Annual Statements Open main menu

FRANKLIN FINANCIAL SERVICES CORP /PA/ - Quarter Report: 2019 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, 2019

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 001-38884

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)

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

 Title of classSymbolName of exchange on which registered

Common stock FRAFNasdaq Stock Market, Inc.



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 every Interactive Data File required to be submitted 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 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 4,389,414 outstanding shares of the Registrant’s common stock as of April  30, 2019.

 


 

INDEX



               



 

 

Part I - FINANCIAL INFORMATION

 



 

 

Item 1

Financial Statements

 



Consolidated Balance Sheets as of March  31, 2019 and December 31, 2018 (unaudited)

1



Consolidated Statements of Income for the Three Months ended March  31, 2019 

2



and 2018 (unaudited)

 



Consolidated Statements of Comprehensive Income for the Three Months ended

3



March  31, 2019 and 2018 (unaudited)

 



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

3



ended March 31, 2019 and 2018 (unaudited)

 



Consolidated Statements of Cash Flows for the Three Months ended March  31, 2019 

4



and 2018 (unaudited)

 



Notes to Consolidated Financial Statements (unaudited)

5



 

 

Item 2

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

24

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,



2019

 

2018

Assets

 

 

 

 

 

Cash and due from banks

$

11,771 

 

$

16,957 

Interest-bearing deposits in other banks

 

35,262 

 

 

36,000 

Total cash and cash equivalents

 

47,033 

 

 

52,957 

Debt securities available for sale, at fair value

 

127,881 

 

 

131,472 

Equity securities

 

377 

 

 

374 

Restricted stock

 

452 

 

 

452 

Loans held for sale

 

195 

 

 

118 

Loans

 

980,466 

 

 

973,375 

Allowance for loan losses

 

(12,681)

 

 

(12,415)

Net Loans

 

967,785 

 

 

960,960 

Premises and equipment, net

 

13,347 

 

 

13,521 

Right of use asset

 

6,099 

 

 

 —

Bank owned life insurance

 

23,623 

 

 

23,496 

Goodwill

 

9,016 

 

 

9,016 

Other real estate owned

 

2,684 

 

 

2,684 

Deferred tax asset, net

 

5,700 

 

 

5,992 

Other assets

 

8,768 

 

 

8,545 

Total assets

$

1,212,960 

 

$

1,209,587 



 

 

 

 

 

Liabilities

 

 

 

 

 

Deposits

 

 

 

 

 

Non-interest bearing checking

$

192,004 

 

$

197,417 

Money management, savings and interest checking

 

795,411 

 

 

823,619 

Time

 

89,076 

 

 

61,593 

Total deposits

 

1,076,491 

 

 

1,082,629 

Lease liability

 

6,113 

 

 

 —

Other liabilities

 

8,865 

 

 

8,562 

Total liabilities

 

1,091,469 

 

 

1,091,191 



 

 

 

 

 

Shareholders' equity

 

 

 

 

 

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

 

 

 

 

 

4,708,349 shares issued and 4,410,880 shares outstanding at March 31, 2019 and

 

 

 

 

 

4,701,367 shares issued and 4,408,761 shares outstanding at December 31, 2018

 

4,708 

 

 

4,701 

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

 

 

 

 

 

shares issued and outstanding

 

 —

 

 

 —

Additional paid-in capital

 

41,841 

 

 

41,530 

Retained earnings

 

85,991 

 

 

83,946 

Accumulated other comprehensive loss

 

(5,281)

 

 

(6,380)

Treasury stock, 297,469 shares at March 31, 2019 and 292,606 shares at

 

 

 

 

 

December 31, 2018, at cost

 

(5,768)

 

 

(5,401)

Total shareholders' equity

 

121,491 

 

 

118,396 

Total liabilities and shareholders' equity

$

1,212,960 

 

$

1,209,587 

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,



 

2019

 

2018

Interest income

 

 

 

 

 

 

Loans, including fees

 

$

11,009 

 

$

9,577 

Interest and dividends on investments:

 

 

 

 

 

 

Taxable interest

 

 

540 

 

 

513 

Tax exempt interest

 

 

338 

 

 

274 

Dividend income

 

 

 

 

Deposits and obligations of other banks

 

 

97 

 

 

118 

Total interest income

 

 

11,989 

 

 

10,488 

Interest expense

 

 

 

 

 

 

Deposits

 

 

1,624 

 

 

795 

Short-term borrowings

 

 

36 

 

 

 —

Total interest expense

 

 

1,660 

 

 

795 

Net interest income

 

 

10,329 

 

 

9,693 

Provision for loan losses

 

 

399 

 

 

200 

Net interest income after provision for loan losses

 

 

9,930 

 

 

9,493 

Noninterest income

 

 

 

 

 

 

Investment and trust services fees

 

 

1,452 

 

 

1,397 

Loan service charges

 

 

203 

 

 

231 

Deposit service charges and fees

 

 

545 

 

 

574 

Other service charges and fees

 

 

353 

 

 

333 

Debit card income

 

 

402 

 

 

385 

Increase in cash surrender value of life insurance

 

 

127 

 

 

128 

Debt securities gains, net

 

 

24 

 

 

 —

Change in fair value of equity securities

 

 

 

 

45 

Other

 

 

56 

 

 

55 

Total noninterest income

 

 

3,165 

 

 

3,148 

Noninterest Expense

 

 

 

 

 

 

Salaries and employee benefits

 

 

5,442 

 

 

4,986 

Net occupancy

 

 

856 

 

 

815 

Advertising

 

 

402 

 

 

427 

Legal and professional

 

 

430 

 

 

329 

Data processing

 

 

705 

 

 

596 

Pennsylvania bank shares tax

 

 

243 

 

 

239 

FDIC Insurance

 

 

65 

 

 

129 

ATM/debit card processing

 

 

258 

 

 

238 

Foreclosed real estate

 

 

17 

 

 

14 

Telecommunications

 

 

105 

 

 

109 

Other

 

 

889 

 

 

766 

Total noninterest expense

 

 

9,412 

 

 

8,648 

Income before federal income taxes

 

 

3,683 

 

 

3,993 

Federal income tax expense

 

 

446 

 

 

491 

Net income

 

$

3,237 

 

$

3,502 

Per share

 

 

 

 

 

 

Basic earnings per share

 

$

0.73 

 

$

0.80 

Diluted earnings per share

 

$

0.73 

 

$

0.80 

Cash dividends declared

 

$

0.27 

 

$

0.24 

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)

 

2019

 

2018

Net Income

 

$

3,237 

 

$

3,502 



 

 

 

 

 

 

Debt Securities:

 

 

 

 

 

 

Unrealized gains (losses) arising during the period

 

 

1,414 

 

 

(1,043)

Reclassification adjustment included in net income (1)

 

 

(24)

 

 

 —

Net unrealized gains (losses)

 

 

1,390 

 

 

(1,043)

Tax effect

 

 

(291)

 

 

262 

Net of tax amount

 

 

1,099 

 

 

(781)



 

 

 

 

 

 

Total other comprehensive income (loss)

 

 

1,099 

 

 

(781)



 

 

 

 

 

 

Total Comprehensive Income

 

$

4,336 

 

$

2,721 



 

 

 

 

 

 



 

 

 

 

 

 

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, 2019 and 2018





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

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, 2018

$

4,701 

 

$

41,530 

 

$

83,946 

 

$

(6,380)

 

$

(5,401)

 

$

118,396 

Net income

 

 —

 

 

 —

 

 

3,237 

 

 

 —

 

 

 —

 

 

3,237 

Other comprehensive income

 

 —

 

 

 —

 

 

 —

 

 

1,099 

 

 

 —

 

 

1,099 

Cash dividends declared, $.27 per share

 

 —

 

 

 —

 

 

(1,192)

 

 

 —

 

 

 —

 

 

(1,192)

Acquisition of 15,163 shares of treasury stock

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(560)

 

 

(560)

Treasury shares issued under employee stock purchase plan, 150 shares

 

 —

 

 

 

 

 —

 

 

 —

 

 

 

 

Treasury shares issued under dividend reinvestment plan, 10,150 shares

 

 —

 

 

161 

 

 

 —

 

 

 —

 

 

190 

 

 

351 

Common stock issued under incentive stock option plan, 6,982 shares

 

 

 

148 

 

 

 —

 

 

 —

 

 

 —

 

 

155 

Balance at March 31, 2019

$

4,708 

 

$

41,841 

 

$

85,991 

 

$

(5,281)

 

$

(5,768)

 

$

121,491 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 (loss)

 

 —

 

 

 —

 

 

 —

 

 

(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,



 

2019

 

2018

(Dollars in thousands) (unaudited)

 

 

 

 

 

 

Cash flows from operating activities

 

 

 

 

 

 

Net income

 

$

3,237 

 

$

3,502 

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

 

 

 

 

 

 

Depreciation and amortization

 

 

338 

 

 

333 

Net amortization of loans and investment securities

 

 

409 

 

 

438 

Provision for loan losses

 

 

399 

 

 

200 

Change in fair value of equity securities

 

 

(3)

 

 

(45)

Debt securities gains, net

 

 

(24)

 

 

 —

Loans originated for sale

 

 

(6,467)

 

 

(2,527)

Proceeds from sale of loans

 

 

6,390 

 

 

2,969 

Write-down of other real estate owned

 

 

 —

 

 

Loss on sale of premises

 

 

 —

 

 

17 

Increase in cash surrender value of life insurance

 

 

(127)

 

 

(128)

Stock option compensation

 

 

 —

 

 

31 

Contribution to pension plan

 

 

 —

 

 

(1,000)

Increase in other assets

 

 

(50)

 

 

(448)

Increase in other liabilities

 

 

118 

 

 

148 

Net cash provided by operating activities

 

 

4,220 

 

 

3,496 

Cash flows from investing activities

 

 

 

 

 

 

Proceeds from sales and calls of investment securities available for sale

 

 

3,876 

 

 

 —

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

 

 

6,084 

 

 

5,726 

Purchase of investment securities available for sale

 

 

(5,344)

 

 

(13,380)

Net (increase) decrease in loans

 

 

(7,245)

 

 

1,031 

Capital expenditures

 

 

(136)

 

 

(107)

Proceeds from sale of other assets

 

 

 —

 

 

117 

Net cash used in investing activities

 

 

(2,765)

 

 

(6,613)

Cash flows from financing activities

 

 

 

 

 

 

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

 

 

(33,621)

 

 

(3,636)

Net increase (decrease) in time deposits

 

 

27,483 

 

 

(9,084)

Dividends paid

 

 

(1,192)

 

 

(1,045)

Purchase of Treasury shares

 

 

(560)

 

 

 —

Cash received from option exercises

 

 

160 

 

 

206 

Treasury shares under dividend reinvestment plan

 

 

351 

 

 

155 

Net cash used in financing activities

 

 

(7,379)

 

 

(13,404)

Decrease in cash and cash equivalents

 

 

(5,924)

 

 

(16,521)

Cash and cash equivalents as of January 1

 

 

52,957 

 

 

58,603 

Cash and cash equivalents as of March 31

 

$

47,033 

 

$

42,082 

Supplemental Disclosures of Cash Flow Information

 

 

 

 

 

 

Cash paid during the year for:

 

 

 

 

 

 

Interest on deposits and other borrowed funds

 

$

1,562 

 

$

792 

Noncash Activities

 

 

 

 

 

 

Recognition of Operating Lease Right-of-Use Asset

 

$

6,236 

 

$

 —

Recognition of Operating Lease Liability

 

$

6,236 

 

$

 —

 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, 2019, 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 2018 Annual Report on Form 10-K.  The consolidated results of operations for the three month period ended March 31, 2019 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, 2018 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)

 

2019

 

2018

Weighted average shares outstanding (basic)

 

 

4,412 

 

 

4,359 

Impact of common stock equivalents

 

 

21 

 

 

28 

Weighted average shares outstanding (diluted)

 

 

4,433 

 

 

4,387 

Anti-dilutive options excluded from calculation

 

 

 —

 

 

 —

Net income

 

$

3,237 

 

$

3,502 

Basic earnings per share

 

$

0.73 

 

$

0.80 

Diluted earnings per share

 

$

0.73 

 

$

0.80 

 

5


 

Note 2. Recent Accounting Pronouncements

The following accounting pronouncements have recently been adopted or will be adopted in future periods.  For information on accounting pronouncements previously adopted, please refer to the Corporation’s report on Form 10-K for the year-ended December 31, 2018.





 

 

 

 

 

 

Standard

 

Description

 

Effective Date

 

Effect on the financial statements or other significant matters



 

 

 

 

 

 

ASU 2016-02, Leases (Topic 842) and all subsequently issued amendments

 

In February 2016, the FASB issued ASU 2016-02, "Leases (Subtopic 842)."  This ASU requires all lessees to recognize a lease liability and a right-of-use asset, measured at the present value of the future minimum lease payments, at the lease commencement date.  Lessor accounting remains largely unchanged under the new guidance.  FASB subsequently issued various amendments that provided implementation guidance designed to provide entities with relief from the costs of implementing certain aspects of the new standard.  From the lessee's perspective, the new standard requires a lessee to record a right-of-use asset and a lease liability on the balance sheet for all leases.  Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for lessees. ASU 2016-02 and all subsequent amendments are effective for fiscal years, including interim periods, beginning after December 15, 2018.  Early adoption of ASU 2016-02 is permitted.

 

January 1, 2019

 

The Corporation adopted ASU 2016-02, "Leases (Topic 842)" and all subsequent amendments on January 1, 2019 using the modified retrospective approach, and it did not have a material effect on its consolidated results of operations. Adoption of the new standard resulted in the recognition of a lease liability and a right-of-use asset of $6.2 million without a cumulative effect adjustment to retained earnings.  The Corporation did not restate any prior period results. The Corporation adopted the package of practical expedients offered in ASU 2016-02 and therefore, existing lease classifications were not reassessed, expired or existing contracts were not reassessed for a lease, and the initial direct costs for any existing leases were not reassessed.  In addition to the package of practical expedients, the Corporation also utilized other practical expedients offered: (1) the hindsight expedient which allows entities to use hindsight to determine the lease term was not adopted, (2) leases, for all underlying asset classes, with a term less than 12 months and no purchase option were excluded, (3) the option to not separate lease and non-lease components and account for them as a single component was adopted for real estate leases, and (4) the option to not apply lease accounting to existing land easements was adopted.  See Note 7 for additional information on the adoption of the new standard.



 

 

 

 

 

 

ASU 2018-13, Disclosure Framework (Topic 820)

 

This guidance eliminates, adds and modifies certain disclosure requirements for fair value measurements.  Among the changes, entities will no longer be required to disclose the amount of and reason for transfers between Level 1 and Level 2 of the fair value hierarchy, but will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements.

 

January 1, 2019

 

The Corporation adopted the standard on January 1, 2019 and it did not have a material effect on its consolidated results of operations. 



 

 

 

 

 

 

ASU 2018-15, Accounting for Implementation Costs in a Cloud Computing Arrangement (Topic 350)

 

This ASU required an entity in a cloud computing arrangement (i.e., hosting arrangement) that is a service contract to follow the internal-use software guidance in ASC 350-40 to determine which implementation costs to capitalize as assets or expense as incurred.  Capitalized implementation costs should be presented in the same line item on the balance sheet as amounts prepaid for the hosted service, if any (generally as an "other asset").  The capitalized costs will be amortized over the term of the hosting arrangement, with the amortization expense being presented in the same income statement line item as the fees paid for the hosted service.  The ASU is effective January 1, 2020 with early adoption permitted.

 

January 1, 2020

 

The Corporation adopted the standard on January 1, 2019 and it did not have a material effect on its consolidated results of operations. 



 

 

 

 

 

 

6


 

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. Early adoption is permitted for any impairment tests performed after January 1, 2017, applied prospectively.

 

January 1, 2020

 

The Corporation early adopted the ASU in the fourth quarter of 2018 with the completion of the 2018 impairment analysis.  The Corporation is still evaluating the effect of the standard on its consolidated financial statements.



 

 

 

 

 

 

ASU 2018-14, Disclosure Framework (Topic 715): Changes to the Disclosure Requirements for Defined Benefit Plans

 

This ASU makes minor changes to the disclosure requirements for employers that sponsor defined benefit pension and/or other postretirement benefit plans. ASU 2018-14 is effective for fiscal years ending after December 15, 2020; early adoption is permitted.

 

January 1, 2020

 

The Corporation will adopt the provisions of the ASU on January 1, 2020.  As the ASU only revises disclosure requirements, it is not expected to have a material effect on the consolidated financial statements.



 

 

 

 

 

 

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 accounting 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.  A third-party vendor has been selected to assist with the CECL calculations and the implementation process has started.  The Corporation expects to be able to run the CECL model in test mode starting in the second quarter of 2019.



 

 

 

 

 

 



Note 3. Accumulated Other Comprehensive Loss

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







 

 

 

 

 

 



 

 

 

 

 

 



 

March 31,

 

December 31,



 

2019

 

2018

(Dollars in thousands)

 

 

 

 

 

 

Net unrealized (losses) gains on debt securities

 

$

290 

 

$

(1,100)

Tax effect

 

 

(61)

 

 

230 

Net of tax amount

 

 

229 

 

 

(870)



 

 

 

 

 

 

Accumulated pension adjustment

 

 

(6,975)

 

 

(6,975)

Tax effect

 

 

1,465 

 

 

1,465 

Net of tax amount

 

 

(5,510)

 

 

(5,510)



 

 

 

 

 

 

Total accumulated other comprehensive loss

 

$

(5,281)

 

$

(6,380)

 

7


 

Note 4. Investments

Available for Sale (AFS) Securities

The amortized cost and estimated fair value of AFS securities as of March 31, 2019 and December 31, 2018 are as follows:







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

March 31, 2019

 

cost

 

gains

 

losses

 

value

U.S. Government and Agency securities

 

$

9,634 

 

$

24 

 

$

(40)

 

$

9,618 

Municipal securities

 

 

63,820 

 

 

845 

 

 

(108)

 

 

64,557 

Trust preferred securities

 

 

4,080 

 

 

 —

 

 

(180)

 

 

3,900 

Agency mortgage-backed securities

 

 

42,818 

 

 

135 

 

 

(364)

 

 

42,589 

Private-label mortgage-backed securities

 

 

448 

 

 

30 

 

 

 —

 

 

478 

Asset-backed securities

 

 

6,791 

 

 

 —

 

 

(52)

 

 

6,739 



 

$

127,591 

 

$

1,034 

 

$

(744)

 

$

127,881 







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

December 31, 2018

 

cost

 

gains

 

losses

 

value

U.S. Government and Agency securities

 

$

9,120 

 

$

21 

 

$

(65)

 

$

9,076 

Municipal securities

 

 

67,811 

 

 

320 

 

 

(484)

 

 

67,647 

Trust preferred securities

 

 

4,074 

 

 

 —

 

 

(316)

 

 

3,758 

Agency mortgage-backed securities

 

 

45,241 

 

 

65 

 

 

(648)

 

 

44,658 

Private-label mortgage-backed securities

 

 

457 

 

 

31 

 

 

 —

 

 

488 

Asset-backed securities

 

 

5,869 

 

 

 —

 

 

(24)

 

 

5,845 



 

$

132,572 

 

$

437 

 

$

(1,537)

 

$

131,472 



At March 31, 2019 and December 31, 2018, the fair value of AFS securities pledged to secure public funds and trust deposits totaled $76.7 million and  $84.6 million, respectively.

The amortized cost and estimated fair value of debt securities at March 31, 2019, 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

 

$

21,030 

 

$

21,084 

Due after one year through five years

 

 

25,764 

 

 

25,839 

Due after five years through ten years

 

 

35,173 

 

 

35,467 

Due after ten years

 

 

2,358 

 

 

2,424 



 

 

84,325 

 

 

84,814 

Mortgage-backed securities

 

 

43,266 

 

 

43,067 



 

$

127,591 

 

$

127,881 



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)

 

2019

 

2018

Gross gains realized

 

$

33 

 

$

 —

Gross losses realized

 

 

(9)

 

 

 —

Net gains realized

 

$

24 

 

$

 —



Impairment:

The AFS securities portfolio contained 125 securities with $57.7 million of temporarily impaired fair value and $744 thousand in unrealized losses at March 31, 2019. The total unrealized loss position has decreased $793 thousand since year-end 2018. 

8


 

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. The impairment identified on debt securities and subject to assessment at March 31, 2019, was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted.

 The following table reflects temporary impairment in the 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, 2019 and December 31, 2018:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



March 31, 2019



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

$

 —

 

$

 —

 

 —

 

$

4,777 

 

$

(40)

 

14 

 

$

4,777 

 

$

(40)

 

14 

Municipal securities

 

238 

 

 

 —

 

 

 

12,377 

 

 

(108)

 

21 

 

 

12,615 

 

 

(108)

 

22 

Trust preferred securities

 

1,166 

 

 

(33)

 

 

 

2,734 

 

 

(147)

 

 

 

3,900 

 

 

(180)

 

Agency mortgage-backed securities

 

895 

 

 

(1)

 

 

 

28,746 

 

 

(363)

 

71 

 

 

29,641 

 

 

(364)

 

75 

Asset-backed securities

 

6,721 

 

 

(51)

 

 

 

18 

 

 

(1)

 

 

 

6,739 

 

 

(52)

 

Total temporarily impaired
  securities

$

9,020 

 

$

(85)

 

14 

 

$

48,652 

 

$

(659)

 

111 

 

$

57,672 

 

$

(744)

 

125 









 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



December 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

$

2,071 

 

$

(6)

 

 

$

5,175 

 

$

(59)

 

14 

 

$

7,246 

 

$

(65)

 

16 

Municipal securities

 

5,832 

 

 

(12)

 

10 

 

 

25,091 

 

 

(472)

 

42 

 

 

30,923 

 

 

(484)

 

52 

Trust preferred securities

 

2,008 

 

 

(159)

 

 

 

1,750 

 

 

(157)

 

 

 

3,758 

 

 

(316)

 

Agency mortgage-backed securities

 

7,687 

 

 

(46)

 

16 

 

 

30,511 

 

 

(602)

 

74 

 

 

38,198 

 

 

(648)

 

90 

Asset-backed securities

 

5,826 

 

 

(22)

 

 

 

19 

 

 

(2)

 

 

 

5,845 

 

 

(24)

 

Total temporarily impaired
  securities

$

23,424 

 

$

(245)

 

37 

 

$

62,546 

 

$

(1,292)

 

134 

 

$

85,970 

 

$

(1,537)

 

171 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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







 

 

 

 

 

 



 

 

 

 

 

 



 

Three Months Ended

(Dollars in thousands)

 

March 31,



 

2019

 

2018

Balance of cumulative credit-related OTTI at January 1

 

$

272 

 

$

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

 

$

272 

 

$

595 



 

 

 

 

 

 

Equity securities at Fair Value

The Corporation owns one equity investment. At March 31, 2019 and December 31, 2018, this investment was reported at fair value of $377 thousand and $374 thousand, respectively, with changes in value reported through income. 

9


 

Restricted Stock at Cost

The Bank held $452 thousand of restricted stock at March 31, 2019.  Except for $30 thousand, this investment represents stock in FHLB Pittsburgh. The Bank is required to hold this stock to be a member of FHLB and it is carried at cost of $100 per share. The level of FHLB stock held is determined by FHLB and is comprised of a minimum membership amount plus a variable activity amount. FHLB stock is evaluated for impairment primarily based on an assessment of the ultimate recoverability of its cost. As a government sponsored entity, FHLB has the ability to raise funding through the U.S. Treasury that can be used to support its operations.  There is not a public market for FHLB stock and the benefits of FHLB membership (e.g., liquidity and low cost funding) add value to the stock beyond purely financial measures. Management intends to remain a member of the FHLB and believes that it will be able to fully recover the cost basis of this investment.  





Note 5. Loans

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

10


 

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



 

 

 

 

 

 



 

 

 

 

 

 



 

March 31,

 

December 31,

(Dollars in thousands)

 

2019

 

2018

Residential Real Estate 1-4 Family

 

 

 

 

 

 

Consumer first liens

 

$

89,212 

 

$

89,673 

Commercial first lien

 

 

58,210 

 

 

59,227 

Total first liens

 

 

147,422 

 

 

148,900 



 

 

 

 

 

 

Consumer junior liens and lines of credit

 

 

41,831 

 

 

42,504 

Commercial junior liens and lines of credit

 

 

4,859 

 

 

4,716 

Total junior liens and lines of credit

 

 

46,690 

 

 

47,220 

Total residential real estate 1-4 family

 

 

194,112 

 

 

196,120 



 

 

 

 

 

 

Residential real estate - construction

 

 

 

 

 

 

Consumer

 

 

2,750 

 

 

1,667 

Commercial

 

 

11,231 

 

 

8,558 

Total residential real estate construction

 

 

13,981 

 

 

10,225 



 

 

 

 

 

 

Commercial real estate

 

 

497,974 

 

 

487,980 

Commercial

 

 

269,243 

 

 

274,054 

        Total commercial

 

 

767,217 

 

 

762,034 



 

 

 

 

 

 

Consumer

 

 

5,156 

 

 

4,996 



 

 

980,466 

 

 

973,375 

Less: Allowance for loan losses

 

 

(12,681)

 

 

(12,415)

Net Loans

 

$

967,785 

 

$

960,960 



 

 

 

 

 

 

Included in the loan balances are the following:

 

 

 

 

 

 

Net unamortized deferred loan costs

 

$

125 

 

$

123 



 

 

 

 

 

 

Loans pledged as collateral for borrowings and commitments from:

 

 

 

 

 

 

FHLB

 

$

787,055 

 

$

772,564 

Federal Reserve Bank

 

 

33,645 

 

 

34,160 



 

$

820,700 

 

$

806,724 

 

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 shown:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

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, 2018

 

$

491 

 

$

133 

 

$

108 

 

$

5,698 

 

$

4,511 

 

$

70 

 

$

1,404 

 

$

12,415 

Charge-offs

 

 

(33)

 

 

(1)

 

 

(3)

 

 

(63)

 

 

(61)

 

 

(26)

 

 

 —

 

 

(187)

Recoveries

 

 

 

 

 —

 

 

 —

 

 

 

 

42 

 

 

10 

 

 

 —

 

 

54 

Provision

 

 

28 

 

 

 —

 

 

47 

 

 

270 

 

 

70 

 

 

18 

 

 

(34)

 

 

399 

ALL at March 31, 2019

 

$

487 

 

$

132 

 

$

152 

 

$

5,906 

 

$

4,562 

 

$

72 

 

$

1,370 

 

$

12,681 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



11


 

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, 2019 and December 31, 2018:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

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, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for ALL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

401 

 

$

 —

 

$

652 

 

$

13,247 

 

$

 —

 

$

 —

 

$

 —

 

$

14,300 

Collectively

 

 

147,021 

 

 

46,690 

 

 

13,329 

 

 

484,727 

 

 

269,243 

 

 

5,156 

 

 

 —

 

 

966,166 

Total

 

$

147,422 

 

$

46,690 

 

$

13,981 

 

$

497,974 

 

$

269,243 

 

$

5,156 

 

$

 —

 

$

980,466 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL established for
  loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

Collectively

 

 

487 

 

 

132 

 

 

152 

 

 

5,906 

 

 

4,562 

 

 

72 

 

 

1,370 

 

 

12,681 

ALL at March 31, 2019

 

$

487 

 

$

132 

 

$

152 

 

$

5,906 

 

$

4,562 

 

$

72 

 

$

1,370 

 

$

12,681 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for ALL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

405 

 

$

 —

 

$

455 

 

$

10,099 

 

$

181 

 

$

 —

 

$

 —

 

$

11,140 

Collectively

 

 

148,495 

 

 

47,220 

 

 

9,770 

 

 

477,881 

 

 

273,873 

 

 

4,996 

 

 

 —

 

 

962,235 

Total

 

$

148,900 

 

$

47,220 

 

$

10,225 

 

$

487,980 

 

$

274,054 

 

$

4,996 

 

$

 —

 

$

973,375 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL established for
  loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

Collectively

 

 

491 

 

 

133 

 

 

108 

 

 

5,698 

 

 

4,511 

 

 

70 

 

 

1,404 

 

 

12,415 

ALL at December 31, 2018

 

$

491 

 

$

133 

 

$

108 

 

$

5,698 

 

$

4,511 

 

$

70 

 

$

1,404 

 

$

12,415 

12


 

The following table shows additional information about those loans considered to be impaired at March 31, 2019 and December 31, 2018:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Impaired Loans



 

With No Allowance

 

With Allowance

(Dollars in thousands)

 

 

 

 

Unpaid

 

 

 

 

Unpaid

 

 

 



 

Recorded

 

Principal

 

Recorded

 

Principal

 

Related

March 31, 2019

 

Investment

 

Balance

 

Investment

 

Balance

 

Allowance

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

889 

 

$

889 

 

$

 —

 

$

 —

 

$

 —

Junior liens and lines of credit

 

 

44 

 

 

44 

 

 

 —

 

 

 —

 

 

 —

Total

 

 

933 

 

 

933 

 

 

 —

 

 

 —

 

 

 —

 Residential real estate - construction

 

 

652 

 

 

729 

 

 

 —

 

 

 —

 

 

 —

 Commercial real estate

 

 

13,446 

 

 

14,022 

 

 

 —

 

 

 —

 

 

 —

 Commercial

 

 

129 

 

 

146 

 

 

 —

 

 

 —

 

 

 —

Total

 

$

15,160 

 

$

15,830 

 

$

 —

 

$

 —

 

$

 —







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

871 

 

$

958 

 

$

 —

 

$

 —

 

$

 —

Junior liens and lines of credit

 

 

49 

 

 

49 

 

 

 —

 

 

 —

 

 

 —

Total

 

 

920 

 

 

1,007 

 

 

 —

 

 

 —

 

 

 —

 Residential real estate - construction

 

 

455 

 

 

531 

 

 

 —

 

 

 —

 

 

 —

 Commercial real estate

 

 

10,236 

 

 

10,808 

 

 

 —

 

 

 —

 

 

 —

 Commercial

 

 

315 

 

 

9,763 

 

 

 —

 

 

 —

 

 

 —

Total

 

$

11,926 

 

$

22,109 

 

$

 —

 

$

 —

 

$

 —



The following table shows the average of impaired loans and related interest income for the three months ended March 31, 2019 and 2018:





 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

Three Months Ended



 

March 31, 2019

 

March 31, 2018



 

Average

 

Interest

 

Average

 

Interest

(Dollars in thousands)

 

Recorded

 

Income

 

Recorded

 

Income



 

Investment

 

Recognized

 

Investment

 

Recognized

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

893 

 

$

11 

 

$

805 

 

$

11 

Junior liens and lines of credit

 

 

44 

 

 

 —

 

 

 —

 

 

 —

Total

 

 

937 

 

 

11 

 

 

805 

 

 

11 

 Residential real estate - construction

 

 

653 

 

 

 —

 

 

466 

 

 

 —

 Commercial real estate

 

 

13,494 

 

 

102 

 

 

10,994 

 

 

105 

 Commercial

 

 

129 

 

 

 —

 

 

185 

 

 

 —

Total

 

$

15,213 

 

$

113 

 

$

12,450 

 

$

116 

13


 

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, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

146,866 

 

$

309 

 

$

30 

 

$

137 

 

$

476 

 

$

80 

 

$

147,422 

Junior liens and lines of credit

 

 

46,588 

 

 

29 

 

 

29 

 

 

18 

 

 

76 

 

 

26 

 

 

46,690 

Total

 

 

193,454 

 

 

338 

 

 

59 

 

 

155 

 

 

552 

 

 

106 

 

 

194,112 

Residential real estate - construction

 

 

13,329 

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

652 

 

 

13,981 

Commercial real estate

 

 

491,462 

 

 

438 

 

 

1,331 

 

 

 —

 

 

1,769 

 

 

4,743 

 

 

497,974 

Commercial

 

 

268,527 

 

 

273 

 

 

262 

 

 

52 

 

 

587 

 

 

129 

 

 

269,243 

Consumer

 

 

5,135 

 

 

21 

 

 

 —

 

 

 —

 

 

21 

 

 

 —

 

 

5,156 

Total

 

$

971,907 

 

$

1,070 

 

$

1,652 

 

$

207 

 

$

2,929 

 

$

5,630 

 

$

980,466 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

148,183 

 

$

322 

 

$

202 

 

$

113 

 

$

637 

 

$

80 

 

$

148,900 

Junior liens and lines of credit

 

 

47,040 

 

 

131 

 

 

 —

 

 

26 

 

 

157 

 

 

23 

 

 

47,220 

Total

 

 

195,223 

 

 

453 

 

 

202 

 

 

139 

 

 

794 

 

 

103 

 

 

196,120 

Residential real estate - construction

 

 

9,572 

 

 

 —

 

 

198 

 

 

 —

 

 

198 

 

 

455 

 

 

10,225 

Commercial real estate

 

 

481,774 

 

 

1,343 

 

 

3,323 

 

 

113 

 

 

4,779 

 

 

1,427 

 

 

487,980 

Commercial

 

 

273,534 

 

 

65 

 

 

40 

 

 

100 

 

 

205 

 

 

315 

 

 

274,054 

Consumer

 

 

4,933 

 

 

46 

 

 

12 

 

 

 

 

63 

 

 

 —

 

 

4,996 

Total

 

$

965,036 

 

$

1,907 

 

$

3,775 

 

$

357 

 

$

6,039 

 

$

2,300 

 

$

973,375 



The following table reports the risk rating for those loans in the portfolio that are assigned an individual risk rating.  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, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

$

146,986 

 

$

 —

 

$

436 

 

$

 —

 

$

147,422 

Junior liens and lines of credit

 

46,646 

 

 

 —

 

 

44 

 

 

 —

 

 

46,690 

Total

 

193,632 

 

 

 —

 

 

480 

 

 

 —

 

 

194,112 

Residential real estate - construction

 

13,329 

 

 

 —

 

 

652 

 

 

 —

 

 

13,981 

Commercial real estate

 

490,057 

 

 

655 

 

 

7,262 

 

 

 —

 

 

497,974 

Commercial

 

268,345 

 

 

 —

 

 

898 

 

 

 —

 

 

269,243 

Consumer

 

5,156 

 

 

 —

 

 

 —

 

 

 —

 

 

5,156 

Total

$

970,519 

 

$

655 

 

$

9,292 

 

$

 —

 

$

980,466 









 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

$

148,453 

 

$

 —

 

$

447 

 

$

 —

 

$

148,900 

Junior liens and lines of credit

 

47,171 

 

 

 —

 

 

49 

 

 

 —

 

 

47,220 

Total

 

195,624 

 

 

 —

 

 

496 

 

 

 —

 

 

196,120 

Residential real estate - construction

 

9,572 

 

 

 —

 

 

653 

 

 

 —

 

 

10,225 

Commercial real estate

 

479,969 

 

 

660 

 

 

7,351 

 

 

 —

 

 

487,980 

Commercial

 

272,959 

 

 

 —

 

 

1,095 

 

 

 —

 

 

274,054 

Consumer

 

4,991 

 

 

 —

 

 

 

 

 —

 

 

4,996 

Total

$

963,115 

 

$

660 

 

$

9,600 

 

$

 —

 

$

973,375 

14


 



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, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

$

454 

 

$

 —

 

$

454 

 

 —

 

$

 —

Residential real estate

 

 

 

673 

 

 

673 

 

 

 —

 

 —

 

 

 —

Commercial real estate

 

11 

 

 

9,982 

 

 

8,703 

 

 

1,279 

 

 —

 

 

 —

  Total

 

16 

 

$

11,109 

 

$

9,376 

 

$

1,733 

 

 —

 

$

 —



   

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

$

455 

 

$

 —

 

$

455 

 

 —

 

$

 —

Residential real estate

 

 

 

678 

 

 

678 

 

 

 —

 

 —

 

 

 —

Commercial real estate

 

11 

 

 

10,099 

 

 

8,809 

 

 

1,290 

 

 —

 

 

 —

  Total

 

16 

 

$

11,232 

 

$

9,487 

 

$

1,745 

 

 —

 

$

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

There were no new TDR loans during 2019 and 2018.





Note 7. Leases

The Corporation adopted ASU 2016-02 “Leases (Topic 842)” and all subsequent amendments on January 1, 2019 using the modified retrospective method.  The Corporation has elected the option to apply the new standard as of January 1, 2019 without restatement of any prior period results. Adoption of the new standard resulted in the recognition of a lease liability and a right-of-use asset of $6.2 million without a cumulative effect adjustment to retained earnings.   

The Corporation leases various assets in the course of its operations that are subject to recognition under the new standard. The Corporation considers all of its leases to be operating leases and it has no finance leases. The leased assets are comprised of equipment; and buildings and land (collectively real estate).  The equipment leases are shorter-term than the real estate leases, and generally have a fixed payment over a defined term without renewal options. Certain equipment leases have purchase options and it was determined the option was not reasonably certain to be exercised.  The real estate leases are longer-term and may contain renewal options after the initial term, but none of the real estate leases contain a purchase option. The renewal options on real estate leases were reviewed and if it was determined the option was reasonably certain to be renewed, the option term was considered in the determination of the lease liability.  There is only one real estate lease with a variable payment based on an index included in the lease liability. None of the leases contain any restrictive covenants and there are no significant leases that have not yet commenced.  The discount rate used to determine the lease liability is based on the Bank’s fully secured borrowing rate from the Federal Home Loan Bank for a term similar to the lease term.  Adoption of the new standard did not affect the Corporation’s status as a “well-capitalized” institution.  The Corporation has one real estate lease to a related party with a liability value of $1.8 million.  Operating lease expense is included in net occupancy expense in the consolidated statements of income. See Note 1 for additional information on the adoption of the new standard.



Lease costs for the three months ended March 31, 2019 were as follows:





 

 

 



 

Three Months Ended

(Dollars in thousands)

 

March 31, 2019

Operating lease cost

 

$

188 

Short-term lease cost

 

 

Variable lease cost

 

 

11 

Total lease cost

 

$

205 



15


 

Cash paid for amounts included in the measurement of lease liabilities and the weighted-average remaining lease term and discount rate were as follows:





 

 

 



 

Three Months Ended

(Dollars in thousands)

 

March 31, 2019

Cash paid for amounts included in the measurement of lease liabilities:

 

 

 

Operating cash flows from operating leases

 

$

123 



 

 

 

Weighted-average remaining lease term

 

 

13.7 years

Weighted-average discount rate

 

 

3.54% 



As of March 31, 2019, the future minimum payments for operating leases having initial or remaining lease terms in excess of one year were as follows:





 

 

 

(Dollars in thousands)

 

 

 



 

 

 

2019

 

$

706 

2020

 

 

664 

2021

 

 

651 

2022

 

 

543 

2023

 

 

539 

2024 and beyond

 

 

4,790 

    Total undiscounted cash flows

 

 

7,893 

Discounted cash flows

 

 

(1,780)

    Total lease liability

 

$

6,113 





Note 8. Other Real Estate Owned

Changes in other real estate owned were as follows:





 

 

 

 

 

 



 

Three Months Ended



 

March 31,

(Dollars in thousands)

 

2019

 

2018

Balance at beginning of the period

 

$

2,684 

 

$

2,598 

   Additions

 

 

 —

 

 

 —

   Proceeds from dispositions

 

 

 —

 

 

 —

   Loss on sales, net

 

 

 —

 

 

 —

   Valuation adjustment

 

 

 —

 

 

(6)

Balance at the end of the period

 

$

2,684 

 

$

2,592 

 

Note 9. Pension

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





 

 

 

 

 

 



 

Three Months Ended



 

March 31,

(Dollars in thousands)

 

2019

 

2018

Components of net periodic cost:

 

 

 

 

 

 

Service cost

 

$

80 

 

$

90 

Interest cost

 

 

158 

 

 

138 

Expected return on plan assets

 

 

(270)

 

 

(279)

Recognized net actuarial loss

 

 

152 

 

 

176 

Net period cost

 

$

120 

 

$

125 



The Bank expects its pension expense to decrease to approximately $420 thousand in 2019 compared to $500 thousand in 2018, due primarily to decreases in service costs and recognized net actuarial losses.  The service cost component of pension expense is in the salaries and employee benefits line on the income statement. All other cost components are in the other expense line on the income statement.

 

16


 



Note 10.  Fair Value Measurements and Fair Values of Financial Instruments

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

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

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

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

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

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

The following 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, 2019



Carrying

 

Fair

 

 

 

 

 

 

 

(Dollars in thousands)

Amount

 

Value

 

Level 1

 

Level 2

 

Level 3

Financial assets, carried at cost:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

$

47,033 

 

$

47,033 

 

$

47,033 

 

$

 —

 

$

 —

Restricted stock

 

452 

 

 

452 

 

 

 —

 

 

452 

 

 

 —

Loans held for sale

 

195 

 

 

195 

 

 

 

 

 

195 

 

 

 

Net loans

 

967,785 

 

 

952,024 

 

 

 —

 

 

 —

 

 

952,024 

Accrued interest receivable

 

3,963 

 

 

3,963 

 

 

 —

 

 

3,963 

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial assets, available for sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt securities

 

127,881 

 

 

127,881 

 

 

 —

 

 

127,881 

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial assets, fair value

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

377 

 

 

377 

 

 

377 

 

 

 —

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

$

1,076,491 

 

$

1,076,572 

 

$

 —

 

$

1,076,572 

 

$

 —

Accrued interest payable

 

291 

 

 

291 

 

 

 —

 

 

291 

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 



December 31, 2018



Carrying

 

Fair

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

Amount

 

Value

 

Level 1

 

Level 2

 

Level 3

Financial assets, carried at cost:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

$

52,957 

 

$

52,957 

 

$

52,957 

 

$

 —

 

$

 —

Restricted stock

 

452 

 

 

452 

 

 

 —

 

 

452 

 

 

 —

Loans held for sale

 

118 

 

 

118 

 

 

 —

 

 

118 

 

 

 —

Net loans

 

960,960 

 

 

941,930 

 

 

 —

 

 

 —

 

 

941,930 

Accrued interest receivable

 

4,103 

 

 

4,103 

 

 

 —

 

 

4,103 

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial assets, available for sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt securities

 

131,472 

 

 

131,472 

 

 

 —

 

 

131,472 

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial assets, fair value

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

374 

 

 

374 

 

 

374 

 

 

 —

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

$

1,082,629 

 

$

1,082,425 

 

$

 —

 

$

1,082,425 

 

$

 —

Accrued interest payable

 

193 

 

 

193 

 

 

 —

 

 

193 

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

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, 2019 and December 31, 2018 are as follows:







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands

 

Fair Value at March 31, 2019

Asset  Description

 

Level 1

 

Level 2

 

Level 3

 

Total

Equity securities, at fair value

 

$

377 

 

$

 —

 

$

 —

 

$

377 



 

 

 

 

 

 

 

 

 

 

 

 

Available for sale:

 

 

 

 

 

 

 

 

 

 

 

 

 U.S. Government and Agency securities

 

 

 —

 

 

9,618 

 

 

 —

 

 

9,618 

 Municipal securities

 

 

 —

 

 

64,557 

 

 

 —

 

 

64,557 

 Trust Preferred Securities

 

 

 —

 

 

3,900 

 

 

 —

 

 

3,900 

 Agency mortgage-backed securities

 

 

 —

 

 

42,589 

 

 

 —

 

 

42,589 

  Private-label mortgage-backed securities

 

 

 —

 

 

478 

 

 

 —

 

 

478 

 Asset-backed securities

 

 

 —

 

 

6,739 

 

 

 —

 

 

6,739 

Total assets

 

$

377 

 

$

127,881 

 

$

 —

 

$

128,258 



 

 

 

 

 

 

 

 

 

 

 

 







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

 

Fair Value at December 31, 2018

Asset  Description

 

Level 1

 

Level 2

 

Level 3

 

Total

Equity securities, at fair value

 

$

374 

 

$

 —

 

$

 —

 

$

374 



 

 

 

 

 

 

 

 

 

 

 

 

Available for sale:

 

 

 

 

 

 

 

 

 

 

 

 

 U.S. Government and Agency securities

 

 

 —

 

 

9,076 

 

 

 —

 

 

9,076 

 Municipal securities

 

 

 —

 

 

67,647 

 

 

 —

 

 

67,647 

 Trust Preferred Securities

 

 

 —

 

 

3,758 

 

 

 —

 

 

3,758 

 Agency mortgage-backed securities

 

 

 —

 

 

44,658 

 

 

 —

 

 

44,658 

  Private-label mortgage-backed securities

 

 

 —

 

 

488 

 

 

 —

 

 

488 

 Asset-backed securities

 

 

 —

 

 

5,845 

 

 

 —

 

 

5,845 

Total assets

 

$

374 

 

$

131,472 

 

$

 —

 

$

131,846 



 

 

 

 

 

 

 

 

 

 

 

 

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

The Corporation did not record any assets at fair value for which measurement of the fair value was made on a nonrecurring basis at March 31, 2019.  For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at December 31, 2018 was as follows:





 



 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

 

Fair Value at December 31, 2018

Asset  Description

 

Level 1

 

Level 2

 

Level 3

 

Total

Other real estate owned (1)

 

$

 —

 

$

 —

 

$

71 

 

$

71 

Total assets

 

$

 —

 

$

 —

 

$

71 

 

$

71 

(1)

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



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

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

The Corporation did not record any liabilities at fair value for which measurement of the fair value was made on a nonrecurring basis at March 31, 2019. 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, 2019.

19


 

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







 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

 

 

December 31, 2018

 

 

Fair Value

 

Valuation Technique

 

Unobservable Input

 

Weighted Average

Other real estate owned (1)

 

$

71 

 

Appraisal

 

Cost to sell

 

8% (8%)



 

 

 

 

 

 

 

 

 

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

 

 

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

 

 

 

Note 11. Capital Ratios

Capital adequacy is currently defined by regulatory agencies through the use of several minimum required ratios.  In July 2013, Federal banking regulators approved the final rules from the Basel Committee on Banking Supervision for the regulation of capital requirements for bank holding companies and U.S banks, generally referred to as “Basel III.” The Basel III standards were effective for the Corporation and the Bank, effective January 1, 2015 (subject to a phase-in period for certain provisions).  Basel III imposes significantly higher capital requirements and more restrictive leverage and liquidity ratios than those previously in place.  The capital ratios to be considered “well capitalized” under Basel III are: (1) Common Equity Tier 1 (CET1) of 6.5%, (2) Tier 1 Leverage of 5%, (3) Tier 1 Risk-Based Capital of 8%, and (4) Total Risk-Based Capital of 10%.  The CET1 ratio is a new capital ratio under Basel III and the Tier 1 risk-based capital ratio of 8% has been increased from 6%. The rules also include changes in the risk weights of certain assets to better reflect credit and other risk exposures. In addition, a capital conservation buffer will be phased-in beginning January 1, 2016 at 0.625%,  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, 2019 was 6.95% (total risk-based capital 14.95% less 8.00%) compared to the 2019 regulatory buffer of 2.50%.  Compliance with the capital conservation buffer is required in order to avoid limitations to certain capital distributions.  As of March 31, 2019, the Bank was “well capitalized’ under the Basel III requirements. 

The following table summarizes regulatory capital information as of March 31, 2019 and December 31, 2018 for the Corporation and the Bank:    





 

 

 

 

 

 

 

 



 

 

 

 

 

Regulatory Ratios



 

 

 

 

 

Adequately

 

Well



 

March 31,

 

December 31,

 

Capitalized

 

Capitalized

(Dollars in thousands)

 

2019

 

2018

 

Minimum

 

Minimum



 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

13.78% 

 

13.96% 

 

4.500% 

 

N/A

Farmers & Merchants Trust Company

 

13.69% 

 

13.80% 

 

4.500% 

 

6.50% 



 

 

 

 

 

 

 

 

Tier 1 Risk-based Capital Ratio (2)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

13.78% 

 

13.96% 

 

6.000% 

 

N/A

Farmers & Merchants Trust Company

 

13.69% 

 

13.80% 

 

6.000% 

 

8.00% 



 

 

 

 

 

 

 

 

Total Risk-based Capital Ratio (3)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

15.04% 

 

15.21% 

 

8.000% 

 

N/A

Farmers & Merchants Trust Company

 

14.95% 

 

15.06% 

 

8.000% 

 

10.00% 



 

 

 

 

 

 

 

 

Tier 1 Leverage Ratio (4)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

9.88% 

 

9.78% 

 

4.000% 

 

N/A

Farmers & Merchants Trust Company

 

9.82% 

 

9.68% 

 

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

 

20


 

Note 12. 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 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 were $1.3 million for the first quarters of 2019 and 2018.

·

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 obligations 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 were $70 thousand for the first quarter of 2019, compared to $61 thousand for the first quarter of 2018.

·

Commissions from the sale of investment and insurance products are recognized upon the completion of the transaction.  Fees recognized were $68 thousand for the first quarters of 2019 and 2018.

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.

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

21


 

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 13.  Commitments and Contingencies

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

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

The Bank had the following outstanding commitments for the periods presented:





 

 

 

 

 

 



 

March 31,

 

December 31,

(Dollars in thousands)

 

2019

 

2018

Financial instruments whose contract amounts represent credit risk

 

 

 

 

 

 

Commercial commitments to extend credit

 

$

231,555 

 

$

216,913 

Consumer commitments to extend credit (secured)

 

 

50,950 

 

 

49,221 

Consumer commitments to extend credit (unsecured)

 

 

5,506 

 

 

5,605 



 

$

288,011 

 

$

271,739 

Standby letters of credit

 

$

25,306 

 

$

25,429 



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

Standby letters of credit are instruments issued by the Bank, which guarantee the beneficiary payment by the Bank in the event of default by the Bank’s customer in the nonperformance of an obligation or service.  Most standby letters of credit are extended for one-year periods.  Generally, the credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.  The Bank holds collateral supporting those commitments for which collateral is deemed necessary primarily in the form of certificates of deposit and liens on real estate. Management believes that the proceeds obtained through a liquidation of such collateral would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees.  As of June 30, 2018, the Bank established a $2.4 million allowance against letters of credit issued in connection with a commercial borrower that declared bankruptcy in the second quarter of 2018 which remains at March 31, 2019.  Except for the liability recorded for standby letters of credit, liabilities for credit loss associated with off-balance sheet commitments were not material at March 31, 2019 and December 31, 2018.

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

Legal Proceedings

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

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.

22


 

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 at this time will have a material adverse effect on our financial position.  We cannot now determine, however, whether or not any claim asserted against us 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, 2019, we are unable to provide an evaluation of the likelihood of an unfavorable outcome or an estimate of the amount or range of potential loss with respect to such other matters and, accordingly, have not yet established any specific accrual for such other matters.

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

23


 

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

For the Three Months Ended March  31, 2019 and 2018



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.  We caution readers not to place undue reliance on these forward-looking statements.  They only reflect management’s analysis as of this date.  The Corporation does not revise or update these forward-looking statements to reflect events or changed circumstances.



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 2018 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 2018 Annual Report on Form 10-K for a more detailed disclosure of the critical accounting policies.



Results of Operations



Year-to-Date Summary

Reported net income of $3.2 million for the first quarter

·

Net interest income increased $636 thousand quarter over quarter due to the growth in interest income from the loan portfolio that outpaced higher interest expense.  

·

The provision for loan losses increased $199 thousand quarter over quarter due primarily to loan growth.  

·

Noninterest income increased $17 thousand quarter over quarter primarily from asset management fees in the Bank’s Investment and Trust Services department, foreign ATM fees and fees from the merchant card program.    

·

Noninterest expense increased $764 thousand quarter over quarter primarily from increases in salaries and benefits.

Total assets were $1.213 billion at March  31, 2019, an increase of $3.4 million from the 2018 year-end balance of $1.210 billion

·

The loan portfolio increased approximately $7 million due to loan growth in commercial real estate loans for hotels and motels and land development

·

A lease liability and a right-of-use asset of $6.2 million were recognized during the quarter.

·

Deposits decreased $6.1 million in the first quarter,  primarily in municipal money management accounts.  

·

Shareholders’ equity increased $3.1 million due to net income of $3.2 million and $1.1 million increase in other comprehensive income for the quarter, offset by the first quarter dividend of $1.2 million.

24


 

Key performance ratios as of, or for the three months ended March 31, 2019 and 2018 and the year ended December 31, 2018 are listed below:







 

 

 

 

 

 

 

 

 



 

March 31,

 

December 31,

 

March 31,



 

2019

 

2018

 

2018

(Dollars in thousands, except per share)

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

Balance Sheet Highlights

 

 

 

 

 

 

 

 

 

Total assets

 

$

1,212,960 

 

$

1,209,587 

 

$

1,168,542 

Investment and equity securities

 

 

128,258 

 

 

131,846 

 

 

133,732 

Loans, net

 

 

967,785 

 

 

960,960 

 

 

930,664 

Deposits

 

 

1,076,491 

 

 

1,082,629 

 

 

1,034,461 

Shareholders' equity

 

 

121,491 

 

 

118,396 

 

 

117,124 



 

 

 

 

 

 

 

 

 

Summary of Operations

 

 

 

 

 

 

 

 

 

Interest income

 

$

11,989 

 

$

44,868 

 

$

10,488 

Interest expense

 

 

1,660 

 

 

4,214 

 

 

795 

Net interest income

 

 

10,329 

 

 

40,654 

 

 

9,693 

Provision for loan losses

 

 

399 

 

 

9,954 

 

 

200 

Net interest income after provision for loan losses

 

 

9,930 

 

 

30,700 

 

 

9,493 

Noninterest income

 

 

3,165 

 

 

12,629 

 

 

3,148 

Noninterest expense

 

 

9,412 

 

 

37,369 

 

 

8,648 

Income before income taxes

 

 

3,683 

 

 

5,960 

 

 

3,993 

Federal income tax (benefit) expense

 

 

446 

 

 

(165)

 

 

491 

Net income

 

$

3,237 

 

$

6,125 

 

$

3,502 



 

 

 

 

 

 

 

 

 

Performance Measurements

 

 

 

 

 

 

 

 

 

Return on average assets*

 

 

1.08% 

 

 

0.52% 

 

 

1.21% 

Return on average equity*

 

 

10.90% 

 

 

5.34% 

 

 

12.17% 

Return on average tangible equity (1)*

 

 

11.79% 

 

 

5.80% 

 

 

13.20% 

Efficiency ratio (1)

 

 

67.93% 

 

 

68.27% 

 

 

65.68% 

Net interest margin*

 

 

3.86% 

 

 

3.78% 

 

 

3.72% 



 

 

 

 

 

 

 

 

 

Shareholders' Value (per common share)

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

$

0.73 

 

$

1.39 

 

$

0.80 

Basic earnings per share

 

 

0.73 

 

 

1.40 

 

 

0.80 

Regular cash dividends declared

 

 

0.27 

 

 

1.05 

 

 

0.24 

Book value

 

 

27.54 

 

 

26.85 

 

 

26.83 

Tangible book value (1)

 

 

25.50 

 

 

24.81 

 

 

24.77 

Market value

 

 

36.00 

 

 

31.50 

 

 

36.54 

Market value/book value ratio

 

 

130.72% 

 

 

117.32% 

 

 

136.19% 

Price/earnings multiple*

 

 

12.33 

 

 

22.66 

 

 

11.42 

Current quarter dividend yield

 

 

3.00% 

 

 

3.43% 

 

 

2.63% 

Dividend payout ratio year-to-date

 

 

36.82% 

 

 

75.07% 

 

 

29.84% 



 

 

 

 

 

 

 

 

 

Safety and Soundness

 

 

 

 

 

 

 

 

 

Risk-based capital ratio (Total)

 

 

15.04% 

 

 

15.21% 

 

 

15.55% 

Leverage ratio (Tier 1)

 

 

9.88% 

 

 

9.78% 

 

 

9.95% 

Common equity ratio (Tier 1)

 

 

13.78% 

 

 

13.96% 

 

 

14.30% 

Nonperforming loans/gross loans

 

 

0.60% 

 

 

0.27% 

 

 

0.29% 

Nonperforming assets/total assets

 

 

0.70% 

 

 

0.44% 

 

 

0.46% 

Allowance for loan losses as a % of loans

 

 

1.29% 

 

 

1.28% 

 

 

1.27% 

Net loans charged-off/average loans*

 

 

0.05% 

 

 

0.97% 

 

 

0.00% 



 

 

 

 

 

 

 

 

 

Assets under Management

 

 

 

 

 

 

 

 

 

Trust assets under management (fair value)

 

$

753,086 

 

$

684,825 

 

$

684,648 

Held at third-party brokers (fair value)

 

 

127,515 

 

 

122,213 

 

 

152,728 

*Year-to-date 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 (Goodwill), 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, 2019

 

December 31, 2018

 

March 31, 2018

Return on Tangible Equity (non-GAAP)

 

 

 

 

 

 

 

 

 

Net income

 

$

3,237 

 

$

6,125 

 

$

3,502 



 

 

 

 

 

 

 

 

 

Average shareholders' equity

 

 

118,793 

 

 

114,625 

 

 

115,129 

Less average intangible assets

 

 

(9,016)

 

 

(9,016)

 

 

(9,016)

Average shareholders' equity (non-GAAP)

 

 

109,777 

 

 

105,609 

 

 

106,113 



 

 

 

 

 

 

 

 

 

 Return on average tangible equity (non-GAAP)*

 

 

11.79% 

 

 

5.80% 

 

 

13.20% 



 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Shareholders' equity

 

$

121,491 

 

$

118,396 

 

$

117,124 

Less intangible assets

 

 

(9,016)

 

 

(9,016)

 

 

(9,016)

Shareholders' equity (non-GAAP)

 

 

112,475 

 

 

109,380 

 

 

108,108 



 

 

 

 

 

 

 

 

 

Shares outstanding (in thousands)

 

 

4,411 

 

 

4,409 

 

 

4,365 



 

 

 

 

 

 

 

 

 

 Tangible book value (non-GAAP)

 

 

25.50 

 

 

24.81 

 

 

24.77 



 

 

 

 

 

 

 

 

 

Efficiency Ratio

 

 

 

 

 

 

 

 

 

Noninterest expense

 

$

9,412 

 

$

37,369 

 

$

8,648 



 

 

 

 

 

 

 

 

 

Net interest income  

 

 

10,329 

 

 

40,654 

 

 

9,693 

Plus tax equivalent adjustment to net interest income

 

 

388 

 

 

1,522 

 

 

370 

Plus noninterest income, net of securities transactions

 

 

3,138 

 

 

12,564 

 

 

3,103 

Total revenue

 

 

13,855 

 

 

54,740 

 

 

13,166 



 

 

 

 

 

 

 

 

 

 Efficiency ratio

 

 

67.93% 

 

 

68.27% 

 

 

65.68% 



 

 

 

 

 

 

 

 

 

* Year-to-date annualized

 

 

 

 

 

 

 

 

 



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, 2019 to the three months ended March 31, 2018:

Tax equivalent net interest income increased $654 thousand to $10.7 million in the first quarter of 2019 compared to $10.1 million in the same period in 2018Balance sheet volume contributed $348 thousand to this increase and $306 thousand was the result of changes in rates.    

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







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



For the Three Months Ended March 31,



2019

 

2018



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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

$

15,112 

 

$

97 

 

2.60% 

 

$

29,478 

 

$

118 

 

1.62% 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

82,297 

 

 

545 

 

2.69% 

 

 

86,783 

 

 

519 

 

2.43% 

Tax Exempt

 

51,167 

 

 

425 

 

3.33% 

 

 

44,253 

 

 

344 

 

3.11% 

               Investments

 

133,464 

 

 

970 

 

2.95% 

 

 

131,036 

 

 

863 

 

2.67% 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, industrial and agricultural

 

837,906 

 

 

9,644 

 

4.60% 

 

 

787,614 

 

 

8,261 

 

4.20% 

Residential mortgage

 

69,466 

 

 

752 

 

4.32% 

 

 

71,927 

 

 

733 

 

4.07% 

Home equity loans and lines

 

65,981 

 

 

832 

 

5.11% 

 

 

71,423 

 

 

809 

 

4.59% 

Consumer

 

5,124 

 

 

82 

 

6.49% 

 

 

5,075 

 

 

74 

 

5.91% 

Loans

 

978,477 

 

 

11,310 

 

4.63% 

 

 

936,039 

 

 

9,877 

 

4.23% 

Total interest-earning assets

 

1,127,053 

 

$

12,377 

 

4.45% 

 

 

1,096,553 

 

$

10,858 

 

4.02% 

Other assets

 

67,718 

 

 

 

 

 

 

 

62,845 

 

 

 

 

 

Total assets

$

1,194,771 

 

 

 

 

 

 

$

1,159,398 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking

$

295,786 

 

$

263 

 

0.36% 

 

$

281,421 

 

$

177 

 

0.26% 

Money Management

 

424,969 

 

 

1,046 

 

1.00% 

 

 

416,555 

 

 

442 

 

0.43% 

Savings

 

81,156 

 

 

107 

 

0.54% 

 

 

80,253 

 

 

56 

 

0.28% 

Time

 

72,481 

 

 

208 

 

1.16% 

 

 

71,452 

 

 

120 

 

0.68% 

Total interest-bearing deposits

 

874,392 

 

 

1,624 

 

0.75% 

 

 

849,681 

 

 

795 

 

0.38% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other borrowings

 

5,386 

 

 

36 

 

2.61% 

 

 

22 

 

 

 —

 

2.02% 

Total interest-bearing liabilities

 

879,778 

 

 

1,660 

 

0.77% 

 

 

849,703 

 

 

795 

 

0.38% 

Noninterest-bearing deposits

 

183,809 

 

 

 

 

 

 

 

177,101 

 

 

 

 

 

Other liabilities

 

12,391 

 

 

 

 

 

 

 

17,465 

 

 

 

 

 

Shareholders' equity

 

118,793 

 

 

 

 

 

 

 

115,129 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,194,771 

 

 

 

 

 

 

$

1,159,398 

 

 

 

 

 

T/E net interest income/Net interest margin

 

 

 

 

10,717 

 

3.86% 

 

 

 

 

 

10,063 

 

3.72% 

Tax equivalent adjustment

 

 

 

 

(388)

 

 

 

 

 

 

 

(370)

 

 

Net interest income

 

 

 

$

10,329 

 

 

 

 

 

 

$

9,693 

 

 



27


 

Provision for Loan Losses

Provision for loan loss expense for the first quarter was $399 thousand,  $199 thousand higher than in 2018For 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 2019, noninterest income increased $17 thousand from the same period in 2018.  Investment and trust service fees increased due to growth in assets under management.  Loan service charges were less than the same period in 2018 due to a lower volume of commercial loan originations. Deposit service charges were less than the same period in 2018 due to fewer fees from the Bank’s overdraft protection program, partially offset by increased fees from retail checking accounts. Other service charges and fees were higher from increased income from the Bank’s merchant card program. Debit card income was higher due to an increase in transaction volume.  The change in the fair value of equity investments recorded through income was a gain of $3 thousand compared to a gain of $45 thousand in the same period in 2018. 

The following table presents a comparison of noninterest income for the three months ended March 31, 2019 and 2018





 

 

 

 

 

 

 

 

 

 

 



 

For the Three Months Ended

 

 

 

 

 



 

March 31,

 

Change

(Dollars in thousands)

 

2019

 

2018

 

Amount

 

%

Noninterest Income

 

 

 

 

 

 

 

 

 

 

 

Investment and trust services fees

 

$

1,452 

 

$

1,397 

 

$

55 

 

3.9 

Loan service charges

 

 

203 

 

 

231 

 

 

(28)

 

(12.1)

Deposit service charges and fees

 

 

545 

 

 

574 

 

 

(29)

 

(5.1)

Other service charges and fees

 

 

353 

 

 

333 

 

 

20 

 

6.0 

Debit card income

 

 

402 

 

 

385 

 

 

17 

 

4.4 

Increase in cash surrender value of life insurance

 

 

127 

 

 

128 

 

 

(1)

 

(0.8)

Debt securities gains, net

 

 

24 

 

 

 —

 

 

24 

 

NA

Change in fair value of equity securities

 

 

 

 

45 

 

 

(42)

 

(93.3)

Other

 

 

56 

 

 

55 

 

 

 

1.8 

Total noninterest income

 

$

3,165 

 

$

3,148 

 

$

17 

 

0.5 



Noninterest Expense

Noninterest expense for the first quarter of 2018 increased $764 thousand compared to the same period in 2018.  The increase in salaries and benefits was primarily due to an increase in salary expense ($389 thousand) from merit increases and incentive plans ($90 thousand) compared to the same period in 2018.  Legal and professional increased due to fees for various consulting services.    FDIC insurance expense decreased due to a reduction in the Bank’s base assessment rate.  Other expenses increased related to the Nasdaq listing fee, increased director’s fees and recruiting fees.

The following table presents a comparison of noninterest expense for the three months ended March 31, 2019 and 2018



 

 

 

 

 

 

 

 

 

 

 



 

For the Three Months Ended

 

 

 

 

 

(Dollars in thousands)

 

March 31,

 

Change

Noninterest Expense

 

2019

 

2018

 

Amount

 

%

Salaries and benefits

 

$

5,442 

 

$

4,986 

 

$

456 

 

9.1 

Net occupancy

 

 

856 

 

 

815 

 

 

41 

 

5.0 

Advertising

 

 

402 

 

 

427 

 

 

(25)

 

(5.9)

Legal and professional

 

 

430 

 

 

329 

 

 

101 

 

30.7 

Data processing

 

 

705 

 

 

596 

 

 

109 

 

18.3 

Pennsylvania bank shares tax

 

 

243 

 

 

239 

 

 

 

1.7 

FDIC insurance

 

 

65 

 

 

129 

 

 

(64)

 

(49.6)

ATM/debit card processing

 

 

258 

 

 

238 

 

 

20 

 

8.4 

Foreclosed real estate

 

 

17 

 

 

14 

 

 

 

21.4 

Telecommunications

 

 

105 

 

 

109 

 

 

(4)

 

(3.7)

Other

 

 

889 

 

 

766 

 

 

123 

 

16.1 

Total noninterest expense

 

$

9,412 

 

$

8,648 

 

$

764 

 

8.8 



28


 

Provision for Income Taxes

For the first quarter, the Corporation recorded a Federal income tax expense of $446 thousand compared to $491 thousand for the same quarter in  2018.   The effective tax rate for the first quarter of 2019 was 12.1% compared to 12.3% for the same period in 2018. The federal statutory tax rate is 21% for 2019 and 2018.

Financial Condition

Cash and Cash Equivalents:

Cash and cash equivalents totaled $47.0 million at March 31, 2019, a decrease of $6.0 million from the prior year-end balance of $53.0 million. The decrease was mainly due to a reduction in non-interest bearing balances at the Federal Reserve. Interest-bearing deposits are held primarily at the Federal Reserve ($26.8 million) and in short-term bank owned certificates of deposit ($8.0 million).



Investment Securities: 

AFS Securities: The AFS securities portfolio has decreased $5.0 million on a cost basis, since year-end 2018. 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 50% and 33% of the portfolio fair value, respectively.  The average life of the portfolio was 3.98 years. 

The AFS securities portfolio had a net unrealized gain of $290 thousand at March 31, 2019 compared to a net unrealized loss of $1.1 million at the prior year-end.  The portfolio averaged $133.5 million with a yield of 2.95% for the first three months of 2019. This compares to an average of $131.0 million and a yield of 2.67% for the same period in 2018.    

The municipal bond portfolio is well diversified geographically (issuers from within 27 states) and is comprised primarily of general obligation bonds (67.4%).  Many municipal bonds have credit enhancements in the form of private bond insurance or other credit support. The largest geographic municipal bond exposure is in the states of Texas (13.5%), Washington (10.3%), and Ohio (9.1%).  The average rating of the municipal portfolio from Moody’s is AA.  No municipal bonds are rated below investment grade.

The amortized cost and estimated fair value of AFS securities available for sale as of March 31, 2019 and December 31, 2018 is as follows:





 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

March 31, 2019

 

cost

 

gains

 

losses

 

value

U.S. Government and Agency securities

 

$

9,634 

 

$

24 

 

$

(40)

 

$

9,618 

Municipal securities

 

 

63,820 

 

 

845 

 

 

(108)

 

 

64,557 

Trust preferred securities

 

 

4,080 

 

 

 —

 

 

(180)

 

 

3,900 

Agency mortgage-backed securities

 

 

42,818 

 

 

135 

 

 

(364)

 

 

42,589 

Private-label mortgage-backed securities

 

 

448 

 

 

30 

 

 

 —

 

 

478 

Asset-backed securities

 

 

6,791 

 

 

 —

 

 

(52)

 

 

6,739 



 

$

127,591 

 

$

1,034 

 

$

(744)

 

$

127,881 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

December 31, 2018

 

cost

 

gains

 

losses

 

value

U.S. Government and Agency securities

 

$

9,120 

 

$

21 

 

$

(65)

 

$

9,076 

Municipal securities

 

 

67,811 

 

 

320 

 

 

(484)

 

 

67,647 

Trust preferred securities

 

 

4,074 

 

 

 —

 

 

(316)

 

 

3,758 

Agency mortgage-backed securities

 

 

45,241 

 

 

65 

 

 

(648)

 

 

44,658 

Private-label mortgage-backed securities

 

 

457 

 

 

31 

 

 

 —

 

 

488 

Asset-backed securities

 

 

5,869 

 

 

 —

 

 

(24)

 

 

5,845 



 

$

132,572 

 

$

437 

 

$

(1,537)

 

$

131,472 



The AFS securities portfolio contained 125 securities with $57.7 million of temporarily impaired fair value and $744 thousand in unrealized losses at March 31, 2019. The total unrealized loss position has decreased $793 thousand since year-end 2018. 

29


 

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. The impairment identified on debt securities and subject to assessment at March 31, 2019, was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted.

The following table reflects temporary impairment in the AFS securities 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, 2019 and December 31, 2018:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



March 31, 2019



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

$

 —

 

$

 —

 

 —

 

$

4,777 

 

$

(40)

 

14 

 

$

4,777 

 

$

(40)

 

14 

Municipal securities

 

238 

 

 

 —

 

 

 

12,377 

 

 

(108)

 

21 

 

 

12,615 

 

 

(108)

 

22 

Trust preferred securities

 

1,166 

 

 

(33)

 

 

 

2,734 

 

 

(147)

 

 

 

3,900 

 

 

(180)

 

Agency mortgage-backed securities

 

895 

 

 

(1)

 

 

 

28,746 

 

 

(363)

 

71 

 

 

29,641 

 

 

(364)

 

75 

Asset-backed securities

 

6,721 

 

 

(51)

 

 

 

18 

 

 

(1)

 

 

 

6,739 

 

 

(52)

 

Total temporarily impaired
  securities

$

9,020 

 

$

(85)

 

14 

 

$

48,652 

 

$

(659)

 

111 

 

$

57,672 

 

$

(744)

 

125 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



December 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

$

2,071 

 

$

(6)

 

 

$

5,175 

 

$

(59)

 

14 

 

$

7,246 

 

$

(65)

 

16 

Municipal securities

 

5,832 

 

 

(12)

 

10 

 

 

25,091 

 

 

(472)

 

42 

 

 

30,923 

 

 

(484)

 

52 

Trust preferred securities

 

2,008 

 

 

(159)

 

 

 

1,750 

 

 

(157)

 

 

 

3,758 

 

 

(316)

 

Agency mortgage-backed securities

 

7,687 

 

 

(46)

 

16 

 

 

30,511 

 

 

(602)

 

74 

 

 

38,198 

 

 

(648)

 

90 

Asset-backed securities

 

5,826 

 

 

(22)

 

 

 

19 

 

 

(2)

 

 

 

5,845 

 

 

(24)

 

Total temporarily impaired
  securities

$

23,424 

 

$

(245)

 

37 

 

$

62,546 

 

$

(1,292)

 

134 

 

$

85,970 

 

$

(1,537)

 

171 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The unrealized loss in the municipal bond portfolio decreased to $108 thousand from $484 thousand at December 31, 2018 as interest rates remained flat during the year.  There are twenty-two 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 five securities with a fair value of $3.9 million and an unrealized loss of $180 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, 2019, 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 ValueThe Corporation owns one equity investment. At March 31, 2019 and December 31, 2018, this investment was reported at fair value of $377 thousand and $374 thousand, respectively, with changes in value reported through income. 

Restricted Stock at CostThe Bank held $452 thousand of restricted stock at March 31, 2019.  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

30


 

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



Loans:    

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

Total residential real estate loans decreased $2.0 million over year-end 2018,  as the Bank retained a lower percentage of its originations.  For the first three months of 2019, the Bank originated and sold $6.2 million in mortgages 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 ($11.2 million), while loans for individuals to construct personal residences totaled $2.8 million at March 31, 2019.  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, 2019, the Bank had $8.7 million in real estate construction loans funded with an interest reserve and capitalized $23 thousand of interest in 2019 from these reserves on active projects.  These loans were comprised of $2.5 million in residential construction and $6.2 million in commercial construction. 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 $498.0 million from $488.0 million at the end of 2018, an increase of $10.0 million.  The increase was primarily in hotels and motels ($4.0 million) and land development ($5.1 million).  The largest sectors (by collateral) in the commercial real estate category are: hotels and motels ($74.5 million), office buildings ($62.6 million), land development ($48.3 million), manufacturing facilities ($41.5 million) and auto dealerships ($32.8 million).

Commercial (C&I): This category includes commercial, industrial, farm, agricultural, and municipal loans.  C&I loans decreased $4.8 million to $269.2 million at March 31, 2019, compared to $274.1 million at the end of 2018, primarily due to a $3.9 million tax free loan pay-off. At March 31, 2019, the Bank had approximately $162 million in tax-free loans in the C&I portfolio. The largest sectors (by industry) in the commercial C&I category are: public administration ($84.4 million), utilities ($34.8 million), educational services ($25.0 million) and real estate rental and leasing ($15.2 million).  The Bank expects that commercial lending will continue to be the primary area of loan growth in the future via in-market lending.

Participations: The Bank may supplement its own commercial loan production by purchasing loan participations.  These participations are primarily located in south-central Pennsylvania. At March 31, 2019, the outstanding commercial participations accounted for 9.3%, or $91.0 million, of total gross loans compared to 9.6% and $93.4 million at December 31, 2018.  The Bank’s total exposure (including outstanding balances and unfunded commitments) to purchased participations is $115.2 million, compared to $120.4 million at December 31, 2018. The commercial loan participations are comprised of $21.6 million of C&I loans and $69.4 million of CRE loans, reported in the respective loan class. The above results indicate that Management has been executing its strategy to emphasize loan originations over purchasing participations.

Consumer loans: This category remained unchanged over year-end and is mainly comprised of unsecured personal lines of credit. 

31


 

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





 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



 

March 31,

 

December 31,

 

 

Change

(Dollars in thousands)

 

2019

 

2018

 

 

Amount

 

%

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

Consumer first liens

 

$

89,212 

 

$

89,673 

 

$

(461)

 

(0.5)

Commercial first lien

 

 

58,210 

 

 

59,227 

 

 

(1,017)

 

(1.7)

Total first liens

 

 

147,422 

 

 

148,900 

 

 

(1,478)

 

(1.0)



 

 

 

 

 

 

 

 

 

 

 

Consumer junior liens and lines of credit

 

 

41,831 

 

 

42,504 

 

 

(673)

 

(1.6)

Commercial junior liens and lines of credit

 

 

4,859 

 

 

4,716 

 

 

143 

 

3.0 

Total junior liens and lines of credit

 

 

46,690 

 

 

47,220 

 

 

(530)

 

(1.1)

Total residential real estate 1-4 family

 

 

194,112 

 

 

196,120 

 

 

(2,008)

 

(1.0)



 

 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

 

2,750 

 

 

1,667 

 

 

1,083 

 

65.0 

Commercial

 

 

11,231 

 

 

8,558 

 

 

2,673 

 

31.2 

Total residential real estate construction

 

 

13,981 

 

 

10,225 

 

 

3,756 

 

36.7 



 

 

 

 

 

 

 

 

 

 

 

Commercial real estate

 

 

497,974 

 

 

487,980 

 

 

9,994 

 

2.0 

Commercial

 

 

269,243 

 

 

274,054 

 

 

(4,811)

 

(1.8)

        Total commercial

 

 

767,217 

 

 

762,034 

 

 

5,183 

 

0.7 



 

 

 

 

 

 

 

 

 

 

 

Consumer

 

 

5,156 

 

 

4,996 

 

 

160 

 

3.2 



 

 

980,466 

 

 

973,375 

 

 

7,091 

 

0.7 

Less: Allowance for loan losses

 

 

(12,681)

 

 

(12,415)

 

 

(266)

 

2.1 

Net Loans

 

$

967,785 

 

$

960,960 

 

$

6,825 

 

0.7 



 

 

 

 

 

 

 

 

 

 

 

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 three primary measurements: (1) loans rated 6-Special Mention or worse (collectively “watch list”), (2) delinquent loans, and (3) net-charge-offs.,

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 $9.9 million at quarter end, compared to $10.3 million at December 31, 2018. The watch list includes both performing and nonperforming loans.  It is comprised entirely of loans rate 6-Special Mention and 7-Substandard. Included in the substandard total are $5.6 million of nonaccrual loans.  The credit composition of the watch list (loans rate 6, 7, or 8), by primary collateral is shown in Note 6 of the accompanying financial statements.

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

32


 

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 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, 2019 the Bank had loans of $18.8 million (1.9% of gross loans) that exceeded the supervisory limit, compared to 1.9% at year-end 2018.

Loan quality has declined since year-end 2018, as measured by the balance of nonaccrual loans.  Nonaccrual loans increased $3.3 million from year-end 2018 as one commercial real estate credit ($3.5 million) moved from 60-89 days past due to nonaccrual during the first quarter of 2019. Potential problem loans, defined as watch list loans less loans on nonaccrual or past due more than 90 days declined to $4.1 million at March 31, 2019 compared to $7.6 million at December 31, 2018 as a result of the commercial real estate loan moving to nonaccrual. 

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



 

 

 

 

 

 



 

March 31,

 

December 31,

(Dollars in thousands)

 

2019

 

2018



 

 

 

 

 

 

Nonaccrual loans

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

First liens

 

$

80 

 

$

80 

Junior liens and lines of credit

 

 

26 

 

 

23 

Total

 

 

106 

 

 

103 

Residential real estate - construction

 

 

652 

 

 

455 

Commercial real estate

 

 

4,743 

 

 

1,427 

Commercial

 

 

129 

 

 

315 

Total nonaccrual loans

 

 

5,630 

 

 

2,300 



 

 

 

 

 

 

Loans past due 90 days or more and still accruing

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

First liens

 

 

137 

 

 

113 

Junior liens and lines of credit

 

 

18 

 

 

26 

Total

 

 

155 

 

 

139 

Commercial real estate

 

 

 —

 

 

113 

Commercial

 

 

52 

 

 

100 

Consumer

 

 

 —

 

 

Total loans past due 90 days or more and still accruing

 

 

207 

 

 

357 



 

 

 

 

 

 

Total nonperforming loans

 

 

5,837 

 

 

2,657 



 

 

 

 

 

 

Other real estate owned

 

 

2,684 

 

 

2,684 

Total nonperforming assets

 

$

8,521 

 

$

5,341 



 

 

 

 

 

 

Nonperforming loans to total gross loans

 

 

0.60% 

 

 

0.27% 

Nonperforming assets to total assets

 

 

0.70% 

 

 

0.44% 

Allowance for loan losses to nonperforming loans

 

 

217.25% 

 

 

467.26% 

33


 

The following table identifies the most significant loans in nonaccrual status. These two nonaccrual loans account for 87% of the total nonaccrual balance.



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

ALL

 

Nonaccrual

 

TDR

 

 

 

 

 

Collateral



 

Balance

 

 

Reserve

 

Date

 

Status

 

Collateral

 

Location

 

Value



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit 1

$

1,408 

 

$

 —

 

Mar-12

 

Y

 

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

 

PA

 

$

3,267 

Credit 2

 

3,464 

 

 

 —

 

Mar-19

 

N

 

land for residential development, residential and commercial real estate

 

PA

 

$

5,203 



$

4,872 

 

$

 —

 

 

 

 

 

 

 

 

 

 

 



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 increased to $15.2 million at quarter-end compared to $11.9 million at year-end 2018, primarily from the new nonaccrual loan previously discussed.

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







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

March 31, 2019

(Dollars in thousands)

 

Nonaccrual

 

Accruing

 

 

Accruing

 

Total



 

Non-TDR

 

TDR

 

TDR

 

 

Other (1)

 

Impaired

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

80 

 

$

 —

 

$

673 

 

$

136 

 

$

889 

Junior liens and lines of credit

 

 

26 

 

 

 —

 

 

 —

 

 

18 

 

 

44 

Total

 

 

106 

 

 

 —

 

 

673 

 

 

154 

 

 

933 

Residential real estate - construction

 

 

198 

 

 

454 

 

 

 —

 

 

 —

 

 

652 

Commercial real estate

 

 

3,464 

 

 

1,279 

 

 

8,703 

 

 

 —

 

 

13,446 

Commercial

 

 

129 

 

 

 —

 

 

 —

 

 

 —

 

 

129 

Total

 

$

3,897 

 

$

1,733 

 

$

9,376 

 

$

154 

 

$

15,160 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1) impaired consumer purpose loans not on nonaccrual

 

 

 

 

 

 



Allowance for Loan Losses: 

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

34


 

Committee of the Board of Directors. Management believes that the allowance for loan losses at March 31, 2019 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 three components; specific, general and unallocated. The specific component addresses specific reserves established for impaired loans. A loan is considered to be impaired when, based on current information and events, it is probable that the Bank will be unable to collect all interest and principal payments due according to the originally contracted terms of the loan agreement.  Collateral values discounted for market conditions and selling costs are used to establish specific allocations for impaired loans. However, it is possible that as a result of the credit analysis, a specific reserve is not required for an impaired loan. For impaired loans with balances less than $250 thousand and all consumer purpose loans, a specific reserve analysis is not performed and these loans are added to the general allocation pool.  These loans totaled $860 thousand at March 31, 2019 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. There was no specific reserve established for any of the impaired loans.  Note 6 of 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 segments 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 segment may be further segregated by type of collateral, lien position, or owner/nonowner occupied properties.  The quantitative analysis uses the Bank’s twenty quarter rolling historical loan loss experience as determined for each loan segment to determine a loss factor applicable to each loan segment. The qualitative analysis utilizes a risk matrix that incorporates four primary risk factors:  economic conditions, delinquency, classified loans, and level of risk, and assigns a risk level (as measured in basis points) to each factor. In determining the risk level for these primary factors, consideration is given to operational factors such as: loan volume, management, loan review process, credit concentrations, competition, and legal and regulatory issues. The level of risk (as measured in basis points) for each primary factor is set for five risk levels ranging from minimal risk to very high risk and is determined independently for commercial loans, residential mortgage loans and consumer loans.

The unallocated component is maintained to cover uncertainties that could affect Management’s estimate of probable loss.  The unallocated component of the ALL reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

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

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

35


 

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, 2019 and December 31, 2018:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

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, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for ALL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

401 

 

$

 —

 

$

652 

 

$

13,247 

 

$

 —

 

$

 —

 

$

 —

 

$

14,300 

Collectively

 

 

147,021 

 

 

46,690 

 

 

13,329 

 

 

484,727 

 

 

269,243 

 

 

5,156 

 

 

 —

 

 

966,166 

Total

 

$

147,422 

 

$

46,690 

 

$

13,981 

 

$

497,974 

 

$

269,243 

 

$

5,156 

 

$

 —

 

$

980,466 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL established for
  loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

Collectively

 

 

487 

 

 

132 

 

 

152 

 

 

5,906 

 

 

4,562 

 

 

72 

 

 

1,370 

 

 

12,681 

ALL at March 31, 2019

 

$

487 

 

$

132 

 

$

152 

 

$

5,906 

 

$

4,562 

 

$

72 

 

$

1,370 

 

$

12,681 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for ALL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

405 

 

$

 —

 

$

455 

 

$

10,099 

 

$

181 

 

$

 —

 

$

 —

 

$

11,140 

Collectively

 

 

148,495 

 

 

47,220 

 

 

9,770 

 

 

477,881 

 

 

273,873 

 

 

4,996 

 

 

 —

 

 

962,235 

Total

 

$

148,900 

 

$

47,220 

 

$

10,225 

 

$

487,980 

 

$

274,054 

 

$

4,996 

 

$

 —

 

$

973,375 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL established for
  loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

Collectively

 

 

491 

 

 

133 

 

 

108 

 

 

5,698 

 

 

4,511 

 

 

70 

 

 

1,404 

 

 

12,415 

ALL at December 31, 2018

 

$

491 

 

$

133 

 

$

108 

 

$

5,698 

 

$

4,511 

 

$

70 

 

$

1,404 

 

$

12,415 



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, 2018

 

$

491 

 

$

133 

 

$

108 

 

$

5,698 

 

$

4,511 

 

$

70 

 

$

1,404 

 

$

12,415 

Charge-offs

 

 

(33)

 

 

(1)

 

 

(3)

 

 

(63)

 

 

(61)

 

 

(26)

 

 

 —

 

 

(187)

Recoveries

 

 

 

 

 —

 

 

 —

 

 

 

 

42 

 

 

10 

 

 

 —

 

 

54 

Provision

 

 

28 

 

 

 —

 

 

47 

 

 

270 

 

 

70 

 

 

18 

 

 

(34)

 

 

399 

ALL at March 31, 2019

 

$

487 

 

$

132 

 

$

152 

 

$

5,906 

 

$

4,562 

 

$

72 

 

$

1,370 

 

$

12,681 



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, 2019

 

December 31, 2018

 

March 31, 2018

Net charge-offs (recoveries)/average loans*

 

0.05% 

 

 

0.97% 

 

 

0.00% 

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

 

33.33% 

 

 

93.74% 

 

 

1.50% 

Allowance for loan losses as a % of loans

 

1.29% 

 

 

1.28% 

 

 

1.27% 

Net charge-offs (recoveries)

$

133 

 

$

9,331 

 

$

* Annualized

 

 

 

 

 

 

 

 





36


 

Other Real Estate Owned: 

The Bank holds $2.7 million of other real estate owned (OREO), comprised of two properties. The most significant OREO holding is one property carried at $2.6 million (98% of total OREO) that is secured by 196 acres of land intended for residential real estate development. The Bank has a contract on the property that is expected to settle in 2019 with no loss to the Bank. During 2019, the expense to hold and maintain OREO was $17 thousand. Note 8 of the accompanying financial statements provides additional information on activity in OREO.



Deposits: 

Total deposits decreased $6.1 million during the first three months of 2019 to $1.076 billion. Non-interest bearing deposits decreased $5.4 million (primarily in commercial checking deposits) and interest-bearing checking deposits decreased $28.2 million, while time deposits increased $27.5 million. Interest bearing checking decreased by $9.3 million, primarily in commercial and retail deposits while the Bank’s Money Management product decreased $19.8 million, primarily in retail accounts as customers moved funds to higher rate time depositsTime deposits increased since year-end from CD promotions.  The Bank acquired $10 million of short-term wholesale brokered CDs in the first quarter of 2019. 

As of March 31, 2019, the Bank had $155.7 million placed in the ICS program ($108.7 million in interesting-bearing checking and $47.0 million in money management) and $3.3 million in reciprocal time deposits in the CDARS program included in 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. 



 

 

 

 

 

 

 

 

 

 

 



 

March 31,

 

December 31,

 

 

Change

(Dollars in thousands)

 

2019

 

2018

 

 

Amount

 

%

Noninterest-bearing checking

 

$

192,004 

 

$

197,417 

 

$

(5,413)

 

(2.7)



 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking

 

 

296,346 

 

 

305,661 

 

 

(9,315)

 

(3.0)

Money management

 

 

416,976 

 

 

436,752 

 

 

(19,776)

 

(4.5)

Savings

 

 

82,089 

 

 

81,206 

 

 

883 

 

1.1 

Total interest-bearing checking and savings

 

 

795,411 

 

 

823,619 

 

 

(28,208)

 

(3.4)



 

 

 

 

 

 

 

 

 

 

 

Time deposits

 

 

79,076 

 

 

61,593 

 

 

17,483 

 

28.4 

Brokered time deposits

 

 

10,000 

 

 

 —

 

 

10,000 

 

N/A

  Total time deposits

 

 

89,076 

 

 

61,593 

 

 

27,483 

 

44.6 



 

 

 

 

 

 

 

 

 

 

 

Total deposits

 

$

1,076,491 

 

$

1,082,629 

 

$

(6,138)

 

(0.6)



 

 

 

 

 

 

 

 

 

 

 

Overdrawn deposit accounts reclassified as loans

 

$

99 

 

$

120 

 

 

 

 

 



Borrowings:

The Corporation had no short-term borrowings at March 31, 2019 and December 31, 2018. 

Shareholders’ Equity:

Total shareholders’ equity increased $3.1 million to $121.5 million at March 31, 2019, from $118.4 million at the end of 2018.  The Corporation’s net earnings of $3.2 million were partially offset by the cash dividend of $1.2 million. The Corporation’s Dividend Reinvestment Plan (DRIP) added $161 thousand in new capital from optional cash contributions and $190 thousand from the reinvestment of quarterly dividends. The Corporation’s dividend payout ratio was 36.8% for the first three months of 2019 compared to 29.8% in 2018.

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 2019, the Corporation paid a $0.27 per share dividend, compared to $0.27 paid in the fourth quarter of 2018. On April 18, 2019 the Board of Directors declared a $0.30 per share regular quarterly dividend for the second quarter of 2019, which will be paid on May 22, 2019.

On December 20, 2018, the Board of Directors authorized the 2018 Repurchase Plan for 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 December 21, 2018 and continuing through December 21, 2019.  During the first three months of 2019, 14,553 shares were repurchased.  No shares were repurchased in the first three months of 2018.  The 2017 Repurchase Plan expired on September 30, 2018.

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

37


 

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, 2019 was 6.95% (total risk-based capital 14.95% less 8.00%) compared to the 2018 regulatory buffer of 2.50%.  Compliance with the capital conservation buffer is required in order to avoid limitations to certain capital distributions.  As of March 31, 2019, 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, 2019 and December 31, 2018 for the Corporation and the Bank. 





 

 

 

 

 

 

 

 



 

 

 

 

 

Regulatory Ratios



 

 

 

 

 

Adequately

 

Well



 

March 31,

 

December 31,

 

Capitalized

 

Capitalized

(Dollars in thousands)

 

2019

 

2018

 

Minimum

 

Minimum



 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

13.78% 

 

13.96% 

 

4.500% 

 

N/A

Farmers & Merchants Trust Company

 

13.69% 

 

13.80% 

 

4.500% 

 

6.50% 



 

 

 

 

 

 

 

 

Tier 1 Risk-based Capital Ratio (2)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

13.78% 

 

13.96% 

 

6.000% 

 

N/A

Farmers & Merchants Trust Company

 

13.69% 

 

13.80% 

 

6.000% 

 

8.00% 



 

 

 

 

 

 

 

 

Total Risk-based Capital Ratio (3)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

15.04% 

 

15.21% 

 

8.000% 

 

N/A

Farmers & Merchants Trust Company

 

14.95% 

 

15.06% 

 

8.000% 

 

10.00% 



 

 

 

 

 

 

 

 

Tier 1 Leverage Ratio (4)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

9.88% 

 

9.78% 

 

4.000% 

 

N/A

Farmers & Merchants Trust Company

 

9.82% 

 

9.68% 

 

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 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 3.1% in Cumberland County to 6.4% in Huntingdon County.  The market area has a diverse economic base and local industries include warehousing, truck & rail shipping centers, light and heavy manufacturers, health-care, higher education institutions, farming and agriculture, and a varied service sector.  The Corporation’s primary market area is located in South Central PA 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.

38


 

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

Economic Data





 

 

 

 



 

 

 

 



 

March 31,

 

December 31,



 

2019

 

2018

Unemployment Rate (seasonally adjusted)

 

 

 

 

Market area range (1)

 

3.1% - 6.4%

 

3.0 - 4.5%

Pennsylvania

 

4.0% 

 

4.0% 

United States

 

3.8% 

 

3.7% 



 

 

 

 

Housing Price Index - year over year change

 

 

 

 

PA, nonmetropolitan statistical area

 

3.0% 

 

3.6% 

United States

 

6.0% 

 

6.6% 



 

 

 

 

Building Permits - year over year change -12 months

 

 

 

 

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

 

 

 

 

Residential, estimated

 

6.8% 

 

15.9% 

Multifamily, estimated

 

94.6% 

 

136.0% 



 

 

 

 

(1) Franklin, Cumberland, Fulton and Huntingdon Counties

 

 

 



Unlike many companies, the assets and liabilities of the Corporation are financial in nature. As such, interest rates and changes in interest rates may have a more significant effect on the Corporation’s financial results than on other types of industries. Because of this, the Corporation watches the actions of the Federal Reserve Open Market Committee (FOMC) as it makes decisions about interest rate changes. FOMC members had estimated in December that two rate hikes would be appropriate in 2019 after four increases in 2018.  However, there now appears to be no likelihood of a hike unless conditions change significantly.  In its post-meeting statement, the FOMC indicated it would remain “patient” before adopting any further 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.

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 unencumbered (approximately $65.4 million fair value) as collateral for borrowings are an additional source of readily available liquidity, either by selling the security or, more preferably, to provide collateral for additional borrowing. The Bank also has access to other wholesale funding via the brokered CD market.

The FHLB system has always been a major funding source for community banks.  The Bank’s maximum borrowing capacity with the FHLB at March 31, 2019 was $367.8 million with $367.8 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. 

39


 

The Bank has established credit at the Federal Reserve Discount Window and as of quarter-end had the ability to borrow approximately $17.5 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 $288.0 million and  $271.7 million, respectively, at March 31, 2019 and December 31, 2018.    As of June 30, 2018, the Bank established a $2.4 million allowance against letters of credit issued in connection with a commercial borrower that declared bankruptcy in the second quarter of 2018 which remains at March 31, 2019.

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 2018 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, 2019. For more information on market risk refer to the Corporation’s 2018 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, 2019, 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, 2019, 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. 



40


 

Part II – OTHER INFORMATION

Item 1.    Legal Proceedings

The nature of the Corporation’s business generates a certain amount of litigation. In management’s opinion, there are no 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.

As described in our current report on Form 8-K filed on August 3, 2018, the court entered an order on July 31, 2018 granting final approval of the settlement agreements in the Kalan et al. v. Farmers and Merchants Trust Company of Chambersburg, et al. (Case No. 2:15-CV-01435-WB) case filed against F&M Trust in the United States District Court for the Eastern District of Pennsylvania in March, 2015 and described in our current reports on Form 8-K filed July 29, 2016, July 28, 2017, November 3, 2017, January 2, 2018, April 13, 2018, May 7, 2018 and August 3, 2018. Among other things, the order also dismissed the case against F&M Trust with prejudice; certified the settlement class; and, permanently enjoined the named plaintiffs and the members of the settlement class from asserting any further claims arising out of or related to the claims alleged or that could have been alleged in the case against F&M Trust. The settlement agreements provide for the Bank to make a settlement payment of $10 million in full and final settlement of all such claims.  The settlement agreements further provide for general releases by all parties.  F&M Trust made the settlement payment in May, 2018, in accordance with the court’s earlier order preliminarily approving the settlement agreements. The Corporation previously accrued the $10 million settlement payment as an expense for the year ended December 31, 2017.



Item 1A. Risk Factors 

There were no material changes in the Corporation’s risk factors during the three months ended March 31, 2019. For more information, refer to the Corporation’s 2018 Annual Report on Form 10-K.





41


 

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







 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands, except per share)

 

 

 

 

 

 

Period

 

Number of
Shares Purchased as Part of Publically Announced Program

 

 

Weighted
Average
Price Paid
per Share

 

 

Dollar Amount of
Shares Purchased
as Part of Publically
Announced Program

 

 


Shares Yet
To Be Purchased
Under Program

January 1, 2019

 

 —

 

$

 —

 

$

 —

 

 

100,000 

February 2019

 

7,387 

 

 

37.16 

 

 

275 

 

 

92,613 

March 2019

 

7,166 

 

 

36.65 

 

 

263 

 

 

85,447 



 

14,553 

 

 

 

 

$

538 

 

 

 



On December 20, 2018, the Board of Directors authorized the 2018 Repurchase Plan for 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 December 21, 2018 and continuing through December 21, 2019. No shares were repurchased in the first three months of 2018.  The 2017 Repurchase Plan expired on September 30, 2018.



Item 3.   Defaults by the Company on its Senior Securities

None

Item 4.   Mine Safety Disclosures

Not Applicable

42


 

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 Current Report on Form 8-K, as filed with the commission on December 21, 2018 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)



 

43


 

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 8, 2019

 

/s/ Timothy G. Henry



 

Timothy G. Henry



 

Chief Executive Office and President



 

(Principal Executive Officer)



 

 

May 8, 2019

 

/s/ Mark R. Hollar



 

Mark R. Hollar



 

Treasurer and Chief Financial Officer



 

(Principal Financial and Accounting Officer)



44