed securities

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 —

Asset-backed securities

 

 —

 

 

 —

 

 —

 

 

 

 

(1)

 

 

 

 

 

(1)

 

Total temporarily impaired securities

$

33,585 

 

$

(241)

 

58 

 

$

36,203 

 

$

(805)

 

69 

 

$

69,788 

 

$

(1,046)

 

127 









 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



December 31, 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

$

789 

 

$

(9)

 

 

$

3,413 

 

$

(17)

 

10 

 

$

4,202 

 

$

(26)

 

11 

Municipal securities

 

23,407 

 

 

(417)

 

43 

 

 

1,598 

 

 

(154)

 

 

 

25,005 

 

 

(571)

 

45 

Trust preferred securities

 

 —

 

 

 —

 

 —

 

 

5,461 

 

 

(518)

 

 

 

5,461 

 

 

(518)

 

Agency mortgage-backed securities

 

26,995 

 

 

(359)

 

39 

 

 

4,656 

 

 

(93)

 

11 

 

 

31,651 

 

 

(452)

 

50 

Private-label mortgage-backed securities

 

281 

 

 

(5)

 

 

 

 —

 

 

 —

 

 —

 

 

281 

 

 

(5)

 

Asset-backed securities

 

 —

 

 

 —

 

 —

 

 

 

 

(2)

 

 

 

 

 

(2)

 

Total temporarily impaired securities

$

51,472 

 

$

(790)

 

84 

 

$

15,132 

 

$

(784)

 

31 

 

$

66,604 

 

$

(1,574)

 

115 



The unrealized loss in the trust preferred sector declined by $335 thousand compared to the prior year-end and market prices continued to show some improvement during the year. All of the Bank’s trust preferred securities are variable rate notes with long maturities (2027-2028) from companies that received money (and in some cases paid back) from the Troubled Asset Relief Program (TARP), continue to pay dividends and have raised capital.  The credit ratings on this portfolio are similar to the prior year and no bonds have missed or suspended any payments. At December 31, 2017, the Bank believes it will be able to collect all interest and principal due on these bonds and that it will not be forced to sell these bonds prior to maturity. Therefore, no other-than-temporary-impairment charges were recorded.



The municipal securities portfolio had a $319 thousand decrease in unrealized losses since the end of 2016.  The change in value in this sector is driven by market interest rates since these bonds have very low credit risk.



The Bank held $456 thousand of restricted stock at the end of 2017 of which $426 thousand is stock in the Federal Home Loan Bank of Pittsburgh (FHLB). FHLB stock is carried at a cost of $100 per share. 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 it 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. If FHLB stock were deemed to be impaired, the write-down for the Bank could be significant. 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.



26


 

 

Loans: 



Average gross loans for 2017 increased by $76.6 million to $909.5 million compared to $832.9 million in 2016.  Commercial loans and home equity loans and lines of credit showed an increase in average balances during the year, which was partially offset by a decline in average residential mortgage and consumer loans during the year.  The yield on the portfolio increased in 2017 increased to 4.22% in 2017 from 4.15% in 2016. Table 3 presents detail on the average balances and yields earned on loans for the past three years. The following table shows loans outstanding, by primary collateral, as of December 31 for the past 5 years.



Table 9. Loan Portfolio







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

(Dollars in thousands)

2017

 

2016

 

2015

 

2014

 

2013



Balance

 

%
Change

 

Balance

 

%
Change

 

Balance

 

%
Change

 

Balance

 

%
Change

 

Balance

Residential real estate 1-4 family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer first lien

$

97,159 

 

(5.8)

 

$

103,125 

 

(0.6)

 

$

103,698 

 

(1.3)

 

$

105,014 

 

1.4 

 

$

103,573 

Commercial first lien

 

61,275 

 

(6.4)

 

 

65,445 

 

13.3 

 

 

57,780 

 

2.6 

 

 

56,300 

 

(3.7)

 

 

58,466 

Total first liens

 

158,434 

 

(6.0)

 

 

168,570 

 

4.4 

 

 

161,478 

 

0.1 

 

 

161,314 

 

(0.4)

 

 

162,039 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer junior lien and lines of credit

 

45,043 

 

0.5 

 

 

44,817 

 

(0.4)

 

 

44,996 

 

18.0 

 

 

38,132 

 

10.1 

 

 

34,636 

Commercial junior liens and lines of credit

 

5,328 

 

(1.3)

 

 

5,396 

 

(8.8)

 

 

5,917 

 

4.5 

 

 

5,663 

 

(4.6)

 

 

5,939 

Total junior liens and lines of credit

 

50,371 

 

0.3 

 

 

50,213 

 

(1.4)

 

 

50,913 

 

16.3 

 

 

43,795 

 

7.9 

 

 

40,575 

Total residential real estate 1-4 family

 

208,805 

 

(4.6)

 

 

218,783 

 

3.0 

 

 

212,391 

 

3.6 

 

 

205,109 

 

1.2 

 

 

202,614 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate construction

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer purpose

 

1,813 

 

34.3 

 

 

1,350 

 

147.7 

 

 

545 

 

(66.5)

 

 

1,627 

 

(58.9)

 

 

3,960 

Commercial purpose

 

8,088 

 

6.1 

 

 

7,625 

 

3.8 

 

 

7,343 

 

(9.2)

 

 

8,088 

 

(5.5)

 

 

8,559 

Total residential real estate construction

 

9,901 

 

10.3 

 

 

8,975 

 

13.8 

 

 

7,888 

 

(18.8)

 

 

9,715 

 

(22.4)

 

 

12,519 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate

 

428,428 

 

9.7 

 

 

390,584 

 

14.6 

 

 

340,695 

 

4.4 

 

 

326,482 

 

(0.9)

 

 

329,373 

Commercial

 

291,519 

 

7.6 

 

 

270,826 

 

25.4 

 

 

215,942 

 

20.6 

 

 

179,071 

 

5.1 

 

 

170,327 

    Total commercial

 

719,947 

 

8.9 

 

 

661,410 

 

18.8 

 

 

556,637 

 

10.1 

 

 

505,553 

 

1.2 

 

 

499,700 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

5,047 

 

7.3 

 

 

4,705 

 

(7.7)

 

 

5,100 

 

(17.1)

 

 

6,154 

 

(28.3)

 

 

8,580 

Total loans

 

943,700 

 

5.6 

 

 

893,873 

 

14.3 

 

 

782,016 

 

7.6 

 

 

726,531 

 

0.4 

 

 

723,413 

Less: Allowance for loan losses

 

(11,792)

 

6.5 

 

 

(11,075)

 

9.8 

 

 

(10,086)

 

10.7 

 

 

(9,111)

 

(6.1)

 

 

(9,702)

Net loans

$

931,908 

 

5.6 

 

$

882,798 

 

14.4 

 

$

771,930 

 

7.6 

 

$

717,420 

 

0.5 

 

$

713,711 

 

Residential real estate:  This category is comprised of first lien loans and, to a lesser extent, junior liens and lines of credit secured by residential real estate.  Total residential real estate loans decreased $10.0 million over 2016, primarily in consumer first lien loans.  The Bank’s residential mortgage portfolio decreased during 2017 as paydowns were greater than originations booked to the portfolio.  In 2017, the Bank originated $17.8 million in mortgages, including approximately $10.0 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.



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.



Residential real estate construction:  The largest component of this category represents loans to residential real estate developers of $8.1 million, while loans for individuals to construct personal residences totaled $1.8 million at December 31, 2017. 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 December 31, 2017, the Bank had $6.6 million in real estate construction loans funded with an interest reserve and capitalized $119 thousand of interest from these reserves on active projects during 2017.  These loans are comprised of $908 thousand in residential construction and $5.7 million in commercial construction (reported in the commercial real estate category). 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 or AIA documents (depending on the complexity of the project) detailing costs incurred by the borrower, on-site inspections, and a signature by the assigned loan officer for disbursement of funds. 



Commercial loans: Commercial loans continue to be the largest loan category on the balance sheet and increased 8.9% compared to the end of 2016. In 2017, the Bank approved approximately $194 million in commercial loans and commitments with approximately $114 million in new money advances. The competition for good quality loans continues to be strong with the best customers able to attract multiple offers.

27


 

 



Commercial real estate (CRE): This category includes commercial, industrial, farm and agricultural loans, where real estate serves as the primary collateral for the loan. This loan category increased by $37.8 million over the prior year. The increases in 2017 were primarily in office buildings and manufacturing facilities. The largest sectors (by collateral) in CRE are: office buildings ($56.8 million), land development ($53.0 million), hotel and motel ($49.6 million) and manufacturing facilities ($38.4 million).



Commercial (C&I): This category includes commercial, industrial, farm, agricultural, and tax free loans. Collateral for these loans may include business assets or equipment, personal guarantees, or other non-real estate collateral. C&I loans increased $20.7 million over the 2016 ending balance, primarily in tax free municipal loans. At December 31, 2017, the Bank had approximately $176 million of tax free loans in its portfolio. The largest sectors (by industry) are: public administration ($80.1 million), utilities ($36.1 million), educational services ($31.6 million) and retail trade ($23.7 million). The Bank does not have any loan exposure to the oil and gas industry.



The Bank continues to reduce its portfolio of purchased participation commercial loans. At December 31, 2017, the Bank held $115.3 million in purchased loan participations in its portfolio compared to $133.3 million at the prior year-end. During the year, $25 million of loan participations paid off and this partially offset the growth in this loan category. The Bank expects that commercial lending will continue to be the primary area of loan growth in the future via in-market lending, but it expects new purchase participations to decline. 



Consumer loans: This category is mainly comprised of unsecured personal lines of credit and showed a slight increase of $342 thousand in 2017 over 2016 ending balances.



Table 10. Maturities and Interest Rate Terms of Selected Loans



The following table presents the stated maturities (or earlier call dates) of selected loans as of December 31, 2017.  Consumer purpose residential mortgages and consumer loans are excluded from the presentation.







 

 

 

 

 

 

 

 

 

 

 



Less than

 

 

 

 

Over

 

 

 

(Dollars in thousands)

1 year

 

1-5 years

 

5 years

 

Total

Loans:

 

 

 

 

 

 

 

 

 

 

 

Residential real estate construction

$

6,134 

 

$

1,954 

 

$

 —

 

$

8,088 

Commercial real estate

 

29,183 

 

 

57,598 

 

 

341,647 

 

 

428,428 

Commercial

 

50,278 

 

 

44,968 

 

 

196,273 

 

 

291,519 

Total

$

85,595 

 

$

104,520 

 

$

537,920 

 

$

728,035 

 



Loans with fixed and variable interest rates at December 31, 2017 are shown below:







 

 

 

 

 

 

 

 

 

 

 



Less than

 

 

 

 

Over

 

 

 

(Dollars in thousands)

1 year

 

1-5 years

 

5 years

 

Total

Loans with fixed rates

$

4,433 

 

$

60,708 

 

$

72,552 

 

$

137,693 

Loans with variable rates

 

81,162 

 

 

43,812 

 

 

465,368 

 

 

590,342 

Total

$

85,595 

 

$

104,520 

 

$

537,920 

 

$

728,035 

 



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 based on the performance status of the loans. 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-Substandard.   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 primary measurements: (1) loans rated 6-Special Mention or worse (collectively “watch list”), (2) delinquent loans, (3) net-charge-offs, and (4) other real estate owned (OREO).



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 includes both performing and nonperforming loans. Watch list loans totaled $12.8 million at year-end compared to $18.5 million one year earlier. Included in the watch list are $2.7 million of

28


 

 

nonaccrual loans. The composition of the watch list (loans rated 6, 7 or 8), by primary collateral, is shown in Note 6 of the accompanying financial statements. 



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



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-Substandard 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 less than the supervisory loan-to-value limits.  However, in certain circumstances, the Bank may make a loan that exceeds  the supervisory loan-to-value.  At December 31, 2017, the Bank had loans of $30.2 million (3.2% of gross loans) that exceeded the supervisory loan-to value limit, compared to 3.0% at the prior year end.



Loan quality improved during 2017, as measured by the balance of nonperforming loans reported in Table 11. Nonperforming loans have decreased by $2.8 million with $2.1 million of the decrease coming in commercial real estate loans as the result of pay-offs or third-party refinancing.   Potential problem loans, defined as watch list loans less loans on nonaccrual or past due more than 90 days, at December 31, 2017 totaled $10.1 million compared to $13.1 million at December 31, 2016.



29


 

 

The following table presents a five year summary of nonperforming assets as of December 31 of each year:



Table 11. Nonperforming Assets







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

(Dollars in thousands)

 

2017

 

2016

 

2015

 

2014

 

2013

Nonaccrual loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

168 

 

$

231 

 

$

806 

 

$

1,124 

 

$

2,599 

Junior liens and lines of credit

 

 

 —

 

 

86 

 

 

105 

 

 

169 

 

 

107 

Total

 

 

168 

 

 

317 

 

 

911 

 

 

1,293 

 

 

2,706 

Residential real estate - construction

 

 

466 

 

 

480 

 

 

502 

 

 

931 

 

 

538 

Commercial real estate

 

 

1,854 

 

 

3,956 

 

 

3,681 

 

 

8,430 

 

 

19,001 

Commercial

 

 

187 

 

 

23 

 

 

276 

 

 

1,637 

 

 

2,398 

Total nonaccrual loans

 

 

2,675 

 

 

4,776 

 

 

5,370 

 

 

12,291 

 

 

24,643 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans past due 90 days or more and not included above

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

 

 —

 

 

 —

 

 

214 

 

 

165 

 

 

302 

Junior liens and lines of credit

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

41 

Total

 

 

 —

 

 

 —

 

 

214 

 

 

165 

 

 

343 

Commercial real estate

 

 

 —

 

 

665 

 

 

152 

 

 

140 

 

 

207 

Commercial

 

 

 —

 

 

 —

 

 

 

 

 —

 

 

44 

  Consumer

 

 

 —

 

 

 —

 

 

 —

 

 

17 

 

 

10 

Total loans past due 90 days or more and still accruing

 

 

 —

 

 

665 

 

 

368 

 

 

322 

 

 

604 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total nonperforming loans

 

 

2,675 

 

 

5,441 

 

 

5,738 

 

 

12,613 

 

 

25,247 

Other real estate owned

 

 

2,598 

 

 

4,915 

 

 

6,451 

 

 

3,666 

 

 

4,708 

Total nonperforming assets

 

$

5,273 

 

$

10,356 

 

$

12,189 

 

$

16,279 

 

$

29,955 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nonperforming loans to total gross loans

 

 

0.28% 

 

 

0.61% 

 

 

0.73% 

 

 

1.74% 

 

 

3.49% 

Nonperforming assets to total assets

 

 

0.45% 

 

 

0.92% 

 

 

1.18% 

 

 

1.63% 

 

 

3.04% 

Allowance for loan losses to nonperforming loans

 

 

440.82% 

 

 

203.55% 

 

 

175.78% 

 

 

72.23% 

 

 

38.43% 

 









The following table provides information on the most significant nonaccrual loans as of December 31, 2017.



Table 12. Significant Nonaccrual Loans







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

ALL

 

Nonaccrual

 

TDR

 

 

 

 

 

Last

(Dollars in thousands)

Balance

 

Reserve

 

Date

 

Status

 

Collateral

 

Location

 

Appraisal(1)

Credit 1

$

1,647 

 

$

 —

 

Mar-12

 

Y

 

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

 

PA

 

Nov-17

$

3,924 

Credit 2

 

595 

 

 

 —

 

Sep-16

 

Y

 

1st lien on farmland

 

PA

 

Jul-14

$

1,526 

Total

$

2,242 

 

$

 —

 

 

 

 

 

 

 

 

 

 

 

 



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



Credit 1 is a TDR that is in compliance with its modified terms. Credit 2 is in the process of foreclosure and is listed for sale.   .



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 (excluding consumer purpose loans) and TDR loans are considered impaired. 



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 interest rate, extending the maturity, reamortization of payment, or a combination of multiple concessions.  The Bank reviews all loans rated 6-Special Mention or worse when it is providing a loan restructure, modification or new credit facility to

30


 

 

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.



 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 $12.6 million at year-end compared to $15.1 million at the prior year end. Included in the impaired loan totals are $12.2 million of TDR loans.



The following table shows the composition of the Bank’s impaired loans as of December 31, 2017.



Table 13. Composition of Impaired Loans





 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

 

(Dollars in thousands)

 

Nonaccrual

 

Accruing

 

Total



 

Non-TDR

 

TDR

 

TDR

 

Impaired

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

132 

 

$

36 

 

$

701 

 

$

869 

Junior liens and lines of credit

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Total

 

 

132 

 

 

36 

 

 

701 

 

 

869 

Residential real estate - construction

 

 

 —

 

 

466 

 

 

 —

 

 

466 

Commercial real estate

 

 

78 

 

 

1,776 

 

 

9,207 

 

 

11,061 

Commercial

 

 

187 

 

 

 —

 

 

 —

 

 

187 

Total

 

$

397 

 

$

2,278 

 

$

9,908 

 

$

12,583 



Note 6 of the accompanying financial statements provides additional information on the composition of the impaired loans, including the allowance for loan loss that has been established for impaired loans and new TDR loans during the year.



Allowance for Loan Losses:



Management monitors loan performance on a monthly basis and 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. 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 - Special Mention or worse, and obtains a new appraisal or asset valuation for any placed on nonaccrual and 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 December 31, 2017 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. However, it is possible that as a result of the credit analysis, a specific reserve is not required for an impaired loan. For impaired 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.  These loans totaled $677 thousand at year-end 2017 and are comprised primarily of loans secured by residential real estate.   Management does not believe that excluding these loans from the specific reserve analysis presents any additional risk. The balance of impaired loans and the ALL for these loans declined in 2017.  Note 6 of the accompanying financial statements provides additional information about the ALL established for impaired loans.

31


 

 

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.  Each sector may be further segregated by type of collateral, lien position, or owner/nonowner occupied properties.  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. 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 qualitative factor of 37.5 basis points of gross loans.  The following table shows the composition of the allowance for loan losses as of December 31 for each of the past five years.

Table 14. Composition of the Allowance for Loan Losses





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

2017

 

2016

 

2015

 

2014

 

2013



 

 

 

% of

 

 

 

 

% of

 

 

 

 

% of

 

 

 

 

% of

 

 

 

 

% of

Allowance Component

 

Balance

 

Loans

 

 

Balance

 

Loans

 

 

Balance

 

Loans

 

 

Balance

 

Loans

 

 

Balance

 

Loans

General - Quantitative

$

7,808 

 

0.83 

 

$

7,477 

 

0.84 

 

$

7,073 

 

0.90 

 

$

6,315 

 

0.87 

 

$

6,282 

 

0.87 

General - Qualitative

 

2,547 

 

0.27 

 

 

2,277 

 

0.25 

 

 

1,679 

 

0.21 

 

 

1,552 

 

0.21 

 

 

1,468 

 

0.20 

Specific

 

 -

 

 -

 

 

 -

 

 -

 

 

 

 -

 

 

232 

 

0.03 

 

 

1,100 

 

0.15 

Unallocated

 

1,437 

 

0.15 

 

 

1,321 

 

0.15 

 

 

1,325 

 

0.17 

 

 

1,012 

 

0.14 

 

 

852 

 

0.12 



$

11,792 

 

1.25 

 

$

11,075 

 

1.24 

 

$

10,086 

 

1.29 

 

$

9,111 

 

1.25 

 

$

9,702 

 

1.34 



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 nonaccrual and a risk rating of 7-Substandard 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. We believe this practice complies with the regulatory guidance.



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.



The following table shows, by loan segment, the activity in the ALL, the amount of the allowance established in each category and the loans that were evaluated for the ALL under a specific reserve (individually) and those that were evaluated under a general reserve (collectively) as of December 31, 2017.



Table 15. Allowance for Loan Losses by Segment









 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

Junior Liens &

 

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

 

 



 

First Liens

 

Lines of Credit

 

Construction

 

Real Estate

 

Commercial

 

Consumer

 

Unallocated

 

Total



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance at December 31, 2016

 

$

1,105 

 

$

323 

 

$

224 

 

$

6,109 

 

$

1,893 

 

$

100 

 

$

1,321 

 

$

11,075 

Charge-offs

 

 

(13)

 

 

 —

 

 

 —

 

 

(14)

 

 

(8)

 

 

(102)

 

 

 —

 

 

(137)

Recoveries

 

 

 

 

11 

 

 

 —

 

 

17 

 

 

117 

 

 

37 

 

 

 —

 

 

184 

Provision

 

 

(34)

 

 

(4)

 

 —

 

 

414 

 

 

108 

 

 

70 

 

 

116 

 

 

670 

Allowance at December 31, 2017

 

$

1,060 

 

$

330 

 

$

224 

 

$

6,526 

 

$

2,110 

 

$

105 

 

$

1,437 

 

$

11,792 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance established for
  loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

Collectively

 

 

1,060 

 

 

330 

 

 

224 

 

 

6,526 

 

 

2,110 

 

 

105 

 

 

1,437 

 

 

11,792 

Allowance at December 31, 2017

 

$

1,060 

 

$

330 

 

$

224 

 

$

6,526 

 

$

2,110 

 

$

105 

 

$

1,437 

 

$

11,792 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for allowance:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

459 

 

$

 —

 

$

466 

 

$

10,981 

 

$

 —

 

$

 —

 

$

 —

 

$

11,906 

Collectively

 

 

157,975 

 

 

50,371 

 

 

9,435 

 

 

417,447 

 

 

291,519 

 

 

5,047 

 

 

 —

 

 

931,794 

Total

 

$

158,434 

 

$

50,371 

 

$

9,901 

 

$

428,428 

 

$

291,519 

 

$

5,047 

 

$

 —

 

$

943,700 

 

32


 

 

The following table shows the allocation of the allowance for loan losses by loan category as of December 31 for each of the past five years:



Table 16. Allocation of the Allowance for Loan Losses





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

2017

 

2016

 

2015

 

2014

 

2013



 

 

 

% of

 

 

 

 

% of

 

 

 

 

% of

 

 

 

 

% of

 

 

 

 

% of



Balance

 

Allowance

 

Balance

 

Allowance

 

Balance

 

Allowance

 

Balance

 

Allowance

 

Balance

 

Allowance

Residential real estate
  1-4 family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

$

1,060 

 

 

$

1,105 

 

10 

 

$

989 

 

10 

 

$

994 

 

11 

 

$

913 

 

Junior liens and
  lines of credit

 

330 

 

 

 

323 

 

 

 

308 

 

 

 

271 

 

 

 

228 

 

Total

 

1,390 

 

12 

 

 

1,428 

 

13 

 

 

1,297 

 

13 

 

 

1,265 

 

14 

 

 

1,141 

 

12 

Residential real estate
  construction

 

224 

 

 

 

224 

 

 

 

194 

 

 

 

214 

 

 

 

276 

 

Commercial real estate

 

6,526 

 

55 

 

 

6,109 

 

55 

 

 

5,649 

 

56 

 

 

4,978 

 

55 

 

 

5,196 

 

54 

Commercial

 

2,110 

 

18 

 

 

1,893 

 

17 

 

 

1,519 

 

15 

 

 

1,515 

 

17 

 

 

2,099 

 

22 

Consumer

 

105 

 

 

 

100 

 

 

 

102 

 

 

 

127 

 

 

 

138 

 

Unallocated

 

1,437 

 

12 

 

 

1,321 

 

12 

 

 

1,325 

 

13 

 

 

1,012 

 

11 

 

 

852 

 

Total

$

11,792 

 

100 

 

$

11,075 

 

100 

 

$

10,086 

 

100 

 

$

9,111 

 

100 

 

$

9,702 

 

100 

 

The allocation of the allowance for loan losses is based on estimates and is not intended to imply limitations on the usage of the allowance. The entire allowance is available to absorb any losses without regard to the category in which the loan is classified.



The following table shows the percentage of the loans in each category to total gross loans as of December 31 for each of the past five years:







 

 

 

 

 

 

 

 

 

 

 

 

2017

 

2016

 

2015

 

2014

 

2013

Residential real estate 1-4 family

 

 

 

 

 

 

 

 

 

 

First liens

 

17% 

 

19% 

 

21% 

 

22% 

 

22% 

Junior liens and lines of credit

 

5% 

 

5% 

 

6% 

 

6% 

 

6% 

Total

 

22% 

 

24% 

 

27% 

 

28% 

 

28% 

Residential real estate construction

 

1% 

 

1% 

 

1% 

 

1% 

 

2% 

Commercial real estate

 

45% 

 

44% 

 

43% 

 

45% 

 

45% 

Commercial

 

31% 

 

30% 

 

28% 

 

25% 

 

24% 

Consumer

 

1% 

 

1% 

 

1% 

 

1% 

 

1% 

Total

 

100% 

 

100% 

 

100% 

 

100% 

 

100% 

 

The Bank added $670 thousand to the ALL through the provision for loan loss expense in 2017 compared to $3.8 million in the prior year. The provision expense for the year was due primarily to growth in the commercial loan portfolio.  In 2016, the increase in the provision expense was primarily due to growth in the commercial loan portfolio and a $2.7 million charge-off on one commercial real estate loan that reduced the balance in the ALL. Charged-off loans usually result from: (1) a borrower being legally relieved of loan repayment responsibility through bankruptcy, (2) insufficient proceeds from the sale of collateral to repay a loan; or (3) the borrower and/or guarantor does not own other marketable assets that, if sold, would generate sufficient sale proceeds to repay a loan.



33


 

 

The following table presents details on activity in the ALL as well as key ALL ratios at December 31:



Table 17. Historical Allowance for Loan Losses







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

2017

 

2016

 

2015

 

2014

 

2013



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at beginning of year

 

$

11,075 

 

$

10,086 

 

$

9,111 

 

$

9,702 

 

$

10,379 

Charge-offs:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate 1-4 family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

 

(13)

 

 

(49)

 

 

(43)

 

 

(291)

 

 

(547)

Junior liens and lines of credit

 

 

 —

 

 

 —

 

 

(39)

 

 

 —

 

 

(45)

Total

 

 

(13)

 

 

(49)

 

 

(82)

 

 

(291)

 

 

(592)

Residential real estate construction

 

 

 —

 

 

(41)

 

 

(21)

 

 

(41)

 

 

 —

Commercial real estate

 

 

(14)

 

 

(2,751)

 

 

 —

 

 

(408)

 

 

(2,855)

Commercial

 

 

(8)

 

 

(74)

 

 

(270)

 

 

(644)

 

 

(363)

Consumer

 

 

(102)

 

 

(167)

 

 

(198)

 

 

(189)

 

 

(162)

Total charge-offs

 

 

(137)

 

 

(3,082)

 

 

(571)

 

 

(1,573)

 

 

(3,972)



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Recoveries:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate 1-4 family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

 

 

 

35 

 

 

 

 

21 

 

 

13 

Junior liens and lines of credit

 

 

11 

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Total

 

 

13 

 

 

35 

 

 

 

 

21 

 

 

13 

Residential real estate construction

 

 

 —

 

 

 —

 

 

18 

 

 

 —

 

 

 —

Commercial real estate

 

 

17 

 

 

19 

 

 

14 

 

 

50 

 

 

203 

Commercial

 

 

117 

 

 

167 

 

 

148 

 

 

65 

 

 

100 

Consumer

 

 

37 

 

 

75 

 

 

74 

 

 

82 

 

 

59 

Total recoveries

 

 

184 

 

 

296 

 

 

261 

 

 

218 

 

 

375 

Net recoveries (charge-offs)

 

 

47 

 

 

(2,786)

 

 

(310)

 

 

(1,355)

 

 

(3,597)

Provision for loan losses

 

 

670 

 

 

3,775 

 

 

1,285 

 

 

764 

 

 

2,920 

Balance at end of year

 

$

11,792 

 

$

11,075 

 

$

10,086 

 

$

9,111 

 

$

9,702 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ratios:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net (recoveries) charge-offs/average loans

 

 

-0.01%

 

 

0.33% 

 

 

0.04% 

 

 

0.19% 

 

 

0.49% 

Net (recoveries) charge-offs/provision for loan losses

 

 

-7.01%

 

 

73.80% 

 

 

24.12% 

 

 

177.36% 

 

 

123.18% 

ALL as a percentage of loans

 

 

1.25% 

 

 

1.24% 

 

 

1.29% 

 

 

1.25% 

 

 

1.34% 

 

34


 

 

Other Real Estate Owned:



The Bank holds $2.6 million of other real estate owned (OREO), comprised of three properties compared to $4.9 million and five properties one year earlier. The Bank sold $2.3 million of OREO during 2017, including one property carried at $1.9 million.  The most significant OREO holding is one property carried at $2.5 million (97% of total OREO) that is secured by 196 acres of land intended for residential real estate development. This property is under contract to be sold; however, the agreement allowed for multiple due diligence periods. The due diligence period was extended for the final time in November 2017 to May 2018.  Therefore, the final outcome is not certain. This property was part of a participated loan and the workout is being handled by the lead bank.  During 2017, the Bank recorded write downs of $83 thousand and incurred expense of $68 thousand to hold and maintain OREO. Note 8 of the accompanying financial statements provides additional information on activity in OREO.

 







Goodwill:  



The Bank has $9.0 million of goodwill recorded on its balance sheet as the result of corporate acquisitions.  Goodwill is not amortized, nor deductible for tax purposes.   However, goodwill is tested for impairment at least annually in accordance with ASC Topic 350.   Goodwill was tested for impairment as of August 31, 2017. The 2017 impairment test was conducted using a qualitative assessment method.  The qualitative assessment included: macroeconomic factors, banking industry conditions, banking merger and acquisition trends, the Bank’s historical financial performance, the Corporation’s stock price, forecast Bank financial performance, and change of control premiums.  Based upon this qualitative assessment, Management determined the Bank’s goodwill was not impaired. The 2016 impairment test was conducted following the step-one test under ASC Topic 350. The step-one test used several different weighted methods to determine the fair value of the reporting unit under the step-one test, including a dividend analysis, comparable sale transactions, and change of control premium estimates.  As a result of the 2016 step-one test, Management also  determined goodwill was not impaired.  At December 31, 2017, Management subsequently considered certain qualitative factors affecting the Corporation and determined that it was not likely that the results of the prior test had changed and it determined that goodwill was not impaired at year-end.



Deposits:



The Bank depends on deposits generated by its community banking offices as its primary source of funds.  The Bank offers numerous deposit products including demand deposits (noninterest and interest-bearing accounts), savings, money management accounts, and time deposits (certificates of deposits/CDs). Table 18 shows a comparison of the major deposit categories over a five-year period at December 31, including balances and the percentage change in balances year-over-year. Table 3, presented previously, shows the average balance of the major deposit categories and the average cost of these deposits over a three year period. 



Table 18. Deposits





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

(Dollars in thousands)

 

2017

 

 

 

2016

 

 

 

2015

 

 

 

2014

 

 

 

2013



 

 

 

 

%

 

 

 

 

%

 

 

 

 

%

 

 

 

 

%

 

 

 



 

Balance

 

Change

 

Balance

 

Change

 

Balance

 

Change

 

Balance

 

Change

 

Balance

Noninterest-bearing checking

 

$

196,853 

 

15.6 

 

$

170,345 

 

12.0 

 

$

152,095 

 

11.1 

 

$

136,910 

 

12.6 

 

$

121,565 

Interest-bearing checking

 

 

280,944 

 

16.1 

 

 

241,906 

 

4.2 

 

 

232,181 

 

19.1 

 

 

194,992 

 

8.1 

 

 

180,450 

Money management

 

 

415,045 

 

(1.3)

 

 

420,309 

 

10.8 

 

 

379,331 

 

(2.2)

 

 

388,043 

 

4.8 

 

 

370,401 

Savings

 

 

78,868 

 

5.3 

 

 

74,925 

 

8.3 

 

 

69,174 

 

10.4 

 

 

62,637 

 

5.5 

 

 

59,394 

Retail time deposits

 

 

72,211 

 

1.3 

 

 

71,264 

 

(13.6)

 

 

82,468 

 

(11.3)

 

 

92,973 

 

(14.1)

 

 

108,283 

Brokered time deposits

 

 

3,260 

 

(3.3)

 

 

3,371 

 

3.3 

 

 

3,263 

 

(42.0)

 

 

5,626 

 

(0.1)

 

 

5,631 

Total

 

$

1,047,181 

 

6.6 

 

$

982,120 

 

6.9 

 

$

918,512 

 

4.2 

 

$

881,181 

 

4.2 

 

$

845,724 



Noninterest-bearing checking:  This category experienced double digit percentage growth for the fourth consecutive year. Nearly every sector of this product increased during the year with business accounts showing the largest dollar growth, approximately $29 million. The average balance for the year increased by approximately $7 million. As a noninterest bearing account, these deposits contribute approximately 6 basis points to the net interest margin.



Interest-bearing checking: This category saw an increase in both the ending and average balance for the year compared to prior year-end, while the cost of these accounts remained flat. Retail accounts and commercial accounts in the fully-insured interest-bearing checking account product were growth leaders in this product during 2017.

 

Money management:  The year over year balance declined slightly; however, the average balance increased approximately $21 million compared to the 2016 average balance. The cost of this product increased slightly during the year as the Bank restructured segments of this product that it believed were the most rate sensitive. If market rates continue to increase, this product is the most likely to have higher costs in 2018.



35


 

 

Savings:  Savings accounts increased 5.3% during the year and represents the ninth consecutive year of growth. Regular retail balances grew the most in 2017. The cost of this product more than doubled due to higher priced IRA savings accounts.

 

Time deposits:  Retail time deposits grew slightly in 2017 after seven consecutive years of decline. Retail time deposits greater than $100 thousand held steady at just over $3 million.  Consumers do not seem to be inclined to invest in longer maturity deposits as they want more liquid accounts and are afraid of missing out on the opportunity to take advantage of rising rates, whenever that may occur. As a result of this sentiment, the Bank has seen some maturing CDs migrate to the Money Management product and new CDs being written for short-terms.  In 2018, 65% of the Bank’s retail CDs will mature.   



Brokered deposits:  At year-end 2017, the Bank had $150.1 million placed in the ICS program ($100.0 million included in interest-bearing checking and $50.1 million included in money management) and $3.3 million of time deposits placed into the CDARS program.  These programs allow the Bank to offer full FDIC coverage to large depositors, but with the convenience to the customer of only having to deal with one bank.  The Bank solicits these deposits from within its market and it believes they present no greater risk than any other local deposit. However, regulatory guidance requires that these deposits be classified as brokered deposits. The Bank had no wholesale brokered CDs at year-end.



The Bank continually reviews different methods of funding growth that include traditional deposits and other wholesale sources. Competition from other local financial institutions, internet banks and brokerages will continue to be a challenge for the Bank in its efforts to attract new and retain existing deposit accounts.  This competition is not expected to lessen in the future.





Table 19. Time Deposits of $100,000 or More







 

 

 

 

 

 

 

 

 



 

Retail

 

Brokered

 

Total

(Dollars in thousands)

 

Time Deposits

 

Time Deposits

 

Time Deposits

Maturity distribution:

 

 

 

 

 

 

 

 

 

Within three months

 

$

12,432 

 

$

 —

 

$

12,432 

Over three through six months

 

 

2,990 

 

 

240 

 

 

3,230 

Over six through twelve months

 

 

3,420 

 

 

2,182 

 

 

5,602 

Over twelve months

 

 

6,399 

 

 

168 

 

 

6,567 

Total

 

$

25,241 

 

$

2,590 

 

$

27,831 



Borrowings:



Short-term Borrowings: Short-term borrowings from the FHLB are in the form of a revolving term commitment. The short-term FHLB borrowings are used as overnight borrowings to fund the short-term liquidity needs of the Bank.  These borrowings reprice on a daily basis and the interest rate fluctuates with short-term market interest rates. The Bank’s maximum borrowing capacity with the FHLB at December 31, 2017 was $314.6 million with $314.6 million available to borrow.



The Bank had previously used securities sold under repurchase agreements (Repo), which were accounted for as collateralized financings, as an additional funding source. The Bank discontinued its Repo product in 2015.



Table 20. Short-Term Borrowings







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

2017

 

2016

 

2015



 

Short-Term

Repurchase

 

Short-Term

Repurchase

 

Short-Term

Repurchase



 

Borrowings

Agreements

 

Borrowings

Agreements

 

Borrowings

Agreements

Ending balance

 

$

 —

$

 —

 

$

24,270 

$

 —

 

$

 —

$

 —

Average balance

 

 

1,894 

 

 —

 

 

5,258 

 

 —

 

 

923 

 

25 

Maximum month-end balance

 

 

13,000 

 

 —

 

 

24,270 

 

 —

 

 

3,500 

 

 —

Weighted-average interest rate

 

 

0.83% 

 

 —

 

 

0.63% 

 

 —

 

 

0.38% 

 

0.15% 



Long-term Debt:  The Bank had no long-term debt outstanding during 2017, 2016 or 2015. 

 



Shareholders’ Equity:



Shareholders’ equity declined by $1.3 million to $115.1 million at December 31, 2017. The  decline was the result of lower 2017 net income that was negatively affected by a $10 million (pre-tax) legal reserve expense and increased income tax expense of $2.3 million from the revaluation of net deferred tax assets.  The effect of the net deferred tax asset revaluation was partially offset by an

36


 

 

increase of $992 thousand to retained earnings, representing a component of the deferred tax asset that was originally created through other comprehensive income.  The Corporation paid out $4.0 million in dividends ($0.93 per share) during 2017.  With the lower 2017 earnings, the dividend payout ratio was abnormally high at 185.2% compared to 43.6% in 2016.



The Board of Directors frequently authorizes the repurchase of the Corporation’s $1.00 par value common stock. Information regarding stock repurchase in place during the year in included in Item 5- Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities. Additional information on Shareholders’ Equity is reported in Note 17 of the accompanying consolidated financial statements.



The Corporation’s dividend reinvestment plan (DRIP) allows for shareholders to purchase additional shares of the Corporation’s common stock by reinvesting cash dividends paid on their shares or through optional cash payments. The Dividend Reinvestment Plan (DRIP) added $991 thousand to capital during 2017. This total was comprised of $669 thousand from the reinvestment of quarterly dividends and $322 thousand of optional cash contributions.



A strong capital position is important to the Corporation as it provides a solid foundation for the future growth of the Corporation, as well as instills confidence in the Bank by depositors, regulators and investors, and is considered essential by Management. The Corporation is continually exploring other sources of capital as part of its capital management plan for the Corporation and the Bank.



Common measures of adequate capitalization for banking institutions are capital ratios.  These ratios indicate the proportion of permanently committed funds to the total asset base.  Guidelines issued by federal and state regulatory authorities require both banks and bank holding companies to meet minimum leverage capital ratios and risk-based capital ratios.



The leverage ratio compares Tier 1 capital to average assets while the risk-based ratio compares Tier 1 and total capital to risk-weighted assets and off-balance-sheet activity in order to make capital levels more sensitive to the risk profiles of individual banks. Tier 1 capital is comprised of common stock, additional paid-in capital, retained earnings and components of other comprehensive income, reduced by goodwill and other intangible assets.  Total capital is comprised of Tier 1 capital plus the allowable portion of the allowance for loan losses.



The Corporation, as a bank holding company, is required to comply with the capital adequacy standards established by Federal Reserve Board.  The Bank is required to comply with capital adequacy standards established by the FDIC. In addition, the Pennsylvania Department of Banking also requires state chartered banks to maintain a 6% leverage capital level and 10% risk based capital, defined substantially the same as the federal regulations.



The Corporation and the Bank are subject to the capital requirements contained in the regulation 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 rules also included changes in the risk weights of certain assets to better reflect credit and other risk exposures. In addition, a capital conservation buffer is being phased-in beginning in at 0.625% for 2016, 1.25% for 2017, 1.875% for 2018 and 2.50% for 2019 and thereafter. The capital conservation buffer is applicable to all of the capital ratios except for the Tier 1 Leverage ratio. The capital conservation buffer is equal to the lowest value of the three applicable capital ratios less the regulatory minimum for each respective capital measurement.   The Bank’s capital conservation buffer at December 31, 2017 was 7.19% (total risk-based capital 15.19% less 8.00%) compared to the 2017 regulatory buffer of 1.25%. Compliance with the capital conservation buffer is required in order to avoid limitations certain capital distributions.  As of December 31, 2017, 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 minimum capital ratios (shown as “adequately capitalized”) and the “well capitalized” capital ratios are reported on Note 2 of the accompanying financial statements.



37


 

 

The following table presents capital ratios for the Corporation at December 31:



Table 21. Capital Ratios







 

 

 

 

 



 



2017

 

2016

 

2015

Common Equity Tier 1 risk-based capital ratio

14.06% 

 

14.41% 

 

14.77% 

Total risk-based capital ratio

15.31% 

 

15.67% 

 

16.03% 

Tier 1 risk-based capital ratio

14.06% 

 

14.41% 

 

14.77% 

Tier 1 leverage ratio

9.73% 

 

10.11% 

 

10.38% 



For additional information on capital adequacy refer to Note 2 of the accompanying consolidated financial statements.

 

Local 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 249,000 in Cumberland County. Unemployment in the Bank’s market area has decreased in 2016 and ranges from a low of 3.3% in Cumberland County to high of 4.5% in Fulton 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.  The following provides selected economic data for the Bank’s primary market at December 31:



Economic Data



 

 

 

 



 

2017

 

2016

Unemployment Rate (seasonally adjusted)

 

 

 

 

Market area range (1)

 

3.3% - 4.5%

 

4.2 - 6.6%

Pennsylvania

 

4.6% 

 

5.7% 

United States

 

4.1% 

 

4.6% 



 

 

 

 

Housing Price Index - year over year change

 

 

 

 

PA, nonmetropolitan statistical area

 

2.3% 

 

2.8% 

United States

 

6.3% 

 

5.6% 



 

 

 

 

Building Permits - year over year change -12 moths

 

 

 

 

Harrisburg-Carlisle, PA MSA & Chambersburg-Waynesboro, PA MSA

 

 

 

 

Residential, estimated

 

5.2% 

 

20.9% 

Multifamily, estimated

 

-27.8%

 

-31.7%



 

 

 

 

(1) Franklin, Cumberland, Fulton and Huntingdon Counties

 

 

 

  



The assets and liabilities of the Corporation are financial in nature, as such, the pricing of products, customer demand for certain types of products, and the value of assets and liabilities are greatly influenced by interest rates.  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 and monetary policy.  In December 2016, the FOMC increased the federal funds rate target range by 25 basis points and then followed with three more similar increases in 2017.   Looking ahead to 2018, the FOMC continues to state that the timing and magnitude of rate increases will be data dependent; therefore, the likelihood of any rate increase or decrease in 2018 is unknown, despite predictions of two or more increases.   In determining the timing and size of future adjustments to the target range for the federal funds rate, the FOMC  assesses realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.  We expect that the normalization of monetary policy will be quite gradual.  At its January 2018 meeting, the FOMC voted to maintain the current federal funds target rate, but the market believes a March 2018 increase in probable.  

 

38


 

 

Liquidity



The Corporation conducts substantially all of its business through its bank subsidiary. The liquidity needs of the Corporation are funded primarily by the bank subsidiary, supplemented with liquidity from its dividend reinvestment plan.

 

The Bank 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 helps 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 Bank has satisfied its liquidity needs from earnings, repayment of loans, amortizing and 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 (approximately $42.9 million fair value) 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. The Bank also has access to other wholesale funding via the brokered CD market.



The FHLB system has always been a major source of funding for community banks. The Bank’s maximum borrowing capacity with the FHLB at December 31, 2017 was $314.6 million with $314.6 million available to borrow. There are no indicators that lead the Bank to believe the FHLB will discontinue its lending function or restrict the Bank’s ability to borrow.  If either of these events were to occur, it would have a negative effect on the Bank and it is unlikely that the Bank could replace the level of FHLB funding in a short time.



The Bank has established credit at the Federal Reserve Discount Window and as of year-end had the ability to borrow approximately $20 million. The Bank also has a $6 million unsecured line of credit at a correspondent bank.    



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 loans and lines of credit.  Because these unfunded instruments have fixed maturity dates and 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 $300.1 million and $28.6 million, respectively, at December 31, 2017, compared to $277.4 million and $23.9 million, respectively, at December 31, 2016. See Note 18 of the accompanying consolidated financial statements for more information on commitments and contingencies.



Management believes that any amounts actually drawn upon can be funded in the normal course of operations.  The Corporation has no investment in or financial relationship with any unconsolidated entities that are reasonably likely to have a material effect on liquidity.



39


 

 

The following table represents the Corporation’s aggregate on and off balance sheet contractual obligations to make future payments as of December 31, 2017.



Table 22. Contractual Obligations











 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

1 year

 

 

 

 

 

Over

 

 



 

and under

 

Years 2-3

 

Years 4-5

 

5 years

 

Total

Time deposits

 

$

49,346 

 

$

18,117 

 

$

8,008 

 

$

 —

 

$

75,471 

Operating leases

 

 

634 

 

 

1,013 

 

 

967 

 

 

3,628 

 

 

6,242 

Deferred compensation

 

 

745 

 

 

565 

 

 

172 

 

 

919 

 

 

2,401 

Estimated future pension payments

 

 

1,043 

 

 

2,547 

 

 

2,178 

 

 

6,580 

 

 

12,348 

Pending legal settlement

 

 

10,000 

 

 

 —

 

 

 —

 

 

 —

 

 

10,000 

Total

 

$

61,768 

 

$

22,242 

 

$

11,325 

 

$

11,127 

 

$

106,462 

 

The Corporation is not aware of any known trends, demands, commitments, events or uncertainties which would result in any material increase or decrease in liquidity.

 

Item 7A.  Quantitative and Qualitative Disclosures about Market Risk



Market Risk



In the course of its normal business operations, the Corporation is exposed to certain market risks.  The Corporation has no foreign currency exchange rate risk, no commodity price risk or material equity price risk.  However, it is exposed to interest rate risk.  All interest rate risk arises in connection with financial instruments entered into for purposes other than trading.  Financial instruments, which are sensitive to changes in market interest rates, include fixed and variable-rate loans, fixed-income securities, derivatives, interest-bearing deposits and other borrowings. 



Changes in interest rates can have an impact on the Corporation’s net interest income and the economic value of equity.  The objective of interest rate risk management is to identify and manage the sensitivity of net interest income and economic value of equity to changing interest rates in order to achieve consistent earnings that are not contingent upon favorable trends in interest rates.



The Corporation uses several tools to measure and evaluate interest rate risk.  One tool is interest rate sensitivity or gap analysis.  Gap analysis classifies assets and liabilities by repricing and maturity characteristics and provides Management with an indication of how different interest rate scenarios will impact net interest income.  Table 23 presents a gap analysis of the Corporation’s balance sheet at December 31, 2017. A positive gap in the under one-year time interval suggests that, all else being equal, the Corporation’s near-term earnings would rise in a higher interest rate environment and decline in a lower rate environment. A negative gap suggests the opposite result.  At December 31, 2017, the Corporation’s cumulative gap position at one year was negative.  However, the incremental benefit of future rate decreases has been reduced as the rates paid on the Bank’s liabilities have been reduced greatly, leaving little room for future reductions.  In addition, many of the liabilities are reported in Table 23 at the earliest period at which the rate could change. Since these rates change at the discretion of the Bank, certain liabilities may or may not be repriced with the same magnitude or at the same time as market rates. These circumstances are not captured by a gap analysis.  Consequently, gap analysis is not a good indicator of future earnings.



Another tool for analyzing interest rate risk is financial simulation modeling which captures the effect of not only changing interest rates but also other sources of cash flow variability including loan and securities prepayments and customer preferences.  Financial simulation modeling forecasts both net interest income and the economic value of equity under a variety of different interest rate environments that cannot be captured with a gap analysis. The Corporation regularly measures the effects of multiple yield curve rate changes.  The magnitude of each change scenario may vary depending on the current interest rate environment In addition, the balance sheet is held static in each scenario so that the effect of an interest rate change can be isolated and not distorted by changes in the balance sheet.



Table 24 presents the results of three different rate change scenarios and measures the change in net interest income against a base  (unchanged) scenario over one year.  As shown, the Bank’s net interest income compared to the base scenario decreases in the down 100 basis point scenario, but increases in each of the up scenarios. For each scenario, interest rate changes are ramped up or down over a period of 1 year, except for the plus 400 basis point scenario which is ramped over 2 years. The Bank believes a ramp scenario is more realistic than an interest rate shock scenario; however, the Bank also runs scenarios using shocks and yield curve twists.  Economic value of equity (EVE) is defined as the estimated discounted present value of assets minus the discounted present value of liabilities and is a surrogate for long-term earnings. EVE measures the degree to which the economic value of a bank changes under different rate scenarios. EVE focuses on a longer-term time horizon and captures all balance sheet cash flows and is more effective in considering embedded options. The discount rates used in the EVE calculation are based on market rates for like assets and liabilities

40


 

 

and the balance sheet position is held constant in order to isolate the risk of interest rate changes. For EVE simulation, all rates change by the defined amount immediately and simultaneously in a shock fashion.



Computations of prospective effects of hypothetical interest rate changes are based on many assumptions, including relative levels of market interest rates, loan prepayments and deposit repricing.  Certain shortcomings are inherent in the computation of discounted present value and, if key relationships do not unfold as assumed, actual values may differ from those presented.  Further, the computations do not contemplate any actions Management could undertake in response to changes in market interest rates.



The following table shows interest rate sensitivity for the Corporation as of December 31, 2017.



Table 23. Interest Rate Sensitivity Analysis







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

1-90

 

91-181

 

182-365

 

1-5

 

Beyond

 

 

 



Days

 

Days

 

Days

 

Years

 

5 Years

 

Total

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits
  in other banks

$

31,195 

 

$

750 

 

$

2,000 

 

$

2,975 

 

$

250 

 

$

37,170 

Investment securities and
  restricted stock

 

6,054 

 

 

5,406 

 

 

7,465 

 

 

77,560 

 

 

31,307 

 

 

127,792 

Loans

 

282,756 

 

 

37,818 

 

 

124,127 

 

 

399,729 

 

 

99,270 

 

 

943,700 

Total interest-earning assets

 

320,005 

 

 

43,974 

 

 

133,592 

 

 

480,264 

 

 

130,827 

 

 

1,108,662 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking

 

280,944 

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

280,944 

Money market deposit accounts

 

415,045 

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

415,045 

Savings

 

78,868 

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

78,868 

Time

 

22,377 

 

 

10,984 

 

 

15,985 

 

 

21,797 

 

 

4,328 

 

 

75,471 

Total interest-bearing liabilities

$

797,234 

 

$

10,984 

 

$

15,985 

 

$

21,797 

 

$

4,328 

 

$

850,328 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate gap

$

(477,229)

 

$

32,990 

 

$

117,607 

 

$

458,467 

 

$

126,499 

 

$

258,334 

Cumulative interest rate gap

$

(477,229)

 

$

(444,239)

 

$

(326,632)

 

$

131,835 

 

$

258,334 

 

 

 



Table 24. Sensitivity to Changes in Market Interest Rates





 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

Net Interest Income

 

Economic Value of Equity (EVE)

Change in rates (basis points)

 

Projected

 

% Change

 

Projected

 

% Change

+400

 

$

40,160 

 

2.3% 

 

$

182,132 

 

(1.9)%

+200

 

$

39,994 

 

1.9% 

 

$

185,723 

 

0.1% 

unchanged

 

$

39,253 

 

 

$

185,621 

 

(100)

 

$

37,516 

 

(4.4)%

 

$

146,143 

 

(21.3)%



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 “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, change 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.



Impact of Inflation



The impact of inflation upon financial institutions such as the Corporation differs from its effect upon other commercial enterprises.  Unlike most other commercial enterprises, virtually all of the assets of the Corporation are monetary in nature.  As a result, interest rates have a more significant impact on the Corporation’s performance than do the effects of general levels of inflation. 

41


 

 

Although inflation (and inflation expectations) may affect the interest rate environment, it is not possible to measure with any precision the impact of future inflation upon the Corporation.

42


 

 

Item 8.  Financial Statements and Supplementary Data

Report of Independent Registered Public Accounting Firm





Board of Directors and Shareholders

Franklin Financial Services Corporation

Chambersburg, Pennsylvania

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheets of Franklin Financial Services Corporation (the “Corporation”) and subsidiaries as of December 31, 2017 and 2016, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2017, and the related notes (collectively referred to as the consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Corporation and subsidiaries at December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Corporation's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated March 12, 2018 expressed an unqualified opinion thereon.

Basis for Opinion

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

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

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



/s/ BDO USA, LLP

We have served as the Corporation's auditor since 2013.



Harrisburg, Pennsylvania

March 12, 2018

 

43


 

 

Consolidated Balance Sheets







 

 

 

 

 

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

December 31,



2017

 

2016

Assets

 

 

 

 

 

Cash and due from banks

$

21,433 

 

$

16,888 

Interest-bearing deposits in other banks

 

37,170 

 

 

19,777 

Total cash and cash equivalents

 

58,603 

 

 

36,665 

Investment securities available for sale, at fair value

 

127,336 

 

 

143,875 

Restricted stock

 

456 

 

 

1,767 

Loans held for sale

 

442 

 

 

540 

Loans

 

943,700 

 

 

893,873 

Allowance for loan losses

 

(11,792)

 

 

(11,075)

Net Loans

 

931,908 

 

 

882,798 

Premises and equipment, net

 

13,741 

 

 

14,058 

Bank owned life insurance

 

22,980 

 

 

22,459 

Goodwill

 

9,016 

 

 

9,016 

Other real estate owned

 

2,598 

 

 

4,915 

Deferred tax asset, net

 

5,803 

 

 

5,844 

Other assets

 

6,930 

 

 

5,506 

Total assets

$

1,179,813 

 

$

1,127,443 



 

 

 

 

 

Liabilities

 

 

 

 

 

Deposits

 

 

 

 

 

Non-interest bearing checking

$

196,853 

 

$

170,345 

Money management, savings and interest checking

 

774,857 

 

 

737,140 

Time

 

75,471 

 

 

74,635 

Total deposits

 

1,047,181 

 

 

982,120 

Short-term borrowings

 

 —

 

 

24,270 

Other liabilities

 

17,488 

 

 

4,560 

Total liabilities

 

1,064,669 

 

 

1,010,950 



 

 

 

 

 

Shareholders' equity

 

 

 

 

 

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

 

 

 

 

 

4,689,099 shares issued and 4,354,788 shares outstanding at December 31, 2017 and

 

 

 

 

 

4,688,349 shares issued and 4,316,836 shares outstanding at December 31, 2016

 

4,689 

 

 

4,688 

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

 

 

 

 

 

shares issued and outstanding

 

 —

 

 

 —

Additional paid-in capital

 

40,396 

 

 

39,752 

Retained earnings

 

82,218 

 

 

83,081 

Accumulated other comprehensive loss

 

(6,028)

 

 

(4,215)

Treasury stock, 334,311 shares at December 31, 2017 and 371,513 shares at

 

 

 

 

 

December 31, 2016, at cost

 

(6,131)

 

 

(6,813)

Total shareholders' equity

 

115,144 

 

 

116,493 

Total liabilities and shareholders' equity

$

1,179,813 

 

$

1,127,443 



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

44


 

 

Consolidated Statements of Income







 

 

 

 

 

 

 

 

 

(Dollars in thousands, except per share data)

 

Years ended December 31,



 

2017

 

2016

 

2015

Interest income

 

 

 

 

 

 

 

 

 

Loans, including fees

 

$

36,274 

 

$

32,992 

 

$

30,279 

Interest and dividends on investments:

 

 

 

 

 

 

 

 

 

Taxable interest

 

 

2,062 

 

 

2,271 

 

 

2,415 

Tax exempt interest

 

 

1,122 

 

 

1,412 

 

 

1,607 

Dividend income

 

 

26 

 

 

17 

 

 

67 

Deposits and obligations of other banks

 

 

401 

 

 

287 

 

 

247 

Total interest income

 

 

39,885 

 

 

36,979 

 

 

34,615 

Interest expense

 

 

 

 

 

 

 

 

 

Deposits

 

 

2,475 

 

 

2,212 

 

 

2,367 

Short-term borrowings

 

 

16 

 

 

33 

 

 

Total interest expense

 

 

2,491 

 

 

2,245 

 

 

2,371 

Net interest income

 

 

37,394 

 

 

34,734 

 

 

32,244 

Provision for loan losses

 

 

670 

 

 

3,775 

 

 

1,285 

Net interest income after provision for loan losses

 

 

36,724 

 

 

30,959 

 

 

30,959 

Noninterest income

 

 

 

 

 

 

 

 

 

Investment and trust services fees

 

 

5,370 

 

 

4,969 

 

 

5,036 

Loan service charges

 

 

831 

 

 

714 

 

 

1,002 

Deposit service charges and fees

 

 

2,399 

 

 

2,468 

 

 

2,318 

Other service charges and fees

 

 

1,327 

 

 

1,257 

 

 

1,239 

Debit card income

 

 

1,543 

 

 

1,469 

 

 

1,368 

Increase in cash surrender value of life insurance

 

 

521 

 

 

531 

 

 

551 

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

 

 

(26)

 

 

(31)

 

 

32 

OTTI losses on debt securities

 

 

 —

 

 

(40)

 

 

(20)

Gain on conversion of investment security

 

 

 —

 

 

 —

 

 

728 

Securities gains, net

 

 

 

 

22 

 

 

Other

 

 

221 

 

 

246 

 

 

390 

Total noninterest income

 

 

12,189 

 

 

11,605 

 

 

12,652 

Noninterest Expense

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

 

18,871 

 

 

18,276 

 

 

17,186 

Occupancy, furniture and equipment, net

 

 

3,152 

 

 

3,120 

 

 

3,164 

Advertising

 

 

1,197 

 

 

1,155 

 

 

1,105 

Legal and professional

 

 

1,813 

 

 

1,508 

 

 

1,093 

Data processing

 

 

2,229 

 

 

2,093 

 

 

2,051 

Pennsylvania bank shares tax

 

 

971 

 

 

902 

 

 

815 

Intangible amortization

 

 

 —

 

 

 —

 

 

181 

FDIC Insurance

 

 

372 

 

 

580 

 

 

663 

ATM/debit card processing

 

 

959 

 

 

855 

 

 

830 

Foreclosed real estate

 

 

151 

 

 

1,333 

 

 

462 

Telecommunications

 

 

418 

 

 

429 

 

 

555 

Legal reserve

 

 

10,000 

 

 

 —

 

 

 —

Other

 

 

3,039 

 

 

2,924 

 

 

3,031 

Total noninterest expense

 

 

43,172 

 

 

33,175 

 

 

31,136 

Income before federal income taxes

 

 

5,741 

 

 

9,389 

 

 

12,475 

Federal income tax expense

 

 

3,565 

 

 

1,302 

 

 

2,271 

Net income

 

$

2,176 

 

$

8,087 

 

$

10,204 

Per share

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.50 

 

$

1.88 

 

$

2.40 

Diluted earnings per share

 

$

0.50 

 

$

1.88 

 

$

2.40 

Cash dividends declared

 

$

0.93 

 

$

0.82 

 

$

0.74 



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

45


 

 

Consolidated Statements of Comprehensive Income







 

 

 

 

 

 

 

 

 



 

Years ended December 31,

(Dollars in thousands)

 

2017

 

2016

 

2015

Net Income

 

$

2,176 

 

$

8,087 

 

$

10,204 



 

 

 

 

 

 

 

 

 

Securities (1)

 

 

 

 

 

 

 

 

 

Unrealized gains (losses) arising during the period

 

 

177 

 

 

(1,176)

 

 

(498)

Reclassification for net (gains) losses and OTTI

 

 

 

 

 

 

 

 

 

    included in net income

 

 

(3)

 

 

18 

 

 

(716)

Net unrealized gains (losses)

 

 

174 

 

 

(1,158)

 

 

(1,214)

Tax effect

 

 

(60)

 

 

394 

 

 

413 

Net of tax amount

 

 

114 

 

 

(764)

 

 

(801)



 

 

 

 

 

 

 

 

 

Derivatives (2)

 

 

 

 

 

 

 

 

 

Unrealized gains (losses) arising during the period

 

 

 —

 

 

 —

 

 

31 

Reclassification for net losses included in net income

 

 

 —

 

 

 —

 

 

160 

Net unrealized gains

 

 

 —

 

 

 —

 

 

191 

Tax effect

 

 

 —

 

 

 —

 

 

(65)

Net of tax amount

 

 

 —

 

 

 —

 

 

126 



 

 

 

 

 

 

 

 

 

Pension (3)

 

 

 

 

 

 

 

 

 

Change in plan assets and benefit obligations

 

 

(1,965)

 

 

(638)

 

 

(416)

Reclassification for net actuarial losses included in net income

 

 

547 

 

 

1,049 

 

 

497 

Net unrealized (losses) gains

 

 

(1,418)

 

 

411 

 

 

81 

Tax effect

 

 

483 

 

 

(140)

 

 

(28)

Net of tax amount

 

 

(935)

 

 

271 

 

 

53 



 

 

 

 

 

 

 

 

 

Total other comprehensive loss

 

 

(821)

 

 

(493)

 

 

(622)



 

 

 

 

 

 

 

 

 

Total Comprehensive Income

 

$

1,355 

 

$

7,594 

 

$

9,582 



 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

Reclassification adjustment / Statement line item

 

Tax  expense (benefit)

(1) Securities / securities (gains) losses and OTTI losses, net

 

$

 

$

(6)

 

$

243 

(2) Derivatives

 

 

 —

 

 

 —

 

 

(54)

(3) Pension / Salary & Benefits

 

 

(186)

 

 

(357)

 

 

(169)



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

46


 

 

Consolidated Statements of Changes in Shareholders' Equity

For years ended December 31, 2017,  2016, and 2015:







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 



 

 

 

Additional

 

 

 

 

Other

 

 

 

 

 

 



Common

 

Paid-in

 

Retained

 

Comprehensive

 

Treasury

 

 

 

(Dollars in thousands, except per share data)

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

 

 —

 

 

 —

 

 

10,204 

 

 

 —

 

 

 —

 

 

10,204 

Other comprehensive income

 

 —

 

 

 —

 

 

 —

 

 

(622)

 

 

 —

 

 

(622)

Cash dividends declared, $.74 per share

 

 —

 

 

 —

 

 

(3,139)

 

 

 —

 

 

 —

 

 

(3,139)

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

 

 —

 

 

 

 

 —

 

 

 —

 

 

86 

 

 

92 

Common stock issued under dividend reinvestment plan,
  52,755 shares

 

52 

 

 

1,194 

 

 

 —

 

 

 —

 

 

 —

 

 

1,246 

Stock option compensation expense

 

 —

 

 

74 

 

 

 —

 

 

 —

 

 

 —

 

 

74 

Balance at December 31, 2015

 

4,659 

 

 

38,778 

 

 

78,517 

 

 

(3,722)

 

 

(6,856)

 

 

111,376 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 —

 

 

 —

 

 

8,087 

 

 

 —

 

 

 —

 

 

8,087 

Other comprehensive income

 

 —

 

 

 —

 

 

 —

 

 

(493)

 

 

 —

 

 

(493)

Cash dividends declared, $.82 per share

 

 —

 

 

 —

 

 

(3,523)

 

 

 —

 

 

 —

 

 

(3,523)

Acquisition of 34,048 shares of treasury stock

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(795)

 

 

(795)

Treasury shares issued under employer stock option plans,
  907 shares

 

 —

 

 

 

 

 —

 

 

 —

 

 

16 

 

 

20 

Treasury shares issued under dividend reinvestment plan,
  45,068 shares

 

 —

 

 

296 

 

 

 —

 

 

 —

 

 

822 

 

 

1,118 

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

 

25 

 

 

528 

 

 

 —

 

 

 —

 

 

 —

 

 

553 

Common stock issued under incentive stock option plan,
  3,800 shares

 

 

 

58 

 

 

 —

 

 

 —

 

 

 —

 

 

62 

Stock option compensation expense

 

 —

 

 

88 

 

 

 —

 

 

 —

 

 

 —

 

 

88 

Balance at December 31, 2016

 

4,688 

 

 

39,752 

 

 

83,081 

 

 

(4,215)

 

 

(6,813)

 

 

116,493 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 —

 

 

 —

 

 

2,176 

 

 

 —

 

 

 —

 

 

2,176 

Other comprehensive income

 

 —

 

 

 —

 

 

 —

 

 

(821)

 

 

 —

 

 

(821)

Cash dividends declared, $.93 per share

 

 —

 

 

 —

 

 

(4,031)

 

 

 —

 

 

 —

 

 

(4,031)

Treasury shares issued under employee stock purchase plan,
  6,827 shares

 

 —

 

 

32 

 

 

 —

 

 

 —

 

 

125 

 

 

157 

Treasury shares issued under dividend reinvestment plan,
  30,375 shares

 

 —

 

 

434 

 

 

 —

 

 

 —

 

 

557 

 

 

991 

Common stock issued under incentive stock option plan,
  750 shares

 

 

 

17 

 

 

 —

 

 

 —

 

 

 —

 

 

18 

Revaluation of net deferred tax assets

 

 —

 

 

 —

 

 

992 

 

 

(992)

 

 

 —

 

 

 —

Stock option compensation expense

 

 —

 

 

161 

 

 

 —

 

 

 —

 

 

 —

 

 

161 

Balance at December 31, 2017

$

4,689 

 

$

40,396 

 

$

82,218 

 

$

(6,028)

 

$

(6,131)

 

$

115,144 



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

47


 

 

Consolidated Statements of Cash Flows



 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 



 

December 31,



 

2017

 

2016

 

2015

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

 

Net income

 

$

2,176 

 

$

8,087 

 

$

10,204 

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

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

1,325 

 

 

1,345 

 

 

1,328 

Net amortization of loans and investment securities

 

 

1,730 

 

 

1,617 

 

 

1,659 

Amortization and net change in mortgage servicing rights valuation

 

 

55 

 

 

55 

 

 

34 

Amortization of intangibles

 

 

 —

 

 

 —

 

 

181 

Provision for loan losses

 

 

670 

 

 

3,775 

 

 

1,285 

Gain on sales of securities

 

 

(3)

 

 

(22)

 

 

(8)

Impairment write-down on securities recognized in earnings

 

 

 —

 

 

40 

 

 

20 

Gain on conversion of investment security

 

 

 —

 

 

 —

 

 

(728)

Legal reserve

 

 

10,000 

 

 

 —

 

 

 —

Loans originated for sale

 

 

(9,887)

 

 

(8,972)

 

 

(9,121)

Proceeds from sale of loans

 

 

9,985 

 

 

8,893 

 

 

9,049 

Write-down on premise and equipment

 

 

45 

 

 

69 

 

 

60 

Write-down of other real estate owned

 

 

83 

 

 

1,209 

 

 

365 

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

 

 

26 

 

 

31 

 

 

(32)

Increase in cash surrender value of life insurance

 

 

(521)

 

 

(531)

 

 

(551)

Gain from surrender of life insurance policy

 

 

 —

 

 

(76)

 

 

(103)

Stock option compensation

 

 

161 

 

 

88 

 

 

74 

Decrease in other assets

 

 

293 

 

 

1,174 

 

 

2,443 

Increase (decrease) in other liabilities

 

 

945 

 

 

(1,094)

 

 

(2,758)

Deferred tax benefit

 

 

(831)

 

 

(832)

 

 

(111)

Net cash provided by operating activities

 

 

16,252 

 

 

14,856 

 

 

13,290 

Cash flows from investing activities

 

 

 

 

 

 

 

 

 

Proceeds from sales and calls of investment securities available for sale

 

 

1,205 

 

 

3,825 

 

 

1,381 

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

 

 

22,424 

 

 

25,393 

 

 

30,123 

Purchase of investment securities available for sale

 

 

(8,602)

 

 

(985)

 

 

(21,688)

Net decrease (increase) in restricted stock

 

 

1,311 

 

 

(16,605)

 

 

(344)

Net increase in loans

 

 

(49,911)

 

 

(114,780)

 

 

(58,496)

Proceeds from sale of other real estate/other repossessed assets

 

 

2,298 

 

 

625 

 

 

508 

Proceeds from surrender of life insurance policy

 

 

 —

 

 

436 

 

 

389 

Proceeds from the sale of other assets

 

 

154 

 

 

 —

 

 

 —

Capital expenditures

 

 

(1,119)

 

 

(579)

 

 

(1,041)

Net cash used in investing activities

 

 

(32,240)

 

 

(102,670)

 

 

(49,168)

Cash flows from financing activities

 

 

 

 

 

 

 

 

 

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

 

 

64,225 

 

 

74,704 

 

 

50,199 

Net increase (decrease) in time deposits

 

 

836 

 

 

(11,096)

 

 

(12,868)

Net decrease in repurchase agreements

 

 

 —

 

 

 —

 

 

(9,079)

Net (decrease) increase in short-term borrowings

 

 

(24,270)

 

 

24,270 

 

 

 —

Dividends paid

 

 

(4,031)

 

 

(3,523)

 

 

(3,139)

Purchase of Treasury shares

 

 

 —

 

 

(795)

 

 

 —

Cash received from option exercises

 

 

175 

 

 

82 

 

 

92 

Common stock issued under dividend reinvestment plan

 

 

991 

 

 

1,671 

 

 

1,246 

Net cash provided by financing activities

 

 

37,926 

 

 

85,313 

 

 

26,451 

Increase (decrease) in cash and cash equivalents

 

 

21,938 

 

 

(2,501)

 

 

(9,427)

Cash and cash equivalents as of January 1

 

 

36,665 

 

 

39,166 

 

 

48,593 

Cash and cash equivalents as of December 31

 

$

58,603 

 

$

36,665 

 

$

39,166 

Supplemental Disclosures of Cash Flow Information

 

 

 

 

 

 

 

 

 

Cash paid during the year for:

 

 

 

 

 

 

 

 

 

Interest on deposits and other borrowed funds

 

$

2,458 

 

$

2,253 

 

$

2,416 

Income taxes

 

$

3,955 

 

$

2,100 

 

$

3,016 

Noncash Activities:

 

 

 

 

 

 

 

 

 

Loans transferred to Other Real Estate

 

$

90 

 

$

329 

 

$

3,626 



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

48


 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 1. Summary of Significant Accounting Policies



The accounting policies of Franklin Financial Services Corporation and its subsidiaries conform to U.S. generally accepted accounting principles and to general industry practices.  A summary of the more significant accounting policies, which have been consistently applied in the preparation of the accompanying consolidated financial statements, follows:



Principles of Consolidation – 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 and Franklin Future Fund Inc. Farmers and Merchants Trust Company of Chambersburg is a commercial bank (the Bank) that has one wholly-owned subsidiary, Franklin Financial Properties Corp., which holds real estate assets that are leased by the Bank.  Franklin Future Fund Inc. is a non-bank investment company that makes venture capital investments within the Corporation’s primary market area.  The activities of non-bank entities are not significant to the consolidated totals.  All significant intercompany transactions have been eliminated in consolidation.  Management has evaluated subsequent events for potential recognition and/or disclosure through the date these consolidated financial statements were issued.



Nature of Operations – The Corporation conducts substantially all of its business through its subsidiary bank, Farmers and Merchants Trust Company of Chambersburg, which serves its customer base through twenty-two community-banking offices located in Franklin, Cumberland, Fulton and Huntingdon Counties, Pennsylvania. These counties are considered to be the Corporation’s primary market area, but it may do business in the greater South-Central Pennsylvania market.  The Bank is a community-oriented commercial bank that emphasizes customer service and convenience.  As part of its strategy, the Bank has sought to develop a variety of products and services that meet the needs of both its retail and commercial customers.  The Corporation and the Bank are subject to the regulations of various federal and state agencies and undergo periodic examinations by these regulatory authorities.



Use of Estimates in the Preparation of Financial Statements – The preparation of financial statements in conformity with generally accepted accounting principles requires Management to make estimates and assumptions.  These estimates and assumptions affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, and the assessment of other than temporary impairment of investment securities and the valuation allowance on the deferred tax asset.



Significant Group Concentrations of Credit Risk – Most of the Corporation’s activities are with customers located within its primary market area.  Note 4 of the consolidated financial statements shows the types of securities in which the Corporation invests.  Note 5 of the consolidated financial statements shows the types of lending in which the Corporation engages.  The Corporation does not have any significant concentrations of any one industry or customer.



Statement of Cash Flows – 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.



Investment Securities – Management classifies its securities at the time of purchase as available for sale or held to maturity. At December 31, 2017 and 2016, all securities were classified as available for sale, meaning that the Corporation intends to hold them for an indefinite period of time, but not necessarily to maturity. Available for sale securities are stated at estimated fair value, adjusted for amortization of premiums and accretion of discounts which are recognized as adjustments of interest income through call date or maturity.  The related unrealized holding gains and losses are reported as other comprehensive income or loss, net of tax, until realized.  Declines in the fair value of held-to-maturity and available-for-sale securities to amounts below cost that are deemed to be other-than-temporary are reflected in earnings as realized losses.  In estimating the other-than-temporary impairment losses, Management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) determines if the Corporation does not intend to sell the security or it if is not more likely than not that the Corporation will be required to sell the security before recovery of its amortized cost. When a determination is made that an other-than-temporary impairment exists but the Corporation does not intend to sell the debt security and it is not more likely than not that it will be required to sell the debt security prior to its anticipated recovery, the other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income. Realized securities gains and losses are computed using the specific identification method. Gains or losses on the disposition of investment securities are based on the net proceeds and the adjusted carrying amount of the specific security sold. Any decision to sell a security classified as available for sale would be based on various factors, including significant movement in interest rates, changes in maturity or mix of the Bank’s assets and liabilities, liquidity needs, regulatory capital considerations and other similar factors.



49


 

 

Restricted Stock– – Restricted stock, which is carried at cost, consists of stock of the Federal Home Loan Bank of Pittsburgh (FHLB) and Atlantic Central Bankers Bank (ACBB).  The Bank held $456 thousand of restricted stock at the end of 2017. With the exception of $30 thousand, this investment represents stock in the FHLB that the Bank is required to hold in order to be a member of FHLB and is carried at a cost of $100 per share. FHLB stock is divided into two classes: membership stock and activity stock, which is based on outstanding loan balances. Federal law requires a member institution of the FHLB to hold FHLB stock according to a predetermined formula. Management evaluates the restricted stock for impairment in accordance with ASC Topic 320.  Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value.  The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) the significance of the decline in net assets of the banks as compared to the capital stock amount for the banks and the length of time this situation has persisted, (2) commitments by the banks to make payments required by law or regulation and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the banks.  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 or ACBB stock and the benefits of 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. Management believes no impairment charge is necessary related to the FHLB or ACBB restricted stock as of December 31, 2017. 



Financial Derivatives – The Corporation may use interest rate swaps to manage interest rate risk associated with variable-rate funding sources.  All such derivatives are recognized on the balance sheet at estimated fair value in other assets or liabilities as appropriate.  To the extent the derivatives are effective and meet the requirements for hedge accounting, changes in fair value are recognized in other comprehensive income with income statement reclassification occurring as the hedged item affects earnings.  Conversely, changes in fair value attributable to ineffectiveness or to derivatives that do not qualify as hedges are recognized as they occur in the income statement’s interest expense account associated with the hedged item.



Interest rate derivative financial instruments receive hedge accounting treatment only if they are designated as a hedge and are expected to be, and are, effective in substantially reducing interest rate risk arising from the assets and liabilities identified as exposing the Corporation to risk.  Those derivative financial instruments that do not meet the hedging criteria discussed below would be classified as trading activities and would be recorded at fair value with changes in fair value recorded in income.  Derivative hedge contracts must meet specific effectiveness tests (i.e., over time the change in their fair values due to the designated hedge risk must be within 80 to 125 percent of the opposite change in the fair values of the hedged assets or liabilities).  Changes in fair value of the derivative financial instruments must be effective at offsetting changes in the fair value of the hedged items due to the designated hedge risk during the term of the hedge.  Further, if the underlying financial instrument differs from the hedged asset or liability, there must be a clear economic relationship between the prices of the two financial instruments.  If periodic assessments indicate derivatives no longer provide an effective hedge, the derivatives contracts would be closed out and settled or classified as a trading activity.



Cash flows resulting from the derivative financial instruments that are accounted for as hedges of assets and liabilities are classified in the cash flow statement in the same category as the cash flows of the items being hedged.



Loans – Loans, that Management has the intent and ability to hold for the foreseeable future or until maturity or payoff, are stated at the outstanding unpaid principal balances, net of any deferred fees.  Interest income is accrued on the unpaid principal balance.  Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (interest income) of the related loans using the interest method.  The Corporation is amortizing these amounts over the contractual life of the loan.



The accrual of interest is generally discontinued when the contractual payment of principal or interest has become 90 days past due or Management has serious doubts about further collectability of principal or interest, even though the loan is currently performing.  A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured.  When a loan is placed on nonaccrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in a prior year is charged against the allowance for loan losses.  Payments received on nonaccrual loans are applied initially against principal, then interest income, late charges and any other expenses and fees.  Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectability of the total contractual principal and interest is no longer in doubt.  Consumer loans are typically charged off no later than 180 days past due.  Past due status is based on contractual terms of the loans.



Loans Held for Sale – Mortgage loans originated and intended for sale in the secondary market at the time of origination are carried at the lower of cost or estimated fair value (determined on an aggregate basis).  All sales are made without recourse.  Loans held for sale at December 31, 2017 represent loans originated through a third-party brokerage agreement for a fee and present no price risk to the Bank.



Loan Servicing – Servicing assets are recognized as separate assets when rights are acquired through sale of financial assets.  A portion of the cost of originating the loan is allocated to the servicing right based on relative fair value.  Fair value is based on a valuation model that calculates the present value of estimated future net servicing income.  The valuation model incorporates

50


 

 

assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, prepayment speeds, default rates and losses.  Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the periods of, the estimated future net servicing income of the underlying financial assets.  Servicing rights are evaluated for impairment based upon the fair value of the rights as compared to amortized cost.  For the purpose of computing impairment, mortgage servicing rights are stratified based on risk characteristics of the underlying loans that are expected to have the most impact on projected prepayments including loan type, interest rate and term.  Impairment is recognized through a valuation allowance to the extent that fair value is less than the capitalized amount.  If the Corporation later determines that all or a portion of the impairment no longer exists, a reduction of the allowance may be recorded as an increase to income.  Servicing fee income is recorded for fees earned for servicing loans.  The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned.  The amortization of mortgage servicing rights is netted against loan servicing fee income.  Loans serviced by the Bank for the benefit of others totaled $12.6 million, $15.8 million and $21.6 million at December 31, 2017, 2016 and 2015, respectively.



Allowance for Loan Losses – The allowance for loan losses is established through provisions for loan losses charged against income.  Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance.



The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated.  Management’s periodic evaluation of the adequacy of the allowance is based on the Bank’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions,  diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, borrowers’ actual or perceived financial and managerial strengths, and other relevant factors. This evaluation is inherently subjective, as it requires 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.



A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by Management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured on a loan by loan basis for commercial and commercial real estate loans by one of the following methods: the fair value of the collateral if the loan is collateral dependent,  the present value of expected future cash flows discounted at the loan’s effective interest rate or the loan’s obtainable market price.



The Corporation’s allowance for possible loan losses consists of three elements: (1) specific valuation allowances established for probable losses on specific loans, (2) historical valuation allowances calculated based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary to reflect the impact general economic conditions and other qualitative risk factors both internal and external to the Corporation and (3) an unallocated component. An unallocated component is maintained to cover uncertainties that could affect Management’s estimate of probable loss.  The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.



Large groups of smaller balance homogeneous loans are collectively evaluated for impairment using historical charge-offs as the starting point in estimating loss.  Accordingly, the Corporation may not separately identify individual consumer and residential loans for impairment disclosures.



Premises and Equipment – Premises and equipment are stated at cost less accumulated depreciation and amortization.  Depreciation is computed using the straight-line method over the estimated useful lives of the related assets or the lease term for lease hold improvements, whichever is shorter.  When assets are retired or sold, the asset cost and related accumulated depreciation are eliminated from the respective accounts, and any resultant gain or loss is included in net income.



The cost of maintenance and repairs is charged to operating expense as incurred, and the cost of major additions and improvements is capitalized.



Intangible Assets – The Bank has $9.0 million of goodwill recorded on its balance sheet as the result of corporate acquisitions.  Goodwill is not amortized, nor deductible for tax purposes.   However, goodwill is tested for impairment at least annually, as of August 31, in accordance with ASC Topic 350. ASC Topic 350 allows for a qualitative assessment method that requires the use of significant assumptions in order to make a determination of impairment which the Corporation used as of August 31, 2017. These assumptions may include, but are not limited to: macroeconomic factors, banking industry conditions, banking merger and acquisition trends, the Bank’s historical financial performance, the Corporation’s stock price, forecast Bank financial performance, and change of

51


 

 

control premiums. ASC Topic 350 requires the use of the “step-one” test if the qualitative assessment is not used. The step-one test is more quantitative than the qualitative test, but still requires numerous assumptions. The assumptions that may be used in the step-one test may include, but are not limited to: a dividend analysis, comparable sale transactions, and change of control premium estimates. If the step-one test fails, a more comprehensive step-two test is performed before a final determination of impairment is made. If goodwill is determined to be impaired, an impairment write-down is charged to results of operations in the period in which the impairment is determined.    



Bank Owned Life Insurance – The Bank invests in bank owned life insurance (BOLI) as a source of funding for employee benefit expenses.  The Bank purchases life insurance coverage on the lives of a select group of employees.  The Bank is the owner and beneficiary of the policies and records the investment at the cash surrender value of the underlying policies.  Income from the increase in cash surrender value of the policies is included in noninterest income.



Other Real Estate Owned (OREO) – Foreclosed real estate (OREO) is comprised of property acquired through a foreclosure proceeding or an acceptance of a deed in lieu of foreclosure.  Balances are initially reflected at the estimated fair value less any estimated disposition costs, with subsequent adjustments made to reflect further declines in value.  Any losses realized upon disposition of the property, and holding costs prior thereto, are charged against income. All properties are actively marketed to potential buyers.



Transfers of Financial Assets – Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered.  Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Corporation, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Corporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.



Federal Income Taxes – Deferred income taxes are provided on the liability method whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences.  Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases.  Deferred tax assets are reduced by a valuation allowance, when in the opinion of Management, it is more likely than not that some portion or all deferred tax assets will not be realized.  Deferred tax assets and liabilities are adjusted through the provision for income taxes for the effects of changes in tax laws and rates on the date of enactment. ASC Topic 740   prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Benefits from tax positions should be recognized in the financial statements only when it is more-likely-than-not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. ASC Topic 740, “Income Taxes” also provides guidance on the accounting for and disclosure of unrecognized tax benefits, interest and penalties.



Advertising Expenses – Advertising costs are expensed as incurred.



Treasury Stock – The acquisition of treasury stock is recorded under the cost method.  The subsequent disposition or sale of the treasury stock is recorded using the average cost method.



Investment and Trust Services – Assets held in a fiduciary capacity are not assets of the Corporation and therefore are not included in the consolidated financial statements.  The fair value of trust assets under management at December 31, 2017  was $686.9 million and $622.6 million at the prior year-end.  We expect that certain revenue from investment and trust services will be effected by the adoption of ASU 2014,-09 Revenue from Contracts with Customers in 2018.  See the section on Recent Accounting Pronouncements.



Off-Balance Sheet Financial Instruments – In the ordinary course of business, the Bank has entered into off-balance sheet financial instruments consisting of commitments to extend credit and letters of credit. Such financial instruments are recorded on the balance sheet when they are funded.  The amount of any liability for the credit risk associated with off-balance sheet financial instruments is recorded in other liabilities and was not material to the financial position of the Corporation at December 31, 2017 or 2016.



Stock-Based Compensation – The Corporation accounts for stock based compensation in accordance with the ASC Topic 718, “Stock Compensation.”  ASC Topic 718 requires compensation costs related to share-based payment transactions to be recognized in the financial statements (with limited exceptions).  The amount of compensation cost is measured based on the grant-date fair value of the equity or liability instruments issued and forfeitures are accounted for as they occur.  Compensation cost is recognized over the period that an employee provides services in exchange for the award.  Compensation expense was $161 thousand in 2017 and

52


 

 

$88 thousand in 2016 and $74 thousand in 2015.  The Corporation does not allow the employee to use shares to satisfy employer income tax withholding obligations.



Pension – The provision for pension expense was actuarially determined using the projected unit credit actuarial cost method.  The funding policy is to contribute an amount sufficient to meet the requirements of ERISA, subject to Internal Revenue Code contribution limitations.



In accordance with ASC Topic 715, Compensation – Retirement Benefits”, the Corporation recognizes the plan’s over-funded or under-funded status as an asset or liability with an offsetting adjustment to Accumulated Other Comprehensive Income (AOCI).  ASC Topic 715 requires the determination of the fair value of a plan’s assets at the company’s year-end and the recognition of actuarial gains and losses, prior service costs or credits, transition assets or obligations as a component of AOCI.  These amounts were previously netted against the plan’s funded status in the Corporation’s consolidated Balance Sheet. These amounts will be subsequently recognized as components of net periodic benefit costs.  Further, actuarial gains and losses that arise in subsequent periods that are not initially recognized as a component of net periodic benefit costs will be recognized as a component of AOCI.  Those amounts will subsequently be recorded as component of net periodic benefit costs as they are amortized during future periods. 



Earnings per share – Earnings per share are computed based on the weighted average number of shares outstanding during each year.  The Corporation’s basic earnings per share are calculated as net income divided by the weighted average number of shares outstanding.  For diluted earnings per share, net income is divided by the weighted average number of shares outstanding plus the incremental number of shares added as a result of converting common stock equivalents, calculated using the treasury stock method.  The Corporation’s common stock equivalents consist of stock options.



A reconciliation of the weighted average shares outstanding used to calculate basic earnings per share and diluted earnings per share follows:





 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

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

 

2017

 

2016

 

2015

Weighted average shares outstanding (basic)

 

 

4,337 

 

 

4,297 

 

 

4,244 

Impact of common stock equivalents

 

 

22 

 

 

 

 

Weighted average shares outstanding (diluted)

 

 

4,359 

 

 

4,302 

 

 

4,250 

Anti-dilutive options excluded from calculation

 

 

 —

 

 

 

 

27 

Net income

 

$

2,176 

 

$

8,087 

 

$

10,204 

Basic earnings per share

 

$

0.50 

 

$

1.88 

 

$

2.40 

Diluted earnings per share

 

$

0.50 

 

$

1.88 

 

$

2.40 

 



 Segment Reporting – The Bank acts as an independent community financial services provider and offers traditional banking and related financial services to individual, business and government customers.  Through its community office and electronic banking applications, the Bank offers a full array of commercial and retail financial services, including the taking of time, savings and demand deposits; the making of commercial, consumer and mortgage loans; and the providing of safe deposit services.  The Bank also performs personal, corporate, pension and fiduciary services through its Investment and Trust Services Department. 



Management does not separately allocate expenses, including the cost of funding loan demand, between the commercial, retail, mortgage banking and trust operations of the Bank.  As such, discrete information is not available and segment reporting would not be meaningful.



Comprehensive Income – Comprehensive income is reflected in the Consolidated Statements of Comprehensive Income and includes net income and unrealized gains or losses, net of tax, on investment securities and derivatives and the change in plan assets and benefit obligations on the Bank’s pension plan, net of tax.



53


 

 

Recent Accounting Pronouncements:







 

 

 

 

 

 

Standard

 

Description

 

Effective Date

 

Effect on the financial statements or other significant matters



 

 

 

 

 

 

ASU 2016-09, Stock Compensation (Topic 718): Improvements to Employee Share-based Payment Accounting

 

The standard requires entities to recognize the income tax effects of share-based awards in the income statement when the awards vest or are settled (i.e. the additional paid-in capital pools will be eliminated).  The guidance on employers' accounting for an employee's use of shares to satisfy the employer's statutory income tax withholding obligation and for forfeitures is changing.  The standard also provides an entity the option to make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures when they occur.

 

January 1, 2017

 

We adopted the standard during the first quarter of 2017.  Due to the type of stock compensation plans used by the Corporation, there was no effect on the Corporation's consolidated financial statements.



 

 

 

 

 

 

ASU 2017-09,  Premium Amortization on Purchased Callable Debt Securities

 

The standard shortens the amortization period for premiums on purchased callable debt securities to the earliest call date, rather than amortizing over the full contractual term.  The standard does change the standard for securities held at a discount.  The amendments require companies to reset the effective yield using the payment terms of the debt security if the call option is not exercised on the earliest call date.  If the security has additional future called dates, any excess of the amortized cost basis over the amount repayable by the issuer at the next call date should be amortized to the next call date.

 

January 1, 2017

 

We adopted the standard during the first quarter of 2017, and there was no material effect on the Corporation's consolidated financial statements.



 

 

 

 

 

 

ASU 2018-02, Income Statement (Topic 220), Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income

 

Under ASU 2018-02, entities are allowed, but not required, to reclassify from Accumulated Other Comprehensive Income (AOCI) to retained earnings stranded tax effects resulting from the new federal corporate income tax rate of the Tax Cuts and Jobs Act (the Act).  The reclassification could include other stranded tax effects that related to the Act but do not directly related to the change in the federal rate.  Tax effects that are stranded in AOCI for other reasons may not be reclassified.  Entities also will have an option to adopt the standard retrospectively or in the period of adoption. 

 

January 1, 2018

 

The Corporation adopted the provisions of the ASU in the fourth quarter of 2017.  The Company reclassified the disproportionate tax effect resulting from the Act by increasing retained earnings by $992 thousand and reducing AOCI by $992 thousand.



 

 

 

 

 

 

ASU 2016-15, Statements of Cash Flow (Topic 320): Classification of Certain Cash Receipts and Cash Payments

 

The standard clarifies how certain cash receipts and cash payments are presented and classified in the statement of cash flows.  The amendments are intended to reduce diversity in practice.  The standard contains additional guidance clarifying when an entity should separate cash receipts and cash payments and classifies them into more than one class of cash flows (including when reasonable judgement is required to estimate and allocate cash flows) versus when an entity should classify the aggregate amount into one class of cash flows on the basis of predominance.

 

January 1, 2018

 

The Corporation determined this guidance will not have an effect on the consolidated financial statements.



 

 

 

 

 

 

ASU 2017-07, Employee Benefits Plan (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost

 

This standard requires an employer to report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period.  The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations.  The amendments in this update also allow only the service cost component to be eligible for capitalization when applicable.  

 

January 1, 2018

 

These items are currently reported in Salaries and Benefits Expense on the Consolidated Statement of Income.  With the adoption of the ASU in January 2018, the service cost will be reported in Salaries and Benefits expense and the nonservice cost will be included in Other Expense on the Consolidated Statement of Income statement and there will be no effect on the Corporation's consolidated financial statements.



 

 

 

 

 

 

54


 

 

ASU 2014-09, Revenue from Contracts with Customers (Topic 606)

 

The amendments in this Update (ASU 2014-09) establish a comprehensive revenue recognition standard. 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. Three basic transition methods are available – full retrospective, retrospective with certain practical expedients, and a cumulative effect approach.

 

January 1, 2018

 

The majority of our revenue comes from net interest income, and is explicitly out of scope of the guidance.  The contracts in noninterest income that are in scope of the guidance are primarily related to service charges and fees on deposit accounts, investment and trust income and other service charges and fees.  We are completing the analysis of the contracts in scope and currently do not expect the adoption of the guidance to have a material effect on the Corporation's financial condition and results of operations.  In addition, we are evaluating certain revenue streams for principal versus agent treatment of the related revenue (i.e., reporting revenue on a gross basis or net of related expenses).  The Corporation adopted this ASU on January 1, 2018, on a modified retrospective approach.



 

 

 

 

 

 

ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities

 

The standard amends the guidance on the classification and measurement of financial instruments.  Some of the amendments include the following: 1) requires equity investments 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.

 

January 1, 2018

 

The adoption of the guidance will not have a material effect on the Corporation's consolidated financial statements.  We currently do not have a significant number of Available For Sale equity securities that are subject to the new standard.  Additionally we do not have financial liabilities accounted for under the fair value option.  The Corporation has not yet determined how to calculate an exit price for the fair value of financial instruments.



 

 

 

 

 

 

ASU 2016-02, Leases (Topic 842)

 

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.

 

January 1, 2019

 

The Corporation currently has real estate and equipment leases that it classifies as operating leases that are not recognized on the balance sheet.  Under the new standard, these leases will move onto the balance sheet in the form of a lease liability (the present value of a lessee's obligation to make lease payments) and a right-of-use asset (an asset that represents the lessee's right to use a specified asset for the lease term).  The offsetting transactions will gross-up the Consolidated Balance Sheet, but the Corporation has not yet determined this amount.The Corporation has acquired a lease accounting model to implement the standard.  The model has been installed and will be used in a test mode during 2018, but the Corporation does not plan to early adopt the standard. The Corporation currently expects that the new standard will not have a material effect on its consolidated results of operations.



 

 

 

 

 

 

55


 

 

ASU 2017-04, Goodwill (Topic 350)

 

This guidance, among other things, removes step 2 of the goodwill impairment test thus eliminating the need to determine the fair value of individual assets and liabilities of the reporting unit.  Upon adoption of this standard, goodwill impairment will be the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of goodwill.  This may result in more or less impairment being recognized than under the current guidance.

 

January 1, 2020

 

We do not currently expect this guidance to have a material effect on the Corporation's consolidated financial statements based upon the most recent goodwill impairment analysis.



 

 

 

 

 

 

ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments

 

This standard 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.

 

January 1, 2020

 

We have formed an implementation team led by the Corporation's Risk Management function. The team is reviewing the requirements of the ASU and evaluating methods and models for implementation.  The new standard will result in earlier recognition of additions to the allowance for loan losses and possibly a larger allowance for loan loss balance with a corresponding increase in the provision for loan losses in results of operations; however, the Corporation is continuing to evaluate the impact of the pending adoption of the new standard on its consolidated financial statements.  The Corporation expects to have its methodology and process complete by the end of 2018 so that it can run the new CECL model during 2019 in test mode, prior to the 2020 implementation.





Note 2.  Regulatory Matters



The Bank is limited as to the amount it may lend to the Corporation, unless such loans are collateralized by specific obligations. State regulations also limit the amount of dividends the Bank can pay to the Corporation and are generally limited to the Bank’s accumulated net earnings, which were $92.3 million at December 31, 2017.  In addition, dividends paid by the Bank to the Corporation would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below applicable minimum capital requirements.  The Corporation and the Bank are subject to various regulatory capital requirements administered by federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Corporation’s financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.  The capital amounts and classification are also subject to qualitative judgements by the regulators about components, risk weightings, and other factors.



Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined).  Although not adopted in regulation form, the Pennsylvania Department of Banking utilizes capital standards requiring a minimum leverage capital ratio of 6% and a risk-based capital ratio of 10%, defined substantially the same as those by the FDIC.  Management believes, as of December 31, 2017, that the Corporation and the Bank met all capital adequacy requirements to which it is subject.    



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 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 is phased-in beginning in at 0.625% for 2016, 1.25% for 2017, 1.875% for 2018 and 2.50% for 2019 and thereafter. The capital conservation buffer is applicable to all of the capital ratios except for the Tier 1 Leverage ratio. The capital conservation buffer is equal to the lowest value of the three applicable capital ratios less the regulatory minimum for each respective capital measurement.   The Bank’s capital conservation buffer at December 31, 2017 was 7.19% (total risk-based capital 15.19% less 8.00%) compared to the 2017 regulatory buffer of 1.25%. Compliance with the capital conservation buffer is required in order to avoid limiting certain capital distributions.  As of December 31, 2017, 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. 

56


 

 



The following table presents the regulatory capital ratio requirements for the Corporation and the Bank. 





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

As of December 31, 2017



 

 

 

 

 

 

Regulatory Ratios



 

 

 

 

 

 

Adequately Capitalized

 

Well Capitalized



 

Actual

 

Minimum

 

Minimum

(Dollars in thousands)

 

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporation

 

$

112,315 

 

14.06% 

 

$

35,953 

 

4.50% 

 

 

N/A

 

N/A

Bank

 

 

111,496 

 

13.93% 

 

 

36,010 

 

4.50% 

 

$

52,014 

 

6.50% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier 1 Risk-based Capital Ratio (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporation

 

$

112,315 

 

14.06% 

 

$

47,938 

 

6.00% 

 

 

N/A

 

N/A

Bank

 

 

111,496 

 

13.93% 

 

 

48,013 

 

6.00% 

 

$

64,018 

 

8.00% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Risk-based Capital Ratio (3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporation

 

$

122,324 

 

15.31% 

 

$

63,917 

 

8.00% 

 

 

N/A

 

N/A

Bank

 

 

121,521 

 

15.19% 

 

 

64,018 

 

8.00% 

 

$

80,022 

 

10.00% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier 1 Leverage Ratio (4)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporation

 

$

112,315 

 

9.73% 

 

$

46,175 

 

4.00% 

 

 

N/A

 

N/A

Bank

 

 

111,496 

 

9.64% 

 

 

46,242 

 

4.00% 

 

$

57,802 

 

5.00% 

 





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

As of December 31, 2016



 

 

 

 

 

 

Regulatory Ratios



 

 

 

 

 

 

Adequately Capitalized

 

Well Capitalized



 

Actual

 

Minimum

 

Minimum

(Dollars in thousands)

 

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporation

 

$

111,691 

 

14.41% 

 

$

34,889 

 

4.50% 

 

 

N/A

 

N/A

Bank

 

 

110,932 

 

14.29% 

 

 

34,943 

 

4.50% 

 

$

50,473 

 

6.50% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier 1 Risk-based Capital Ratio (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporation

 

$

111,691 

 

14.41% 

 

$

46,518 

 

6.00% 

 

 

N/A

 

N/A

Bank

 

 

110,932 

 

14.29% 

 

 

46,590 

 

6.00% 

 

$

62,121 

 

8.00% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Risk-based Capital Ratio (3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporation

 

$

121,456 

 

15.67% 

 

$

62,024 

 

8.00% 

 

 

N/A

 

N/A

Bank

 

 

120,712 

 

15.55% 

 

 

62,121 

 

8.00% 

 

$

77,651 

 

10.00% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier 1 Leverage Ratio (4)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporation

 

$

111,691 

 

10.11% 

 

$

44,209 

 

4.00% 

 

 

N/A

 

N/A

Bank

 

 

110,932 

 

10.02% 

 

 

44,270 

 

4.00% 

 

$

55,337 

 

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

 



Note 3. Restricted Cash Balances



The Bank is required to maintain reserves against its deposit liabilities in the form of vault cash and/or balances with the Federal Reserve Bank.  Deposit reserves that the Bank was required to hold were approximately $7.1 million and $6.4 million at December 31, 2017 and 2016, respectively and were satisfied by the Bank’s vault cash.

 

57


 

 

Note 4. Investments



The investment portfolio serves as a mechanism to invest funds if funding sources out pace lending activity, to provide liquidity for lending and operations, and provide collateral for deposits and borrowings. The mix of securities and investing decisions are made as a component of balance sheet management. Debt securities include U.S. Government Agencies, U.S. Government Agency mortgage-backed securities, non-agency mortgage-backed securities, state and municipal government bonds, and trust preferred securities.  The equity portfolio consists of one community bank stock.  The average life of the portfolio is 3.5 years and $84.1 million (fair value) is pledged as collateral for deposits. The Bank has no investments in a single issuer that exceeds 10% of shareholders equity.  All securities are classified as available for sale and all investment balances refer to fair value, unless noted otherwise.



The amortized cost and estimated fair value of investment securities available for sale as of December 31, 2017 and 2016 is as follows:





 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

December 31, 2017

 

cost

 

gains

 

losses

 

value

Equity securities

 

$

164 

 

$

201 

 

$

 —

 

$

365 

U.S. Government and Agency securities

 

 

11,451 

 

 

64 

 

 

(43)

 

 

11,472 

Municipal securities

 

 

57,374 

 

 

650 

 

 

(252)

 

 

57,772 

Trust preferred securities

 

 

6,000 

 

 

 —

 

 

(183)

 

 

5,817 

Agency mortgage-backed securities

 

 

51,307 

 

 

197 

 

 

(567)

 

 

50,937 

Private-label mortgage-backed securities

 

 

858 

 

 

88 

 

 

 —

 

 

946 

Asset-backed securities

 

 

28 

 

 

 —

 

 

(1)

 

 

27 

Total

 

$

127,182 

 

$

1,200 

 

$

(1,046)

 

$

127,336 







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

December 31, 2016

 

cost

 

gains

 

losses

 

value

Equity securities

 

$

164 

 

$

126 

 

$

 —

 

$

290 

U.S. Government and Agency securities

 

 

12,598 

 

 

148 

 

 

(26)

 

 

12,720 

Municipal securities

 

 

62,763 

 

 

793 

 

 

(571)

 

 

62,985 

Trust preferred securities

 

 

5,979 

 

 

 —

 

 

(518)

 

 

5,461 

Agency mortgage-backed securities

 

 

61,305 

 

 

431 

 

 

(452)

 

 

61,284 

Private-label mortgage-backed securities

 

 

1,053 

 

 

56 

 

 

(5)

 

 

1,104 

Asset-backed securities

 

 

33 

 

 

 —

 

 

(2)

 

 

31 

Total

 

$

143,895 

 

$

1,554 

 

$

(1,574)

 

$

143,875 

 



At December 31, 2017 and 2016, the fair value of investment securities pledged to secure public fund and trust deposit totaled $84.1 million and $79.1 million, respectively.



The amortized cost and estimated fair value of debt securities at December 31, 2017, 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

 

 

 

 

$

19 

 

$

19 

Due after one year through five years

 

 

 

 

 

13,784 

 

 

13,920 

Due after five years through ten years

 

 

 

 

 

33,748 

 

 

33,770 

Due after ten years

 

 

 

 

 

27,302 

 

 

27,379 



 

 

 

 

 

74,853 

 

 

75,088 

Mortgage-backed securities

 

 

 

 

 

52,165 

 

 

51,883 

Total

 

 

 

 

$

127,018 

 

$

126,971 



58


 

 

The composition of the net realized securities gains for the years ended December 31 is as follows:







 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

2017

 

2016

 

2015

Gross gains realized (including gain on conversion)

 

$

 

$

22 

 

$

736 

Gross losses realized

 

 

 —

 

 

 —

 

 

 —

Net gains realized

 

$

 

$

22 

 

$

736 

 



The 2017 and 2016 gains were generated from calls on bonds.  A gain on conversion of an investment security of $728 thousand was recorded in 2015 when one bank equity stock owned by the Bank was acquired by another bank. The remaining security gains were generated by the sale of equity securities.



Impairment:



The following table reflects the temporary impairment in the investment portfolio, 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 December 31, 2017 and 2016.



The condition of the portfolio at year-end 2017, as measured by the dollar amount of temporarily impaired securities is better since year-end 2016. The Agency Mortgage-backed sector recorded the largest unrealized loss and the greatest number of securities with an unrealized loss.



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 December 31, 2017, was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted.  The following tables present the temporary impairment in the security portfolio for the years presented:







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



December 31, 2017



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

$

2,315 

 

$

(11)

 

 

$

3,528 

 

$

(32)

 

10 

 

$

5,843 

 

$

(43)

 

15 

Municipal securities

 

13,767 

 

 

(89)

 

22 

 

 

7,507 

 

 

(163)

 

14 

 

 

21,274 

 

 

(252)

 

36 

Trust preferred securities

 

1,216 

 

 

(12)

 

 

 

4,601 

 

 

(171)

 

 

 

5,817 

 

 

(183)

 

Agency mortgage-backed securities

 

16,287 

 

 

(129)

 

29 

 

 

20,563 

 

 

(438)

 

39 

 

 

36,850 

 

 

(567)

 

68 

Private-label mortgage-backed securities

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 —

Asset-backed securities

 

 —

 

 

 —

 

 —

 

 

 

 

(1)

 

 

 

 

 

(1)

 

Total temporarily impaired securities

$

33,585 

 

$

(241)

 

58 

 

$

36,203 

 

$

(805)

 

69 

 

$

69,788 

 

$

(1,046)

 

127 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



December 31, 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

$

789 

 

$

(9)

 

 

$

3,413 

 

$

(17)

 

10 

 

$

4,202 

 

$

(26)

 

11 

Municipal securities

 

23,407 

 

 

(417)

 

43 

 

 

1,598 

 

 

(154)

 

 

 

25,005 

 

 

(571)

 

45 

Trust preferred securities

 

 —

 

 

 —

 

 —

 

 

5,461 

 

 

(518)

 

 

 

5,461 

 

 

(518)

 

Agency mortgage-backed securities

 

26,995 

 

 

(359)

 

39 

 

 

4,656 

 

 

(93)

 

11 

 

 

31,651 

 

 

(452)

 

50 

Private-label mortgage-backed securities

 

281 

 

 

(5)

 

 

 

 —

 

 

 —

 

 —

 

 

281 

 

 

(5)

 

Asset-backed securities

 

 —

 

 

 —

 

 —

 

 

 

 

(2)

 

 

 

 

 

(2)

 

Total temporarily impaired securities

$

51,472 

 

$

(790)

 

84 

 

$

15,132 

 

$

(784)

 

31 

 

$

66,604 

 

$

(1,574)

 

115 

 



59


 

 

The following table represents the cumulative credit losses on debt securities recognized in earnings as of December 31:   





 

 

 

 

 

 



 

 

 

 

 

 

(Dollars in thousands)

 

Twelve Months Ended



 

2017

 

2016

Balance of cumulative credit-related OTTI at January 1

 

$

595 

 

$

555 

Additions for credit-related OTTI not previously recognized

 

 

 —

 

 

40 

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 December 31

 

$

595 

 

$

595 

 



The Bank held $456 thousand of restricted stock at the end of 2017 of which $426 thousand is stock in the Federal Home Loan Bank of Pittsburgh (FHLB). FHLB stock is carried at a cost of $100 per share. 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 it 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. If FHLB stock were deemed to be impaired, the write-down for the Bank could be significant. Management intends to remain a member of the FHLB and believes that it will be able to fully recover the cost basis of this investment.

 

Note 5. Loans



The Bank reports its loan portfolio based on the primary collateral of the loan. It further classifies these loans by the primary purpose, either consumer or commercial. The Bank’s mortgage loans include long-term loans to individuals and businesses secured by mortgages on the borrower’s real property.  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 loans are made to businesses of various sizes for a variety of purposes including construction, property, plant and equipment, and working capital.  Commercial loans also include 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, home equity and unsecured personal lines of credit. 



60


 

 

A summary of loans outstanding, by primary collateral, at December 31 is as follows:







 

 

 

 

 

 



 

 

 

 

 

 



 

 

 

 

(Dollars in thousands)

 

2017

 

2016

Residential Real Estate 1-4 Family

 

 

 

 

 

 

Consumer first liens

 

$

97,159 

 

$

103,125 

Commercial first lien

 

 

61,275 

 

 

65,445 

Total first liens

 

 

158,434 

 

 

168,570 



 

 

 

 

 

 

Consumer junior liens and lines of credit

 

 

45,043 

 

 

44,817 

Commercial junior liens and lines of credit

 

 

5,328 

 

 

5,396 

Total junior liens and lines of credit

 

 

50,371 

 

 

50,213 

Total residential real estate 1-4 family

 

 

208,805 

 

 

218,783 



 

 

 

 

 

 

Residential real estate - construction

 

 

 

 

 

 

Consumer

 

 

1,813 

 

 

1,350 

Commercial

 

 

8,088 

 

 

7,625 

Total residential real estate construction

 

 

9,901 

 

 

8,975 



 

 

 

 

 

 

Commercial real estate

 

 

428,428 

 

 

390,584 

Commercial

 

 

291,519 

 

 

270,826 

Total commercial

 

 

719,947 

 

 

661,410 



 

 

 

 

 

 

Consumer

 

 

5,047 

 

 

4,705 



 

 

943,700 

 

 

893,873 

Less: Allowance for loan losses

 

 

(11,792)

 

 

(11,075)

Net Loans

 

$

931,908 

 

$

882,798 



 

 

 

 

 

 

Included in the loan balances are the following:

 

 

 

 

 

 

Net unamortized deferred loan costs

 

$

98 

 

$

242 



 

 

 

 

 

 

Loans pledged as collateral for borrowings and commitments from:

 

 

 

 

 

 

FHLB

 

$

737,313 

 

$

711,682 

Federal Reserve Bank

 

 

35,740 

 

 

41,152 

Total

 

$

773,053 

 

$

752,834 



Loans to directors and executive officers and related interests and affiliated enterprises were as follows:







 

 

 

 

 

 

(Dollars in thousands)

 

2017

 

2016

Balance at beginning of year

 

$

23,243 

 

$

18,954 

New loans made

 

 

1,513 

 

 

6,400 

Repayments

 

 

(2,633)

 

 

(2,111)

Balance at end of year

 

$

22,123 

 

$

23,243 

 



Note 6. 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 - Substandard. The following represents 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.



61


 

 

The following table reports on the risk rating for those loans in the portfolio that are assigned an individual risk rating as of December 31, 2017 and 2016:    







 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



Pass

 

Special Mention

 

Substandard

 

Doubtful

 

 

 

(Dollars in thousands)

(1-5)

 

(6)

 

(7)

 

(8)

 

Total

December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

$

157,395 

 

$

 —

 

$

1,039 

 

$

 —

 

$

158,434 

Junior liens and lines of credit

 

50,371 

 

 

 —

 

 

 —

 

 

 —

 

 

50,371 

Total

 

207,766 

 

 

 —

 

 

1,039 

 

 

 —

 

 

208,805 

Residential real estate - construction

 

8,893 

 

 

 —

 

 

1,008 

 

 

 —

 

 

9,901 

Commercial real estate

 

419,277 

 

 

680 

 

 

8,471 

 

 

 —

 

 

428,428 

Commercial

 

289,916 

 

 

 —

 

 

1,603 

 

 

 —

 

 

291,519 

Consumer

 

5,047 

 

 

 —

 

 

 —

 

 

 —

 

 

5,047 

Total

$

930,899 

 

$

680 

 

$

12,121 

 

$

 —

 

$

943,700 







 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

$

167,199 

 

$

227 

 

$

1,144 

 

$

 —

 

$

168,570 

Junior liens and lines of credit

 

50,017 

 

 

28 

 

 

168 

 

 

 —

 

 

50,213 

Total

 

217,216 

 

 

255 

 

 

1,312 

 

 

 —

 

 

218,783 

Residential real estate - construction

 

8,220 

 

 

 —

 

 

755 

 

 

 —

 

 

8,975 

Commercial real estate

 

377,283 

 

 

 —

 

 

13,301 

 

 

 —

 

 

390,584 

Commercial

 

267,901 

 

 

957 

 

 

1,968 

 

 

 —

 

 

270,826 

Consumer

 

4,705 

 

 

 —

 

 

 —

 

 

 —

 

 

4,705 

Total

$

875,325 

 

$

1,212 

 

$

17,336 

 

$

 —

 

$

893,873 



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. 

62


 

 

The following table presents the aging of payments in the loan portfolio as of December 31, 2017 and 2016:  







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Loans Past Due and Still Accruing

 

 

 

 

Total



 

Current

 

30-59 Days

 

60-89 Days

 

90 Days+

 

Total

 

Non-Accrual

 

Loans

December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

157,247 

 

$

485 

 

$

534 

 

$

 —

 

$

1,019 

 

$

168 

 

$

158,434 

Junior liens and lines of credit

 

 

50,202 

 

 

139 

 

 

30 

 

 

 —

 

 

169 

 

 

 —

 

 

50,371 

Total

 

 

207,449 

 

 

624 

 

 

564 

 

 

 —

 

 

1,188 

 

 

168 

 

 

208,805 

Residential real estate - construction

 

 

9,435 

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

466 

 

 

9,901 

Commercial real estate

 

 

425,806 

 

 

421 

 

 

347 

 

 

 —

 

 

768 

 

 

1,854 

 

 

428,428 

Commercial

 

 

291,221 

 

 

111 

 

 

 —

 

 

 —

 

 

111 

 

 

187 

 

 

291,519 

Consumer

 

 

5,017 

 

 

23 

 

 

 

 

 —

 

 

30 

 

 

 —

 

 

5,047 

Total

 

$

938,928 

 

$

1,179 

 

$

918 

 

$

 —

 

$

2,097 

 

$

2,675 

 

$

943,700 









 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

166,689 

 

$

1,236 

 

$

414 

 

$

 —

 

$

1,650 

 

$

231 

 

$

168,570 

Junior liens and lines of credit

 

 

50,031 

 

 

96 

 

 

 —

 

 

 —

 

 

96 

 

 

86 

 

 

50,213 

Total

 

 

216,720 

 

 

1,332 

 

 

414 

 

 

 —

 

 

1,746 

 

 

317 

 

 

218,783 

Residential real estate - construction

 

 

8,495 

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

480 

 

 

8,975 

Commercial real estate

 

 

384,658 

 

 

858 

 

 

447 

 

 

665 

 

 

1,970 

 

 

3,956 

 

 

390,584 

Commercial

 

 

270,478 

 

 

250 

 

 

75 

 

 

 —

 

 

325 

 

 

23 

 

 

270,826 

Consumer

 

 

4,672 

 

 

30 

 

 

 

 

 —

 

 

33 

 

 

 —

 

 

4,705 

Total

 

$

885,023 

 

$

2,470 

 

$

939 

 

$

665 

 

$

4,074 

 

$

4,776 

 

$

893,873 



Impaired 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.    At December 31, 2017, the Bank had $132 thousand of residential properties in the process of foreclosure compared to $123 thousand at the end of 2016.



Interest not recognized on nonaccrual loans was $159 thousand,  $175 thousand and $335 thousand for the years ended December 31, 2017,  2016 and 2015, respectively. In addition to monitoring nonaccrual loans, the Bank also closely monitors impaired loans and troubled debt restructurings.  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, excluding consumer purpose loans, and troubled-debt restructuring (TDR) loans are considered impaired. For impaired loans with balances less than $250 thousand and consumer purpose loans, a specific reserve analysis is not performed and these loans are added to the general allocation pool. These loans totaled $677 thousand at December 31, 2017 and are comprised primarily of loans secured by residential real estate. Management does not believe that excluding these loans from the specific reserve analysis presents any additional risk.  Impaired loans totaled $12.6 million at December 31, 2017 compared to $15.1 million at December 31, 2016The following tables present information on impaired loans:





63


 

 





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Impaired Loans



 

With No Allowance

 

With Allowance

(Dollars in thousands)

 

 

 

 

Unpaid

 

 

 

 

Unpaid

 

 

 



 

Recorded

 

Principal

 

Recorded

 

Principal

 

Related

December 31, 2017

 

Investment

 

Balance

 

Investment

 

Balance

 

Allowance

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

869 

 

$

950 

 

$

 —

 

$

 —

 

$

 —

Junior liens and lines of credit

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Total

 

 

869 

 

 

950 

 

 

 —

 

 

 —

 

 

 —

 Residential real estate - construction

 

 

466 

 

 

531 

 

 

 —

 

 

 —

 

 

 —

 Commercial real estate

 

 

11,061 

 

 

11,541 

 

 

 —

 

 

 —

 

 

 —

 Commercial

 

 

187 

 

 

201 

 

 

 —

 

 

 —

 

 

 —

Total

 

$

12,583 

 

$

13,223 

 

$

 —

 

$

 —

 

$

 —







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

956 

 

$

1,030 

 

$

 —

 

$

 —

 

$

 —

Junior liens and lines of credit

 

 

85 

 

 

93 

 

 

 —

 

 

 —

 

 

 —

Total

 

 

1,041 

 

 

1,123 

 

 

 —

 

 

 —

 

 

 —

 Residential real estate - construction

 

 

480 

 

 

535 

 

 

 —

 

 

 —

 

 

 —

 Commercial real estate

 

 

13,523 

 

 

14,133 

 

 

 

 

 

 —

 

 

 —

 Commercial

 

 

23 

 

 

35 

 

 

 —

 

 

 —

 

 

 —

Total

 

$

15,067 

 

$

15,826 

 

$

 —

 

$

 —

 

$

 —









 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Twelve Months Ended



 

December 31, 2017

 

December 31, 2016

 

December 31, 2015



 

Average

 

Interest

 

Average

 

Interest

 

Average

 

Interest

(Dollars in thousands)

 

Recorded

 

Income

 

Recorded

 

Income

 

Recorded

 

Income



 

Investment

 

Recognized

 

Investment

 

Recognized

 

Investment

 

Recognized

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

1,083 

 

$

39 

 

$

1,194 

 

$

38 

 

$

1,531 

 

$

13 

Junior liens and lines of credit

 

 

64 

 

 

 —

 

 

93 

 

 

 

 

105 

 

 

 —

Total

 

 

1,147 

 

 

39 

 

 

1,287 

 

 

39 

 

 

1,636 

 

 

13 

 Residential real estate - construction

 

 

473 

 

 

 —

 

 

492 

 

 

 

 

505 

 

 

 —

 Commercial real estate

 

 

11,938 

 

 

435 

 

 

17,806 

 

 

589 

 

 

14,509 

 

 

122 

 Commercial

 

 

245 

 

 

 —

 

 

32 

 

 

 —

 

 

278 

 

 

 —

Total

 

$

13,803 

 

$

474 

 

$

19,617 

 

$

632 

 

$

16,928 

 

$

135 



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 interest rate, extending the maturity, reamortization of 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.



64


 

 

The following table presents TDR loans as of December 31, 2017 and 2016:



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

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

December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

$

466 

 

$

466 

 

$

 —

 

 —

 

$

 —

Residential real estate

 

 

 

737 

 

 

701 

 

 

36 

 

 

 

39 

Commercial real estate

 

11 

 

 

10,983 

 

 

10,388 

 

 

595 

 

 

 

595 

  Total

 

17 

 

$

12,186 

 

$

11,555 

 

$

631 

 

 

$

634 









 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

$

480 

 

$

480 

 

$

 —

 

 —

 

$

 —

Residential real estate

 

 

 

875 

 

 

724 

 

 

151 

 

 

 

151 

Commercial real estate

 

11 

 

 

12,064 

 

 

10,814 

 

 

1,250 

 

 

 

1,250 

  Total

 

17 

 

$

13,419 

 

$

12,018 

 

$

1,401 

 

 

$

1,401 



*The performing status is determined by the loans compliance with the modified terms.

 



There were no new TDR loans made during the year ended December 31, 2017.



The following table reports new TDR loans made during 2016, concession granted and the recorded investment as of December 31, 2016:







 

 

 

 

 

 

 

 

 

 

 

 

 



 

New During Period

Twelve Months Ended

 

Number of

 

Pre-TDR

 

After-TDR

 

Recorded

 

 

December 31, 2016

 

Contracts

 

Modification

 

Modification

 

Investment

 

Concession

Commercial real estate

 

 

$

525 

 

$

525 

 

$

513 

 

multiple

Residential real estate

 

 

 

238 

 

 

238 

 

 

237 

 

maturity

  Total

 

 

$

763 

 

$

763 

 

$

750 

 

 



Allowance for Loan Losses:



Management monitors loan performance on a monthly basis and 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. 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 - Special Mention or worse, and obtains a new appraisal or asset valuation for any placed on nonaccrual and 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 December 31, 2017 is adequate.



65


 

 

The following table shows, by loan class, the activity in the Allowance for Loan Loss (ALL), for the years ended December 31, 2017,  2016 and 2015:









 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 



 

First

 

Junior Liens &

 

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

Liens

 

Lines of Credit

 

Construction

 

Real Estate

 

Commercial

 

Consumer

 

Unallocated

 

Total



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at December 31, 2014

 

$

994 

 

$

271 

 

$

214 

 

$

4,978 

 

$

1,515 

 

$

127 

 

$

1,012 

 

$

9,111 

Charge-offs

 

 

(43)

 

 

(39)

 

 

(21)

 

 

 —

 

 

(270)

 

 

(198)

 

 

 —

 

 

(571)

Recoveries

 

 

 

 

 —

 

 

18 

 

 

14 

 

 

148 

 

 

74 

 

 

 —

 

 

261 

Provision

 

 

31 

 

 

76 

 

 

(17)

 

 

657 

 

 

126 

 

 

99 

 

 

313 

 

 

1,285 

ALL at December 31, 2015

 

$

989 

 

$

308 

 

$

194 

 

$

5,649 

 

$

1,519 

 

$

102 

 

$

1,325 

 

$

10,086 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at December 31, 2015

 

$

989 

 

$

308 

 

$

194 

 

$

5,649 

 

$

1,519 

 

$

102 

 

$

1,325 

 

$

10,086 

Charge-offs

 

 

(49)

 

 

 —

 

 

(41)

 

 

(2,751)

 

 

(74)

 

 

(167)

 

 

 —

 

 

(3,082)

Recoveries

 

 

35 

 

 

 —

 

 

 —

 

 

19 

 

 

167 

 

 

75 

 

 

 —

 

 

296 

Provision

 

 

130 

 

 

15 

 

 

71 

 

 

3,192 

 

 

281 

 

 

90 

 

 

(4)

 

 

3,775 

ALL at December 31, 2016

 

$

1,105 

 

$

323 

 

$

224 

 

$

6,109 

 

$

1,893 

 

$

100 

 

$

1,321 

 

$

11,075 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at December 31, 2016

 

$

1,105 

 

$

323 

 

$

224 

 

$

6,109 

 

$

1,893 

 

$

100 

 

$

1,321 

 

$

11,075 

Charge-offs

 

 

(13)

 

 

 —

 

 

 —

 

 

(14)

 

 

(8)

 

 

(102)

 

 

 —

 

 

(137)

Recoveries

 

 

 

 

11 

 

 

 —

 

 

17 

 

 

117 

 

 

37 

 

 

 —

 

 

184 

Provision

 

 

(34)

 

 

(4)

 

 

 —

 

 

414 

 

 

108 

 

 

70 

 

 

116 

 

 

670 

ALL at December 31, 2017

 

$

1,060 

 

$

330 

 

$

224 

 

$

6,526 

 

$

2,110 

 

$

105 

 

$

1,437 

 

$

11,792 



The following table shows, by loan class, the loans that were evaluated for the Allowance for Loan Loss (ALL) under a specific reserve (individually) and those that were evaluated under a general reserve (collectively), and the amount of the allowance established in each category as of December 31, 2017 and 2016







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 



 

First

 

Junior Liens &

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

Liens

 

Lines of Credit

 

Construction

 

Real Estate

 

Commercial

 

Consumer

 

Unallocated

 

Total



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for ALL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

459 

 

$

 —

 

$

466 

 

$

10,981 

 

$

 —

 

$

 —

 

$

 —

 

$

11,906 

Collectively

 

 

157,975 

 

 

50,371 

 

 

9,435 

 

 

417,447 

 

 

291,519 

 

 

5,047 

 

 

 —

 

 

931,794 

Total

 

$

158,434 

 

$

50,371 

 

$

9,901 

 

$

428,428 

 

$

291,519 

 

$

5,047 

 

$

 —

 

$

943,700 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL established for
  loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

Collectively

 

 

1,060 

 

 

330 

 

 

224 

 

 

6,526 

 

 

2,110 

 

 

105 

 

 

1,437 

 

 

11,792 

ALL at December 31, 2017

 

$

1,060 

 

$

330 

 

$

224 

 

$

6,526 

 

$

2,110 

 

$

105 

 

$

1,437 

 

$

11,792 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for ALL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

628 

 

$

52 

 

$

480 

 

$

13,523 

 

$

 —

 

$

 —

 

$

 —

 

$

14,683 

Collectively

 

 

167,942 

 

 

50,161 

 

 

8,495 

 

 

377,061 

 

 

270,826 

 

 

4,705 

 

 

 —

 

 

879,190 

Total

 

$

168,570 

 

$

50,213 

 

$

8,975 

 

$

390,584 

 

$

270,826 

 

$

4,705 

 

$

 —

 

$

893,873 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL established for
  loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

Collectively

 

 

1,105 

 

 

323 

 

 

224 

 

 

6,109 

 

 

1,893 

 

 

100 

 

 

1,321 

 

 

11,075 

ALL at December 31, 2016

 

$

1,105 

 

$

323 

 

$

224 

 

$

6,109 

 

$

1,893 

 

$

100 

 

$

1,321 

 

$

11,075 

 

66


 

 

Note 7. Premises and Equipment



At December 31, premises and equipment consisted of:





 

 

 

 

 

 

 

(Dollars in thousands)

Estimated Life

 

2017

 

2016

Land

 

 

$

2,962 

 

$

3,000 

Buildings and leasehold improvements

15 - 30 years, or lease term

 

 

24,347 

 

 

24,190 

Furniture, fixtures and equipment

3  - 10 years

 

 

12,447 

 

 

11,902 

Total cost

 

 

 

39,756 

 

 

39,092 

Less: Accumulated depreciation

 

 

 

(26,015)

 

 

(25,034)

Net premises and equipment

 

 

$

13,741 

 

$

14,058 



The following table shows the amount of depreciation and rental expense for the years ended December 31:





 

 

 

 

 

 

 

 



2017

 

2016

 

2015

Depreciation expense

$

1,236 

 

$

1,270 

 

$

1,269 

Rent expense on leases

$

704 

 

$

713 

 

$

735 



The Corporation leases various premises and equipment for use in banking operations through 2032.  Some of these leases provide renewal options of varying terms.  The rental cost of these optional renewals is not included below.  At December 31, 2017, future minimum payments on these leases are as follows:





 

 

(Dollars in thousands)

 

 

2018

$

634 

2019

 

523 

2020

 

490 

2021

 

485 

2022

 

482 

2023 and beyond

 

3,628 

Total

$

6,242 

 

Note 8. Other Real Estate Owned



The following table summarizes the changes in other real estate owned for the years ended December 31:











 

 

 

 

 

 

 

 

 



 

 

(Dollars in thousands)

 

2017

 

2016

 

2015

Balance at beginning of the period

 

$

4,915 

 

$

6,451 

 

$

3,666 

   Additions

 

 

90 

 

 

329 

 

 

3,626 

   Proceeds from dispositions

 

 

(2,298)

 

 

(625)

 

 

(508)

   (Loss) gain on sales, net

 

 

(26)

 

 

(31)

 

 

32 

   Valuation adjustment

 

 

(83)

 

 

(1,209)

 

 

(365)

Balance at the end of the period

 

$

2,598 

 

$

4,915 

 

$

6,451 

 

Note 9. Intangible Assets



The Bank has $9.0 million of goodwill recorded on its balance sheet as the result of corporate acquisitions.  Goodwill is not amortized, nor deductible for tax purposes.    Goodwill was tested for impairment using the qualitative assessment method as of August 31, 2017.  Based upon this assessment, Management determined the Bank’s goodwill was not impaired.



 



67


 

 

Note 10. Deposits



Deposits are summarized as follows at December 31:









 

 

 

 

 

 

(Dollars in thousands)

 

2017

 

2016

Noninterest-bearing checking

 

$

196,853 

 

$

170,345 



 

 

 

 

 

 

Interest-bearing checking

 

 

280,944 

 

 

241,906 

Money management

 

 

415,045 

 

 

420,309 

Savings

 

 

78,868 

 

 

74,925 

Total interest-bearing checking and savings

 

 

774,857 

 

 

737,140 



 

 

 

 

 

 

Retail time deposits

 

 

72,211 

 

 

71,264 

Brokered time deposits

 

 

3,260 

 

 

3,371 

Total time deposits

 

 

75,471 

 

 

74,635 

Total deposits

 

$

1,047,181 

 

$

982,120 



 

 

 

 

 

 

Overdrawn deposit accounts reclassified as loans

 

$

154 

 

$

181 



The following table shows the maturity of time deposits greater than $250,000 at December 31, 2017:









 

 

 

(Dollars in thousands)

 

 

 

Maturity distribution:

 

 

 

Within three months

 

$

9,964 

Over three through six months

 

 

628 

Over six through twelve months

 

 

755 

Over twelve months

 

 

672 

Total

 

$

12,019 



 

 

 



Time deposits greater than $250,000 at December 31, 2016 were $6.2 million.



At  December 31, 2017 the scheduled maturities of time deposits are as follows:



 



 

 

 

 

 

 

 

 

 



 

Retail

 

Brokered

 

Total

(Dollars in thousands)

 

Time Deposits

 

Time Deposits

 

Time Deposits

2018

 

$

46,338 

 

$

3,008 

 

$

49,346 

2019

 

 

10,451 

 

 

252 

 

 

10,703 

2020

 

 

7,414 

 

 

 —

 

 

7,414 

2021

 

 

3,680 

 

 

 —

 

 

3,680 

2022

 

 

4,328 

 

 

 —

 

 

4,328 

Total

 

$

72,211 

 

$

3,260 

 

$

75,471 

 

The deposits of directors, executive officers, related interests and affiliated enterprises totaled $4.1 million and $3.3 million at December 31, 2017 and 2016, respectively.

68


 

 

Note 11.  Other Borrowings 



The Bank's short-term borrowings are comprised of a line-of-credit with the Federal Home Loan Bank of Pittsburgh (Open Repo Plus). Open Repo Plus is a revolving term commitment used on an overnight basis.  The term of this commitment may not exceed 364 days and it reprices daily at market rates. These borrowings at December 31 are described below:



 

 

 

 

 

 



 

 



 

2017

 

2016



 

FHLB

 

FHLB

(Dollars in thousands)

 

Open Repo

 

Open Repo

Ending balance

 

$

—  

 

$

24,270 

Weighted average rate at year end

 

 

—  

 

 

0.74% 

Range of interest rates paid at year end

 

 

—  

 

 

0.74% 

Maximum month-end balance during the year

 

$

13,000 

 

$

24,270 

Average balance during the year

 

$

1,894 

 

$

5,258 

Weighted average interest rate during the year

 

 

0.83% 

 

 

0.63% 



 

The Bank’s maximum borrowing capacity with the FHLB at December 31, 2017 was $314.6 million with $314.6 million available to borrow. The Bank has established credit at the Federal Reserve Discount Window and as of year-end had the ability to borrow approximately $20 million. The Bank also has a $6 million unsecured line of credit at a correspondent bank.    

 

Note 12. Federal Income Taxes 



The temporary differences which give rise to significant portions of deferred tax assets and liabilities at December 31 are as follows:





 

 

 

 

 

 

(Dollars in thousands)

 

 

Deferred Tax Assets

 

2017

 

2016

Allowance for loan losses

 

$

2,476 

 

$

3,766 

Deferred compensation

 

 

676 

 

 

986 

Purchase accounting

 

 

16 

 

 

23 

Deferred loan fees and costs, net

 

 

99 

 

 

160 

Capital loss carryover

 

 

173 

 

 

280 

Other than temporary impairment of investments

 

 

124 

 

 

260 

Accumulated other comprehensive loss

 

 

1,603 

 

 

2,171 

Depreciation

 

 

 —

 

 

45 

Other

 

 

2,191 

 

 

561 



 

 

7,358 

 

 

8,252 

Valuation allowance

 

 

(297)

 

 

(467)

Total gross deferred tax assets

 

 

7,061 

 

 

7,785 



 

 

 

 

 

 

Deferred Tax Liabilities

 

 

 

 

 

 

Depreciation

 

 

162 

 

 

 —

Joint ventures and partnerships

 

 

28 

 

 

36 

Pension

 

 

1,068 

 

 

1,886 

Mortgage servicing rights

 

 

 —

 

 

19 

Total gross deferred tax liabilities

 

 

1,258 

 

 

1,941 

Net deferred tax asset

 

$

5,803 

 

$

5,844 



In assessing the realizability of deferred tax assets, Management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized.  The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during periods in which those temporary differences become deductible.  Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment.  Based on the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, Management believes it is more likely than not that the Bank will realize the benefits of these deferred tax assets other than those for which a valuation allowance has been recorded. 



69


 

 

The components of the provision for Federal income taxes attributable to income from operations were as follows:





 

 

 

 

 

 

 

 

 



 

For the Years Ended December 31

(Dollars in thousands)

 

2017

 

2016

 

2015

Current tax expense

 

$

4,396 

 

$

2,134 

 

$

2,382 

Deferred tax expense (benefit)

 

 

(831)

 

 

(832)

 

 

(111)

Income tax provision

 

$

3,565 

 

$

1,302 

 

$

2,271 



For the years ended December 31, 2017,  2016, and 2015, the income tax provisions are different from the tax expense which would be computed by applying the Federal statutory rate to pretax operating earnings.  A reconciliation between the tax provision at the statutory rate and the tax provision at the effective tax rate is as follows:





 

 

 

 

 

 

 

 

 



 

For the Years Ended December 31

(Dollars in thousands)

 

2017

 

2016

 

2015

Tax provision at statutory rate (34%)

 

$

3,252 

 

$

3,192 

 

$

4,241 

Income on tax-exempt loans and securities

 

 

(2,056)

 

 

(1,751)

 

 

(1,566)

Nondeductible interest expense relating to carrying  tax-exempt obligations

 

 

32 

 

 

24 

 

 

22 

Revaluation of deferred tax assets

 

 

2,291 

 

 

 —

 

 

 —

Dividends received exclusion

 

 

 —

 

 

 —

 

 

(2)

Income from bank owned life insurance

 

 

(171)

 

 

(210)

 

 

(182)

Life insurance proceeds

 

 

 —

 

 

 —

 

 

(35)

Change in valuation allowance

 

 

 —

 

 

 —

 

 

(200)

Stock option compensation

 

 

55 

 

 

30 

 

 

25 

Other, net

 

 

162 

 

 

17 

 

 

(32)

Income tax provision

 

$

3,565 

 

$

1,302 

 

$

2,271 



 

 

 

 

 

 

 

 

 

Effective income tax rate

 

 

62.1% 

 

 

13.9% 

 

 

18.2% 



In 2017, income tax expense and the effective tax rate increased due to the write-down of net deferred tax assets as a result of the passage of the Tax Cuts and Jobs Act of 2017 (the Act). The Act reduced the federal corporate income tax rate to 21%, effective January 1, 2018, from the Corporation’s statutory rate of 34% in prior periods.   With the passage of the Act, net deferred tax assets were required to be revalued using the new rate of 21%.  The Corporation recorded additional income tax expense of $2.3 million in 2017 as a result of the revaluation of net deferred tax assets.    The Corporation has determined that the accounting for the Tax Cuts and Jobs Act is final as of December 31, 2017.



At December 31, 2017, the Corporation had a capital loss carryover of $823 thousand, with $663 thousand expiring in 2018.  This loss carryover can only be offset with capital gains for federal income tax purposes.  The tax benefit of this carryover is $173 thousand, and the Corporation has recorded a valuation allowance of $173 thousand against the capital loss carryover.



The Corporation recognizes interest accrued related to unrecognized tax benefits and penalties in income tax expense for all periods presented.  No penalties or interest were recognized in 2017, 2016 or 2015.  The Corporation has no uncertain tax positions at December 31, 2017.  The Corporation is no longer subject to U.S. Federal examinations by tax authorities for the years before 2014.

 

Note 13. Accumulated Other Comprehensive Loss



The components of accumulated other comprehensive loss included in shareholders' equity at December 31 are as follows:





 

 

 

 

 

 



 

 

 

 

 

 



 

 

(Dollars in thousands)

 

2017

 

2016

Net unrealized gains (losses) on securities

 

$

154 

 

$

(20)

Tax effect

 

 

(33)

 

 

Net of tax amount

 

 

121 

 

 

(13)



 

 

 

 

 

 

Accumulated pension adjustment

 

 

(7,784)

 

 

(6,366)

Tax effect

 

 

1,635 

 

 

2,164 

Net of tax amount

 

 

(6,149)

 

 

(4,202)



 

 

 

 

 

 

Total accumulated other comprehensive loss

 

$

(6,028)

 

$

(4,215)

 

70


 

 







Note 14.  Benefit Plans



The Bank has a 401(k) plan covering substantially all employees of F&M Trust who have completed one year and 1,000 hours of service.  Employee contributions to the plan are matched at 100% up to 4% of each participant’s deferrals plus 50% of the next 2% of deferrals from participants’ eligible compensation. Under this plan, the maximum amount of employee contributions in any given year is defined by Internal Revenue Service regulations. In addition, a 100% discretionary profit sharing contribution of up to 2% of each employee’s eligible compensation is possible provided net income targets are achieved. The Personnel Committee of the Corporation’s Board of Directors approves the established net income targets annually. Effective January 1, 2017 the time in service requirement for 401(k) eligibility was reduced from one year to four months, the hours of service requirement was removed and an auto-enrollment feature was added. The related expense for the 401(k) plan, and the profit sharing plan as approved by the Board of Directors, was $707 thousand in 2017, $494 thousand in 2016, and $606 thousand in 2015. 



The Bank has a noncontributory defined benefit pension plan covering employees hired prior to April 1, 2007.  The pension plan was closed to new participants on April 1, 2007. Benefits are based on years of service and the employee’s compensation using a career average formula. The Bank’s funding policy is to contribute the annual amount required to meet the minimum funding requirements of the Employee Retirement Income Security Act of 1974.  Contributions are intended to provide not only for the benefits attributed to service to date but also for those expected to be earned in the future. Employees who are eligible for pension benefits may elect to receive an annuity style payment or a lump-sum payout of their pension benefits.



The return on pension assets and the discount rate are the two largest variables in determining pension expense. A low rate environment generally results in higher pension expense. The Bank uses the Citigroup Above Median Pension Discount Curve from the Citigroup Pension Discount Curve and Liability Index for its discount rate.  The Bank’s pension expense for each of the last three years is shown in the section of the following table titled “Components of Net Periodic Pension Cost”. The pension expense in 2017 was less than in 2016  due to the expense of a lump sum settlement loss that was recorded in 2016.



Pension plan asset classes include cash, fixed income securities and equities. The fixed income portion is comprised of Government Bonds, Corporate Bonds and Taxable Municipal Bonds; the equity portion is comprised of financial institution equities and individual corporate equities across a broad range of sectors.  Investments are made on the basis of sound economic principles and in accordance with established guidelines.  Target allocations of fund assets measured at fair value are as follows: fixed income, a range of 60%-90%, equities, a range of 10% to 30% and cash as needed. The allocation as of December 31, 2017 is shown in a table within this note.  The Bank manages its pension portfolio in order to closely align the duration of the assets with the duration of the pension liability.



On a regular basis, the Pension and Benefits Committee (the “Committee”) monitors the allocation to each asset class.  Due to changes in market conditions, the asset allocation may vary from time to time.  The Committee is responsible to direct the rebalancing of Plan assets when allocations are not within the established guidelines and to ensure that such action is implemented. The Bank attempts to allocate the pension assets in a manner that the cash flow from the assets is similar to the cash flow of the liabilities. This has and will continue to result in a smaller allocation of equity investments and a higher allocation of longer duration bonds. By closely matching the asset and liability cash flow, large fluctuations in projected benefit obligations should be reduced. 



Specific guidelines for fixed income investments are that no individual bond shall have a rating of less than an A as rated by Standard and Poor’s and Moody’s at the time of purchase.  If the rating subsequently falls below an A rating, the Committee, at its next quarterly meeting, will discuss the merits of retaining that particular security.  Allowable securities include obligations of the U.S. Government and its agencies, CDs, commercial paper, corporate obligations and insured municipal bonds.



General guidelines for equities are that a diversified common stock program is used and that diversification patterns can be changed with the ongoing analysis of the outlook for economic and financial conditions.  Specific guidelines for equities include a sector cap and an individual stock cap. The guidelines for the sector cap direct that because the Plan sponsor is a bank, a significantly large exposure to the financial sector is permissible; therefore, there is no sector cap for financial equities.  All other sectors are limited to 25% of the equity component.  The individual stock cap guidelines direct that no one stock may represent more than 5% of the total equity portfolio.



The Committee revisits and determines the expected long-term rate of return on Plan assets annually.  The policy of the Committee has been to take a conservative approach to all Plan assumptions.  This rate is reviewed annually and historical investment returns play a significant role in determining what this rate should be.



71


 

 

The following table sets forth the plan’s funded status, based on the December 31, 2017,  2016 and 2015 actuarial valuations.





 

 

 

 

 

 

 

 

 



 

For the Years Ended December 31

(Dollars in thousands)

 

2017

 

2016

 

2015

Change in projected benefit obligation

 

 

 

 

 

 

 

 

 

Benefit obligation at beginning of measurement year

 

$

17,881 

 

$

18,609 

 

$

19,679 

Service cost

 

 

317 

 

 

337 

 

 

377 

Interest cost

 

 

667 

 

 

701 

 

 

695 

Actuarial loss (gain)

 

 

2,260 

 

 

632 

 

 

(906)

Settlement loss

 

 

 —

 

 

(1,590)

 

 

 —

Benefits paid

 

 

(1,236)

 

 

(808)

 

 

(1,236)

Benefit obligation at end of measurement year

 

 

19,889 

 

 

17,881 

 

 

18,609 



 

 

 

 

 

 

 

 

 

Change in plan assets

 

 

 

 

 

 

 

 

 

Fair value of plan assets at beginning of measurement year

 

 

17,062 

 

 

18,301 

 

 

19,677 

Actual return on plan assets net of expenses

 

 

1,366 

 

 

1,159 

 

 

(140)

Settlement loss

 

 

 —

 

 

(1,590)

 

 

 —

Employer contribution

 

 

 —

 

 

 —

 

 

 —

Benefits paid

 

 

(1,236)

 

 

(808)

 

 

(1,236)

Fair value of plan assets at end of measurement year

 

 

17,192 

 

 

17,062 

 

 

18,301 



 

 

 

 

 

 

 

 

 

Funded status of projected benefit obligation

 

$

(2,697)

 

$

(819)

 

$

(308)







 

 

 

 

 

 

 

 

 

Amounts recognized in accumulated other comprehensive

 

For the Years Ended December 31

income (loss), net of tax

 

2017

 

2016

 

2015

Net actuarial loss

 

$

(7,784)

 

$

(6,366)

 

$

(6,871)

Prior service cost obligation

 

 

 —

 

 

 —

 

 

94 

 

 

 

(7,784)

 

 

(6,366)

 

 

(6,777)

Tax effect

 

 

1,635 

 

 

2,164 

 

 

2,304 

Net amount recognized in accumulated other comprehensive loss

 

$

(6,149)

 

$

(4,202)

 

$

(4,473)







 

 

 

 

 

 

 

 

 



 

For the Years Ended December 31

Components of net periodic pension cost

 

2017

 

2016

 

2015

Service cost

 

$

317 

 

$

337 

 

$

377 

Interest cost

 

 

667 

 

 

701 

 

 

695 

Expected return on plan assets

 

 

(1,072)

 

 

(1,165)

 

 

(1,182)

Amortization of prior service cost

 

 

 —

 

 

(94)

 

 

(126)

Recognized net actuarial loss

 

 

547 

 

 

579 

 

 

623 

Net periodic pension cost

 

 

459 

 

 

358 

 

 

387 

Effect of settlement loss

 

 

 —

 

 

564 

 

 

 —

Total pension expense

 

$

459 

 

$

922 

 

$

387 



72


 

 





 

 

 

 

 

 

 

 

 



 

For the Years Ended December 31



 

2017

 

2016

 

2015

Assumptions used to determine benefit obligations:

 

 

 

 

 

 

 

 

 

Discount rate

 

 

3.46% 

 

 

3.89% 

 

 

4.06% 

Rate of compensation increase

 

 

4.00% 

 

 

4.00% 

 

 

4.00% 



 

 

 

 

 

 

 

 

 

Assumptions used to determine net periodic benefit cost:

 

 

 

 

 

 

 

 

 

Discount rate

 

 

3.89% 

 

 

3.89% 

 

 

3.72% 

Expected long-term return on plan assets

 

 

6.50% 

 

 

6.50% 

 

 

6.50% 

Rate of compensation increase

 

 

4.00% 

 

 

4.00% 

 

 

4.00% 



 

 

 

 

 

 

 

 

 

Asset allocations:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

2% 

 

 

4% 

 

 

8% 

Common stocks

 

 

24% 

 

 

33% 

 

 

31% 

Corporate bonds

 

 

18% 

 

 

8% 

 

 

7% 

Municipal bonds

 

 

38% 

 

 

42% 

 

 

43% 

Investment fund - debt

 

 

9% 

 

 

9% 

 

 

8% 

Insurance contracts

 

 

4% 

 

 

3% 

 

 

2% 

Other

 

 

5% 

 

 

1% 

 

 

1% 

Total

 

 

100% 

 

 

100% 

 

 

100% 



 

 

 

 

 

 

 

 

 

Shares of the Corporation's common stock held in the plan

 

 

 

 

 

 

 

 

 

Value of shares  (in thousands)

 

$

 —

 

$

 —

 

$

68 

Percent of total plan assets

 

 

0.0% 

 

 

0.0% 

 

 

0.4% 



The following table sets forth by level, within the fair value hierarchy, the Plan's investments at fair value as of December 31, 2017 and 2016. For more information on the levels within the fair value hierarchy, please refer to Note 19.







 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

 

December 31, 2017

Asset  Description

 

Fair Value

 

Level 1

 

Level 2

 

Level 3

Cash and cash equivalents

 

$

399 

 

$

399 

 

$

 —

 

$

 —

Common stocks

 

 

4,158 

 

 

4,158 

 

 

 —

 

 

 —

Corporate bonds

 

 

3,108 

 

 

 —

 

 

3,108 

 

 

 —

Municipal bonds

 

 

6,556 

 

 

 —

 

 

6,556 

 

 

 —

Investment fund - debt

 

 

1,570 

 

 

1,570 

 

 

 —

 

 

 —

Cash value of life insurance

 

 

25 

 

 

 —

 

 

 —

 

 

25 

Deposit in immediate participation guarantee contract

 

 

683 

 

 

683 

 

 

 —

 

 

 —

Other

 

 

693 

 

 

143 

 

 

550 

 

 

 —

Total assets

 

$

17,192 

 

$

6,953 

 

$

10,214 

 

$

25 







 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

 

December 31, 2016

Asset  Description

 

Fair Value

 

Level 1

 

Level 2

 

Level 3

Cash and cash equivalents

 

$

726 

 

$

726 

 

$

 —

 

$

 —

Common stocks

 

 

5,688 

 

 

5,688 

 

 

 —

 

 

 —

Corporate bonds

 

 

1,310 

 

 

 —

 

 

1,310 

 

 

 —

Municipal bonds

 

 

7,146 

 

 

 —

 

 

7,146 

 

 

 —

Investment fund - debt

 

 

1,454 

 

 

1,454 

 

 

 —

 

 

 —

Cash value of life insurance

 

 

25 

 

 

 —

 

 

 —

 

 

25 

Deposit in immediate participation guarantee contract

 

 

479 

 

 

479 

 

 

 

 

 

 —

Other

 

 

234 

 

 

234 

 

 

 —

 

 

 —

Total assets

 

$

17,062 

 

$

8,581 

 

$

8,456 

 

$

25 



73


 

 

The following table sets forth a summary of the changes in the fair value of the Plan's level 3 investments for the years ended December 31, 2017 and 2016





 

 

 

 

 



Cash Value of Life Insurance



December 31



2017

 

2016

Balance at the beginning of the period

$

25 

 

$

62 

Unrealized gain (loss)  relating to investments held at the reporting date

 

 —

 

 

Purchases, sales, issuances and settlement, net

 

 —

 

 

(38)

Balance at the end of the period

$

25 

 

$

25 



Contributions



The Bank contributed $1.0 million to its pension plan in February 2018, but does not expect to make any additional contributions in 2018. 



Estimated future benefit payments at December 31, 2017 (in thousands)







 

 

 

2018

 

$

1,043 

2019

 

 

1,064 

2020

 

 

1,483 

2021

 

 

969 

2022

 

 

1,209 

2023-2027

 

 

6,580 

Total

 

$

12,348 

 



Note 15. Stock Based Compensation



In 2004, the Corporation adopted the Employee Stock Purchase Plan of 2004 (ESPP). Under the ESPP of 2004, options for 250,000 shares of stock can be issued to eligible employees. The number of shares that can be purchased by each participant is defined by the plan and the Board of Directors sets the option price. However, the option price cannot be less than 90% of the fair market value of a share of the Corporation’s common stock on the date the option is granted.  The Board of Directors also determines the expiration date of the options; however, no option may have a term that exceeds one year from the grant date. ESPP options are exercisable immediately upon grant.  Any shares related to unexercised options are available for future grant The Board of Directors may amend, suspend or terminate the ESPP at any time.  The grant price of the 2017 ESPP options was set at 95% of the stock’s fair value at the time of the award.  There was no compensation expense recognized in 2017, 2016 or 2015 for the ESPP.



In 2002, the Corporation adopted the Incentive Stock Option Plan of 2002 (ISOP). The plan had a 10 year life with regard to awarding options and expired in 2012.  However, awards granted prior to expiration of the plan will continue to be exercisable in accordance with the plan. In 2013, the Corporation approved the Incentive Stock Option Plan of 2013. Under the 2013 ISOP, options for 354,877 shares of stock were authorized to be issued to selected Officers, as defined in the plan.  The number of options available to be awarded to each eligible Officer is determined by the Board of Directors, but is limited with respect to the aggregate fair value of the options as defined in the plan.  The exercise price of the option may be no less than 100% of the fair value of a share of the Corporation’s common stock on the date the option is granted.  The options have a life of 10 years and may be exercised only after the optionee has completed 6 months of continuous employment with the Corporation or its Subsidiary immediately following the grant date, or upon a change of control as defined in the plan.  If awards are granted, the Corporation uses the “simplified” method for estimating the expected term of the ISO award.  The risk-free interest rate is the U.S. Treasury rate commensurate with the expected average life of the option at the date of grant.



74


 

 

The ESPP and ISOP options outstanding at December 31, 2017 are all exercisable. The ESPP options expire on June 30, 2018 and the ISOP options expire 10 years from the grant date.  The following table summarizes the stock option activity:







 

 

 

 

 

 

 

(Dollars in thousands except share and per share data)

 

 

 

 

 

 

 



ESPP

 

Weighted Average

 

Aggregate 



Options

 

Price Per Share

 

Intrinsic Value

Balance Outstanding at December 31, 2014

25,970 

 

$

18.91 

 

 

 

Granted

23,379 

 

 

23.42 

 

 

 

Exercised

(4,794)

 

 

19.17 

 

 

 

Expired

(22,269)

 

 

19.08 

 

 

 

Balance Outstanding at December 31, 2015

22,286 

 

$

23.42 

 

$

Granted

24,434 

 

 

22.46 

 

 

 

Exercised

(907)

 

 

22.66 

 

 

 

Expired

(23,055)

 

 

23.38 

 

 

 

Balance Outstanding at December 31, 2016

22,758 

 

$

22.46 

 

$

140 

Granted

19,086 

 

 

29.95 

 

 

 

Exercised

(6,827)

 

 

23.00 

 

 

 

Expired

(17,180)

 

 

22.79 

 

 

 

Balance Outstanding at December 31, 2017

17,837 

 

$

29.95 

 

$

132 



 

 

 

 

 

 

 

Shares available for future grants at December 31, 2017

200,082 

 

 

 

 

 

 







 

 

 

 

 

 

 



ISOP

 

Weighted Average

 

Aggregate 



Options

 

Price Per Share

 

Intrinsic Value

Balance Outstanding at December 31, 2014

44,075 

 

$

23.29 

 

 

 

Granted

17,500 

 

 

22.00 

 

 

 

Exercised

 —

 

 

 —

 

 

 

Forfeited

(8,500)

 

 

25.29 

 

 

 

Balance Outstanding at December 31, 2015

53,075 

 

$

22.56 

 

$

50 

Granted

24,450 

 

 

21.27 

 

 

 

Exercised

(3,800)

 

 

16.00 

 

 

 

Forfeited

(15,000)

 

 

24.14 

 

 

 

Balance Outstanding at December 31, 2016

58,725 

 

$

22.03 

 

$

386 

Granted

33,450 

 

 

30.00 

 

 

 

Exercised

(750)

 

 

23.77 

 

 

 

Forfeited

(6,200)

 

 

27.37 

 

 

 

Balance Outstanding at December 31, 2017

85,225 

 

$

24.75 

 

$

1,075 



 

 

 

 

 

 

 

Shares available for future grants at December 31, 2017

290,177 

 

 

 

 

 

 



The following table provides information about the options outstanding at December 31, 2017:







 

 

 

 

 

 

 

 

 

 

 

 

Options

 

 

 

 

 

 

 

Weighted



 

Outstanding

 

 

Exercise Price or

 

Weighted Average

 

Average Remaining

Stock Option Plan

 

and Exercisable

 

 

Price Range

 

Exercise Price

 

Life (years)

Employee Stock Purchase Plan

 

17,837 

 

$

29.95 

 

$

29.95 

 

0.5



 

 

 

 

 

 

 

 

 

 

Incentive Stock Option Plan

 

5,500 

 

 

16.11 

 

 

16.11 

 

1.2

Incentive Stock Option Plan

 

37,350 

 

 

21.27 - 22.05

 

 

21.56 

 

7.8

Incentive Stock Option Plan

 

8,925 

 

 

23.77 

 

 

23.77 

 

0.1

Incentive Stock Option Plan

 

33,450 

 

 

30.00 

 

 

30.00 

 

9.2

ISOP Total/Average

 

85,225 

 

 

 

 

$

24.75 

 

7.1



75


 

 

The fair value of the ISOP options granted has been estimated using the Black-Scholes method and the following assumptions for the years shown:







 

 

 

 

 

 

 

 

 



 

2017

 

2016

 

2015

Incentive Stock Option Plan

 

 

 

 

 

 

 

 

 

Options granted

 

 

33,450 

 

 

24,450 

 

 

17,500 

Risk-free interest rate

 

 

1.87% 

 

 

1.22% 

 

 

1.47% 

Expected volatility of the Corporation's stock

 

 

23.12% 

 

 

25.76% 

 

 

28.64% 

Expected dividend yield

 

 

2.94% 

 

 

3.23% 

 

 

3.09% 

Expected life (in years)

 

 

5.25 

 

 

5.25 

 

 

5.25 

Weighted average fair value of options granted

 

$

4.81 

 

$

3.58 

 

$

4.22 



 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

Compensation expense included in net income

 

 

 

 

 

 

 

 

 

ESPP

 

$

 —

 

$

 —

 

$

 —

ISOP

 

 

161 

 

 

88 

 

 

74 

Total compensation expense included in net income

 

$

161 

 

$

88 

 

$

74 

 



Note 16. Deferred Compensation Agreement



The Corporation has entered into deferred compensation agreements with one former and one current director that provides for the payment of benefits over a ten-year period, beginning at age 65.  At inception, the present value of the obligations under these deferred compensation agreements amounted to approximately $600 thousand, which is being accrued over the estimated remaining service period of these directors.  Expense associated with the agreements was $2 thousand for 2017,  $2 thousand for 2016 and $76 thousand for 2015 Payments for the directors deferred compensation plan are scheduled through 2022.



The Bank also has a Director’s Deferred Compensation Plan, whereby each director may voluntarily participate and elect each year to defer all or a portion of their Bank director’s fees. Each participant directs the investment of their own account among various publicly available mutual funds designated by the Bank’s Investment and Trust Services department. Changes in the account balance beyond the amount deferred to the account are solely the result of the performance of the selected mutual fund. The Bank maintains an offsetting asset and liability for the deferred account balances and the annual expense is recorded as a component of director’s fees as if it were a direct payment to the director. The Bank will not incur any expense when the account goes into payout. 



The Corporation has two deferred compensation agreements it recorded as part of its acquisition of Fulton Bancshares Corporation in 2006.  No future expense will be recognized for these plans. Payments for the deferred compensation agreements total  $386 thousand through 2021.

 

Note 17.  Shareholders’ Equity

 

The Board of Directors, from time to time, authorizes the repurchase of the Corporation’s $1.00 par value common stock. The repurchased shares will be held as Treasury shares available for issuance in connection with future stock dividends and stock splits, employee benefit plans, executive compensation plans, the Dividend Reinvestment Plan (DRIP) and other appropriate corporate purposes. The term of the repurchase plans is normally one year. The Corporation held 334,311 and 371,513 treasury shares at cost at December 31, 2017 and 2016, respectively.    



The following table provides information about the Corporation’s stock repurchase activity:





 

 

 

 

 

 

 

 



 

 

 

 

 

Shares Repurchased

Plan Date

 

Authorized

 

Expiration

 

2017

 

2016

4/18/2016

 

$350,000 in shares per calendar quarter

 

3/31/2017

 

 -

 

34,048 

10/12/2017

 

100,000 shares

 

9/30/2018

 

 -

 

N/A



The Corporation’s DRIP allows for shareholders to purchase additional shares of the Corporation’s common stock by reinvesting cash dividends paid on their shares or through optional cash payments. The Corporation has authorized one million (1,000,000) shares of its currently authorized common stock to be issued under the plan or may issue from Treasury sharesThe DRIP added $991 thousand to capital during 2017. This total was comprised of $669 thousand from the reinvestment of quarterly dividends and $322 thousand of optional cash contributions. During 2017, 30,375 shares of common stock were purchased through the DRIP at a value of $991 thousand and 614,355 shares remain to be issued

 

76


 

 

Note 18. Commitments and Contingencies



In the normal course of business, the Bank is a party to financial instruments that are not reflected in the accompanying financial statements and are commonly referred to as off-balance-sheet instruments.  These financial instruments are entered into primarily to meet the financing needs of the Bank’s customers and include commitments to extend credit and standby letters of credit.  Those instruments involve, to varying degrees, elements of credit and interest rate risk not recognized in the consolidated balance sheet.



The Corporation’s exposure to credit loss in the event of nonperformance by other parties to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contract or notional amount of those instruments.  The Bank uses the same credit policies in making commitments and conditional obligations as they do for on-balance-sheet instruments.



The Bank had the following outstanding commitments as of December 31:





 

 

 

 

 

 

(Dollars in thousands)

 

2017

 

2016

Financial instruments whose contract amounts represent credit risk

 

 

 

 

 

 

Commercial commitments to extend credit

 

$

249,526 

 

$

227,380 

Consumer commitments to extend credit (secured)

 

 

44,866 

 

 

44,352 

Consumer commitments to extend credit (unsecured)

 

 

5,668 

 

 

5,674 



 

$

300,060 

 

$

277,406 

Standby letters of credit

 

$

28,630 

 

$

23,935 

 



Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses with the exception of home equity lines and personal lines of credit and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The Bank evaluates each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by the Bank, is based on Management’s credit evaluation of the counterparty.  Collateral for most commercial commitments varies but may include accounts receivable, inventory, property, plant, and equipment, and income-producing commercial properties.  Collateral for secured consumer commitments consists of liens on residential real estate.



Standby letters of credit are instruments issued by the Bank, which guarantee the beneficiary payment by the Bank in the event of default by the Bank’s customer in the nonperformance of an obligation or service.  Most standby letters of credit are extended for one-year periods.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.  The Bank holds collateral supporting those commitments for which collateral is deemed necessary primarily in the form of certificates of deposit and liens on real estate. Management believes that the proceeds obtained through a liquidation of such collateral would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees.  The current amount of the liability as of December 31, 2017 and 2016 for guarantees under standby letters of credit issued is not material.



Most of the Bank’s business activity is with customers located within its primary market and does not involve any significant concentrations of credit to any one entity or industry.



Legal Proceedings



The nature of the Corporation’s business generates a certain amount of litigation involving matters arising in the ordinary course of business, including the Kalan et al. v. Farmers and Merchants Trust Company of Chambersburg eta.l (Case No. 2:15-CV-01435-WB) case filed in the United States District Court for the Eastern District of Pennsylvania.  On December 29, 2017, the Bank entered into a Class Action Settlement Term Sheet with the named plaintiffs and certain of the other remaining defendants.  The Term Sheet provides for the Bank to make a settlement payment of $10 million in full and final settlement of all claims that the named plaintiffs and members of the Settlement Class (as defined by the Term Sheet) have brought or could have brought against F&M Trust.  The Term Sheet further provides that the parties will enter into a definitive settlement agreement that is to provide for a general release of all claims by all parties to the case.  The terms of settlement will be subject to preliminary and final approval by the court.  The Corporation has accrued, in other liabilities, the $10 million settlement payment as an expense for the year ended December 31, 2017.



We establish accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probable and the amount of the loss can be reasonably estimated.  When we are able to do so, we also determine estimates of possible losses, whether in excess of any accrued liability or where there is no accrued liability.



These assessments are based on our analysis of currently available information and are subject to significant judgment and a variety of assumptions and uncertainties.  As new information is obtained, we may change our assessments and, as a result, take or adjust the amounts of our accruals and change our estimates of possible losses or ranges of possible losses.  Due to the inherent subjectivity of the assessments and the unpredictability of outcomes of legal proceedings, any amounts that may be accrued or

77


 

 

included in estimates of possible losses or ranges of possible losses may not represent the actual loss to the Corporation from any legal proceeding.  Our exposure and ultimate losses may be higher, possibly significantly higher, than amounts we may accrue or amounts we may estimate.



In management’s opinion, we do not anticipate, at the present time, that the ultimate aggregate liability, if any, arising out of all litigation to which the Corporation is a party will have a material adverse effect on our financial position.  We cannot now determine, however, whether or not any claim asserted against us, other than the Kalan case, will have a material adverse effect on our results of operations in any future reporting period, which will depend on, among other things, the amount of loss resulting from the claim and the amount of income otherwise reported for the reporting period.  Thus, at December 31, 2017, we are unable to provide an evaluation of the likelihood of an unfavorable outcome or an estimate of the amount or range of potential loss with respect to such other matters and, accordingly, have not yet established any specific accrual for such other matters.



No material proceedings are pending or are known to be threatened or contemplated against us by governmental authorities.



Note 19.  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 year-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 level within the hierarchy does not represent risk.



The following methods and assumptions were used to estimate the fair values of the Corporation’s financial instruments at December 31, 2017 and 2016.



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.



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:    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

78


 

 

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 other 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 and long-term debt is estimated by discounting the future cash flows using rates approximating those currently offered for certificates of deposit and borrowings with similar remaining maturities.  Other borrowings consist of a line of credit with the FHLB at a variable interest rate and securities sold under agreements to repurchase, for which 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 fair value of the Corporation's financial instruments are as follows:





 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



December 31, 2017



Carrying

 

Fair

 

 

 

 

 

 

 

(Dollars in thousands)

Amount

 

Value

 

Level 1

 

Level 2

 

Level 3

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

$

58,603 

 

$

58,603 

 

$

58,603 

 

$

 —

 

$

 —

Investment securities available for sale

 

127,336 

 

 

127,336 

 

 

365 

 

 

126,971 

 

 

 —

Restricted stock

 

456 

 

 

456 

 

 

 —

 

 

456 

 

 

 —

Loans held for sale

 

442 

 

 

442 

 

 

 —

 

 

442 

 

 

 —

Net loans

 

931,908 

 

 

929,891 

 

 

 —

 

 

 —

 

 

929,891 

Accrued interest receivable

 

3,847 

 

 

3,847 

 

 

 —

 

 

3,847 

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

$

1,047,181 

 

$

1,046,476 

 

$

 —

 

$

1,046,476 

 

$

 —

Accrued interest payable

 

149 

 

 

149 

 

 

 —

 

 

149 

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 



December 31, 2016



Carrying

 

Fair

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

Amount

 

Value

 

Level 1

 

Level 2

 

Level 3

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

$

36,665 

 

$

36,665 

 

$

36,665 

 

$

 —

 

$

 —

Investment securities available for sale

 

143,875 

 

 

143,875 

 

 

290 

 

 

143,585 

 

 

 —

Restricted stock

 

1,767 

 

 

1,767 

 

 

 —

 

 

1,767 

 

 

 —

Loans held for sale

 

540 

 

 

540 

 

 

 —

 

 

540 

 

 

 —

Net loans

 

882,798 

 

 

889,910 

 

 

 —

 

 

 —

 

 

889,910 

Accrued interest receivable

 

3,592 

 

 

3,592 

 

 

 —

 

 

3,592 

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

$

982,120 

 

$

981,949 

 

$

 —

 

$

981,949 

 

$

 —

Short-term debt

 

24,270 

 

 

24,270 

 

 

24,270 

 

 

 —

 

 

 —

Accrued interest payable

 

116 

 

 

116 

 

 

 —

 

 

116 

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 



79


 

 

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 December 31, 2017 and 2016 are as follows:





 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands

 

Fair Value at December 31, 2017

Asset  Description

 

Level 1

 

Level 2

 

Level 3

 

Total

Equity securities

 

$

365 

 

$

 —

 

$

 —

 

$

365 

U.S. Government and Agency securities

 

 

 —

 

 

11,472 

 

 

 —

 

 

11,472 

Municipal securities

 

 

 —

 

 

57,772 

 

 

 —

 

 

57,772 

Trust Preferred Securities

 

 

 —

 

 

5,817 

 

 

 —

 

 

5,817 

Agency mortgage-backed securities

 

 

 —

 

 

50,937 

 

 

 —

 

 

50,937 

Private-label mortgage-backed securities

 

 

 —

 

 

946 

 

 

 —

 

 

946 

Asset-backed securities

 

 

 —

 

 

27 

 

 

 —

 

 

27 

Total assets

 

$

365 

 

$

126,971 

 

$

 —

 

$

127,336 







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

 

Fair Value at December 31, 2016

Asset  Description

 

Level 1

 

Level 2

 

Level 3

 

Total

Equity securities

 

$

290 

 

$

 —

 

$

 —

 

$

290 

U.S. Government and Agency securities

 

 

 —

 

 

12,720 

 

 

 —

 

 

12,720 

Municipal securities

 

 

 —

 

 

62,985 

 

 

 —

 

 

62,985 

Trust Preferred Securities

 

 

 —

 

 

5,461 

 

 

 —

 

 

5,461 

Agency mortgage-backed securities

 

 

 —

 

 

61,284 

 

 

 —

 

 

61,284 

Private-label mortgage-backed securities

 

 

 —

 

 

1,104 

 

 

 —

 

 

1,104 

Asset-backed securities

 

 

 —

 

 

31 

 

 

 —

 

 

31 

Total assets

 

$

290 

 

$

143,585 

 

$

 —

 

$

143,875 



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.



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 December 31, 2017 and 2016 are as follows:





 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

 

Fair Value at December 31, 2017

Asset  Description

 

Level 1

 

Level 2

 

Level 3

 

Total

Other real estate owned (1)

 

$

 —

 

$

 —

 

$

90 

 

$

90 

Total assets

 

$

 —

 

$

 —

 

$

90 

 

$

90 







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

 

Fair Value at December 31, 2016

Asset  Description

 

Level 1

 

Level 2

 

Level 3

 

Total

Premises held-for-sale (1)

 

$

 —

 

$

 —

 

$

200 

 

$

200 

Other real estate owned (1)

 

 

 —

 

 

 —

 

 

2,407 

 

 

2,407 

Total assets

 

$

 —

 

$

 —

 

$

2,607 

 

$

2,607 



 (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.



Other real estate:  The fair value of other real estate, upon initial recognition, is obtained through a process similar to the valuation process for impaired loans.  In connection with the measurement and initial recognition of the foregoing assets, the Corporation recognizes charge-offs through the allowance for loan losses.



80


 

 

Premises held-for-sale: The fair value of premises held-for-sale is obtained through a process similar to the valuation process for other real estate.



The Corporation did not record any liabilities at fair value for which measurement of the fair value was made on a nonrecurring basis at December 31, 2017. 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 December 31, 2017.



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







 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

 

 

Quantitative Information about Level 3 Fair Value Measurements

December 31, 2017

 

 

Fair Value

 

Valuation Technique

 

Unobservable Input

 

(Weighted Average)

Other real estate owned

 

$

90 

 

Appraisal

 

N/A

 



 

 

 

 

 

 

Cost to sell

 

8%  (8%)



 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

Range

December 31, 2016

 

 

Fair Value

 

Valuation Technique

 

Unobservable Input

 

(Weighted Average)

Premises held-for-sale

 

$

200 

 

Appraisal

 

Qualitative adjustment

 

5%  (5%)



 

 

 

 

 

 

 

 

 

Other real estate owned

 

 

2,407 

 

Appraisal

 

N/A

 



 

 

 

 

 

 

Cost to sell

 

8%  (8%)

 

Note 20. Parent Company (Franklin Financial Services Corporation) Financial Information 



Balance Sheets





 

 

 

 

 

 



 

December 31

(Dollars in thousands)

 

2017

 

2016

Assets:

 

 

 

 

 

 

Cash and cash equivalents

 

$

250 

 

$

851 

Investment securities

 

 

365 

 

 

 —

Equity investment in subsidiaries

 

 

114,387 

 

 

115,794 

Other assets

 

 

184 

 

 

39 

Total assets

 

$

115,186 

 

 

116,684 



 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

Other liabilities

 

$

42 

 

$

191 

Total liabilities

 

 

42 

 

 

191 

Shareholders' equity

 

 

115,144 

 

 

116,493 

Total liabilities and shareholders' equity

 

$

115,186 

 

$

116,684 



Statements of Income





 

 

 

 

 

 

 

 

 



 

Years Ended December 31

  (Dollars in thousands)

 

2017

 

2016

 

2015

Income:

 

 

 

 

 

 

 

 

 

Dividends from Bank subsidiary

 

$

3,225 

 

$

4,006 

 

$

300 

Other income

 

 

 —

 

 

 —

 

 

171 



 

 

3,225 

 

 

4,006 

 

 

471 

Expenses:

 

 

 

 

 

 

 

 

 

Operating expenses

 

 

1,107 

 

 

972 

 

 

986 

Income before income taxes and equity in undistributed income
  of subsidiaries

 

 

2,118 

 

 

3,034 

 

 

(515)

Income tax benefit

 

 

348 

 

 

301 

 

 

328 

Equity in undistributed income of subsidiaries

 

 

(290)

 

 

4,752 

 

 

10,391 

Net income

 

$

2,176 

 

$

8,087 

 

$

10,204 



81


 

 

Statements of Comprehensive Income





 

 

 

 

 

 

 

 

 



 

 

Years ended December 31

(Dollars in thousands)

 

2017

 

2016

 

2015

Net Income

 

$

2,176 

 

$

8,087 

 

$

10,204 

Securities:

 

 

 

 

 

 

 

 

 

Unrealized gains arising during the period

 

 

201 

 

 

 —

 

 

 —

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

 

 

 -

 

 

 —

 

 

 —

Net Unrealized gains

 

 

201 

 

 

 —

 

 

 —

Tax effect

 

 

(68)

 

 

 —

 

 

 —

Net of tax amount

 

 

133 

 

 

 —

 

 

 —

Total other comprehensive income of Parent

 

 

133 

 

 

 —

 

 

 —

Other comprehensive (loss) income of subsidiaries

 

 

(954)

 

 

(493)

 

 

(622)

Total Comprehensive Income

 

$

1,355 

 

$

7,594 

 

$

9,582 



Statements of Cash Flows





 

 

 

 

 

 

 

 

 



 

Years Ended December 31

(Dollars in thousands)

 

2017

 

2016

 

2015

Cash flows from operating activities

 

 

 

 

 

 

 

 

 

Net income

 

$

2,176 

 

$

8,087 

 

$

10,204 

Adjustments to reconcile net income to net cash provided

 

 

 

 

 

 

 

 

 

by operating activities:

 

 

 

 

 

 

 

 

 

Equity in undistributed loss (income) of subsidiary

 

 

290 

 

 

(4,752)

 

 

(10,391)

Stock option compensation

 

 

161 

 

 

88 

 

 

74 

Deferred tax benefit

 

 

(26)

 

 

 —

 

 

 —

(Increase) decrease in other assets/liabilities

 

 

(337)

 

 

(307)

 

 

1,800 

Net cash provided by operating activities

 

 

2,264 

 

 

3,116 

 

 

1,687 



 

 

 

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

 

 

 

 

Dividends paid

 

 

(4,031)

 

 

(3,523)

 

 

(3,139)

Cash received from option exercises

 

 

175 

 

 

82 

 

 

92 

Common stock issued under dividend reinvestment plan

 

 

991 

 

 

1,671 

 

 

1,246 

Treasury stock purchase

 

 

 —

 

 

(795)

 

 

 —

Net cash used in financing activities

 

 

(2,865)

 

 

(2,565)

 

 

(1,801)

(Decrease) increase in cash and cash equivalents

 

 

(601)

 

 

551 

 

 

(114)

Cash and cash equivalents as of January 1

 

 

851 

 

 

300 

 

 

414 

Cash and cash equivalents as of December 31

 

$

250 

 

$

851 

 

$

300 

 

82


 

 

Note 21. Quarterly Results of Operations (unaudited)



The following is a condensed summary of the quarterly results of consolidated operations of the Corporation for the years ended December 31, 2017 and 2016:





 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands, except per share)

 

Three months ended

 



 

March 31, 2017

 

June 30, 2017

 

September 30, 2017

 

December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

9,546 

 

$

9,938 

 

$

10,063 

 

$

10,339 

 

Interest expense

 

 

581 

 

 

590 

 

 

629 

 

 

691 

 

Net interest income

 

 

8,965 

 

 

9,348 

 

 

9,434 

 

 

9,648 

 

Provision for loan losses

 

 

120 

 

 

50 

 

 

250 

 

 

250 

 

Other noninterest income

 

 

2,923 

 

 

3,155 

 

 

2,970 

 

 

3,137 

 

Securities gains

 

 

 

 

 —

 

 

 

 

 —

 

Noninterest expense

 

 

7,957 

 

 

8,161 

 

 

8,305 

 

 

18,750 

*

Income (loss) before income taxes

 

 

3,813 

 

 

4,292 

 

 

3,850 

 

 

(6,215)

 

Federal income tax expense

 

 

793 

 

 

950 

 

 

774 

 

 

1,048 

**

Net Income

 

$

3,020 

 

 

3,342 

 

 

3,076 

 

 

(7,263)

 

Basic earnings per share

 

$

0.70 

 

$

0.77 

 

$

0.71 

 

$

(1.67)

 

Diluted earnings per share

 

$

0.70 

 

$

0.77 

 

$

0.70 

 

$

(1.67)

 

Dividends declared per share

 

$

0.21 

 

$

0.24 

 

$

0.24 

 

$

0.24 

 



*Includes $10 million for the accrual of a legal settlement described in Item 3 Legal Proceedings

** Includes $2.3 million for revaluation of the net deferred tax assets









 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands, except per share)

 

Three months ended



 

March 31, 2016

 

June 30, 2016

 

September 30, 2016

 

December 31, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

9,098 

 

$

8,988 

 

$

9,348 

 

$

9,544 

Interest expense

 

 

545 

 

 

548 

 

 

563 

 

 

589 

Net interest income

 

 

8,553 

 

 

8,440 

 

 

8,785 

 

 

8,955 

Provision for loan losses

 

 

300 

 

 

1,875 

 

 

1,150 

 

 

450 

Other noninterest income

 

 

2,981 

 

 

2,854 

 

 

2,813 

 

 

2,984 

Securities (losses) gains

 

 

(28)

 

 

 

 

(10)

 

 

Noninterest expense

 

 

7,795 

 

 

7,730 

 

 

7,980 

 

 

9,670 

Income before income taxes

 

 

3,411 

 

 

1,691 

 

 

2,458 

 

 

1,827 

Federal income tax expense

 

 

685 

 

 

130 

 

 

383 

 

 

104 

Net Income

 

$

2,726 

 

 

1,561 

 

 

2,075 

 

 

1,723 

Basic earnings per share

 

$

0.64 

 

$

0.36 

 

$

0.48 

 

$

0.40 

Diluted earnings per share

 

$

0.64 

 

$

0.36 

 

$

0.48 

 

$

0.40 

Dividends declared per share

 

$

0.19 

 

$

0.21 

 

$

0.21 

 

$

0.21 

 

Due to rounding, the sum of the quarters may not equal the amount reported for the year.

83


 

 

Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure



None.

 

Item 9A. 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 December 31, 2017, 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.

Management Report on 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.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2017, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control – Integrated Framework (2013).  Based on this assessment, Management concluded that, as of December 31, 2017, the Corporation’s internal control over financial reporting is effective based on those criteria.

There were no changes during the fourth quarter of 2017 in the Corporation’s internal control over financial reporting which materially affected, or which are reasonably likely to affect, the Corporation’s internal control over financial reporting.

The Corporation’s independent registered public accounting firm has audited the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2017.  Their report is included herein. 

84


 

 

Report of Independent Registered Public Accounting Firm



Board of Directors and Shareholders

Franklin Financial Services Corporation

Chambersburg, Pennsylvania

Opinion on Internal Control over Financial Reporting

We have audited Franklin Financial Services Corporation’s (the “Corporation”) internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”).  In our opinion, the Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on the COSO criteria.  

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Corporation and subsidiaries as of December 31, 2017 and 2016, the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2017, and the related notes and our report dated March 12, 2018 expressed an unqualified opinion thereon.

Basis for Opinion

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

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

Definition and Limitations of Internal Control over Financial Reporting

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

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

/s/ BDO USA, LLP

Harrisburg, Pennsylvania

March 12, 2018



 

85


 

 

Item 9B.  Other Information

None. 

Part III



Item 10.  Directors, Executive Officers and Corporate Governance



The information required by this Item relating to the directors and executive officers of the Corporation is incorporated herein by reference to the information set forth under the heading “ELECTION OF DIRECTORS - Information about Nominees, Continuing Directors and Executive Officers” and under the heading “ADDITIONAL INFORMATION – Key Employees” appearing in the Corporation's 2018 proxy statement.



The information required by this item relating to compliance with Section 16(a) of the Exchange Act is incorporated herein by reference to the information set forth under the heading “ADDITIONAL INFORMATION - Compliance with Section 16(a) of the Exchange Act” appearing in the Corporation's 2018 proxy statement.



The information required by this item relating to the Corporation's code of ethics is incorporated herein by reference to the information set forth under the heading “CORPORATE GOVERNANCE POLICIES, PRACTICES AND PROCEDURES” appearing in the Corporation's 2018 proxy statement.  The Corporation will file on Form 8-K any amendments to, or waivers from, the code of ethics applicable to any of its directors or executive officers.



The information required by this item relating to material changes to the procedures by which the Corporation's shareholders may recommend nominees to the Board of Directors is incorporated herein by reference to the information set forth under the heading “ELECTION OF DIRECTORS - Nominations for Election of Directors” appearing in the Corporation's 2018 proxy statement.



The information required by this item relating to the Corporation's audit committee and relating to an audit committee financial expert is incorporated herein by reference to the information set forth under the heading “BOARD STRUCTURE AND COMMITTEES - Audit Committee” appearing in the Corporation's 2018 proxy statement.

 

Item 11.  Executive Compensation



The information required by this item relating to executive compensation is incorporated herein by reference to the information set forth under the heading “EXECUTIVE COMPENSATION” appearing in the Corporation's 2018 proxy statement; provided, however, that the information set forth under the subheading “Compensation Committee Report” is intended to be furnished and not filed.



The information required by this item relating to the compensation committee interlocks and insider participation is incorporated herein by reference to the information set forth under the heading “BOARD STRUCTURE AND COMMITTEES - Compensation Committee Interlocks and Insider Participation” appearing in the Corporation's 2018 proxy statement.

 

Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters



The information required by this item relating to securities authorized for issuance under executive compensation plans is incorporated herein by reference to the information set forth under the heading “EXECUTIVE COMPENSATION – Compensation Tables and Additional Compensation Disclosure” appearing in the Corporation's 2018 proxy statement.



The information required by this item relating to security ownership of certain beneficial owners is incorporated herein by reference to the information set forth under the heading “GENERAL INFORMATION - Voting of Shares and Principal Holders Thereof' appearing in the Corporation's 2018 proxy statement.



The information required by this item relating to security ownership of management is incorporated herein by reference to the information set forth under the heading “ELECTION OF DIRECTORS - Information about Nominees, Continuing Directors and Executive Officers” appearing in the Corporation's 2018 proxy statement.

 

Item 13.  Certain Relationships and Related Transactions, and Director Independence



The information required by this item relating to transactions with related persons is incorporated herein by reference to the information set forth under the heading “ADDITIONAL INFORMATION - Transactions with Related Persons” appearing in the Corporation's 2018 proxy statement.



86


 

 

The information required by this item relating to director independence is incorporated herein by reference to the information set forth under the heading “ELECTION OF DIRECTORS -Director Independence “and under the heading “ADDITIONAL INFORMATION - Transactions with Related Persons” appearing in the Corporation's 2018 proxy statement.

 

Item 14.  Principal Accountant Fees and Services



The information required by this item relating to principal accountant fees and services is incorporated herein by reference to the information set forth under the heading “RELATIONSHIP WITH INDEPENDENT REGISTERED PUBLIC ACCOUNTANTS” appearing in the Corporation's 2018 proxy statement.

 

Part IV

Item 15.  Exhibits and Financial Statement Schedules

(a) The following documents are filed as part of this report:

(1)  The following Consolidated Financial Statements of the Corporation:

Report of Independent Registered Public Accounting Firms

Consolidated Balance Sheets –December 31, 2017 and 2016,

Consolidated Statements of Income – Years ended December 31, 2017,  2016 and 2015,

Consolidated Statements of Comprehensive Income – Years ended December 31, 2017,  2016 and 2015,

Consolidated Statements of Changes in Shareholders’ Equity – Years ended December 31, 2017,  2016 and 2015,

Consolidated Statements of Cash Flows - Years ended December 31, 2017,  2016 and 2015,

Notes to Consolidated Financial Statements.

(2)  All financial statement schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and have therefore been omitted.

(3)  The following exhibits are part of this report:





 

3.1

Articles of Incorporation of the Corporation

3.2

Bylaws of the Corporation

4.

Instruments defining the rights of security holders, including indentures, are contained in the Articles of Incorporation (Exhibit 3.1) and the Bylaws (Exhibit 3.2)

10.1

Deferred Compensation Agreements with Bank Directors*

10.2

Directors’ Deferred Compensation Plan*

10.3

Incentive Stock Option Plan of 2002*

10.4

Management Group Pay for Performance Plan*

10.5

Directors Pay for Performance Plan*

10.6

Incentive Stock Option Plan of 2013*

14.

Code of Ethics posted on the Corporation’s website

21.

Subsidiaries of the Corporation

23.1

Consent of BDO USA, LLP

31.1

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

31.2

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

32.1

Section 1350 Certification (Chief Executive Officer)

32.2

Section 1350 Certification (Chief Financial Officer)

101

Interactive Data File (XBRL)



* Compensatory plan or arrangement.

(b) The exhibits required to be filed as part of this report are submitted as a separate section of this report.

(c) Financial Statement Schedules: None.



87


 

 

SIGNATURES



Pursuant to the requirements of Section 13 or 15(d) of the Securities and 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



By: /s/ Timothy G. Henry



      Timothy G. Henry



      President and Chief Executive Officer



Dated: March 12, 2018



Pursuant to the requirements of the Securities and Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.







 

 

Signature

Title

Date

/s/ G. Warren Elliott

Chairman of the Board and Director

March 12, 2018

G. Warren Elliott

 

 



 

 

/s/ Timothy G. Henry

Chief Executive Officer, President and Director

March 12, 2018

Timothy G. Henry

(Principal Executive Officer)

 



 

 

/s/ Mark R. Hollar

Treasurer and Chief Financial Officer

March 12, 2018

Mark R. Hollar

(Principal Financial and Accounting Officer)

 



 

 

/s/ Martin R. Brown

Director

March 12, 2018

Martin R. Brown

 

 



 

 

/s/ Gregory A. Duffey

Director

March 12, 2018

Gregory A. Duffey

 

 



 

 

/s/ Daniel J. Fisher

Director

March 12, 2018

Daniel J. Fisher

 

 



 

 

/s/ Donald A. Fry

Director

March 12, 2018

Donald A. Fry

 

 



 

 

/s/ Allan E. Jennings, Jr.

Director

March 12, 2018

Allan E. Jennings, Jr.

 

 



 

 

/s/ Richard E. Jordan, III

Director

March 12, 2018

Richard E. Jordan, III

 

 



 

 

/s/ Stanley J. Kerlin

Director

March 12, 2018

Stanley J. Kerlin

 

 



 

 

/s/ Patricia D. Lacy

Director

March 12, 2018

Patricia D. Lacy

 

 



 

 

/s/ Donald H. Mowery

Director

March 12, 2018

Donald H. Mowery

 

 



 

 

/s/ Martha B. Walker

Director

March 12, 2018

Martha B. Walker

 

 

 

88


 

 

Exhibit Index for the Year

Ended December 31, 2017



 

Item

Description

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, 2014 and incorporated herein by reference.) 

3.2

Bylaws of the Corporation 

4.

Instruments defining the rights of securities holders, including indentures, are contained in the Articles of Incorporation (Exhibit 3.1) and Bylaws (Exhibit 3.2)

10.1

Deferred Compensation Agreements with Bank Directors* (Filed as Exhibit 10.1 to Annual Report on Form 10-K for the year ended December 31, 2014 and incorporated herein by reference.)

10.2

Director’s Deferred Compensation Plan* (Filed as Exhibit 10.2 to Annual Report on Form 10-K for the year ended December 31, 2014 and incorporated herein by reference.)

10.3 

Incentive Stock Option Plan of 2002 (Filed as Exhibit 99.1 to Registration Statement No. 333-90348 on Form S-8 and incorporated herein by reference)*   

10.4

Management Group Pay for Performance Program* (Filed as Exhibit 10.4 to Annual Report on Form 10-K for the year ended December 31, 2014 and incorporated herein by reference.)

10.5

Directors Pay for Performance Program* (Filed as Exhibit 10.5 to Annual Report on Form 10-K for the year ended December 31, 2014 and incorporated herein by reference.)

10.6

Incentive Stock Option Plan of 2013 (Filed as Exhibit 10.1 to Registration Statement No. 333-193655 on Form S-8 filed January 30, 2014 and incorporated herein by reference)*

14.

Code of Ethics posted on the Corporation’s website

21.

Subsidiaries of Corporation - filed herewith

23.1

Consent of BDO USA, LLP – filed herewith

31.1

Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer) – filed herewith

31.2

Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer) – filed herewith

32.1

Section 1350 Certification (Chief Executive Officer) – filed herewith

32.2

Section 1350 Certification (Chief Financial Officer) – filed herewith

101

Interactive Data File (XBRL)



* Compensatory plan or arrangement. 

89