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FRANKLIN FINANCIAL SERVICES CORP /PA/ - Quarter Report: 2018 March (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

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

For the quarterly period ended March 31, 2018

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

For the transition period from__________ to___________

Commission file number 0-12126

FRANKLIN FINANCIAL SERVICES CORPORATION

(Exact name of registrant as specified in its charter)



 

PENNSYLVANIA

25-1440803

(State or other jurisdiction of incorporation or organization) 

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







 

20 South Main Street, Chambersburg

PA 17201-0819

(Address of principal executive offices)

(Zip Code)



(717) 264-6116

(Registrant's telephone number, including area code)

Not Applicable

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

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



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



Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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



There were 4,366,279 outstanding shares of the Registrant’s common stock as of April  30, 2018.

 


 

INDEX



               



 

 

Part I - FINANCIAL INFORMATION

 



 

 

Item 1

Financial Statements

 



Consolidated Balance Sheets as of March  31, 2018 and December 31, 2017 (unaudited)

1



Consolidated Statements of Income for the Three Months ended March  31, 2018 

2



and 2017 (unaudited)

 



Consolidated Statements of Comprehensive Income for the Three Months ended

3



March  31, 2018 and 2017 (unaudited)

 



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

3



ended March 31, 2018 and 2017 (unaudited)

 



Consolidated Statements of Cash Flows for the Three Months ended March  31, 2018 

4



and 2017 (unaudited)

 



Notes to Consolidated Financial Statements (unaudited)

5



 

 

Item 2

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

23

Item 3

Quantitative and Qualitative Disclosures about Market Risk

40

Item 4

Controls and Procedures

40



 

 

Part II - OTHER INFORMATION 

 



 

 

Item 1

Legal Proceedings

41

Item 1A

Risk Factors

41

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

42

Item 3

Defaults Upon Senior Securities

42

Item 4

Mine Safety Disclosures

42

Item 5

Other Information

43

Item 6

Exhibits

43

SIGNATURE PAGE

44



 







 

 


 

Part I FINANCIAL INFORMATION

Item 1 Financial Statements

Consolidated Balance Sheets







 

 

 

 

 

 

 

 

 

 

 

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

March 31,

 

December 31,



2018

 

2017

Assets

 

 

 

 

 

Cash and due from banks

$

14,148 

 

$

21,433 

Interest-bearing deposits in other banks

 

27,934 

 

 

37,170 

Total cash and cash equivalents

 

42,082 

 

 

58,603 

Debt securities available for sale, at fair value

 

133,322 

 

 

126,971 

Equity securities

 

410 

 

 

365 

Restricted stock

 

456 

 

 

456 

Loans held for sale

 

 —

 

 

442 

Loans

 

942,653 

 

 

943,700 

Allowance for loan losses

 

(11,989)

 

 

(11,792)

Net Loans

 

930,664 

 

 

931,908 

Premises and equipment, net

 

13,576 

 

 

13,741 

Bank owned life insurance

 

23,108 

 

 

22,980 

Goodwill

 

9,016 

 

 

9,016 

Other real estate owned

 

2,592 

 

 

2,598 

Deferred tax asset, net

 

6,062 

 

 

5,803 

Other assets

 

7,254 

 

 

6,930 

Total assets

$

1,168,542 

 

$

1,179,813 



 

 

 

 

 

Liabilities

 

 

 

 

 

Deposits

 

 

 

 

 

Non-interest bearing checking

$

193,237 

 

$

196,853 

Money management, savings and interest checking

 

774,837 

 

 

774,857 

Time

 

66,387 

 

 

75,471 

Total deposits

 

1,034,461 

 

 

1,047,181 

Other liabilities

 

16,957 

 

 

17,488 

Total liabilities

 

1,051,418 

 

 

1,064,669 



 

 

 

 

 

Shareholders' equity

 

 

 

 

 

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

 

 

 

 

 

4,695,617 shares issued and 4,364,812 shares outstanding at March 31, 2018 and

 

 

 

 

 

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

 

4,696 

 

 

4,689 

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

 

 

 

 

 

shares issued and outstanding

 

 —

 

 

 —

Additional paid-in capital

 

40,668 

 

 

40,396 

Retained earnings

 

84,876 

 

 

82,218 

Accumulated other comprehensive loss

 

(7,010)

 

 

(6,028)

Treasury stock, 330,805 shares at March 31, 2018 and 334,311 shares at

 

 

 

 

 

December 31, 2017, at cost

 

(6,106)

 

 

(6,131)

Total shareholders' equity

 

117,124 

 

 

115,144 

Total liabilities and shareholders' equity

$

1,168,542 

 

$

1,179,813 

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

1


 

Consolidated Statements of Income





 

 

 

 

 

 



 

For the Three Months Ended

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

 

March 31,



 

2018

 

2017

Interest income

 

 

 

 

 

 

Loans, including fees

 

$

9,577 

 

$

8,639 

Interest and dividends on investments:

 

 

 

 

 

 

Taxable interest

 

 

513 

 

 

531 

Tax exempt interest

 

 

274 

 

 

301 

Dividend income

 

 

 

 

13 

Deposits and obligations of other banks

 

 

118 

 

 

62 

Total interest income

 

 

10,488 

 

 

9,546 

Interest expense

 

 

 

 

 

 

Deposits

 

 

795 

 

 

566 

Short-term borrowings

 

 

 —

 

 

15 

Total interest expense

 

 

795 

 

 

581 

Net interest income

 

 

9,693 

 

 

8,965 

Provision for loan losses

 

 

200 

 

 

120 

Net interest income after provision for loan losses

 

 

9,493 

 

 

8,845 

Noninterest income

 

 

 

 

 

 

Investment and trust services fees

 

 

1,397 

 

 

1,295 

Loan service charges

 

 

231 

 

 

147 

Deposit service charges and fees

 

 

574 

 

 

592 

Other service charges and fees

 

 

333 

 

 

324 

Debit card income

 

 

385 

 

 

375 

Increase in cash surrender value of life insurance

 

 

128 

 

 

131 

Debt securities gains, net

 

 

 —

 

 

Change in fair value of equity securities

 

 

45 

 

 

 —

Other

 

 

55 

 

 

59 

Total noninterest income

 

 

3,148 

 

 

2,925 

Noninterest Expense

 

 

 

 

 

 

Salaries and employee benefits

 

 

4,986 

 

 

4,591 

Occupancy, furniture and equipment, net

 

 

815 

 

 

815 

Advertising

 

 

427 

 

 

247 

Legal and professional

 

 

329 

 

 

290 

Data processing

 

 

596 

 

 

541 

Pennsylvania bank shares tax

 

 

239 

 

 

243 

FDIC Insurance

 

 

129 

 

 

106 

ATM/debit card processing

 

 

238 

 

 

218 

Foreclosed real estate

 

 

14 

 

 

58 

Telecommunications

 

 

109 

 

 

100 

Other

 

 

766 

 

 

748 

Total noninterest expense

 

 

8,648 

 

 

7,957 

Income before federal income taxes

 

 

3,993 

 

 

3,813 

Federal income tax expense

 

 

491 

 

 

793 

Net income

 

$

3,502 

 

$

3,020 

Per share

 

 

 

 

 

 

Basic earnings per share

 

$

0.80 

 

$

0.70 

Diluted earnings per share

 

$

0.80 

 

$

0.70 

Cash dividends declared

 

$

0.24 

 

$

0.21 

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

2


 

Consolidated Statements of Comprehensive Income





 

 

 

 

 

 



 

For the Three Months Ended



 

March 31,

(Dollars in thousands) (unaudited)

 

2018

 

2017

Net Income

 

$

3,502 

 

$

3,020 



 

 

 

 

 

 

Debt Securities:

 

 

 

 

 

 

Unrealized (losses) gains arising during the period

 

 

(1,043)

 

 

454 

Reclassification adjustment included in net income (1)

 

 

 —

 

 

(2)

Net unrealized gains

 

 

(1,043)

 

 

452 

Tax effect

 

 

262 

 

 

(153)

Net of tax amount

 

 

(781)

 

 

299 



 

 

 

 

 

 

Total other comprehensive (loss) income

 

 

(781)

 

 

299 



 

 

 

 

 

 

Total Comprehensive Income

 

$

2,721 

 

$

3,319 



 

 

 

 

 

 



 

 

 

 

 

 

Reclassification adjustment / Statement line item

 

Tax  expense (benefit)

(1) Debt securities gains, net

 

$

 —

 

$

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

 

Consolidated Statements of Changes in Shareholders' Equity

For the three months ended March 31, 2018 and 2017









 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 



 

 

 

Additional

 

 

 

 

Other

 

 

 

 

 

 



Common

 

Paid-in

 

Retained

 

Comprehensive

 

Treasury

 

 

 

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

Stock

 

Capital

 

Earnings

 

Loss

 

Stock

 

Total

Balance at December 31, 2016

$

4,688 

 

$

39,752 

 

$

83,081 

 

$

(4,215)

 

$

(6,813)

 

$

116,493 

Net income

 

 —

 

 

 —

 

 

3,020 

 

 

 —

 

 

 —

 

 

3,020 

Other comprehensive income

 

 —

 

 

 —

 

 

 —

 

 

299 

 

 

 —

 

 

299 

Cash dividends declared, $.21 per share

 

 —

 

 

 —

 

 

(907)

 

 

 —

 

 

 —

 

 

(907)

Treasury shares issued under employee stock purchase plan, 1,126 shares

 

 —

 

 

 

 

 —

 

 

 —

 

 

21 

 

 

25 

Treasury shares issued under dividend reinvestment plan, 7,463 shares

 

 —

 

 

84 

 

 

 —

 

 

 —

 

 

137 

 

 

221 

Stock option compensation expense

 

 —

 

 

27 

 

 

 —

 

 

 —

 

 

 —

 

 

27 

Balance at March 31, 2017

$

4,688 

 

$

39,867 

 

$

85,194 

 

$

(3,916)

 

$

(6,655)

 

$

119,178 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2017

$

4,689 

 

$

40,396 

 

$

82,218 

 

$

(6,028)

 

$

(6,131)

 

$

115,144 

Cumulative adjustment for fair value of equity securities

 

 —

 

 

 —

 

 

201 

 

 

(201)

 

 

 —

 

 

 —

Net income

 

 —

 

 

 —

 

 

3,502 

 

 

 —

 

 

 —

 

 

3,502 

Other comprehensive income

 

 —

 

 

 —

 

 

 —

 

 

(781)

 

 

 —

 

 

(781)

Cash dividends declared, $.24 per share

 

 —

 

 

 —

 

 

(1,045)

 

 

 —

 

 

 —

 

 

(1,045)

Acquisition of 2,605 shares of treasury stock

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(88)

 

 

(88)

Treasury shares issued under employee stock purchase plan, 200 shares

 

 —

 

 

 

 

 —

 

 

 —

 

 

 

 

Treasury shares issued under dividend reinvestment plan, 5,911 shares

 

 —

 

 

97 

 

 

 —

 

 

 —

 

 

109 

 

 

206 

Common stock issued under incentive stock option plan, 6,518 shares

 

 

 

142 

 

 

 —

 

 

 —

 

 

 —

 

 

149 

Stock option compensation expense

 

 —

 

 

31 

 

 

 —

 

 

 —

 

 

 —

 

 

31 

Balance at March 31, 2018

$

4,696 

 

$

40,668 

 

$

84,876 

 

$

(7,010)

 

$

(6,106)

 

$

117,124 

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

3


 

Consolidated Statements of Cash Flows





 

 

 

 

 

 



 

 

 

 

 

 



 

Three Months Ended
March 31,



 

2018

 

2017

(Dollars in thousands) (unaudited)

 

 

 

 

 

 

Cash flows from operating activities

 

 

 

 

 

 

Net income

 

$

3,502 

 

$

3,020 

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

 

 

 

 

 

 

Depreciation and amortization

 

 

333 

 

 

332 

Net amortization of loans and investment securities

 

 

438 

 

 

369 

Amortization and net change in mortgage servicing rights valuation

 

 

 —

 

 

14 

Provision for loan losses

 

 

200 

 

 

120 

Equity investments recorded at fair value through income

 

 

(45)

 

 

 —

Debt securities gains, net

 

 

 —

 

 

(2)

Loans originated for sale

 

 

(2,527)

 

 

(1,220)

Proceeds from sale of loans

 

 

2,969 

 

 

1,312 

Write-down of other real estate owned

 

 

 

 

45 

Write-down on premises and equipment available for sale

 

 

 —

 

 

49 

Loss on sale of premises

 

 

17 

 

 

 —

Increase in cash surrender value of life insurance

 

 

(128)

 

 

(131)

Stock option compensation

 

 

31 

 

 

27 

Contribution to pension plan

 

 

(1,000)

 

 

 —

Decrease in other assets

 

 

(448)

 

 

(1,409)

Increase in other liabilities

 

 

148 

 

 

619 

Net cash provided by operating activities

 

 

3,496 

 

 

3,145 

Cash flows from investing activities

 

 

 

 

 

 

Proceeds from sales and calls of investment securities available for sale

 

 

 —

 

 

475 

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

 

 

5,726 

 

 

6,246 

Purchase of investment securities available for sale

 

 

(13,380)

 

 

 —

Net decrease in restricted stock

 

 

 —

 

 

1,331 

Net decrease (increase) in loans

 

 

1,031 

 

 

(9,517)

Capital expenditures

 

 

(107)

 

 

34 

Proceeds from sale of other assets

 

 

117 

 

 

 —

Proceeds from sale of other real estate

 

 

 —

 

 

1,751 

Net cash (used in) provided by investing activities

 

 

(6,613)

 

 

320 

Cash flows from financing activities

 

 

 

 

 

 

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

 

 

(3,636)

 

 

25,360 

Net decrease in time deposits

 

 

(9,084)

 

 

(886)

Net decrease in short-term borrowings

 

 

 —

 

 

(24,270)

Dividends paid

 

 

(1,045)

 

 

(907)

Treasury shares issued under employee stock purchase plan

 

 

 

 

25 

Treasury shares issued under dividend reinvestment plan

 

 

206 

 

 

221 

Common stock issued under stock option plans

 

 

149 

 

 

 —

Net cash used in financing activities

 

 

(13,404)

 

 

(457)

(Decrease) increase in cash and cash equivalents

 

 

(16,521)

 

 

3,008 

Cash and cash equivalents as of January 1

 

 

58,603 

 

 

39,166 

Cash and cash equivalents as of March 31

 

$

42,082 

 

$

42,174 

Supplemental Disclosures of Cash Flow Information

 

 

 

 

 

 

Cash paid during the year for:

 

 

 

 

 

 

Interest on deposits and other borrowed funds

 

$

792 

 

$

566 

Income taxes

 

$

 —

 

$

1,002 



 

 

 

 

 

 

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

4


 

FRANKLIN FINANCIAL SERVICES CORPORATION and SUBSIDIARIES

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 1 - Basis of Presentation

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

In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the consolidated financial position, results of operations, and cash flows as of March 31, 2018, and for all other periods presented have been made.

Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted.  It is suggested that these consolidated financial statements be read in conjunction with the audited consolidated financial statements and notes thereto included in the Corporation’s 2017 Annual Report on Form 10-K.  The consolidated results of operations for the three month period ended March 31, 2018 are not necessarily indicative of the operating results for the full year.  Management has evaluated subsequent events for potential recognition and/or disclosure through the date these consolidated financial statements were issued.

The consolidated balance sheet at December 31, 2017 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete consolidated financial statements.

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

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







 

 

 

 

 

 



 

For the Three Months Ended



 

March 31,

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

 

2018

 

2017

Weighted average shares outstanding (basic)

 

 

4,359 

 

 

4,321 

Impact of common stock equivalents

 

 

28 

 

 

20 

Weighted average shares outstanding (diluted)

 

 

4,387 

 

 

4,341 

Anti-dilutive options excluded from calculation

 

 

 —

 

 

14 

Net income

 

$

3,502 

 

$

3,020 

Basic earnings per share

 

$

0.80 

 

$

0.70 

Diluted earnings per share

 

$

0.80 

 

$

0.70 

 

5


 

Note 2. Recent Accounting Pronouncements





 

 

 

 

 

 

Standard

 

Description

 

Effective Date

 

Effect on the financial statements or other significant matters



 

 

 

 

 

 

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 adopted the provisions of the ASU on January 1, 2018 and it had no material 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

 

The Corporation adopted the provisions of the ASU on January 1, 2018 and it had no material effect on the consolidated financial statements.  The service cost is reported in Salaries and Benefits expense and the nonservice cost is included in Other Expense on the Consolidated Statement of Income, which totaled $35 thousand reclassified for the first quarter of 2017.



 

 

 

 

 

 

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 Corporation adopted this ASU on January 1, 2018, on a modified retrospective approach, and it did not have a material effect on the Corporation's consolidated financial statements.  See Note 11. Revenue Recognition for more information.



 

 

 

 

 

 

6


 

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 Corporation adopted the provisions of the ASU on January 1, 2018 and it had no material effect on the consolidated financial statements. The Corporation reclassified the fair value of equity securities by increasing retained earnings by $201 thousand and decreasing AOCI by $201 thousand.  In addition, according to the standard, the Corporation measured the fair value of the loan portfolio as of March 31, 2018 using an exit price notion.  See Note 9. Fair Value  Measurements and Fair Values of Financial Instruments for more information.



 

 

 

 

 

 

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.



 

 

 

 

 

 

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.



 

 

 

 

 

 

7


 

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 3. Accumulated Other Comprehensive Loss

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







 

 

 

 

 

 



 

 

 

 

 

 



 

March 31,

 

December 31,



 

2018

 

2017

(Dollars in thousands)

 

 

 

 

 

 

Net unrealized (losses) gains on debt securities

 

$

(1,090)

 

$

154 

Tax effect

 

 

229 

 

 

(33)

Net of tax amount

 

 

(861)

 

 

121 



 

 

 

 

 

 

Accumulated pension adjustment

 

 

(7,784)

 

 

(7,784)

Tax effect

 

 

1,635 

 

 

1,635 

Net of tax amount

 

 

(6,149)

 

 

(6,149)



 

 

 

 

 

 

Total accumulated other comprehensive loss

 

$

(7,010)

 

$

(6,028)

 

Note 4. Investments

Available for Sale (AFS) Securities

The amortized cost and estimated fair value of AFS securities available for sale as of March 31, 2018 and December 31, 2017 are as follows:







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

March 31, 2018

 

cost

 

gains

 

losses

 

value

U.S. Government and Agency securities

 

$

10,534 

 

$

22 

 

$

(74)

 

$

10,482 

Municipal securities

 

 

63,520 

 

 

409 

 

 

(619)

 

 

63,310 

Trust preferred securities

 

 

6,007 

 

 

 

 

(159)

 

 

5,849 

Agency mortgage-backed securities

 

 

53,494 

 

 

105 

 

 

(852)

 

 

52,747 

Private-label mortgage-backed securities

 

 

830 

 

 

79 

 

 

 —

 

 

909 

Asset-backed securities

 

 

27 

 

 

 —

 

 

(2)

 

 

25 



 

$

134,412 

 

$

616 

 

$

(1,706)

 

$

133,322 







8


 



 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(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 



 

$

127,182 

 

$

1,200 

 

$

(1,046)

 

$

127,336 



At March 31, 2018 and December 31, 2017, the fair value of AFS securities pledged to secure public funds and trust deposits totaled $78.9 million and  $84.1 million, respectively.



The amortized cost and estimated fair value of debt securities at March 31, 2018, 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

 

$

5,174 

 

$

5,199 

Due after one year through five years

 

 

45,530 

 

 

45,705 

Due after five years through ten years

 

 

25,583 

 

 

25,062 

Due after ten years

 

 

3,801 

 

 

3,700 



 

 

80,088 

 

 

79,666 

Mortgage-backed securities

 

 

54,324 

 

 

53,656 



 

$

134,412 

 

$

133,322 



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





 

 

 

 

 

 



 

For the Three Months Ended



 

March 31,

(Dollars in thousands)

 

2018

 

2017

Gross gains realized

 

$

 —

 

$

Gross losses realized

 

 

 —

 

 

 —

Net gains realized

 

$

 —

 

$



Impairment:

The AFS investment portfolio contained 166 securities with $92.1 million of temporarily impaired fair value and $1.7 million in unrealized losses at March 31, 2018. The total unrealized loss position has increased from a $1.0 million unrealized loss at year-end 2017. 

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 March 31, 2018, was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted.

9


 

The following table reflects temporary impairment in the AFS 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 March 31, 2018 and December 31, 2017:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



March 31, 2018



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

$

5,588 

 

$

(37)

 

 

$

3,331 

 

$

(37)

 

10 

 

$

8,919 

 

$

(74)

 

17 

Municipal securities

 

26,203 

 

 

(339)

 

41 

 

 

7,365 

 

 

(280)

 

14 

 

 

33,568 

 

 

(619)

 

55 

Trust preferred securities

 

1,867 

 

 

(50)

 

 

 

3,700 

 

 

(109)

 

 

 

5,567 

 

 

(159)

 

Agency mortgage-backed securities

 

25,164 

 

 

(337)

 

46 

 

 

18,900 

 

 

(515)

 

40 

 

 

44,064 

 

 

(852)

 

86 

Asset-backed securities

 

18 

 

 

(1)

 

 

 

 

 

(1)

 

 

 

23 

 

 

(2)

 

Total temporarily impaired
  securities

$

58,840 

 

$

(764)

 

97 

 

$

33,301 

 

$

(942)

 

69 

 

$

92,141 

 

$

(1,706)

 

166 









 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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 

Asset-backed securities

 

 —

 

 

 —

 

 —

 

 

 

 

(1)

 

 

 

 

 

(1)

 

Total temporarily impaired
  securities

$

33,585 

 

$

(241)

 

58 

 

$

36,203 

 

$

(805)

 

69 

 

$

69,788 

 

$

(1,046)

 

127 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



The following table represents the cumulative credit losses on AFS securities recognized in earnings for:







 

 

 

 

 

 



 

 

 

 

 

 



 

Three Months Ended

(Dollars in thousands)

 

March 31,



 

2018

 

2017

Balance of cumulative credit-related OTTI at January 1

 

$

595 

 

$

595 

Additions for credit-related OTTI not previously recognized

 

 

 —

 

 

 —

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 March 31

 

$

595 

 

$

595 



 

 

 

 

 

 

Equity Securities at fair value

The Corporation owns one equity investment.  At March 31, 2018, this investment was reported at fair value ($410 thousand) with changes in value report through income.  At December 31, 2017, this investment was reported at fair value with changes in value recorded through other comprehensive income and was included in the Available for Sale Securities table of this note.

Restricted Stock at Cost

The Bank held $456 thousand of restricted stock at March 31, 2018.  Except for $30 thousand, this investment represents stock in FHLB Pittsburgh. The Bank is required to hold this stock to be a member of FHLB and it is carried at cost of $100 per share. The level of FHLB stock held is determined by FHLB and is comprised of a minimum membership amount plus a variable activity amount. FHLB stock is evaluated for impairment primarily based on an assessment of the ultimate recoverability of its cost. As a government sponsored entity, FHLB has the ability to raise

10


 

funding through the U.S. Treasury that can be used to support its operations.  There is not a public market for FHLB stock and the benefits of FHLB membership (e.g., liquidity and low cost funding) add value to the stock beyond purely financial measures. Management intends to remain a member of the FHLB and believes that it will be able to fully recover the cost basis of this investment. 



Note 5. Loans

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

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



 

 

 

 

 

 



 

 

 

 

 

 



 

March 31,

 

December 31,

(Dollars in thousands)

 

2018

 

2017

Residential Real Estate 1-4 Family

 

 

 

 

 

 

Consumer first liens

 

$

93,897 

 

$

97,159 

Commercial first lien

 

 

61,790 

 

 

61,275 

Total first liens

 

 

155,687 

 

 

158,434 



 

 

 

 

 

 

Consumer junior liens and lines of credit

 

 

43,842 

 

 

45,043 

Commercial junior liens and lines of credit

 

 

5,014 

 

 

5,328 

Total junior liens and lines of credit

 

 

48,856 

 

 

50,371 

Total residential real estate 1-4 family

 

 

204,543 

 

 

208,805 



 

 

 

 

 

 

Residential real estate - construction

 

 

 

 

 

 

Consumer

 

 

2,756 

 

 

1,813 

Commercial

 

 

8,735 

 

 

8,088 

Total residential real estate construction

 

 

11,491 

 

 

9,901 



 

 

 

 

 

 

Commercial real estate

 

 

433,821 

 

 

428,428 

Commercial

 

 

287,680 

 

 

291,519 

        Total commercial

 

 

721,501 

 

 

719,947 



 

 

 

 

 

 

Consumer

 

 

5,118 

 

 

5,047 



 

 

942,653 

 

 

943,700 

Less: Allowance for loan losses

 

 

(11,989)

 

 

(11,792)

Net Loans

 

$

930,664 

 

$

931,908 



 

 

 

 

 

 

Included in the loan balances are the following:

 

 

 

 

 

 

Net unamortized deferred loan costs

 

$

40 

 

$

98 



 

 

 

 

 

 

Loans pledged as collateral for borrowings and commitments from:

 

 

 

 

 

 

FHLB

 

$

735,979 

 

$

737,313 

Federal Reserve Bank

 

 

35,137 

 

 

35,740 



 

$

771,116 

 

$

773,053 

 

11


 

Note 6. Loan Quality and Allowance for Loan Losses

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





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 



 

First

 

Junior Liens &

 

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

Liens

 

Lines of Credit

 

Construction

 

Real Estate

 

Commercial

 

Consumer

 

Unallocated

 

Total



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at December 31, 2017

 

$

1,060 

 

$

330 

 

$

224 

 

$

6,526 

 

$

2,110 

 

$

105 

 

$

1,437 

 

$

11,792 

Charge-offs

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(26)

 

 

 —

 

 

(26)

Recoveries

 

 

 

 

 —

 

 

 —

 

 

 —

 

 

 

 

14 

 

 

 —

 

 

23 

Provision

 

 

(18)

 

 

(10)

 

 

36 

 

 

172 

 

 

(45)

 

 

11 

 

 

54 

 

 

200 

ALL at March 31, 2018

 

$

1,043 

 

$

320 

 

$

260 

 

$

6,698 

 

$

2,073 

 

$

104 

 

$

1,491 

 

$

11,989 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at December 31, 2016

 

$

1,105 

 

$

323 

 

$

224 

 

$

6,109 

 

$

1,893 

 

$

100 

 

$

1,321 

 

$

11,075 

Charge-offs

 

 

(8)

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(28)

 

 

 —

 

 

(36)

Recoveries

 

 

 

 

 —

 

 

 —

 

 

 —

 

 

102 

 

 

16 

 

 

 —

 

 

119 

Provision

 

 

 

 

(2)

 

 

50 

 

 

17 

 

 

(11)

 

 

11 

 

 

53 

 

 

120 

ALL at March 31, 2017

 

$

1,100 

 

$

321 

 

$

274 

 

$

6,126 

 

$

1,984 

 

$

99 

 

$

1,374 

 

$

11,278 



12


 

The following table presents, by class, loans that were evaluated for the ALL under the specific reserve (individually) and those that were evaluated under the general reserve (collectively) and the amount of the ALL established in each class as of March 31, 2018 and December 31, 2017:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 



 

First

 

Junior Liens &

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

Liens

 

Lines of Credit

 

Construction

 

Real Estate

 

Commercial

 

Consumer

 

Unallocated

 

Total



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for ALL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

454 

 

$

 —

 

$

466 

 

$

10,878 

 

$

 —

 

$

 —

 

$

 —

 

$

11,798 

Collectively

 

 

155,233 

 

 

48,856 

 

 

11,025 

 

 

422,943 

 

 

287,680 

 

 

5,118 

 

 

 —

 

 

930,855 

Total

 

$

155,687 

 

$

48,856 

 

$

11,491 

 

$

433,821 

 

$

287,680 

 

$

5,118 

 

$

 —

 

$

942,653 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL established for
  loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

Collectively

 

 

1,043 

 

 

320 

 

 

260 

 

 

6,698 

 

 

2,073 

 

 

104 

 

 

1,491 

 

 

11,989 

ALL at March 31, 2018

 

$

1,043 

 

$

320 

 

$

260 

 

$

6,698 

 

$

2,073 

 

$

104 

 

$

1,491 

 

$

11,989 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 

13


 

The following table shows additional information about those loans considered to be impaired at March 31, 2018 and December 31, 2017:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Impaired Loans



 

With No Allowance

 

With Allowance

(Dollars in thousands)

 

 

 

 

Unpaid

 

 

 

 

Unpaid

 

 

 



 

Recorded

 

Principal

 

Recorded

 

Principal

 

Related

March 31, 2018

 

Investment

 

Balance

 

Investment

 

Balance

 

Allowance

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

803 

 

$

882 

 

$

 —

 

$

 —

 

$

 —

Junior liens and lines of credit

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Total

 

 

803 

 

 

882 

 

 

 —

 

 

 —

 

 

 —

 Residential real estate - construction

 

 

466 

 

 

531 

 

 

 —

 

 

 —

 

 

 —

 Commercial real estate

 

 

10,949 

 

 

11,435 

 

 

 —

 

 

 —

 

 

 —

 Commercial

 

 

183 

 

 

198 

 

 

 —

 

 

 —

 

 

 —

Total

 

$

12,401 

 

$

13,046 

 

$

 —

 

$

 —

 

$

 —







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 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 

 

$

 —

 

$

 —

 

$

 —





The following table shows the average of impaired loans and related interest income for the three months ended March 31, 2018 and 2017:





 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

Three Months Ended



 

March 31, 2018

 

March 31, 2017



 

Average

 

Interest

 

Average

 

Interest

(Dollars in thousands)

 

Recorded

 

Income

 

Recorded

 

Income



 

Investment

 

Recognized

 

Investment

 

Recognized

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

805 

 

$

11 

 

$

919 

 

$

10 

Junior liens and lines of credit

 

 

 —

 

 

 —

 

 

85 

 

 

 —

Total

 

 

805 

 

 

11 

 

 

1,004 

 

 

10 

 Residential real estate - construction

 

 

466 

 

 

 —

 

 

479 

 

 

 —

 Commercial real estate

 

 

10,994 

 

 

105 

 

 

13,519 

 

 

116 

 Commercial

 

 

185 

 

 

 —

 

 

23 

 

 

 —

Total

 

$

12,450 

 

$

116 

 

$

15,025 

 

$

126 

14


 

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





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Loans Past Due and Still Accruing

 

 

 

 

Total



 

Current

 

30-59 Days

 

60-89 Days

 

90 Days+

 

Total

 

Non-Accrual

 

Loans

March 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

155,126 

 

$

398 

 

$

56 

 

$

 —

 

$

454 

 

$

107 

 

$

155,687 

Junior liens and lines of credit

 

 

48,743 

 

 

85 

 

 

28 

 

 

 —

 

 

113 

 

 

 —

 

 

48,856 

Total

 

 

203,869 

 

 

483 

 

 

84 

 

 

 —

 

 

567 

 

 

107 

 

 

204,543 

Residential real estate - construction

 

 

11,025 

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

466 

 

 

11,491 

Commercial real estate

 

 

431,542 

 

 

348 

 

 

 —

 

 

89 

 

 

437 

 

 

1,842 

 

 

433,821 

Commercial

 

 

287,289 

 

 

54 

 

 

154 

 

 

 —

 

 

208 

 

 

183 

 

 

287,680 

Consumer

 

 

5,100 

 

 

15 

 

 

 

 

 —

 

 

18 

 

 

 —

 

 

5,118 

Total

 

$

938,825 

 

$

900 

 

$

241 

 

$

89 

 

$

1,230 

 

$

2,598 

 

$

942,653 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 



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



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



Pass

 

Special Mention

 

Substandard

 

Doubtful

 

 

 

(Dollars in thousands)

(1-5)

 

(6)

 

(7)

 

(8)

 

Total



 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

$

155,040 

 

$

 —

 

$

647 

 

$

 —

 

$

155,687 

Junior liens and lines of credit

 

48,856 

 

 

 —

 

 

 —

 

 

 —

 

 

48,856 

Total

 

203,896 

 

 

 —

 

 

647 

 

 

 —

 

 

204,543 

Residential real estate - construction

 

10,370 

 

 

 —

 

 

1,121 

 

 

 —

 

 

11,491 

Commercial real estate

 

423,072 

 

 

2,393 

 

 

8,356 

 

 

 —

 

 

433,821 

Commercial

 

286,905 

 

 

 —

 

 

775 

 

 

 —

 

 

287,680 

Consumer

 

5,117 

 

 

 —

 

 

 

 

 —

 

 

5,118 

Total

$

929,360 

 

$

2,393 

 

$

10,900 

 

$

 —

 

$

942,653 









 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 

15


 



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



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

Troubled Debt Restructurings



 

 

 

 

 

 

 

 

 

 

 

 

Within the Last 12 Months



 

 

 

 

 

 

 

 

 

That Have Defaulted

(Dollars in thousands)

 

Troubled Debt Restructurings

 

On Modified Terms



 

Number of

 

Recorded

 

 

 

 

 

 

 

Number of

 

Recorded



 

Contracts

 

Investment

 

Performing*

 

Nonperforming*

 

Contracts

 

Investment

March 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

$

466 

 

$

 —

 

$

466 

 

 —

 

$

 —

Residential real estate

 

 

 

732 

 

 

696 

 

 

36 

 

 —

 

 

 —

Commercial real estate

 

11 

 

 

10,878 

 

 

9,107 

 

 

1,771 

 

 —

 

 

 —

  Total

 

17 

 

$

12,076 

 

$

9,803 

 

$

2,273 

 

 —

 

$

 —



   

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

$

466 

 

$

466 

 

$

 —

 

 —

 

$

 —

Residential real estate

 

 

 

737 

 

 

701 

 

 

36 

 

 —

 

 

 —

Commercial real estate

 

11 

 

 

10,983 

 

 

10,388 

 

 

595 

 

 —

 

 

 —

  Total

 

17 

 

$

12,186 

 

$

11,555 

 

$

631 

 

 —

 

$

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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



There were no new TDR loans during 2018 and 2017.





Note 7. Other Real Estate Owned

Changes in other real estate owned during the three months ended March 31, 2018 and 2017 were as follows:





 

 

 

 

 

 



 

March 31,

(Dollars in thousands)

 

2018

 

2017

Balance at beginning of the period

 

$

2,598 

 

$

4,915 

   Additions

 

 

 —

 

 

 —

   Proceeds from dispositions

 

 

 —

 

 

(1,751)

   Loss on sales, net

 

 

 —

 

 

 —

   Valuation adjustment

 

 

(6)

 

 

(49)

Balance at the end of the period

 

$

2,592 

 

$

3,115 

 

Note 8. Pension

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





 

 

 

 

 

 



 

Three Months Ended



 

March 31,

(Dollars in thousands)

 

2018

 

2017

Components of net periodic cost:

 

 

 

 

 

 

Service cost

 

$

90 

 

$

78 

Interest cost

 

 

138 

 

 

166 

Expected return on plan assets

 

 

(279)

 

 

(268)

Recognized net actuarial loss

 

 

176 

 

 

137 

Net period cost

 

$

125 

 

$

113 



The Bank expects its pension expense to increase to approximately $500 thousand in 2018 compared to $459 thousand in 2017, due primarily to increases in interest costs and recognized net actuarial losses.  A pension contribution of $1.0 million was made in first quarter of 2018. The service cost component of pension expense is in the salaries and benefits line on the income statement.  All other cost components are in the other expense line on the income statement.

 



16


 

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

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

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

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

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

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

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

On January 1, 2018, the Corporation adopted ASU 2016-01, which requires the use of the exit price notion to measure the fair value of financial instruments.

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

17


 

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







 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



March 31, 2018



Carrying

 

Fair

 

 

 

 

 

 

 

(Dollars in thousands)

Amount

 

Value

 

Level 1

 

Level 2

 

Level 3

Financial assets, carried at cost:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

$

42,082 

 

$

42,082 

 

$

42,082 

 

$

 —

 

$

 —

Restricted stock

 

456 

 

 

456 

 

 

 —

 

 

456 

 

 

 —

Net loans

 

930,664 

 

 

908,491 

 

 

 —

 

 

 —

 

 

908,491 

Accrued interest receivable

 

3,410 

 

 

3,410 

 

 

 —

 

 

3,410 

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial assets, available for sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt securities

 

133,322 

 

 

133,322 

 

 

 —

 

 

133,322 

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial assets, fair value

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

410 

 

 

410 

 

 

410 

 

 

 —

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

$

1,034,461 

 

$

1,033,575 

 

$

 —

 

$

1,033,575 

 

$

 —

Accrued interest payable

 

152 

 

 

152 

 

 

 —

 

 

152 

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 



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 

 

 

 —

 

 

45 

 

 

 —

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 

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

18


 

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 March 31, 2018 and December 31, 2017 are as follows:







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands

 

Fair Value at March 31, 2018

Asset  Description

 

Level 1

 

Level 2

 

Level 3

 

Total

Equity securities, at fair value

 

$

410 

 

$

 —

 

$

 —

 

$

410 



 

 

 

 

 

 

 

 

 

 

 

 

Available for sale:

 

 

 

 

 

 

 

 

 

 

 

 

 U.S. Government and Agency securities

 

 

 —

 

 

10,482 

 

 

 —

 

 

10,482 

 Municipal securities

 

 

 —

 

 

63,310 

 

 

 —

 

 

63,310 

 Trust Preferred Securities

 

 

 —

 

 

5,849 

 

 

 —

 

 

5,849 

 Agency mortgage-backed securities

 

 

 —

 

 

52,747 

 

 

 —

 

 

52,747 

  Private-label mortgage-backed securities

 

 

 —

 

 

909 

 

 

 —

 

 

909 

 Asset-backed securities

 

 

 —

 

 

25 

 

 

 —

 

 

25 

Total assets

 

$

410 

 

$

133,322 

 

$

 —

 

$

133,732 



 

 

 

 

 

 

 

 

 

 

 

 







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(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 



 

 

 

 

 

 

 

 

 

 

 

 

Investment securities:  Level 1 securities represent equity securities that are valued using quoted market prices form 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 March 31, 2018 and December 31, 2017 are as follows:







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

 

 

 

 

 



 

Fair Value at March 31, 2018

Asset  Description

 

Level 1

 

Level 2

 

Level 3

 

Total

Other real estate owned (1)

 

$

 —

 

$

 —

 

$

32 

 

$

32 

Total assets

 

$

 —

 

$

 —

 

$

32 

 

$

32 







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(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 

(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.

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

Other real estate: The fair value of other real estate, upon initial recognition, is estimated using Level 2 inputs within the fair value hierarchy based on observable market data and Level 3 inputs based on customized discounting criteria.  In

19


 

connection with the measurement and initial recognition of the foregoing assets, the Corporation recognizes charge-offs through the allowance for loan losses.  Subsequent charge-offs are recognized as an expense.

The Corporation did not record any liabilities at fair value for which measurement of the fair value was made on a nonrecurring basis at March 31, 2018. 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 March 31, 2018.

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

March 31, 2018

 

 

Fair Value

 

Valuation Technique

 

Unobservable Input

 

(Weighted Average)

Other real estate owned

 

$

32 

 

Sales Contract

 

N/A

 



 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

Range

December 31, 2017

 

 

Fair Value

 

Valuation Technique

 

Unobservable Input

 

(Weighted Average)

Other real estate owned

 

$

90 

 

Appraisal

 

N/A

 



 

 

 

 

 

 

Cost to sell

 

8% (8%)

 

Note 10. Capital Ratios

Capital adequacy is currently defined by regulatory agencies through the use of several minimum required ratios.  In July 2013, Federal banking regulators approved the final rules from the Basel Committee on Banking Supervision for the regulation of capital requirements for bank holding companies and U.S banks, generally referred to as “Basel III.” The Basel III standards were effective for the Corporation and the Bank, effective January 1, 2015 (subject to a phase-in period for certain provisions).  Basel III imposes significantly higher capital requirements and more restrictive leverage and liquidity ratios than those previously in place.  The capital ratios to be considered “well capitalized” under Basel III are: (1) Common Equity Tier 1 (CET1) of 6.5%, (2) Tier 1 Leverage of 5%, (3) Tier 1 Risk-Based Capital of 8%, and (4) Total Risk-Based Capital of 10%.  The CET1 ratio is a new capital ratio under Basel III and the Tier 1 risk-based capital ratio of 8% has been increased from 6%. The rules also include changes in the risk weights of certain assets to better reflect credit and other risk exposures. In addition, a capital conservation buffer will be phased-in beginning January 1, 2016 at 0.625%,  1.25% for 2017, 1.875% for 2018 and 2.50% for 2019 and thereafter.  The capital conservation buffer will be 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 March 31, 2018 was 7.55% (total risk-based capital 15.55% less 8.00%) compared to the 2018 regulatory buffer of 1.875%.  Compliance with the capital conservation buffer is required in order to avoid limitations to certain capital distributions.  As of March 31, 2018, 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.

20


 

The following table summarizes regulatory capital information as of March 31, 2018 and December 31, 2017 for the Corporation and the Bank





 

 

 

 

 

 

 

 



 

 

 

 

 

Regulatory Ratios



 

 

 

 

 

Adequately

 

Well



 

March 31,

 

December 31,

 

Capitalized

 

Capitalized

(Dollars in thousands)

 

2018

 

2017

 

Minimum

 

Minimum



 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

14.30% 

 

14.06% 

 

4.500% 

 

N/A

Farmers & Merchants Trust Company

 

14.16% 

 

13.93% 

 

4.500% 

 

6.50% 



 

 

 

 

 

 

 

 

Tier 1 Risk-based Capital Ratio (2)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

14.30% 

 

14.06% 

 

6.000% 

 

N/A

Farmers & Merchants Trust Company

 

14.16% 

 

13.93% 

 

6.000% 

 

8.00% 



 

 

 

 

 

 

 

 

Total Risk-based Capital Ratio (3)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

15.55% 

 

15.31% 

 

8.000% 

 

N/A

Farmers & Merchants Trust Company

 

15.41% 

 

15.19% 

 

8.000% 

 

10.00% 



 

 

 

 

 

 

 

 

Tier 1 Leverage Ratio (4)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

9.95% 

 

9.73% 

 

4.000% 

 

N/A

Farmers & Merchants Trust Company

 

9.86% 

 

9.64% 

 

4.000% 

 

5.00% 



 

 

 

 

 

 

 

 

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

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

 

Note 11. Revenue Recognition

The Corporation adopted ASC 606 on January 1, 2018 using the modified retrospective approach applied to all contracts initiated on or after the effective date, and for contracts which have remaining obligations as of the effective date. Results for the reporting period beginning January 1, 2018 are presented under ASC 606 while the prior period results continue to be reported under legacy GAAP. Adoption of the standard did not have a material effect on any of the reported periods. The Corporation did not record a cumulative effect adjustment to the beginning retained earnings balance as of January 1, 2018 from the adoption of ASC 606 as it was determined the transition adjustment was immaterial to Corporation’s consolidated financial statements.

All of the Corporation’s revenue from contracts with customers within the scope of ASC 606 is recognized in non-interest income as presented in our consolidated statements of income. Revenue generating activities that fall within the scope of ASC 606 are described as follows:

Investment and Trust Service Fees - these represent fees from wealth management (assets under management), fees from the management and settlement of estates and commissions from the sale of investment and insurance a products.

·

Asset management fees are generally assessed based on a tiered fee schedule, based on the value of assets under management, and are recognized monthly when the service obligation is completed. Fees recognized in the first quarter of 2018 totaled $1.3 million.

·

Fees for estate management services are based on the estimated fair value of the estate. These fees are generally recognized monthly over an 18 month period that Management has determined to represent the average time to fulfill the performance obligation of the contract. Management has the discretion to adjust this time period as needed based upon the nature and complexity of an individual estate. Fees recognized in the first quarter of 2018 totaled $61 thousand.

·

Commissions from the sale of investment and insurance products are recognized upon the completion of the transaction.  Fees recognized in the first quarter of 2018 totaled $68 thousand.

Loan Service Charges – these represent fees on loans for services or charges that occur after the loan has been booked, for example, late payment fees. These also include fees for mortgages settled for a third party mortgage company. All of these fees are transactional in nature and are recognized upon completion of the transaction which represents the performance obligation.

21


 

Deposit Service Charges and Fees – these represent fees from deposit customers for transaction based, account maintenance, and overdraft services. Transaction based fees include, but are not limited to stop payment fees and overdraft fees. These fees are recognized at the time of the transaction when the performance obligation has been fulfilled. Account maintenance fees and account analysis fee are earned over the course of a month, representing the period of the performance obligation, and are recognized monthly.

Debit Card Income – this represents interchange fees from cardholder transactions conducted through the card payment network. Cardholders use the debit card to conduct point-of-sale transactions that produce interchange fees. The fees are transaction based and the fee is recognized with the processing of the transaction.  These fees are reported net of cardholder rewards.

Other Service Charges and Fees – these are comprised primarily of merchant card fees, credit card fees, ATM surcharges and interchange fees and wire transfer fees. Merchant card fees represent fees the Bank earns from a third party for enrolling a customer in the processor’s program. Credit card fees represent a fee earned by the Bank for a successful referral to a card-issuing company. ATM surcharges and interchange fees are the result of Bank customers conducting ATM transactions that generate fee income and are processed through multiple card networks. All of these fees are transaction based and are recognized at the time of the transaction.

Gains/Losses on the Sale of Other Real Estate – these are recognized when control of the property transfers to the buyer.

Increases in the cash surrender value of life insurance and security transactions are not within the scope of ASC 606.

Contract Balances

A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset).  A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s noninterest revenue streams are largely based on transactional activity, or standard month-end revenue accruals such as asset management fees based on month-end market values.  Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized.  The Company does not typically enter into longer-term revenue contracts with customers, and therefore, does not experience significant contract balances. 

Contract Acquisition Costs

The Corporation expenses all contract acquisition costs as costs are incurred.





1Note 12. Contingencies

The nature of the Corporation’s business generates a certain amount of litigation.

We establish accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probably 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 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 described below, will have a material adverse effect on our results of operations in any future reporting period, which will depend on, amount other things, the amount of loss resulting from the claim and the amount of income otherwise reported for the reporting period.  Thus, at March 31, 2018, 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.

22


 

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

On April 11, 2018, the Bank entered into settlement agreements with the named plaintiffs, certain members of the settlement class and certain of the other remaining defendants in 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, to make definitive the terms and conditions of settlement set forth in the Class Action Settlement Term Sheet entered into on December 29, 2017, following a mediation of the case.  The settlement agreements provide 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 have brought or could have brought against F&M Trust.  The settlement agreements further provide for general releases by the parties.  On April 11, 2018, the named plaintiffs filed with the court a motion for preliminary approval of the settlement.  On April 12, 2018, the court entered an order setting a hearing on the motion for preliminary approval for May 4, 2018.  The Corporation has accrued the $10 million settlement payment in the Kalan case as an expense for the year ended December 31, 2017.

 

23


 

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

For the Three Months Ended March  31, 2018 and 2017



Forward Looking Statements



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



Critical Accounting Policies



Management has identified critical accounting policies for the Corporation.  These policies are particularly sensitive, requiring significant judgements, estimates and assumptions to be made by Management. There were no changes to the critical accounting policies disclosed in the 2017 Annual Report on Form 10-K in regards to application or related judgments and estimates used.  Please refer to Item 7 of the Corporation’s 2017 Annual Report on Form 10-K for a more detailed disclosure of the critical accounting policies.



Results of Operations



Year-to-Date Summary

At March 31, 2018, total assets were $1.169 billion.  The investment portfolio increased during the first quarter and the loan portfolio remained relatively unchanged, as loan payoffs and amortization outpaced originationsNew loan originations totaled approximately $32 million, but were offset by payoffs of approximately $18 million.   All deposit categories, except savings, decreased slightly during the first quarter primarily in retail non-maturity deposits and short-term municipal time deposits. Net interest income increased due to the growth in interest income from the loan portfolio. The provision for loan losses increased due to a change in the loan portfolio mixThe increase in noninterest income was primarily from asset management fees in the Bank’s Investment and Trust Services department and loan service charges.  Noninterest expense increased primarily from increases in salaries and benefits, and advertising expense.  

24


 

Key performance ratios as of, or for the three months ended March 31, 2018 and 2017 and the year ended December 31, 2017 are listed below:





 

 

 

 

 

 

 

 

 



 

March 31,

 

December 31,

 

March 31,



 

2018

 

2017

 

2017

(Dollars in thousands, except per share)

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

Balance Sheet Highlights

 

 

 

 

 

 

 

 

 

Total assets

 

$

1,168,542 

 

$

1,179,813 

 

$

1,131,134 

Investment securities

 

 

133,322 

 

 

127,336 

 

 

137,182 

Loans, net

 

 

930,664 

 

 

931,908 

 

 

892,251 

Deposits

 

 

1,034,461 

 

 

1,047,181 

 

 

1,006,594 

Shareholders' equity

 

 

117,124 

 

 

115,144 

 

 

119,178 



 

 

 

 

 

 

 

 

 

Summary of Operations

 

 

 

 

 

 

 

 

 

Interest income

 

$

10,488 

 

$

39,885 

 

$

9,546 

Interest expense

 

 

795 

 

 

2,491 

 

 

581 

Net interest income

 

 

9,693 

 

 

37,394 

 

 

8,965 

Provision for loan losses

 

 

200 

 

 

670 

 

 

120 

Net interest income after provision for loan losses

 

 

9,493 

 

 

36,724 

 

 

8,845 

Noninterest income

 

 

3,148 

 

 

12,189 

 

 

2,925 

Noninterest expense

 

 

8,648 

 

 

43,172 

 

 

7,957 

Income before income taxes

 

 

3,993 

 

 

5,741 

 

 

3,813 

Federal income tax expense

 

 

491 

 

 

3,565 

 

 

793 

Net income

 

$

3,502 

 

$

2,176 

 

$

3,020 



 

 

 

 

 

 

 

 

 

Performance Measurements

 

 

 

 

 

 

 

 

 

Return on average assets*

 

 

1.21% 

 

 

0.19% 

 

 

1.08% 

Return on average equity*

 

 

12.17% 

 

 

1.80% 

 

 

10.33% 

Return on average tangible equity (1)*

 

 

13.20% 

 

 

1.94% 

 

 

11.19% 

Efficiency ratio (1)

 

 

65.68% 

 

 

82.59% 

 

 

63.62% 

Net interest margin*

 

 

3.72% 

 

 

3.72% 

 

 

3.69% 



 

 

 

 

 

 

 

 

 

Shareholders' Value (per common share)

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

$

0.80 

 

$

0.50 

 

$

0.70 

Basic earnings per share

 

 

0.80 

 

 

0.50 

 

 

0.70 

Regular cash dividends paid

 

 

0.24 

 

 

0.93 

 

 

$0.21 

Book value

 

 

26.83 

 

 

26.44 

 

 

27.55 

Tangible book value (1)

 

 

24.77 

 

 

24.37 

 

 

25.47 

Market value

 

 

36.54 

 

 

37.36 

 

 

30.45 

Market value/book value ratio

 

 

136.19% 

 

 

141.30% 

 

 

110.53% 

Price/earnings multiple*

 

 

11.42 

 

 

74.72 

 

 

10.88 

Current dividend yield*

 

 

2.63% 

 

 

2.49% 

 

 

2.76% 

Dividend payout ratio

 

 

29.84% 

 

 

185.25% 

 

 

30.03% 



 

 

 

 

 

 

 

 

 

Safety and Soundness

 

 

 

 

 

 

 

 

 

Risk-based capital ratio (Total)

 

 

15.55% 

 

 

15.31% 

 

 

16.25% 

Leverage ratio (Tier 1)

 

 

9.95% 

 

 

9.73% 

 

 

10.31% 

Common equity ratio (Tier 1)

 

 

14.30% 

 

 

14.06% 

 

 

14.99% 

Nonperforming loans/gross loans

 

 

0.29% 

 

 

0.28% 

 

 

0.58% 

Nonperforming assets/total assets

 

 

0.46% 

 

 

0.45% 

 

 

0.74% 

Allowance for loan losses as a % of loans

 

 

1.27% 

 

 

1.25% 

 

 

1.25% 

Net (recoveries) loan charge-offs/average loans*

 

 

0.00% 

 

 

-0.01%

 

 

-0.04%



 

 

 

 

 

 

 

 

 

Assets under Management

 

 

 

 

 

 

 

 

 

Trust assets under management (fair value)

 

$

684,648 

 

$

686,941 

 

$

639,110 

Held at third-party brokers (fair value)

 

 

152,728 

 

 

158,145 

 

 

147,676 

*Annualized

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

25


 

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





 

 

 

 

 

 

 

 

 

(Dollars in thousands, except per share)

 

Three Months Ended

 

Twelve Months Ended

 

Three Months Ended



 

March 31, 2018

 

December 31, 2017

 

March 31, 2017

Return on Tangible Equity (non-GAAP)

 

 

 

 

 

 

 

 

 

Net income

 

$

3,502 

 

$

2,176 

 

$

3,020 



 

 

 

 

 

 

 

 

 

Average shareholders' equity

 

 

115,129 

 

 

120,993 

 

 

116,989 

Less average intangible assets

 

 

(9,016)

 

 

(9,016)

 

 

(9,016)

Average shareholders' equity (non-GAAP)

 

 

106,113 

 

 

111,977 

 

 

107,973 



 

 

 

 

 

 

 

 

 

 Return on average tangible equity (non-GAAP)

 

 

13.20% 

 

 

1.94% 

 

 

11.19% 



 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Shareholders' equity

 

$

117,124 

 

$

115,144 

 

$

119,178 

Less intangible assets

 

 

(9,016)

 

 

(9,016)

 

 

(9,016)

Shareholders' equity (non-GAAP)

 

 

108,108 

 

 

106,128 

 

 

110,162 



 

 

 

 

 

 

 

 

 

Shares outstanding (in thousands)

 

 

4,365 

 

 

4,355 

 

 

4,325 



 

 

 

 

 

 

 

 

 

 Tangible book value (non-GAAP)

 

 

24.77 

 

 

24.37 

 

 

25.47 



 

 

 

 

 

 

 

 

 

Efficiency Ratio

 

 

 

 

 

 

 

 

 

Noninterest expense

 

$

8,648 

 

$

43,172 

 

$

7,957 



 

 

 

 

 

 

 

 

 

Net interest income  

 

 

9,693 

 

 

37,394 

 

 

8,965 

Plus tax equivalent adjustment to net interest income

 

 

370 

 

 

2,690 

 

 

619 

Plus noninterest income, net of securities transactions

 

 

3,103 

 

 

12,186 

 

 

2,923 

Total revenue

 

 

13,166 

 

 

52,270 

 

 

12,507 



 

 

 

 

 

 

 

 

 

 Efficiency ratio

 

 

65.68% 

 

 

82.59% 

 

 

63.62% 



Net Interest Income

The largest source of the Corporation’s earnings is net interest income, which is defined as the difference between income on interest-earning assets and the expense of interest-bearing liabilities supporting those assets.  Principal categories of interest-earning assets are loans and securities, while deposits, short-term borrowings and long-term debt are the principal categories of interest-bearing liabilities.  Demand deposits enhance net interest income because they are noninterest-bearing deposits. For the purpose of this discussion, balance sheet items refer to the average balance for the year and net interest income is adjusted to a fully taxable-equivalent basis.  This tax-equivalent adjustment facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Corporation’s 21% Federal statutory rate. 



26


 

Comparison of the three months ended March 31, 2018 to the three months ended March 31, 2017:

Tax equivalent net interest income increased $479 thousand to $10.1 million in the first quarter of 2018 compared to $9.6 million in the same period in 2017.  Balance sheet volume contributed $441 thousand to this increase and changes in interest rates added $38 thousand.  Due to the lower corporate tax rate, the benefit of tax-exempt income was less in 2018 as compared to 2017.

The following table presents average balances, tax-equivalent (T/E) interest income, and yields earned or rates paid on the assets or liabilities.  All nontaxable interest income has been adjusted to a tax-equivalent basis using a tax rate of 21% for 2018 and 34% for 2017. 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



For the Three Months Ended March 31,



2018

 

2017



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



Average

 

Income or

 

Average

 

Average

 

Income or

 

Average

(Dollars in thousands)

balance

 

expense

 

yield/rate

 

balance

 

expense

 

yield/rate



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing obligations of other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

banks and federal funds sold

$

29,478 

 

$

118 

 

1.62% 

 

$

20,735 

 

$

62 

 

1.21% 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

86,783 

 

 

519 

 

2.43% 

 

 

94,766 

 

 

544 

 

2.33% 

Tax Exempt

 

44,253 

 

 

344 

 

3.11% 

 

 

46,363 

 

 

452 

 

3.89% 

               Investments

 

131,036 

 

 

863 

 

2.67% 

 

 

141,129 

 

 

996 

 

2.86% 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, industrial and agricultural

 

787,614 

 

 

8,261 

 

4.20% 

 

 

737,071 

 

 

7,489 

 

4.06% 

Residential mortgage

 

71,927 

 

 

733 

 

4.07% 

 

 

76,512 

 

 

753 

 

3.94% 

Home equity loans and lines

 

71,423 

 

 

809 

 

4.59% 

 

 

72,305 

 

 

799 

 

4.48% 

Consumer

 

5,075 

 

 

74 

 

5.91% 

 

 

4,716 

 

 

66 

 

5.68% 

Loans

 

936,039 

 

 

9,877 

 

4.23% 

 

 

890,604 

 

 

9,107 

 

4.10% 

Total interest-earning assets

 

1,096,553 

 

$

10,858 

 

4.02% 

 

 

1,052,468 

 

$

10,165 

 

3.92% 

Other assets

 

62,845 

 

 

 

 

 

 

 

62,966 

 

 

 

 

 

Total assets

$

1,159,398 

 

 

 

 

 

 

$

1,115,434 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking

$

281,421 

 

$

177 

 

0.26% 

 

$

255,741 

 

$

77 

 

0.12% 

Money Management

 

416,555 

 

 

442 

 

0.43% 

 

 

422,255 

 

 

365 

 

0.35% 

Savings

 

80,253 

 

 

56 

 

0.28% 

 

 

76,887 

 

 

20 

 

0.11% 

Time

 

71,452 

 

 

120 

 

0.68% 

 

 

74,089 

 

 

104 

 

0.57% 

Total interest-bearing deposits

 

849,681 

 

 

795 

 

0.38% 

 

 

828,972 

 

 

566 

 

0.28% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other borrowings

 

22 

 

 

 —

 

2.02% 

 

 

7,470 

 

 

15 

 

0.82% 

Total interest-bearing liabilities

 

849,703 

 

 

795 

 

0.38% 

 

 

836,442 

 

 

581 

 

0.28% 

Noninterest-bearing deposits

 

177,101 

 

 

 

 

 

 

 

157,067 

 

 

 

 

 

Other liabilities

 

17,465 

 

 

 

 

 

 

 

4,936 

 

 

 

 

 

Shareholders' equity

 

115,129 

 

 

 

 

 

 

 

116,989 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,159,398 

 

 

 

 

 

 

$

1,115,434 

 

 

 

 

 

T/E net interest income/Net interest margin

 

 

 

 

10,063 

 

3.72% 

 

 

 

 

 

9,584 

 

3.69% 

Tax equivalent adjustment

 

 

 

 

(370)

 

 

 

 

 

 

 

(619)

 

 

Net interest income

 

 

 

$

9,693 

 

 

 

 

 

 

$

8,965 

 

 



27


 

Provision for Loan Losses

Provision for loan loss expense for the first quarter was $200 thousand, compared to $120 thousand in 2017.  The increase in the provision expense was due to a change in the mix of the loan portfolio. For more information refer to the Loan Quality and Allowance for Loan Losses discussion in the Financial Condition section.



Noninterest Income

For the first quarter of 2018, noninterest income increased $223 thousand from the same period in 2017.  Investment and trust service fees increased due to growth in assets under management and investment commissions. Loan service charges increased from higher mortgage production fees and commercial prepayment penalties.    The change in the fair value of equity investments recorded through income was $45 thousand.  In 2017 the change in fair value of equity investments was recorded through other comprehensive income.

The following table presents a comparison of noninterest income for the three months ended March 31, 2018 and 2017.





 

 

 

 

 

 

 

 

 

 

 



 

For the Three Months Ended

 

 

 

 

 



 

March 31,

 

Change

(Dollars in thousands)

 

2018

 

2017

 

Amount

 

%

Noninterest Income

 

 

 

 

 

 

 

 

 

 

 

Investment and trust services fees

 

$

1,397 

 

$

1,295 

 

$

102 

 

7.9 

Loan service charges

 

 

231 

 

 

147 

 

 

84 

 

57.1 

Deposit service charges and fees

 

 

574 

 

 

592 

 

 

(18)

 

(3.0)

Other service charges and fees

 

 

333 

 

 

324 

 

 

 

2.8 

Debit card income

 

 

385 

 

 

375 

 

 

10 

 

2.7 

Increase in cash surrender value of life insurance

 

 

128 

 

 

131 

 

 

(3)

 

(2.3)

Change in fair value of equity securities

 

 

45 

 

 

 —

 

 

45 

 

N/A

Debt securities gains, net

 

 

 —

 

 

 

 

(2)

 

N/A

Other

 

 

55 

 

 

59 

 

 

(4)

 

(6.8)

Total noninterest income

 

$

3,148 

 

$

2,925 

 

$

223 

 

7.6 



Noninterest Expense

Noninterest expense for the first quarter of 2018 increased $691 thousand compared to the same period in 2017.  The increase in salaries and benefits was primarily due to an increase in salary expense ($269 thousand) from merit increases and increased staffing levels, employer taxes ($74 thousand) and incentive plans ($46 thousand) compared to the same period in 2017.  Advertising increased due to digital marketing initiatives and projects.  Data Processing fees increased due to the implementation of new software.

The following table presents a comparison of noninterest expense for the three months ended March 31, 2018 and 2017



 

 

 

 

 

 

 

 

 

 

 



 

For the Three Months Ended

 

 

 

 

 

(Dollars in thousands)

 

March 31,

 

Change

Noninterest Expense

 

2018

 

2017

 

Amount

 

%

Salaries and benefits

 

$

4,986 

 

$

4,591 

 

$

395 

 

8.6 

Occupancy, furniture and equipment, net

 

 

815 

 

 

815 

 

 

 —

 

 —

Advertising

 

 

427 

 

 

247 

 

 

180 

 

72.9 

Legal and professional

 

 

329 

 

 

290 

 

 

39 

 

13.4 

Data processing

 

 

596 

 

 

541 

 

 

55 

 

10.2 

Pennsylvania bank shares tax

 

 

239 

 

 

243 

 

 

(4)

 

(1.6)

FDIC insurance

 

 

129 

 

 

106 

 

 

23 

 

21.7 

ATM/debit card processing

 

 

238 

 

 

218 

 

 

20 

 

9.2 

Foreclosed real estate

 

 

14 

 

 

58 

 

 

(44)

 

(75.9)

Telecommunications

 

 

109 

 

 

100 

 

 

 

9.0 

Other

 

 

766 

 

 

748 

 

 

18 

 

2.4 

Total noninterest expense

 

$

8,648 

 

$

7,957 

 

$

691 

 

8.7 



Provision for Income Taxes

For the first quarter of 2018, the Corporation recorded a Federal income tax expense of $491 thousand compared to $793 thousand for the same quarter in 2017. The effective tax rate was 12.3% for the first quarter of 2018 compared to 20.8% for the same period in 2017.  The decrease in income tax expense and the effective tax rate was due to the passage

28


 

of the Tax Cuts and Jobs Act of 2017.  The variances from the federal statutory rate are generally due to tax-exempt income from investments, loans and bank-owned life insurance. The federal statutory tax rate is 21% for 2018 and was 34% in 2017.



Financial Condition

Summary:

At March 31, 2018, assets totaled $1.169 billion, a decrease of $11.3 million from the 2017 year-end balance of $1.180 billion. Debt securities increased $6.4 million, while net loans decreased $1.2 million due to maturities and payoffs in the commercial loan portfolio. Deposits decreased $12.7 million (1.2%) during the first three months of 2018, mainly in short-term municipal time deposits and noninterest-bearing deposits. The increase in retained earnings from the Corporation’s net income of $3.5 million was partially offset by the cash dividend of $1.0 million. The Corporation’s Dividend Reinvestment Plan (DRIP) added an additional $206 thousand in new capital, $171 thousand from the reinvestment of quarterly dividends and $35 thousand of optional cash contributions.  



Cash and Cash Equivalents:

Cash and cash equivalents totaled $42.1 million at March  31, 2018, a decrease of $16.5 million from the prior year-end balance of $58.6 million.  Interest-bearing deposits are held primarily at the Federal Reserve ($20.8 million) and in short-term bank owned certificates of deposit ($6.2 million).



Investment Securities:    

AFS Securities

The AFS securities portfolio has increased $7.4 million on a cost basis, since year-end 2017. The composition of the portfolio has remained consistent with municipal securities and U.S. Agency mortgage-backed securities comprising the greatest portion of the portfolio at approximately 47% and 40% of the portfolio fair value, respectively.  The average life of the portfolio was 3.90 years. 

The AFS securities portfolio had a net unrealized loss of $1.1 million at March 31, 2018 compared to a net unrealized loss of $47 thousand (excluding equity securities) at the prior year-end. The increase in the unrealized loss is due primarily to the change in interest rates.  The portfolio averaged $131 million with a yield of 2.67% for the first three months of 2018. This compares to an average of $141.1 million and a yield of 2.86% for the same period in 2017. 

The Bank holds only one equity security, a Pennsylvania community bank. The municipal bond portfolio is well diversified geographically (issuers from within 28 states) and is comprised primarily of general obligation bonds (73%).  Many municipal bonds have credit enhancements in the form of private bond insurance or other credit support. The largest geographic municipal bond exposure is to 16 issuers in the state of Texas with a fair value of $9.1 million and 9 issuers in the state of Pennsylvania with a fair value of $5.5 million. The average rating of the municipal portfolio from Moody’s is AA. It contains $61.3 million of bonds rated A3 or higher.  No municipal bonds are rated below investment grade.

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

The amortized cost and estimated fair value of AFS securities available for sale as of March 31, 2018 and December 31, 2017 is as follows:



 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

March 31, 2018

 

cost

 

gains

 

losses

 

value

U.S. Government and Agency securities

 

$

10,534 

 

$

22 

 

$

(74)

 

$

10,482 

Municipal securities

 

 

63,520 

 

 

409 

 

 

(619)

 

 

63,310 

Trust preferred securities

 

 

6,007 

 

 

 

 

(159)

 

 

5,849 

Agency mortgage-backed securities

 

 

53,494 

 

 

105 

 

 

(852)

 

 

52,747 

Private-label mortgage-backed securities

 

 

830 

 

 

79 

 

 

 —

 

 

909 

Asset-backed securities

 

 

27 

 

 

 —

 

 

(2)

 

 

25 



 

$

134,412 

 

$

616 

 

$

(1,706)

 

$

133,322 





29


 



 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(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 



 

$

127,182 

 

$

1,200 

 

$

(1,046)

 

$

127,336 



The AFS securities portfolio contained 166 securities with $92.1 million of temporarily impaired fair value and $1.7 million in unrealized losses at March 31, 2018. The total unrealized loss position has increased from a $1.0 million unrealized loss at year-end 2017. 

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 March 31, 2018, was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted.

30


 

The following table reflects temporary impairment in the AFS securities portfolio (excluding restricted stock), aggregated by investment category, length of time that individual securities have been in a continuous unrealized loss position and the number of securities in each category as of March 31, 2018 and December 31, 2017:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



March 31, 2018



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

$

5,588 

 

$

(37)

 

 

$

3,331 

 

$

(37)

 

10 

 

$

8,919 

 

$

(74)

 

17 

Municipal securities

 

26,203 

 

 

(339)

 

41 

 

 

7,365 

 

 

(280)

 

14 

 

 

33,568 

 

 

(619)

 

55 

Trust preferred securities

 

1,867 

 

 

(50)

 

 

 

3,700 

 

 

(109)

 

 

 

5,567 

 

 

(159)

 

Agency mortgage-backed securities

 

25,164 

 

 

(337)

 

46 

 

 

18,900 

 

 

(515)

 

40 

 

 

44,064 

 

 

(852)

 

86 

Asset-backed securities

 

18 

 

 

(1)

 

 

 

 

 

(1)

 

 

 

23 

 

 

(2)

 

Total temporarily impaired
  securities

$

58,840 

 

$

(764)

 

97 

 

$

33,301 

 

$

(942)

 

69 

 

$

92,141 

 

$

(1,706)

 

166 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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 

Asset-backed securities

 

 —

 

 

 —

 

 —

 

 

 

 

(1)

 

 

 

 

 

(1)

 

Total temporarily impaired
  securities

$

33,585 

 

$

(241)

 

58 

 

$

36,203 

 

$

(805)

 

69 

 

$

69,788 

 

$

(1,046)

 

127 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



The unrealized loss in the municipal bond portfolio increased to $619 thousand from $252 thousand at December 31, 2017 as interest rates rose during the quarter.  There are fifty-five securities in this portfolio with an unrealized loss and the loss in this portfolio is deemed to be non-credit related and no other-than-temporary impairment charges have been recorded.

The trust preferred portfolio contains six securities with a fair value of $5.6 million and an unrealized loss of $159 thousand.  The trust-preferred securities held by the Bank are single entity issues, not pooled trust preferred securities.  Therefore, the impairment review of these securities is based only on the issuer and the security cannot be impaired by the performance of other issuers as if it was a pooled trust-preferred bond. All of the Bank’s trust preferred securities are single issue, variable rate notes with long maturities (2027 – 2028).  None of these bonds have suspended or missed a dividend payment. At March 31, 2018, the Bank believes it will be able to collect all interest and principal due on these bonds and no other-than-temporary-impairment charges were recorded.



Equity securities at Fair Value

The Corporation owns one equity investment. At March 31, 2018, this investment was reported at fair value ($410 thousand) with changes in value reported through income.  At December 31, 2017, this investment was reported at fair value with changes in value recorded through other comprehensive income.



Restricted Stock at Cost

 The Bank held $456 thousand of restricted stock at March 31, 2018.  Except for $30 thousand, this investment represents stock in FHLB Pittsburgh. The Bank is required to hold this stock to be a member of FHLB and it is carried at cost of $100 per share. The level of FHLB stock held is determined by FHLB and is comprised of a minimum membership amount plus a variable activity amount. FHLB stock is evaluated for impairment primarily based on an assessment of the ultimate recoverability of its cost. As a government sponsored entity, FHLB has the ability to raise funding through the U.S. Treasury that can be used to support its operations.  There is not a public market for FHLB stock and the benefits of FHLB membership (e.g., liquidity and low cost funding) add value to the stock beyond purely financial

31


 

measures. Management intends to remain a member of the FHLB and believes that it will be able to fully recover the cost basis of this investment.



Loans:    

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

Total residential real estate loans decreased $4.3 million over 2017, primarily due to pay downs.  For the first three months of 2018, the Bank originated $4.4 million in mortgages, including approximately $2.5 million for a fee through a third party brokerage agreement. The Bank does not originate or hold any loans that would be considered sub-prime or Alt-A, and does not generally originate mortgages outside of its primary market area.

Residential real estate construction:  The largest component of this category represents loans to residential real estate developers ($8.7 million), while loans for individuals to construct personal residences totaled $2.8 million at March  31, 2018.  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 March  31, 2018, the Bank had $16.1 million in residential real estate construction loans funded with an interest reserve and capitalized $131 thousand of interest from these reserves on active projects.  These loans were comprised of $908 thousand in residential construction and $15.2 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 and 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 real estate (CRE): This category includes commercial, industrial, farm and agricultural loans, where real estate serves as the primary collateral for the loans. Total commercial real estate loans increased to $433.8 million from $428.4 million at the end of 2017, an increase of $5.4 million.  The increase was primarily in hotels and motels, offset by a decrease in multi-family units, as a $3.5 million participation loan paid-off. The largest sectors (by collateral) in the commercial real estate category are: hotels and motels ($61.7 million), office buildings ($56.2 million), land development ($48.3 million), manufacturing facilities ($37.9 million) and auto dealerships ($35.0 million).

Commercial (C&I):  This category includes commercial, industrial, farm, agricultural, and municipal loans.  C&I loans decreased $3.8 million to $287.7 million at March  31, 2018, compared to $291.5 million at the end of 2017, primarily due to a loan participation payoff. At March  31, 2018, the Bank had approximately $176 million in tax-free loans. The largest sectors (by industry) in the commercial C&I category are: public administration ($81.5 million), utilities ($35.8 million), educational services ($30.2 million) and retail trade ($23.3 million).  The Bank continues to reduce its portfolio of purchased participation commercial loans. At March 31, 2018, the Bank held $108.9 million in purchased loan participations in its portfolio, a decrease of $6.4 million from December 31, 2017.  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 increased $71 thousand over year-end and is mainly comprised of unsecured personal lines of credit. 

32


 

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





 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



 

March 31,

 

December 31,

 

 

Change

(Dollars in thousands)

 

2018

 

2017

 

 

Amount

 

%

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

Consumer first liens

 

$

93,897 

 

$

97,159 

 

$

(3,262)

 

(3.4)

Commercial first lien

 

 

61,790 

 

 

61,275 

 

 

515 

 

0.8 

Total first liens

 

 

155,687 

 

 

158,434 

 

 

(2,747)

 

(1.7)



 

 

 

 

 

 

 

 

 

 

 

Consumer junior liens and lines of credit

 

 

43,842 

 

 

45,043 

 

 

(1,201)

 

(2.7)

Commercial junior liens and lines of credit

 

 

5,014 

 

 

5,328 

 

 

(314)

 

(5.9)

Total junior liens and lines of credit

 

 

48,856 

 

 

50,371 

 

 

(1,515)

 

(3.0)

Total residential real estate 1-4 family

 

 

204,543 

 

 

208,805 

 

 

(4,262)

 

(2.0)



 

 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

 

2,756 

 

 

1,813 

 

 

943 

 

52.0 

Commercial

 

 

8,735 

 

 

8,088 

 

 

647 

 

8.0 

Total residential real estate construction

 

 

11,491 

 

 

9,901 

 

 

1,590 

 

16.1 



 

 

 

 

 

 

 

 

 

 

 

Commercial real estate

 

 

433,821 

 

 

428,428 

 

 

5,393 

 

1.3 

Commercial

 

 

287,680 

 

 

291,519 

 

 

(3,839)

 

(1.3)

        Total commercial

 

 

721,501 

 

 

719,947 

 

 

1,554 

 

0.2 



 

 

 

 

 

 

 

 

 

 

 

Consumer

 

 

5,118 

 

 

5,047 

 

 

71 

 

1.4 



 

 

942,653 

 

 

943,700 

 

 

(1,047)

 

(0.1)

Less: Allowance for loan losses

 

 

(11,989)

 

 

(11,792)

 

 

(197)

 

1.7 

Net Loans

 

$

930,664 

 

$

931,908 

 

$

(1,244)

 

(0.1)



 

 

 

 

 

 

 

 

 

 

 

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 totaled $13.3 million at quarter end and includes both performing and nonperforming loans.  It is comprised entirely of loans rate 6-Special Mention and 7- Substandard. The Bank has no loans rated 8-Doubtful or 9-Loss. Included in the substandard total are $2.6 million of nonaccrual loans.  The watch list totaled $12.8 million at December 31, 2017. The credit composition of the portfolio, 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 a table that presents the aging of payments in the loan portfolio.

Nonaccruing loans generally represent Management’s determination that the borrower will be unable to repay the loan in accordance with its contractual terms and that collateral liquidation may or may not fully repay both interest and principal. It is the Bank’s policy to evaluate the probable collectability of principal and interest due under terms of loan contracts for all loans 90-days or more, nonaccrual loans, or impaired loans. Further, it is the Bank’s policy to discontinue

33


 

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 have a lower loan-to-value limit, than the supervisory limits. However, in certain instances, the Bank may make a loan that exceeds the supervisory loan-to-value limit.  At March 31, 2018 the Bank had loans of $21.3 million (2.26% of gross loans) that exceeded the supervisory limit, compared to 3.2% at year-end 2017.

Loan quality, as measured by the balance of nonperforming loans has is unchanged since year-end 2017. Potential problem loans, defined as watch list loans less loans on nonaccrual or past due more than 90 days at  March 31, 2018 totaled $10.6 million compared to $10.1 million at year-end 2017.  The balance of OREO declined slightly due to a write-down based on the anticipated sale of a property in the second quarter of 2018. See Note 7 in the accompanying financial statements for additional information about OREO.



The following table presents a summary of nonperforming assets as of:



 

 

 

 

 

 



 

March 31,

 

December 31,

(Dollars in thousands)

 

2018

 

2017



 

 

 

 

 

 

Nonaccrual loans

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

First liens

 

$

107 

 

$

168 

Junior liens and lines of credit

 

 

 —

 

 

 —

Total

 

 

107 

 

 

168 

Residential real estate - construction

 

 

466 

 

 

466 

Commercial real estate

 

 

1,842 

 

 

1,854 

Commercial

 

 

183 

 

 

187 

Total nonaccrual loans

 

 

2,598 

 

 

2,675 



 

 

 

 

 

 

Loans past due 90 days or more and still accruing

 

 

 

 

 

 

Commercial real estate

 

 

89 

 

 

 —

Total loans past due 90 days or more and still accruing

 

 

89 

 

 

 —



 

 

 

 

 

 

Total nonperforming loans

 

 

2,687 

 

 

2,675 



 

 

 

 

 

 

Other real estate owned

 

 

2,592 

 

 

2,598 

Total nonperforming assets

 

$

5,279 

 

$

5,273 



 

 

 

 

 

 

Nonperforming loans to total gross loans

 

 

0.29% 

 

 

0.28% 

Nonperforming assets to total assets

 

 

0.44% 

 

 

0.45% 

Allowance for loan losses to nonperforming loans

 

 

446.19% 

 

 

440.82% 

34


 

The following table identifies the most significant loans in nonaccrual status. These two nonaccrual loans account for 83% of the total nonaccrual balance.



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

ALL

 

Nonaccrual

 

TDR

 

 

 

 

 

Last



 

Balance

 

 

Reserve

 

Date

 

Status

 

Collateral

 

Location

 

Appraisal(1)



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit 1

$

1,642 

 

$

 —

 

Mar-12

 

Y

 

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

 

PA

 

Nov-17

$

3,914 

Credit 2

 

595 

 

 

 —

 

Sep-16

 

Y

 

1st lien on farmland

 

PA

 

Jul-14

$

1,526 



$

2,237 

 

$

 —

 

 

 

 

 

 

 

 

 

 

 

 

 (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 now delinquent under the modified terms. Credit 2 is listed for sale, in the process of foreclosure and is filing for bankruptcy.

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 if the creditor (the Bank), for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. These concessions may include lowering the rate, extending the maturity, re-amortization of the 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 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 or in certain circumstances, refinanced.  However, an impaired TDR loan can be a performing loan. Impaired loans totaled $12.4 million at quarter-end compared to $12.6 million at year-end 2017.



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







 

 

 

 

 

 

 

 

 

 

 

 



 

March 31, 2018

(Dollars in thousands)

 

Nonaccrual

 

Accruing

 

Total



 

Non-TDR

 

TDR

 

TDR

 

Impaired

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

71 

 

$

36 

 

$

696 

 

$

803 

Junior liens and lines of credit

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Total

 

 

71 

 

 

36 

 

 

696 

 

 

803 

Residential real estate - construction

 

 

 —

 

 

466 

 

 

 —

 

 

466 

Commercial real estate

 

 

71 

 

 

1,771 

 

 

9,107 

 

 

10,949 

Commercial

 

 

183 

 

 

 —

 

 

 —

 

 

183 

Total

 

$

325 

 

$

2,273 

 

$

9,803 

 

$

12,401 



 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

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 loan rated 7-Substandard or worse. Management, at its discretion, may determine that additional adjustments to the appraisal or valuation are required.  Valuation adjustments will be made as necessary based on factors, including, but not limited to: the economy, deferred maintenance, industry, type of property/equipment, age of the appraisal, etc. and the knowledge Management has about a particular situation. In addition, the cost to sell or liquidate the collateral is also estimated and deducted from the valuation in order to determine the net realizable value to the Bank. When determining the allowance for loan losses, certain factors involved in the evaluation are inherently subjective and require material estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans. Management monitors the adequacy of the allowance for loan losses on

35


 

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 March 31. 2018 is adequate.

The analysis for determining the ALL is consistent with guidance set forth in generally accepted accounting principles (GAAP) and the Interagency Policy Statement on the Allowance for Loan and Lease Losses. The analysis has two components, specific and general allocations. The specific component addresses specific reserves established for impaired loans. A loan is considered to be impaired when, based on current information and events, it is probable that the Bank will be unable to collect all interest and principal payments due according to the originally contracted terms of the loan agreement.  Collateral values discounted for market conditions and selling costs are used to establish specific allocations for impaired loans. It is possible that as a result of the credit analysis, a specific reserve is not required for an impaired loan. For impaired commercial loans with balances less than $250 thousand and all consumer purpose loans, a specific reserve analysis is not performed and these loans are added to the general allocation pool. These loans totaled $602 thousand at March 31, 2018 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 Bank currently has no specific reserve established for any loans.  Note 6 in the accompanying financial statements provides additional information about the ALL established for impaired loans.

The general allocation component addresses the reserves established for pools of homogenous loans. The general component includes a quantitative and qualitative analysis. When calculating the general allocation, the Bank segregates its loan portfolio into the following sectors based primarily on the type of supporting collateral:  residential real estate, commercial, industrial or agricultural real estate; commercial and industrial (C&I non-real estate), and consumer. Each sector may be further segregated by type of collateral, lien position, or owner/nonowner occupancy. 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 maximum qualitative factor of 37.5 basis points.



The following table shows the composition of the allowance for loan losses.





 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

3/31/2018

 

12/31/2017

Allowance Component

 

 

Balance

 

% of Loans

 

 

Balance

 

% of Loans

General - Quantitative

 

$

7,952 

 

0.84 

 

$

7,808 

 

0.83 

General - Qualitative

 

 

2,544 

 

0.27 

 

 

2,547 

 

0.27 

Specific

 

 

 —

 

 —

 

 

 —

 

 —

Unallocated

 

 

1,493 

 

0.16 

 

 

1,437 

 

0.15 



 

$

11,989 

 

1.27 

 

$

11,792 

 

1.25 



Real estate appraisals and collateral valuations are an important part of the Bank’s process for determining potential loss on collateral dependent loans and thereby have a direct effect on the determination of loan reserves, charge-offs and the calculation of the allowance for loan losses.  As long as the loan remains a performing loan, no further updates to appraisals are required. If a loan or relationship migrates to risk rating of 7-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.

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.

36


 

The following table shows the loans that were evaluated for the allowance for loan losses under a specific reserve (individually) and those that were evaluated under a general reserve (collectively), and the amount of the allowance established in each loan class as of March 31, 2018 and December 31, 2017:



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 



 

First

 

Junior Liens &

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

Liens

 

Lines of Credit

 

Construction

 

Real Estate

 

Commercial

 

Consumer

 

Unallocated

 

Total



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for ALL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

454 

 

$

 —

 

$

466 

 

$

10,878 

 

$

 —

 

$

 —

 

$

 —

 

$

11,798 

Collectively

 

 

155,233 

 

 

48,856 

 

 

11,025 

 

 

422,943 

 

 

287,680 

 

 

5,118 

 

 

 —

 

 

930,855 

Total

 

$

155,687 

 

$

48,856 

 

$

11,491 

 

$

433,821 

 

$

287,680 

 

$

5,118 

 

$

 —

 

$

942,653 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL established for
  loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

Collectively

 

 

1,043 

 

 

320 

 

 

260 

 

 

6,698 

 

 

2,073 

 

 

104 

 

 

1,491 

 

 

11,989 

ALL at March 31, 2018

 

$

1,043 

 

$

320 

 

$

260 

 

$

6,698 

 

$

2,073 

 

$

104 

 

$

1,491 

 

$

11,989 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 



Charged-off loans usually result from: (1) a borrower being legally relieved of loan repayment responsibility through bankruptcy, (2) insufficient collateral sale proceeds to repay a loan; or (3) the borrower and/or guarantor does not own other assets that, if sold, would generate sufficient sale proceeds to repay a loan. Charged-off loans decrease the Bank’s allowance for loan losses (ALL), while the recovery of previously charge-off loans and the provision for loan loss expense increase the ALL.

Year-to-date, the Bank recorded a net loan charge-offs of $3 thousand compared to net recoveries of $83 thousand for the same period in 2017. The Bank recorded $200 thousand for the loan loss provision expense for the first quarter of 2018 compared to $120 thousand for the first quarter of 2017.  See Note 6 in the accompanying financial statements for additional information about the allowance for loan losses.



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





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

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, 2017

 

$

1,060 

 

$

330 

 

$

224 

 

$

6,526 

 

$

2,110 

 

$

105 

 

$

1,437 

 

$

11,792 

Charge-offs

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(26)

 

 

 —

 

 

(26)

Recoveries

 

 

 

 

 —

 

 

 —

 

 

 —

 

 

 

 

14 

 

 

 —

 

 

23 

Provision

 

 

(18)

 

 

(10)

 

 

36 

 

 

172 

 

 

(45)

 

 

11 

 

 

54 

 

 

200 

ALL at March 31, 2018

 

$

1,043 

 

$

320 

 

$

260 

 

$

6,698 

 

$

2,073 

 

$

104 

 

$

1,491 

 

$

11,989 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

37


 

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 ALL and charge-off ratios for the periods ended:





 

 

 

 

 

 

 

 



Three Months Ended

 

Year ended

 

Three Months Ended



March 31, 2018

 

December 31, 2017

 

March 31, 2017

Net (recoveries) charge-offs/average loans

 

0.00% 

 

 

-0.01%

 

 

-0.01%

Net loan charge-offs (recoveries) as a percentage of the provision for loan losses

 

1.50% 

 

 

-7.01%

 

 

-69.17%

Allowance for loan losses as a % of loans

 

1.27% 

 

 

1.25% 

 

 

1.25% 

Net charge-offs (recoveries)

$

 

$

(47)

 

$

(83)





Other Real Estate Owned: 

The Bank holds $2.6 million of other real estate owned (OREO), comprised of three properties, unchanged from year-end 2017.  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 allows for a due diligence period that has been extended until 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 2018, the Bank recorded write downs of $6 thousand and incurred expense of $8 thousand to hold and maintain OREO. Note 7 of the accompanying financial statements provides additional information on activity in OREO.



Deposits: 

Total deposits decreased $12.7 million during the first three months of 2018 to $1.034 billion. Non-interest bearing deposits decreased $3.6 million (primarily in small business accounts), while total interest-bearing checking and savings,  of $774.8 million at March 31, 2018, remained unchanged and time deposits decreased $9.1 million. Interest bearing checking decreased by $2.6 million, primarily in retail deposits and the Bank’s Money Management product decreased $1.6 million, primarily in retail accountsTime deposits decreased since year-end from maturities of short-term municipal deposits

As of March 31, 2018, the Bank had $153.0 million placed in the ICS program ($101.1 million in interesting-bearing checking and $51.9 million in money management) and $3.3 million in reciprocal time deposits in the CDARS program included in brokered time deposits.  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 March 31, 2018.



 

 

 

 

 

 

 

 

 

 

 



 

March 31,

 

December 31,

 

 

Change

(Dollars in thousands)

 

2018

 

2017

 

 

Amount

 

%

Noninterest-bearing checking

 

$

193,237 

 

$

196,853 

 

$

(3,616)

 

(1.8)



 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking

 

 

278,369 

 

 

280,944 

 

 

(2,575)

 

(0.9)

Money management

 

 

413,417 

 

 

415,045 

 

 

(1,628)

 

(0.4)

Savings

 

 

83,051 

 

 

78,868 

 

 

4,183 

 

5.3 

Total interest-bearing checking and savings

 

 

774,837 

 

 

774,857 

 

 

(20)

 

(0.0)



 

 

 

 

 

 

 

 

 

 

 

Time deposits

 

 

63,126 

 

 

72,211 

 

 

(9,085)

 

(12.6)

Brokered time deposits

 

 

3,261 

 

 

3,260 

 

 

 

0.0 

Total time deposits

 

 

66,387 

 

 

75,471 

 

 

(9,084)

 

(12.0)

Total deposits

 

$

1,034,461 

 

$

1,047,181 

 

$

(12,720)

 

(1.2)



 

 

 

 

 

 

 

 

 

 

 

Overdrawn deposit accounts reclassified as loans

 

$

250 

 

$

154 

 

 

 

 

 



Borrowings:

The Corporation had no short-term borrowings at March  31, 2018 and December 31, 2017

Shareholders’ Equity:

Total shareholders’ equity increased $2.0 million to $117.1 million at March 31, 2018, compared to $115.1 million at the end of 2017.  The increase in retained earnings from the Corporation’s net income of $3.5 million was partially offset by the cash dividend of $1.0 million. The Corporation’s dividend payout ratio was 29.8% for the first three months of 2018 compared to 30.0% in 2017.  

38


 

As part of its quarterly dividend decision, the Corporation considers current and future income projections, dividend yield, payout ratio, and current and future capital ratios. For the first quarter of 2018, the Corporation paid a $0.24 per share dividend, compared to $0.21 paid in the first quarter of 2017. On April 5, 2018 the Board of Directors declared a $0.27 per share regular quarterly dividend for the second quarter of 2018, which will be paid on May  23, 2018.

In addition, the Corporation considers how dividend decisions may affect the Dividend Reinvestment Plan (DRIP), which has raised $206 thousand in new capital this year with 5,911 shares issued. On October 12, 2017, the Board of Directors authorized the repurchase of up to 100,000 shares of the Corporation’s $1.00 par value common stock at market prices in open market or privately negotiated transactions beginning October 16, 2017 and continuing through September 30, 2018.  During the first three months of 2018, 2,605 shares were repurchased, compared to no shares repurchased in the first three months of 2017. 

In July 2013, Federal banking regulators approved the final rules from the Basel Committee on Banking Supervision for the regulation of capital requirements for bank holding companies and U.S banks, generally referred to as “Basel III.” The Basel III standards were effective for the Corporation and the Bank, effective January 1, 2015 (subject to a phase-in period for certain provisions).  Basel III imposes significantly higher capital requirements and more restrictive leverage and liquidity ratios than those previously in place.  The capital ratios to be considered “well capitalized” under Basel III are: (1) Common Equity Tier 1 (CET1) of 6.5%, (2) Tier 1 Leverage of 5%, (3) Tier 1 Risk-Based Capital of 8%, and (4) Total Risk-Based Capital of 10%.  The CET1 ratio is a new capital ratio under Basel III and the Tier 1 risk-based capital ratio of 8% has been increased from 6%. The rules also include changes in the risk weights of certain assets to better reflect credit and other risk exposures. In addition, a capital conservation buffer will be phased-in beginning January 1, 2016 at 0.625%, 1.25% for 2017, 1.875% for 2018 and 2.50% for 2019 and thereafter.  The capital conservation buffer will be 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 March 31, 2018 was 7.55% (total risk-based capital 15.55% less 8.00%) compared to the 2018 regulatory buffer of 1.875%.  Compliance with the capital conservation buffer is required in order to avoid limitations to certain capital distributions.  As of March 31, 2018, the Bank was “well capitalized under the Basel III requirements and believes it would be “well capitalized” on a fully-phased in basis had such a requirement been in effect.

The following table summarizes regulatory capital information as of March 31, 2018 and December 31, 2017 for the Corporation and the Bank.    





 

 

 

 

 

 

 

 



 

 

 

 

 

Regulatory Ratios



 

 

 

 

 

Adequately

 

Well



 

March 31,

 

December 31,

 

Capitalized

 

Capitalized

(Dollars in thousands)

 

2018

 

2017

 

Minimum

 

Minimum



 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

14.30% 

 

14.06% 

 

4.500% 

 

N/A

Farmers & Merchants Trust Company

 

14.16% 

 

13.93% 

 

4.500% 

 

6.50% 



 

 

 

 

 

 

 

 

Tier 1 Risk-based Capital Ratio (2)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

14.30% 

 

14.06% 

 

6.000% 

 

N/A

Farmers & Merchants Trust Company

 

14.16% 

 

13.93% 

 

6.000% 

 

8.00% 



 

 

 

 

 

 

 

 

Total Risk-based Capital Ratio (3)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

15.55% 

 

15.31% 

 

8.000% 

 

N/A

Farmers & Merchants Trust Company

 

15.41% 

 

15.19% 

 

8.000% 

 

10.00% 



 

 

 

 

 

 

 

 

Tier 1 Leverage Ratio (4)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

9.95% 

 

9.73% 

 

4.000% 

 

N/A

Farmers & Merchants Trust Company

 

9.86% 

 

9.64% 

 

4.000% 

 

5.00% 



 

 

 

 

 

 

 

 

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

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



Economy 

The Corporation’s primary market area includes Franklin, Fulton, Cumberland and Huntingdon Counties, Pennsylvania.  This area is diverse in demographic and economic makeup.  County populations range from a low of

39


 

approximately 15,000 in Fulton County to over 249,000 in Cumberland County. Unemployment in the Bank’s market area has remained virtually unchanged over the past year and ranges from a low of 4.0% in Cumberland County to 7.9% in Huntingdon County.  The market area has a diverse economic base and local industries include warehousing, truck & rail shipping centers, light and heavy manufacturers, health-care, higher education institutions, farming and agriculture, and a varied service sector.  The Corporation’s primary market area is located in south central Pennsylvania and provides easy access to the major metropolitan markets on the east coast via trucking and rail transportation. Because of this, warehousing and distribution companies continue to find the area attractive. The local economy is not overly dependent on any one industry or business and Management believes that the Bank’s primary market area continues to be well suited for growth.

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

Economic Data





 

 

 

 



 

 

 

 



 

March 31,

 

December 31,



 

2018

 

2017

Unemployment Rate (seasonally adjusted)

 

 

 

 

Market area range (1)

 

4.0% - 7.9%

 

3.4 - 4.5%

Pennsylvania

 

4.8% 

 

4.6% 

United States

 

4.1% 

 

4.1% 



 

 

 

 

Housing Price Index - year over year change

 

 

 

 

PA, nonmetropolitan statistical area

 

1.6% 

 

2.3% 

United States

 

6.3% 

 

6.3% 



 

 

 

 

Building Permits - year over year change -12 moths

 

 

 

 

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

 

 

 

 

Residential, estimated

 

12.4% 

 

5.2% 

Multifamily, estimated

 

-7.2%

 

-27.8%



 

 

 

 

(1) Franklin, Cumberland, Fulton and Huntingdon Counties

 

 

 



Unlike many companies, the assets and liabilities of the Corporation are financial in nature. As such, interest rates and changes in interest rates may have a more significant effect on the Corporation’s financial results than on other types of industries. Because of this, the Corporation watches the actions of the Federal Reserve Open Market Committee (FOMC) as it makes decisions about interest rate changes. In March 2018, the FOMC increased the federal funds rate target range by .25%, its fifth such increase since December 31, 2016.  Despite these actions, the yield curve has flattened during the year.  Looking through the remainder of 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 for the rest of 2018 is unknown, despite predictions of more increases.  

Liquidity

The Corporation must meet the financial needs of the customers that it serves, while providing a satisfactory return on the shareholders’ investment.  In order to accomplish this, the Corporation must maintain sufficient liquidity in order to respond quickly to the changing level of funds required for both loan and deposit activity.  The goal of liquidity management is to meet the ongoing cash flow requirements of depositors who want to withdraw funds and of borrowers who request loan disbursements. The Bank regularly reviews it liquidity position by measuring its projected net cash flows (in and out) at a 30 and 90-day interval.  The Bank stresses the measurements 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.

40


 

Historically, the Corporation has satisfied its liquidity needs from earnings, repayment of loans and amortizing investment securities, maturing investment securities, loan` sales, deposit growth and its ability to access existing lines of credit.  All investment securities are classified as available for sale; therefore, securities that are not pledged as collateral for borrowings are an additional source of readily available liquidity, either by selling the security or, more preferably, to provide collateral for additional borrowing. At March 31, 2018, the Bank had $78.9 million (fair value) in its investment portfolio pledged as collateral for deposits.  The Bank also has access to other wholesale funding via the brokered CD market.

The FHLB system has always been a major funding source for community banks.  The Bank’s maximum borrowing capacity with the FHLB at March 31, 2018 was $332 million with $332 million available to borrow.  There are no indicators that lead the Bank to believe the FHLB would discontinue its lending function or restrict the Bank’s ability to borrow. If either of these events would 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 quarter-end had the ability to borrow approximately $19 million. 



Off Balance Sheet Commitments

The Corporation’s financial statements do not reflect various commitments that are made in the normal course of business, which may involve some liquidity risk.  These commitments consist mainly of unfunded loans and letters of credit made under the same standards as on-balance sheet instruments.  Because these instruments have fixed maturity dates, and because many of them will expire without being drawn upon, they do not generally present any significant liquidity risk to the Corporation.  Unused commitments and standby letters of credit totaled $343.1 million and $300.1 million, respectively, at March 31, 2018 and December 31, 2017.

The Corporation has entered into various contractual obligations to make future payments.  These obligations include time deposits, long-term debt, operating leases, deferred compensation and pension payments.  These amounts have not changed materially from those reported in the Corporation’s 2017 Annual Report on Form 10-K.

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk



There were no material changes in the Corporation’s exposure to market risk during the three months ended March 31, 2018. For more information on market risk refer to the Corporation’s 2017 Annual Report on Form 10-K.



Item 4.  Controls and Procedures

Evaluation of Controls and Procedures

The Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon the evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer concluded that as of March 31, 2018, the Corporation’s disclosure controls and procedures are effective. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in the Corporation’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. There were no changes in the Corporation’s internal control over financial reporting during the quarterly period ended March 31, 2018, that have materially affected, or are reasonably likely to materially affect, the internal control over financial reporting.

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

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

41


 



Part II – OTHER INFORMATION

Item 1.     Legal Proceedings

The nature of the Corporation’s business generates a certain amount of litigation. 

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, January 2, 2018 and April 13, 2018On April 11, 2018, F&M Trust entered into settlement agreements with the named plaintiffs, certain members of the settlement class and certain of the other remaining defendants in the Kalan case to make definitive the terms and conditions of settlement set forth in the Class Action Settlement Term Sheet entered into on December 29, 2017, described in our current report on Form 8-K filed January 2, 2018, following a mediation of the case.  The settlement agreements provide 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 have brought or could have brought against F&M Trust.  The settlement agreements further provide for general releases by the parties.

On April 11, 2018, the named plaintiffs filed with the court a motion for preliminary approval of the settlement.  On April 12, 2018, the court entered an order setting a hearing on the motion for preliminary approval for May 4, 2018.

The Corporation 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 1A. Risk Factors 

Except as set forth below, there were no material changes in the Corporation’s risk factors during the three months ended March 31, 2018. For more information, refer to the Corporation’s 2017 Annual Report on Form 10-K.



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 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 II, Item 1 Legal Proceedings and in Note 12 Contingencies in the Notes to Consolidated Financial Statements in Part I, Item 1 of this Report.



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







 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands, except per share)

 

 

 

 

 

 

Period

 

Number of
Shares Purchased

 

 

Weighted
Average
Price Paid
per Share

 

 

Dollar Amount of
Shares Purchased
as Part of Publically
Announced Program

 

 


Shares Yet
To Be Purchased
Under Program



 

 

 

 

 

 

 

 

 

 

 

March 2018

 

2,605 

 

$

33.80 

 

$

88 

 

 

97,395 



 

 

 

 

 

 

 

 

 

 

 



 

2,605 

 

$

33.80 

 

 

 

 

 

 





These shares were acquired through stock swap transactions by the exercise of incentive stock options.



Item 3.   Defaults by the Company on its Senior Securities

None

Item 4.   Mine Safety Disclosures

Not Applicable

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Item 5.   Other Information

None

Item 6.   Exhibits 

Exhibits



 

3.1

Articles of Incorporation of the Corporation.  (Filed as Exhibit 3.1 to Annual Report on Form 10-K for the year ended December 31, 2014 and incorporated herein by reference.)



 

3.2

Bylaws of the Corporation. (Filed as Exhibit 3.2 to Annual Report on Form 10-K for the year ended December 31, 2016 and incorporated herein by reference.)



 

31.1

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



 

31.2

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



 

32.1

Section 1350 Certifications – Principal Executive Officer



 

32.2

Section 1350 Certifications – Principal Financial Officer



 

101

Interactive Data File (XBRL)



 

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FRANKLIN FINANCIAL SERVICES CORPORATION

and SUBSIDIARIES



SIGNATURES



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



Franklin Financial Services Corporation





 

 



 

 

May 7, 2018

 

/s/ Timothy G. Henry



 

Timothy G. Henry



 

Chief Executive Office and President



 

(Principal Executive Officer)



 

 

May 7, 2018

 

/s/ Mark R. Hollar



 

Mark R. Hollar



 

Treasurer and Chief Financial Officer



 

(Principal Financial and Accounting Officer)



45