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FRANKLIN FINANCIAL SERVICES CORP /PA/ - Quarter Report: 2023 September (Form 10-Q)

fraf-20230930x10q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2023

or

¨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.)

1500 Nitterhouse Drive, 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 class

Symbol

Name of exchange on which registered

Common stock

FRAF

Nasdaq Capital Market

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 x 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 x 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 x Smaller reporting company x 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 x

There were 4,361,559 outstanding shares of the Registrant’s common stock as of October 31, 2023.


INDEX

Part I - FINANCIAL INFORMATION

Item 1

Financial Statements

Consolidated Balance Sheets as of September 30, 2023 and December 31, 2022 (unaudited)

1

Consolidated Statements of Income for the Three and Nine Months ended September 30, 2023 and 2022 (unaudited)

2

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

3

September 30, 2023 and 2022 (unaudited)

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

4

ended September 30, 2023 and 2022 (unaudited)

Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2023

5

and 2022 (unaudited)

Notes to Consolidated Financial Statements (unaudited)

6

Item 2

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

30

Item 3

Quantitative and Qualitative Disclosures about Market Risk

50

Item 4

Controls and Procedures 

50

Part II - OTHER INFORMATION

Item 1

Legal Proceedings

51

Item 1A

Risk Factors

51

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

51

Item 3

Defaults Upon Senior Securities

51

Item 4

Mine Safety Disclosures

51

Item 5

Other Information

52

Item 6

Exhibits

52

SIGNATURE PAGE

53


Part I FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Balance Sheets

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

(unaudited)

September 30,

December 31,

2023

2022

Assets

Cash and due from banks

$

20,113 

$

17,883 

Short-term interest-earning deposits in other banks

53,840 

47,016 

Total cash and cash equivalents

73,953 

64,899 

Long-term interest-earning deposits in other banks

7,728 

13,975 

Debt securities available for sale, at fair value

458,276 

486,836 

Equity securities

386 

411 

Restricted stock

2,294 

644 

Loans held for sale

792 

283 

Loans

1,206,850 

1,051,041 

Allowance for credit losses

(15,528)

(14,175)

Net Loans

1,191,322 

1,036,866 

Premises and equipment, net

29,026 

30,026 

Right of use asset

4,830 

6,010 

Bank owned life insurance

22,644 

22,311 

Goodwill

9,016 

9,016 

Deferred tax asset, net

14,877 

15,630 

Other assets

12,766 

12,672 

Total assets

$

1,827,910 

$

1,699,579 

Liabilities

Deposits

Noninterest-bearing checking

$

295,181 

$

299,231 

Money management, savings, and interest checking

1,161,927 

1,194,827 

Time

110,306 

57,390 

Total deposits

1,567,414 

1,551,448 

Federal Reserve Bank borrowings

70,000 

FHLB advances

40,000 

Subordinate notes

19,653 

19,623 

Lease liability

4,960 

6,144 

Other liabilities

11,114 

8,167 

Total liabilities

1,713,141 

1,585,382 

Commitments and contingent liabilities

 

 

Shareholders' equity

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

4,710,972 shares issued and 4,361,511 shares outstanding at September 30, 2023 and

4,710,972 shares issued and 4,390,397 shares outstanding at December 31, 2022

4,711 

4,711 

Capital stock no par value, 5,000,000 shares authorized with no

shares issued and outstanding

Additional paid-in capital

43,512 

43,535 

Retained earnings

131,919 

125,892 

Accumulated other comprehensive loss

(55,834)

(51,287)

Treasury stock, 349,461 shares at September 30, 2023 and 320,575 shares at

December 31, 2022, at cost

(9,539)

(8,654)

Total shareholders' equity

114,769 

114,197 

Total liabilities and shareholders' equity

$

1,827,910 

$

1,699,579 

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

1


Consolidated Statements of Income

For the Three Months Ended

For the Nine Months Ended

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

September 30,

September 30,

2023

2022

2023

2022

Interest income

Loans, including fees

$

15,308

$

10,767

$

41,712

$

29,589

Interest and dividends on investments:

Taxable interest

3,838

2,728

10,615

6,739

Tax exempt interest

277

521

956

1,570

Dividend income

11

5

30

14

Interesting-earnings deposits in other banks

720

1,022

1,934

1,542

Total interest income

20,154

15,043

55,247

39,454

Interest expense

Deposits

5,127

717

12,934

1,684

Federal Reserve Bank borrowings

789

1,518

FHLB advances

267

267

Subordinate notes

264

263

790

787

Total interest expense

6,447

980

15,509

2,471

Net interest income

13,707

14,063

39,738

36,983

Provision for credit losses - loans

866

1,857

Provision for credit losses - unfunded commitments

9

79

Net interest income after credit loss expense

12,832

14,063

37,802

36,983

Noninterest income

Investment and trust services fees

1,783

1,661

5,576

5,407

Loan service charges

235

177

658

533

Gain on sale of loans

33

183

150

692

Deposit service charges and fees

649

629

1,848

1,885

Other service charges and fees

472

443

1,334

1,293

Debit card income

568

497

1,618

1,393

Increase in cash surrender value of Bank owned life insurance

114

109

333

326

Net losses on sales of debt securities

(15)

(1,119)

(34)

Change in fair value of equity securities

7

(61)

(25)

(46)

Other

152

40

393

190

Total noninterest income

4,013

3,663

10,766

11,639

Noninterest Expense

Salaries and employee benefits

6,982

7,050

21,202

20,403

Net occupancy

1,093

1,124

3,315

3,077

Marketing and advertising

531

433

1,600

1,391

Legal and professional

588

581

1,593

1,580

Data processing

1,300

1,146

3,478

3,544

Pennsylvania bank shares tax

174

335

571

813

FDIC Insurance

230

197

610

550

ATM/debit card processing

320

359

920

1,065

Telecommunications

103

114

300

313

Nonservice pension

(29)

69

(88)

207

Lease termination

495

Other

906

792

2,868

2,553

Total noninterest expense

12,198

12,200

36,864

35,496

Income before federal income taxes

4,647

5,526

11,704

13,126

Federal income tax expense

788

895

1,577

1,905

Net income

$

3,859

$

4,631

$

10,127

$

11,221

Per share

Basic earnings per share

$

0.89

$

1.05

$

2.31

$

2.53

Diluted earnings per share

$

0.88

$

1.05

$

2.31

$

2.52

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

2


Consolidated Statements of Comprehensive Income (Loss)

For the Three Months Ended

For the Nine Months Ended

September 30,

September 30,

(Dollars in thousands) (unaudited)

2023

2022

2023

2022

Net Income

$

3,859

$

4,631

$

10,127

$

11,221

Debt Securities:

Unrealized losses arising during the period

(9,966)

(20,409)

(6,874)

(69,090)

Reclassification adjustment for losses included in net income (1)

15

1,119

34

Net unrealized losses

(9,966)

(20,394)

(5,755)

(69,056)

Tax effect

2,093

4,283

1,208

14,502

Net of tax amount

(7,873)

(16,111)

(4,547)

(54,554)

Total other comprehensive loss

(7,873)

(16,111)

(4,547)

(54,554)

Total Comprehensive (Loss) Income

$

(4,014)

$

(11,480)

$

5,580

$

(43,333)

(1) Reclassified to net losses on sales of debt securities

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

3


Consolidated Statements of Changes in Shareholders’ Equity

For the first nine months ended September 30, 2023 and 2022

Accumulated

Additional

Other

Shares

Common

Paid-in

Retained

Comprehensive

Treasury

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

Outstanding

Stock

Capital

Earnings

Income (Loss)

Stock

Total

Balance at July 1, 2023

4,349,988

$

4,711 

$

43,422 

$

129,452 

$

(47,961)

$

(9,854)

$

119,770 

Net income

3,859 

3,859 

Other comprehensive income

(7,873)

(7,873)

Cash dividends declared, $0.32 per share

(1,392)

(1,392)

Treasury shares issued under dividend reinvestment plan

9,613

13 

263 

276 

Stock Compensation Plans:

Treasury shares issued

1,910

(36)

52 

16 

Compensation expense

113 

113 

Balance at September 30, 2023

4,361,511

$

4,711 

$

43,512 

$

131,919 

$

(55,834)

$

(9,539)

$

114,769 

Balance at January 1, 2023

4,390,397

$

4,711 

$

43,535 

$

125,892 

$

(51,287)

$

(8,654)

$

114,197 

Cumulative change in accounting principle, net of tax

98 

98 

Net income

10,127 

10,127 

Other comprehensive income

(4,547)

(4,547)

Cash dividends declared, $0.96 per share

(4,198)

(4,198)

Acquisition of treasury stock

(84,414)

(2,394)

(2,394)

Treasury shares issued under dividend reinvestment plan

38,292

45 

1,042 

1,087 

Stock Compensation Plans:

Treasury shares issued

17,236

(434)

467 

33 

Compensation expense

366 

366 

Balance at September 30, 2023

4,361,511

$

4,711 

$

43,512 

$

131,919 

$

(55,834)

$

(9,539)

$

114,769 

Balance at July 1, 2022

4,422,280

$

4,711 

$

43,248 

$

120,354 

$

(38,990)

$

(7,526)

$

121,797 

Net income

4,631 

4,631 

Other comprehensive income

(16,111)

(16,111)

Cash dividends declared, $0.32 per share

(1,406)

(1,406)

Acquisition of treasury stock

(38,409)

(1,202)

(1,202)

Treasury shares issued under dividend reinvestment plan

9,245

49 

246 

295 

Stock Compensation Plans:

Treasury shares issued

2,534

(51)

67 

16 

Compensation expense

131 

131 

Balance at September 30, 2022

4,395,650

$

4,711 

$

43,377 

$

123,579 

$

(55,101)

$

(8,415)

$

108,151 

Balance at January 1, 2022

4,441,443

$

4,711 

$

43,085 

$

116,612 

$

(547)

$

(6,796)

$

157,065 

Net income

11,221 

11,221 

Other comprehensive income

(54,554)

(54,554)

Cash dividends declared, $0.96 per share

(4,254)

(4,254)

Acquisition of treasury stock

(86,449)

(2,664)

(2,664)

Treasury shares issued under dividend reinvestment plan

29,757

176 

766 

942 

Stock Compensation Plans:

Treasury shares issued

10,899

(236)

279 

43 

Compensation expense

352 

352 

Balance at September 30, 2022

4,395,650

$

4,711 

$

43,377 

$

123,579 

$

(55,101)

$

(8,415)

$

108,151 

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

4


Consolidated Statements of Cash Flows

Nine Months Ended
September 30,

2023

2022

(Dollars in thousands) (unaudited)

Cash flows from operating activities

Net income

$

10,127 

$

11,221 

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

Depreciation and amortization

1,506 

1,049 

Net amortization of loans and investment securities

1,891 

3,207 

Amortization of subordinate debt issuance costs

30 

27 

Provision for credit losses

1,936 

Change in fair value of equity securities

25 

46 

Realized losses on sales of debt securities

1,119 

34 

Loans originated for sale

(10,686)

(40,342)

Proceeds from sale of loans

10,327 

41,512 

Gain on sale of loans held for sale

(150)

(692)

Increase in cash surrender value of life insurance

(333)

(326)

Change in fair value of derivative

(3)

(17)

Stock based compensation

366 

352 

Decrease in other assets

1,563 

1,679 

Increase (decrease) in other liabilities

2,924 

(4)

Net cash provided by operating activities

20,642 

17,746 

Cash flows from investing activities

Net decrease (increase) in long-term interest-earning deposits in other banks

6,247 

(1,984)

Proceeds from sales and calls of investment securities available for sale

40,117 

1,082 

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

24,779 

31,013 

Purchase of investment securities available for sale

(45,419)

(66,499)

Net increase in restricted stock

(1,650)

(149)

Net increase in loans

(155,677)

(49,886)

Capital expenditures

(479)

(11,007)

Net cash used in investing activities

(132,082)

(97,430)

Cash flows from financing activities

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

(36,950)

135,019 

Net increase (decrease) in time deposits

52,916 

(14,395)

Net increase in short-term borrowings

110,000 

Dividends paid

(4,198)

(4,254)

Purchase of Treasury shares

(2,394)

(2,664)

Cash received from option exercises

33 

43 

Treasury shares issued under dividend reinvestment plan

1,087 

942 

Net cash provided by financing activities

120,494 

114,691 

Increase in cash and cash equivalents

9,054 

35,007 

Cash and cash equivalents at the beginning of the period

64,899 

175,149 

Cash and cash equivalents at the end of the period

$

73,953 

$

210,156 

Supplemental Disclosures of Cash Flow Information

Cash paid during the year for:

Interest on deposits and other borrowed funds

$

12,865 

$

2,208 

Income taxes

1,338 

58 

Noncash Activities

Lease liabilities arising from obtaining right-of-use assets

$

$

1,867 

Noncash extinguishment of lease liability

537 

Noncash decrease in right-of-use asset

507 

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

5


FRANKLIN FINANCIAL SERVICES CORPORATION and SUBSIDIARIES

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Basis of Presentation

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

In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the consolidated financial position, results of operations, and cash flows as of September 30, 2023, 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 2022 Annual Report on Form 10-K. The consolidated results of operations for the first nine-month period ended September 30, 2023 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, 2022 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 cash items with original maturities less than 90 days.

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

For the Three Months Ended

For the Nine Months Ended

September 30,

September 30,

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

2023

2022

2023

2022

Weighted average shares outstanding (basic)

4,355

4,401

4,377

4,432

Impact of common stock equivalents

14

23

14

21

Weighted average shares outstanding (diluted)

4,369

4,424

4,391

4,453

Anti-dilutive options excluded from calculation

49

29

49

30

Net income

$

3,859

$

4,631

$

10,127

$

11,221

Basic earnings per share

$

0.89

$

1.05

$

2.31

$

2.53

Diluted earnings per share

$

0.88

$

1.05

$

2.31

$

2.52

 


6


Note 2. Recent Accounting Pronouncements 

Recently adopted accounting standards

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

Description

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) 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 to determine the initial amortized cost basis. The subsequent accounting for PCD financial assets is the same expected loss model described above.

In addition, ASC 326 made changes to the accounting for available-for-sale debt securities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available-for-sale debt securities. Management does not intend to sell or believes that it is more likely than not they will be required to sell.

The Corporation adopted ASC 326 using the modified retrospective method for all financial assets measured at amortized cost and off-balance-sheet (OBS) credit exposures. Results for reporting periods beginning after January 1, 2023 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP.

Effective Date

January 1, 2023

Effect on the Consolidated Financial Statements

The Corporation adopted the ASU as of January 1, 2023 and recorded a decrease to the allowance for credit loss (ACL) for loans of $536 thousand, an increase of $412 thousand to the ACL for unfunded commitments, an increase of $98 thousand to retained earnings, and a deferred tax liability of $26 thousand.

The following table illustrates the impact of ASC 326:

As Reported

Pre-ASC

Impact of

Under

326

ASC 326

ASC 326

Adoption

Adoption

(Dollars in thousands)

Assets:

Loans

First liens - residential real estate

$

1,555 

$

459 

$

1,096 

Junior liens & lines of credit - residential real estate

727 

234 

493 

Construction

248 

343 

(95)

Commercial real estate

8,077 

7,493 

584 

Commercial

2,939 

4,846 

(1,907)

Consumer

93 

133 

(40)

Unallocated

667 

(667)

Allowance for credit losses on loans

$

13,639 

$

14,175 

$

(536)

Liabilities:

Allowance for credit losses on OBS credit exposures

$

1,887 

$

1,475 

$

412

ASU 2019-05, Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief

Description

This ASU allows entities to irrevocably elect, upon adoption of ASU 2016-13, the fair value option on financial instruments that (1) were previously recorded at amortized cost and (2) are within the scope of ASC 326-20 if the instruments are eligible for the fair value option under ASC 825-10. The fair value option election does not apply to held-to-maturity debt securities. Entities are required to make this election on an instrument-by-instrument basis. ASU 2019-05 has the same effective date as ASU 2016-13.

Effective Date

January 1, 2023

Effect on the Consolidated Financial Statements

The Corporation adopted the ASU on January 1, 2023 and did not elect the fair value option on any financial instruments.

ASU 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructuring and Vintage Disclosures

7


Description

ASU 2022-02 eliminates the accounting guidance for troubled debt restructurings in Accounting Standards Codification ("ASC") 310-40, "Receivables - Troubled Debt Restructurings by Creditors" for entities that have adopted the current expected credit loss model introduced by ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments." ASU 2022-02 also required that public business entities disclosure current-period gross charge-offs by year of origination for financing receivables and net investments in leases within the scope of Subtopic 326-20, "Financial Instruments - Credit Losses - Measured at Amortized Cost."

Effective Date

January 1, 2023

Effect on the Consolidated Financial Statements

The Corporation adopted the standard on January 1, 2023 and it decreased the balance of loans individually evaluated by $3.0 million, and decreased the balance of performing TDR loans by the same amount.

Recently issued but not yet effective accounting standards

ASU 2023-01, Leases (Topic 842): Common Control Arrangements

Description

This ASU requires entities to determine whether a related party arrangement between entities under common control is a lease. If the arrangement is determined to be a lease, an entity must classify and account for the lease on the same basis as an arrangement with a related party (on the basis of legally enforceable terms and conditions).

Effective Date

January 1, 2024

Effect on the Consolidated Financial Statements

The ASU is not expected to have an impact on the Corporation's financial statements.

ASU 2023-02, Investments - Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method

Description

This ASU permits reporting entities to elect to account for their tax equity investments, regardless of the tax credit program from which the income tax credits are received, using the proportional amortization method if certain conditions are met.

Effective Date

January 1, 2024

Effect on the Consolidated Financial Statements

The ASU is not expected to have an impact on the Corporation's financial statements.

     

Note 3. Accumulated Other Comprehensive Income (Loss)

The components of accumulated other comprehensive income (loss), net of income tax effects, included in shareholders' equity are as follows:

September 30,

December 31,

(Dollars in thousands)

2023

2022

Net unrealized losses on debt securities

$

(67,252)

$

(61,497)

Tax effect

14,122

12,914

Net of tax amount

$

(53,130)

$

(48,583)

Accumulated pension adjustment

$

(3,423)

$

(3,423)

Tax effect

719

719

Net of tax amount

$

(2,704)

$

(2,704)

Total accumulated other comprehensive (loss)

$

(55,834)

$

(51,287)

 


8


Note 4. Investments

Available for Sale (AFS) Securities

The amortized cost and estimated fair value of AFS securities as of September 30, 2023 and December 31, 2022 are as follows:

(Dollars in thousands)

Gross

Gross

Amortized

unrealized

unrealized

Fair

September 30, 2023

cost

gains

losses

Value

U.S. Treasury

$

83,672

$

$

(12,531)

$

71,141

Municipal

161,659

(32,942)

128,717

Corporate

26,331

(3,348)

22,983

Agency mortgage & asset-backed

147,099

81

(12,810)

134,370

Non-Agency mortgage & asset-backed

106,767

7

(5,709)

101,065

Total

$

525,528

$

88

$

(67,340)

$

458,276

(Dollars in thousands)

Gross

Gross

Amortized

unrealized

unrealized

Fair

December 31, 2022

cost

gains

losses

value

U.S. Treasury

$

101,980

$

$

(11,723)

$

90,257

Municipal

186,007

14

(30,566)

155,455

Corporate

26,316

(2,077)

24,239

Agency mortgage & asset-backed

163,274

19

(12,358)

150,935

Non-Agency mortgage & asset-backed

70,756

1

(4,807)

65,950

Total

$

548,333

$

34

$

(61,531)

$

486,836

At September 30, 2023 and December 31, 2022, the fair value of debt securities pledged to secure public funds and trust deposits totaled $199.1 million and $208.9 million, respectively. The Bank has no investment in a single issuer that exceeds 10% of shareholders’ equity, except for securities issued by the U.S. Treasury and U.S. government sponsored entities.

The amortized cost and estimated fair value of debt securities at September 30, 2023, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because of prepayment or call options embedded in the securities. Securities not due at a single maturity date are presented separately.

(Dollars in thousands)

Amortized
cost

Fair
value

Due in one year or less

$

$

Due after one year through five years

44,354

38,583

Due after five years through ten years

117,050

97,821

Due after ten years

110,258

86,437

271,662

222,841

Mortgage & asset-backed

253,866

235,435

$

525,528

$

458,276

The composition of the net realized gains (losses) on debt securities for the three and nine months ended are as follows:

For the Three Months Ended

For the Nine Months Ended

September 30,

September 30,

(Dollars in thousands)

2023

2022

2023

2022

Proceeds

$

$

1,000

$

40,117

$

1,082

Gross gains realized

$

$

$

12

$

Gross losses realized

(15)

(1,131)

(34)

Net (losses) gains realized

$

$

(15)

$

(1,119)

$

(34)

Tax benefit (provision) on net (losses) gains realized

$

$

3

$

235

$

7

9


Impairment:

The debt securities portfolio contained 578 securities with $448.9 million of temporarily impaired fair value and $67.3 million in unrealized losses at September 30, 2023. The total unrealized loss position has increased $5.8 million since year-end 2022 due primarily to an increase in long-term interest rates during the period despite the Bank realizing $1.1 million of losses due to restructuring of the portfolio.

AFS securities in an unrealized loss position are evaluated for credit impairment at least quarterly. For these securities, the Bank considers: (1) the extent to which the fair value is less than amortized cost; (2) adverse conditions specifically related to the security, industry or geographic area; (3) the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future; (4) failure of the issuer of the security to make scheduled interest or principal payments; and (5) any changes to the rating of the security by a rating agency. 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 Bank does not have the intent to sell and does not believe it will more likely than not be required to sell any of these securities prior to a recovery of their fair value to amortized cost. The impairment identified on debt securities and subject to evaluation at September 30, 2023, was determined not to be attributable to credit related factors; therefore, the Bank does not have an allowance for credit loss for these investments. During 2023, approximately $40 million of securities was sold as part of a portfolio restructuring to take advantage of higher market interest rates. The realized loss on these sales was $1.1 million.

The following table reflects 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 September 30, 2023 and December 31, 2022:

September 30, 2023

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. Treasury

$

$

$

71,141 

$

(12,531)

28 

$

71,141 

$

(12,531)

28 

Municipal

810 

(193)

2 

127,907 

(32,749)

166 

128,717 

(32,942)

168 

Corporate

1,483 

(167)

5 

21,500 

(3,181)

46 

22,983 

(3,348)

51 

Agency mortgage & asset-backed

7,716 

(195)

22 

120,909 

(12,615)

228 

128,625 

(12,810)

250 

Non-Agency mortgage & asset-backed

49,219 

(859)

25 

48,230 

(4,850)

56 

97,449 

(5,709)

81 

Total temporarily impaired

$

59,228 

$

(1,414)

54 

$

389,687 

$

(65,926)

524 

$

448,915 

$

(67,340)

578 

December 31, 2022

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. Treasury

$

17,598 

$

(183)

3 

$

72,659 

$

(11,540)

28 

$

90,257 

$

(11,723)

31 

Municipal

73,644 

(9,586)

90 

80,503 

(20,980)

104 

154,147 

(30,566)

194 

Corporate

12,221 

(851)

25 

10,368 

(1,226)

21 

22,589 

(2,077)

46 

Agency mortgage & asset-backed

55,393 

(2,747)

139 

88,953 

(9,611)

113 

144,346 

(12,358)

252 

Non-Agency mortgage & asset-backed

49,301 

(3,092)

52 

14,207 

(1,715)

16 

63,508 

(4,807)

68 

Total temporarily impaired

$

208,157 

$

(16,459)

309 

$

266,690 

$

(45,072)

282 

$

474,847 

$

(61,531)

591 

Equity Securities at Fair Value

The Corporation owns one equity investment with a readily determinable fair value. At September 30, 2023 and December 31, 2022, this investment was reported at fair value of $386 thousand and $411 thousand, respectively, with changes in value reported through income.

 

Note 5. Loans

The Bank reports its loan portfolio based on the primary collateral of the loan. It further classifies these loans by the primary purpose, either consumer or commercial. The Bank’s mortgage loans include long-term loans to individuals and

10


businesses secured by mortgages on the borrower’s real property. Construction loans are made to finance the purchase of land and the construction of residential and commercial buildings thereon and are secured by mortgages on real estate. Commercial loans are made to businesses of various sizes for a variety of purposes including construction, property, plant and equipment, and working capital. Commercial loans also include loans to government municipalities. Commercial lending is concentrated in the Bank’s primary market, but also includes purchased loan participations. Consumer loans are comprised of installment, home equity and unsecured personal lines of credit.

Each class of loans involves a different kind of risk. However, risk factors such as changes in interest rates, general economic conditions and changes in collateral values are common across all classes. The risk of each loan class is presented below.

Residential Real Estate 1-4 family

The largest risk in residential real estate loans to retail customers is the borrower’s inability to repay the loan due to the loss of the primary source of income. The Bank attempts to mitigate this risk through prudent underwriting standards including employment history, current financial condition and credit history. These loans are generally owner occupied and serve as the borrower’s primary residence. The Bank usually holds a first lien position on these properties but may hold a second lien position in some home equity loans or lines of credit. Commercial purpose loans, secured by residential real estate, are usually dependent upon repayment from the rental income or other business purposes. These loans are generally non-owner occupied. In addition to the real estate collateral, these loans may have personal guarantees or UCC filings on other business assets. If a payment default occurs on a 1-4 family residential real estate loan, the collateral serves as a source of repayment, but may be subject to a change in value due to economic conditions.

Residential Real Estate Construction

This class includes loans to individuals for construction of a primary residence and to contractors and developers to improve real estate and construct residential properties. Construction loans to individuals generally bear the same risk as 1-4 family residential loans. Additional risks may include cost overruns, delays in construction or contractor problems.

Loans to contractors and developers are primarily dependent on the sale of improved lots or finished homes for repayment. Risks associated with these loans include the borrower’s character and capacity to complete a development, the effect of economic conditions on the valuation of lots or homes, cost overruns, delays in construction or contractor problems. In addition to real estate collateral, these loans may have personal guarantees or UCC filings on other business assets, depending on the financial strength and experience of the developer. Real estate construction loans are monitored on a regular basis by either an independent third party or the responsible loan officer, depending on the size and complexity of the project. This monitoring process includes, at a minimum, the submission of invoices or AIA documents detailing the cost incurred by the borrower, on-site inspections, and an authorizing signature for disbursement of funds.

Commercial Real Estate

Commercial real estate loans may be secured by various types of commercial property including retail space, office buildings, warehouses, hotels and motel, manufacturing facilities and, agricultural land.

Commercial real estate loans present a higher level of risk than residential real estate loans. Repayment of these loans is normally dependent on cash flow generated by the operation of a business that utilizes the real estate. The successful operation of the business, and therefore repayment ability, may be affected by general economic conditions outside of the control of the operator. On most commercial real estate loans ongoing monitoring of cash flow and other financial performance indictors is completed annually through financial statement analysis. In addition, the value of the collateral may be negatively affected by economic conditions and may be insufficient to repay the loan in the event of default. In the event of foreclosure, commercial real estate may be more difficult to liquidate than residential real estate.

Commercial

Commercial loans are made for various business purposes to finance equipment, inventory, accounts receivables, and operating liquidity. These loans are generally secured by business assets or equipment, non-real estate collateral and/or personal guarantees.

Commercial loans present a higher level of credit risk than other loans because repayment ability is usually dependent on cash-flow from a business operation that can be affected by general economic conditions. On most commercial loans ongoing monitoring of cash flow and other financial performance indicators occur at least annually through financial statement analysis. In the event of a default, collateral for these loans may be more difficult to liquidate, and the valuation of the collateral may decline more quickly than loans secured by other types of collateral.

11


Loans to governmental municipalities are also included in the Commercial class. These loans generally have less risk than Commercial & Industrial (C&I) loans due to the taxing authority of the municipality and its ability to assess fees on services.

This class also includes loans made as part of the Paycheck Protection Program (PPP). The PPP is a small business loan program, administered by the Small Business Administration (SBA). The PPP loans are 100 percent guaranteed by the SBA and have a maturity of two years or five years with a fixed interest rate of 1.00% for the life of the loan. Because the PPP loans are 100% guaranteed by the SBA, they present no credit risk to the Bank once the SBA guarantee is fulfilled. However, if the SBA does not grant loan forgiveness, the PPP loan would present the same risk factors as any other commercial loan.

Consumer

These loans are made for a variety of reasons to consumers and include term loans and personal lines-of credit. The loans may be secured or unsecured. Repayment is primarily dependent on the income of the borrower and to a lesser extent the sale of collateral. The underwriting of these loans is based on the consumer’s ability and willingness to repay and is determined by the borrower’s employment history, current financial condition and credit history. Collateral for these loans, if any, usually depreciates quickly and therefore, may not be adequate to repay the loan if it is repossessed. Therefore, the overall health of the economy, including unemployment rates and wages, will have an effect on the credit quality in this loan class.

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

September 30,

December 31,

(Dollars in thousands)

2023

2022

Residential Real Estate 1-4 Family

Consumer first liens

$

124,289

$

82,795

Commercial first lien

62,942

61,702

Total first liens

187,231

144,497

Consumer junior liens and lines of credit

68,141

69,561

Commercial junior liens and lines of credit

3,685

4,127

Total junior liens and lines of credit

71,826

73,688

Total residential real estate 1-4 family

259,057

218,185

Residential real estate - construction

Consumer

11,264

13,908

Commercial

9,820

10,485

Total residential real estate construction

21,084

24,393

Commercial real estate

671,182

566,662

Commercial

249,119

235,602

Total commercial

920,301

802,264

Consumer

6,408

6,199

1,206,850

1,051,041

Less: Allowance for credit losses

(15,528)

(14,175)

Net Loans

$

1,191,322

$

1,036,866

Included in the loan balances are the following:

Net unamortized deferred loan costs

$

1,651

$

2,027

Loans pledged as collateral for borrowings and commitments from:

FHLB

$

651,297

$

585,601

Federal Reserve Bank

85,595

92,922

$

736,892

$

678,523

Paycheck Protection Program (included in commercial loans)

$

68

$

179

 

12


Note 6. Loan Quality and Allowance for Credit Losses

The allowance for credit losses is a valuation account that is deducted from the loans' amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when management believes the collectability of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off.

Management estimates the allowance balance using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience, derived from peer group data, provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for differences in: lending policy, procedures and practice; economic conditions; nature and volume of loans; experience of lending team; volume of past due loans; quality of the loan review system; concentrations of credit; and other external factors.

Expected credit losses are estimated over the contractual term of the loans, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals, and modifications unless either of the following applies: management has a reasonable expectation at the reporting date that a modification will be executed with an individual borrower, or the extension or renewal options are included int eh original or modified contract at the reporting date and are not unconditionally cancellable by the Bank.

The allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist. The Bank measures the Allowance for Credit Loss (ACL) using the following inputs to calculate the quantitative component for the pool:

Segregating loans into homogeneous pools by the FRB Call Code which is primarily a collateral-based and secondarily a purpose-based segmentation.

The average remaining life of each pool is calculated using the weighted average remaining maturity method (WARM). The WARM method produces an estimated remaining balance by pool, by year, until maturity.

Using third party data, the Bank determines a reasonable and supportable economic forecast that it believes is likely to exist for the next four quarters.

A historical credit loss rate is calculated for each pool, using the average historical loss, by FRB Call Code, for a peer group of Pennsylvania community banks over the last eight quarters. The historical loss rate is calculated over a historical period the Bank believes best represents a period that will be similar to the next four quarters.

The historical peer credit loss rate is applied to each WARM bucket through the initial four quarter forecast period.

At the end of the four quarter forecast period, the credit loss rate applied to each WARM bucket reverts to the peer group historical loss rate for the respective pool.

Collectively these estimated losses represent the quantitative component of the pooled reserve.

The qualitative component for the pool utilizes a risk matrix comprised of eight risk factors and assigns a risk level to each factor. The risk factors consider changes in: lending policy, procedures and practice; economic conditions; nature and volume of loans; experience of lending team; volume of past due loans; quality of the loan review system; concentrations of credit; and other external factors. The risk factors are weighted to reflect Management’s estimate of how the factor affects potential losses. The risk levels within each factor are measured in basis points and range from minimal risk to very high risk and are determined independently for commercial loans, residential mortgage loans and consumer loans.

The ACL for pooled loans is the sum of the quantitative and qualitative loss estimates.

The Bank categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, and current economic trends, among other factors. 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 performing or nonperforming based on the payment status of the loans. Nonperforming consumer loans are loans that are nonaccrual or 90 days or more past due and still accruing. The Bank uses the following definitions for risk ratings:

Pass (1-5): are considered pass credits with lower or average risk and are not otherwise classified.

OAEM (6): Loans classified as OAEM have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company’s credit position at some future date.

13


Substandard (7): Loans classified as Substandard are inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Doubtful (8): Loans classified as Doubtful have all the weaknesses inherent in those classified as Substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

Loans that do not share risk characteristics are evaluated on an individual basis. Loans evaluated individually are not included in the pool evaluation. When management determines that foreclosure is probable or when the borrower is experiencing financial difficulty at the reporting date and repayment is expected to be provided substantially through the sale of the collateral, the expected credit losses are based on the fair value of the collateral at the reporting date, adjusted for any discounts and selling costs as appropriate.

Management monitors loan performance on a monthly basis and performs a quarterly evaluation of the adequacy of the Allowance for Credit Loss for loans (ACL). The Bank begins enhanced monitoring of all loans rated 6–OAEM or worse and obtains a new appraisal or asset valuation for any loans 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 ACL, 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. Management monitors the adequacy of the ACL on an ongoing basis and reports its adequacy quarterly to the Board Enterprise Risk Management Committee of the Board of Directors. Management believes the ACL at September 30, 2023 is adequate.


14


The following table presents loans by year of origination and internally assigned risk ratings:

(Dollars in thousands, except per share)

Revolving

Revolving

Term Loans

Loans

Loans

Amortized Cost Basis by Origination Year

Amortized

Converted

As of September 30, 2023

2023

2022

2021

2020

2019

Prior

Cost Basis

to Term

Total

Residential real estate 1-4 family:

Commercial:

Risk rating:

Pass (1-5)

$

7,702 

$

9,386 

$

11,426 

$

9,807 

$

2,454 

$

23,930 

$

1,824 

$

$

66,529 

OAEM (6)

Substandard (7)

98 

98 

Doubtful (8)

Total Commercial

7,702 

9,386 

11,426 

9,807 

2,454 

24,028 

1,824 

66,627 

Consumer:

Performing

37,186 

30,157 

15,746 

10,893 

5,684 

29,605 

42,554 

20,605 

192,430 

Nonperforming

Total Consumer

37,186 

30,157 

15,746 

10,893 

5,684 

29,605 

42,554 

20,605 

192,430 

Total

$

44,888 

$

39,543 

$

27,172 

$

20,700 

$

8,138 

$

53,633 

$

44,378 

$

20,605 

$

259,057 

Current period gross charge-offs

$

$

$

$

$

$

$

$

$

Residential real estate construction:

Commercial:

Risk rating:

Pass (1-5)

$

3,420 

$

2,849 

$

1,503 

$

229 

$

$

1,819 

$

$

$

9,820 

OAEM (6)

Substandard (7)

Doubtful (8)

Total Commercial

3,420 

2,849 

1,503 

229 

1,819 

9,820 

Consumer:

Performing

7,434 

3,830 

11,264 

Nonperforming

Total Consumer

7,434 

3,830 

11,264 

Total

$

10,854 

$

6,679 

$

1,503 

$

229 

$

$

1,819 

$

$

$

21,084 

Current period gross charge-offs

$

$

$

$

$

$

$

$

$

Commercial real estate:

Risk rating:

Pass (1-5)

$

140,948 

$

118,484 

$

99,775 

$

41,944 

$

39,762 

$

219,830 

$

5,310 

$

$

666,053 

OAEM (6)

2,203 

144 

2,347 

Substandard (7)

2,732 

50 

2,782 

Doubtful (8)

Total

$

140,948 

$

118,484 

$

99,775 

$

41,944 

$

39,762 

$

224,765 

$

5,504 

$

$

671,182 

Current period gross charge-offs

$

$

$

$

$

$

$

$

$

Commercial:

Risk rating:

Pass (1-5)

$

28,531 

$

35,229 

$

47,478 

$

23,762 

$

4,121 

$

65,513 

$

39,315 

$

$

243,949 

OAEM (6)

Substandard (7)

116 

340 

3,642 

1,072 

5,170 

Doubtful (8)

Total

$

28,647 

$

35,569 

$

47,478 

$

23,762 

$

4,121 

$

69,155 

$

40,387 

$

$

249,119 

Current period gross charge-offs

$

(8)

$

$

(81)

$

$

$

$

$

$

(89)

Consumer:

Performing

1,421 

759 

2,053 

181 

114 

8 

1,858 

6,394 

Nonperforming

14 

14 

Total

$

1,421 

$

759 

$

2,053 

$

181 

$

114 

$

8 

$

1,872 

$

$

6,408 

Current period gross charge-offs

$

(37)

$

(16)

$

(10)

$

(2)

$

(6)

$

$

(26)

$

$

(97)


15


The following table presents the amortized cost basis of loans on nonaccrual status and loans past due over 90 days and still accruing as of September 30, 2023:

(Dollars in thousands)

Nonaccrual and Loans Past Due Over 90 Days+

Loans Past Due

Nonaccrual

Nonaccrual

Over 90 Days

Without ACL

With ACL

Still Accruing

September 30, 2023

Residential Real Estate 1-4 Family

First liens

$

98 

$

$

Junior liens and lines of credit

Total

98 

Residential real estate - construction

Commercial real estate

Commercial

115 

Consumer

14 

Total

$

213 

$

$

14 

The following table reports the risk rating for those loans in the portfolio that were assigned an individual risk rating at December 31, 2022:

Pass

OAEM

Substandard

Doubtful

(Dollars in thousands)

(1-5)

(6)

(7)

(8)

Total

December 31, 2022

Residential Real Estate 1-4 Family

First liens

$

144,377 

$

$

120 

$

$

144,497 

Junior liens and lines of credit

73,688 

73,688 

Total

218,065 

120 

218,185 

Residential real estate - construction

24,393 

24,393 

Commercial real estate

562,665 

1,095 

2,902 

566,662 

Commercial

228,085 

2,751 

4,766 

235,602 

Consumer

6,199 

6,199 

Total

$

1,039,407 

$

3,846 

$

7,788 

$

$

1,051,041 


16


At September 30, 2023 the Bank had $0 of residential properties in the process of foreclosure compared to $94 thousand at December 31, 2022. The following table presents the aging of payments of the loan portfolio:

(Dollars in thousands)

Loans Past Due

Total

Total

30-59 Days

60-89 Days

90 Days+

Past Due

Current

Loans

September 30, 2023

Residential Real Estate 1-4 Family

First liens

$

21 

$

232 

$

98 

$

351 

$

186,880 

$

187,231 

Junior liens and lines of credit

399 

399 

71,427 

71,826 

Total

420 

232 

98 

750 

258,307 

259,057 

Residential real estate - construction

21,084 

21,084 

Commercial real estate

311 

311 

670,871 

671,182 

Commercial

662 

115 

777 

248,342 

249,119 

Consumer

10 

16 

14 

40 

6,368 

6,408 

Total

$

1,403 

$

248 

$

227 

$

1,878 

$

1,204,972 

$

1,206,850 

Total

Past Due &

Total

December 31, 2022

30-59 Days

60-89 Days

90 Days+

Nonaccrual

Nonaccrual

Current

Loans

Residential Real Estate 1-4 Family

First liens

$

340 

$

177 

$

$

120 

$

637 

$

143,860 

$

144,497 

Junior liens and lines of credit

490 

490 

73,198 

73,688 

Total

830 

177 

120 

1,127 

217,058 

218,185 

Residential real estate - construction

24,393 

24,393 

Commercial real estate

649 

649 

566,013 

566,662 

Commercial

681 

50 

731 

234,871 

235,602 

Consumer

29 

5 

13 

47 

6,152 

6,199 

Total

$

2,189 

$

232 

$

13 

$

120 

$

2,554 

$

1,048,487 

$

1,051,041 

17


The following table presents, by class, the activity in the Allowance for Credit Losses (ACL) 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

ACL at June 30, 2023

$

1,720 

$

683 

$

177 

$

9,083 

$

2,854 

$

98 

$

$

14,615 

Charge-offs

(2)

(21)

(23)

Recoveries

4 

15 

51 

70 

Provision

(519)

(265)

61 

1,124 

503 

(38)

866 

ACL at September 30, 2023

$

1,201 

$

418 

$

242 

$

10,207 

$

3,370 

$

90 

$

$

15,528 

ALL at December 31, 2022

$

459 

$

234 

$

343 

$

7,493 

$

4,846 

$

133 

$

667 

$

14,175 

Impact of adopting ASU 2016-13

1,096 

493 

(95)

584 

(1,907)

(40)

(667)

(56)

Charge-offs

(89)

(97)

(186)

Recoveries

2 

46 

94 

76 

218 

Provision

(356)

(309)

(52)

2,130 

426 

18 

1,857 

ACL at September 30, 2023

$

1,201 

$

418 

$

242 

$

10,207 

$

3,370 

$

90 

$

$

15,528 

ALL at June 30, 2022

$

465 

$

245 

$

289 

$

8,096 

$

5,076 

$

119 

$

725 

$

15,015 

Charge-offs

(6)

(33)

(39)

Recoveries

1 

8 

4 

13 

Provision

(4)

3 

75 

9 

(33)

38 

(88)

ALL at September 30, 2022

$

461 

$

249 

$

364 

$

8,105 

$

5,045 

$

128 

$

637 

$

14,989 

ALL at December 31, 2021

$

475 

$

252 

$

325 

$

8,168 

$

5,127 

$

130 

$

589 

$

15,066 

Charge-offs

(20)

(69)

(79)

(168)

Recoveries

47 

2 

20 

22 

91 

Provision

(41)

(5)

39 

(63)

(33)

55 

48 

ALL at September 30, 2022

$

461 

$

249 

$

364 

$

8,105 

$

5,045 

$

128 

$

637 

$

14,989 

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 December 31, 2022:

Residential Real Estate 1-4 Family

First

Junior Liens &

Commercial

(Dollars in thousands)

Liens

Lines of Credit

Construction

Real Estate

Commercial

Consumer

Unallocated

Total

December 31, 2022

Loans evaluated for ALL:

Individually

$

619 

$

$

$

2,331 

$

$

$

$

2,950 

Collectively

143,878 

73,688 

24,393 

564,331 

235,602 

6,199 

1,048,091 

Total

$

144,497 

$

73,688 

$

24,393 

$

566,662 

$

235,602 

$

6,199 

$

$

1,051,041 

ALL established for
  loans evaluated:

Individually

$

$

$

$

$

$

$

$

Collectively

459 

234 

343 

7,493 

4,846 

133 

667 

14,175 

ALL at December 31, 2022

$

459 

$

234 

$

343 

$

7,493 

$

4,846 

$

133 

$

667 

$

14,175 

At September 30, 2023, there were no loans evaluated individually for the ACL.

18


On January 1, 2023, The Bank adopted ASU 2022-02, “Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures” (“ASU 2022-02”), which eliminated the accounting guidance for troubled debt restructurings (“TDRs”) while enhancing disclosure requirements for certain loan refinancing and restructurings by creditors when a borrower is experiencing financial difficulty. Modifications to borrowers experiencing financial difficulty may include interest rate reductions, principal or interest forgiveness, forbearances, term extensions, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral.

No loan modifications were made to borrowers experiencing financial difficulties during the first nine months of 2023.

Prior to the adoption of ASU 2022-02, certain modified loans were reported as TDRs and impaired. The following table presents impaired loans as of December 31, 2022.

Impaired Loans

With No Allowance

With Allowance

(Dollars in thousands)

Unpaid

Unpaid

Recorded

Principal

Recorded

Principal

Related

December 31, 2022

Investment

Balance

Investment

Balance

Allowance

Residential Real Estate 1-4 Family

First liens

$

619

$

619

$

$

$

Junior liens and lines of credit

Total

619

619

Residential real estate - construction

Commercial real estate

2,331

2,331

Commercial

Total

$

2,950

$

2,950

$

$

$

The following table presents TDR loans as of December 31, 2022:

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

December 31, 2022

Residential real estate - construction

$

$

$

$

Residential real estate

5 

619 

619 

Commercial real estate - owner occupied

3 

783 

783 

Commercial real estate - farm land

3 

1,466 

1,466 

Commercial real estate - construction and land development

Commercial real estate - other

1 

82 

82 

Total

12 

$

2,950 

$

2,950 

$

$

*The performing status is determined by the loans compliance with the modified terms. Nonperforming is considered 90 days or more past due.

Note 7. Leases

The Corporation leases various assets in the course of its operations that are subject to recognition on the balance sheet. The Corporation considers all of its leases to be operating leases and it has no finance leases. The leased assets may include 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 an 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. Operating lease expense is included in net occupancy expense in the consolidated statements of income.

19


Lease costs:

The components of total lease cost were as follows:

Three Months Ended
September 30,

Nine Months Ended
September 30,

(Dollars in thousands)

2023

2022

2023

2022

Operating lease cost

$

191

$

193

$

619

$

566

Short-term lease cost

4

44

12

296

Variable lease cost

36

40

110

95

Total lease cost

$

231

$

277

$

741

$

957

Supplemental Lease Information:

Nine Months Ended
September 30,

(Dollars in thousands)

2023

2022

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

Operating cash flows from operating leases

$

602

$

550

Weighted-average remaining lease term (years)

11.9

12.1

Weighted-average discount rate

3.38%

3.35%

Lease Obligations:

Future undiscounted lease payments for operating leases with initial terms of one year or more as of September 30, 2023 are as follows:

(Dollars in thousands)

2023

$

188

2024

717

2025

666

2026

564

2027

421

2028 and beyond

3,598

Undiscounted cash flow

6,154

Imputed Interest

(1,194)

Total lease liability

$

4,960

A lease termination expense of $495 thousand was recorded in the second quarter of 2023. The lease termination was a long-term real estate lease held for a new community banking office that will not be constructed. Due to the lease termination, the right of use asset decreased $507 thousand and the lease liability decreased $537 thousand.

Note 8. Other Real Estate Owned

The Bank had no other real estate owned at September 30, 2023 and December 31, 2022.

 

Note 9. Derivatives

The Corporation is exposed to certain risks arising from both its business operations and economic conditions.  The Corporation principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Corporation manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its assets and liabilities. 

The Corporation’s existing credit derivatives result from participations in interest rate swaps provided by external lenders as part of loan participation arrangements.  Derivatives not designated as hedges are not speculative and result from a service the Corporation provides to certain lenders which participate in loans.

20


The table below presents the fair value of the Corporation’s derivative financial instruments as well as their classification on the Balance Sheet.

Fair Value of Derivative Instruments

Derivative Liabilities

(Dollars in thousands)

September 30, 2023

December 31, 2022

Notional amount

Balance Sheet Location

Fair Value

Notional amount

Balance Sheet Location

Fair Value

Derivatives not designated as hedging instruments

Other Contracts

$

6,318

Other Liabilities

$

1 

$

6,465 

Other Liabilities

$

3 

Total derivatives not designated as hedging instruments

$

1 

$

3 

The table below presents the effect of the Corporation’s derivative financial instruments that are not designated as hedging instruments on the Income Statement.

Effect of Derivatives as Hedging Instruments on the Income Statement

Derivatives Not Designated as Hedging Instruments under Subtopic 815-20

Location of Gain or (Loss) Recognized in Income on Derivative

Amount of Gain or (Loss) Recognized in Income on Derivatives

(Dollars in thousands)

Three Months Ended

Nine Months Ended

September 30, 2023

September 30, 2022

September 30, 2023

September 30, 2022

Other Contracts

Other income

$

2 

$

4 

$

3 

$

17 

As of September 30, 2023, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $1 thousand.  

Note 10. Pension

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

Three Months Ended

Nine Months Ended

September 30,

September 30,

(Dollars in thousands)

2023

2022

2023

2022

Components of net periodic cost:

Service cost

$

54

$

86

$

162

$

257

Interest cost

202

168

605

504

Expected return on plan assets

(231)

(249)

(693)

(746)

Recognized net actuarial loss

150

449

Total pension expense

$

25

$

155

$

74

$

464

The service cost component of pension expense is recorded in the salaries and employee benefits line and all other cost components are recorded in the nonservice pension line of the Consolidated Statements of Income. 

Note 11. 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

21


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.

The following methods and assumptions were used to estimate the fair values of the Corporation’s financial instruments measured at fair value on a recurring and nonrecurring basis.

Equity Securities: Equity securities are valued using quoted market prices from nationally recognized markets (Level 1). Equity securities are measured at fair value on a recurring basis.

Investment securities: Fair values of investment securities available-for-sale were primarily measured using information from a third-party pricing service. This service provides pricing information by utilizing evaluated pricing models supported with market data information. Standard inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data from market research publications. Level 2 investment securities are primarily comprised of debt securities issued by states and municipalities, corporations, mortgage-backed securities issued by government agencies, and government-sponsored enterprises. Fair values were estimated primarily by obtaining quoted prices for similar assets in active markets or through the use of pricing models. Investment securities are measured at fair value on a recurring basis.

Collateral Dependent Loans: The fair value of collateral dependent loans with specific allocations of the allowance for credit losses is generally based on recent real estate appraisals conducted by an independent, licensed appraiser, less cost to sell. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach (Level 2). If the appraiser makes an adjustment to account for differences between the comparable sales and income data available for similar loans, or if management adjusts the appraised value, then the fair value is considered Level 3. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Collateral dependent loans are evaluated on a quarterly basis for additional impairment and adjusted in accordance with the allowance policy. No partial charge-offs on these loans was taken in the third quarter of 2023. Collateral dependent loans are measured at fair value on a nonrecurring basis.


22


Recurring Fair Value Measurements

For financial assets and liabilities measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2023 and December 31, 2022 are as follows:

(Dollars in thousands)

Fair Value at September 30, 2023

Asset Description

Level 1

Level 2

Level 3

Total

Equity securities, at fair value

$

386

$

$

$

386

Available for sale:

U.S. Treasury

71,141

71,141

Municipal

128,717

128,717

Corporate

22,983

22,983

Agency mortgage & asset-backed

134,370

134,370

Non-Agency mortgage & asset-backed

101,065

101,065

Total assets

$

71,527

$

387,135

$

$

458,662

(Dollars in thousands)

Fair Value at December 31, 2022

Asset Description

Level 1

Level 2

Level 3

Total

Equity securities, at fair value

$

411

$

$

$

411

Available for sale:

U.S. Treasury

90,257

90,257

Municipal

155,455

155,455

Corporate

24,239

24,239

Agency mortgage and asset-backed

150,935

150,935

Non-Agency mortgage and asset-backed

65,950

65,950

Total assets

$

90,668

$

396,579

$

$

487,247

The fair value of derivative liabilities measured at fair value at September 30, 2023 and December 31, 2022 was $1 thousand during each period and was considered immaterial.


23


Nonrecurring Fair Value Measurements

The Corporation did not record any assets or liabilities at fair value for which measurement of the fair value was made on a nonrecurring basis at September 30, 2023. For financial assets and liabilities measured at fair value on a recurring basis, there were no transfers of financial assets or liabilities between Level 1 and Level 2 during the period ending September 30, 2023.

The carrying amounts and estimated fair value of financial instruments not carried at fair value are as follows:

September 30, 2023

Carrying

Fair

(Dollars in thousands)

Amount

Value

Level 1

Level 2

Level 3

Financial assets, carried at cost:

Cash and cash equivalents

$

73,953

$

73,953

$

73,953

$

$

Long-term interest-earning deposits in other banks

7,728

7,728

7,728

Loans held for sale

792

792

792

Net loans

1,191,322

1,131,171

1,131,171

Accrued interest receivable

6,764

6,764

6,764

Financial liabilities:

Deposits

$

1,567,414

$

1,566,099

$

$

1,566,099

$

Federal Reserve Bank borrowings

70,000

69,597

69,597

FHLB advances

40,000

40,117

40,117

Subordinate notes

19,653

18,119

18,119

Accrued interest payable

2,836

2,836

2,836

December 31, 2022

Carrying

Fair

(Dollars in thousands)

Amount

Value

Level 1

Level 2

Level 3

Financial assets, carried at cost:

Cash and cash equivalents

$

64,899

$

64,899

$

64,899

$

$

Long-term interest-earning deposits in other banks

13,975

13,975

13,975

Loans held for sale

283

287

287

Net loans

1,036,866

986,141

986,141

Accrued interest receivable

6,354

6,354

6,354

Financial liabilities:

Deposits

$

1,551,448

$

1,550,030

$

$

1,550,030

$

Subordinate notes

19,623

17,876

17,876

Accrued interest payable

192

192

192

 

Note 12. Deposits

September 30,

December 31,

(Dollars in thousands)

2023

2022

Noninterest-bearing checking

$

295,181

$

299,231

Interest-bearing checking

465,897

496,533

Money management

585,872

569,585

Savings

110,158

128,709

Total interest-bearing checking and savings

1,161,927

1,194,827

Time deposits

110,306

57,390

Total deposits

$

1,567,414

$

1,551,448

Overdrawn deposit accounts reclassified as loans

$

120

$

103

24


Time deposits greater than $250,000 at September 30, 2023 and December 31, 2022 were $30.0 million and $8.8 million, respectively.

Note 13. Borrowings

At September 30, 2023, the Bank had $70.0 million borrowed from the Federal Reserve’s Bank Term Funding Program (BTFP) to temporarily support its liquidity position and $40.0 million in short-term borrowing from the Federal Home Loan Bank of Pittsburgh (FHLB). The BTFP borrowing is comprised of $50.0 million with a rate of 4.38% due March 22, 2024, and $20.0 million with a rate of 4.71% due May 10, 2024. At September 30, 2023, the fair value of debt securities pledged for the BTFP was $79.8 million. The FHLB borrowings have a blended rate of 5.80% and are due during the third quarter of 2024.

At September 30, 2023, the Corporation had $20.0 million of unsecured subordinated debt notes payable, $15.0 million which mature on September 1, 2030 and $5.0 million which mature on September 1, 2035. The notes are recorded on the consolidated balance sheet net of remaining debt issuance costs totaling $347 thousand at September 30, 2023, which is being amortized on a pro-rata basis, based on the maturity date of the notes, on an effective interest method. The subordinated notes totaling $15.0 million have a fixed interest rate of 5.00% through September 1, 2025, then convert to a variable rate of 90-day Secured Overnight Financing Rate (SOFR) plus 4.93% for the applicable interest periods through maturity. The subordinated notes totaling $5.0 million have a fixed interest rate of 5.25% through September 1, 2030, then convert to a variable rate of 90-day SOFR plus 4.92% for the applicable interest periods through maturity. The Corporation may, at its option, redeem the notes, in whole or in part, at any time 5-years prior to the maturity. The notes are structured to qualify as Tier 2 Capital for the Corporation and there are no debt covenants on the notes.

Note 14. Capital Ratios

Capital adequacy for the Bank is currently defined by regulatory agencies through the use of several minimum required ratios. The capital ratios to be considered “well capitalized” 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%. In addition, a capital conservation buffer of 2.5% is applicable to all of the capital ratios except for the Tier 1 Leverage ratio. The capital conservation buffer is equal to the lowest value of the three applicable capital ratios less the regulatory minimum for each respective capital measurement. The Bank’s capital conservation buffer at September 30, 2023 was 6.28% compared to the regulatory buffer of 2.5%. Compliance with the capital conservation buffer is required in order to avoid limitations to certain capital distributions and is in addition to the minimum required capital requirements. As of September 30, 2023, the Bank was “well capitalized.”

In 2019, the Community Bank Leverage Ratio (CBLR) was approved by federal banking agencies as an optional capital measure available to Qualifying Community Banking Organizations (QCBO). If a bank qualifies as a QCBO and maintains a CBLR of 9% or greater, the bank would be considered “well-capitalized” for regulatory capital purposes and exempt from complying with the risk-based capital rule described above. The CBLR rule took effect January 1, 2020 and banks could opt-in through an election in the first quarter 2020 regulatory filing. The Bank met the criteria of a QCBO but did not opt-in to the CBLR.

The consolidated asset limit on small bank holding companies is $3.0 billion and a company with assets under that limit is not subject to the consolidated capital rules but may file reports that include capital amounts and ratios. The Corporation has elected to file those reports.


25


The following table summarizes the regulatory capital requirements and results as of September 30, 2023 and December 31, 2022 for the Corporation and the Bank:

Regulatory Ratios

Adequately

Well

September 30,

December 31,

Capitalized

Capitalized

(Dollars in thousands)

2023

2022

Minimum

Minimum

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

Franklin Financial Services Corporation

12.43%

14.22%

N/A

N/A

Farmers & Merchants Trust Company

13.03%

14.63%

4.50%

6.50%

Tier 1 Risk-based Capital Ratio (2)

Franklin Financial Services Corporation

12.43%

14.22%

N/A

N/A

Farmers & Merchants Trust Company

13.03%

14.63%

6.00%

8.00%

Total Risk-based Capital Ratio (3)

Franklin Financial Services Corporation

15.16%

17.21%

N/A

N/A

Farmers & Merchants Trust Company

14.28%

15.88%

8.00%

10.00%

Tier 1 Leverage Ratio (4)

Franklin Financial Services Corporation

9.10%

8.95%

N/A

N/A

Farmers & Merchants Trust Company

9.53%

9.21%

4.00%

5.00%

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

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

(3)Total risk-based capital / total risk-weighted assets

(4)Tier 1 capital / average quarterly assets

Note 15. Revenue Recognition

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 its 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 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. Commissions from the sale of investment and insurance products are recognized upon the completion of the transaction.

The following table presents Investment and Trust Service Fees for the three and nine months ended September 30, 2023 and 2022:

For the Three Months Ended

For the Nine Months Ended

(Dollars in thousands)

September 30,

September 30,

Investment and Trust Service Fees

2023

2022

2023

2022

Asset Management Fees

$

1,660

$

1,519

$

5,141

$

4,888

Estate Management Fees

65

113

218

415

Commissions

58

29

217

104

Total

$

1,783

$

1,661

$

5,576

$

5,407

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 third-party mortgage companies. All of

26


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 fees 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.

Contract Balances

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

Contract Acquisition Costs

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

1Note 16. 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.


27


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

September 30,

December 31,

(Dollars in thousands)

2023

2022

Financial instruments whose contract amounts represent credit risk

Commercial commitments to extend credit

$

318,116

$

275,867

Consumer commitments to extend credit (secured)

101,059

93,124

Consumer commitments to extend credit (unsecured)

4,970

5,247

$

424,145

$

374,238

Standby letters of credit

$

28,341

$

30,734

ACL - Unfunded Commitments*

$

1,965

$

1,475

*Reported in Other Liabilities on the Consolidated Balance Sheet

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.

On January 1, 2023, the Corporation adopted ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, referred to as the current expected credit loss (CECL) methodology. Upon adoption, $412 thousand was added to the allowance for credit losses (ACL) – unfunded commitments. For the third quarter of 2023, the provision for credit losses-unfunded commitments was $9 thousand compared to $0 for the third quarter of 2022. Year-to-date 2023, the provision for credit losses on unfunded commitments was $79 thousand compared to $0 for the same period in 2022.

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.

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

These assessments are based on the analysis of currently available information and are subject to significant judgment and a variety of assumptions and uncertainties. As new information is obtained, the Corporation may change its assessments and, as a result, take or adjust the amounts of its accruals and change its 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. Its exposure and ultimate losses may be higher, possibly significantly higher, than amounts it may accrue or amounts it may estimate.

28


In management’s opinion, the Corporation does 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 its financial position. The Corporation cannot now determine, however, whether or not any claim asserted against it will have a material adverse effect on its results of operations in any future reporting period, which will depend on, among other things, the amount of loss resulting from the claim and the amount of income otherwise reported for the reporting period. Thus, at September 30, 2023, the Corporation is 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.

 

Note 17. Reclassification

Certain prior period amounts may have been reclassified to conform to the current year presentation. Such reclassifications did not affect prior year net income or shareholders’ equity.


29


Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition

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

For the First Nine Months Ended September 30, 2023 and 2022

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 the rates of inflation and the effects of inflation, changes in interest rates, ongoing disruption in the financial services industry caused by the bank failures and continuing uncertainty of various banks, changes in the Corporation’s cost of funds, changes in government monetary policy, changes in government regulation and taxation of financial institutions, 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.

On January 1, 2023, the Corporation adopted ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (CECL) methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables and held-to-maturity debt securities. It also applies to off-balance sheet credit commitments not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees, and other similar instruments) and net investments in leases recognized by a lessor in accordance with Topic 842 on leases.

The Company adopted ASC 326 using the modified retrospective method for all financial assets measured at amortized cost, and unfunded credit exposures. Results for reporting periods beginning after January 1, 2023 are presented under ASC 326 while prior period amounts continue to be reported in accordance with the previously applicable incurred loss methodology.

The Corporation has determined this accounting policy to be critical to the results of operations. A summary of the adoption of the new ASU follows:

Investment Securities – Management classifies its debt securities at the time of purchase as available for sale (AFS) or held to maturity (HTM). At September 30, 2023 and December 31, 2022, all debt securities were classified as available for sale, meaning that the Corporation intends to hold them for an indefinite period of time, but not necessarily to maturity. Available for sale debt securities are stated at estimated fair value, adjusted for amortization of premiums and accretion of discounts which are recognized as adjustments of interest income through call date or maturity. The related unrealized gains and losses are reported as other comprehensive income or loss, net of tax, until realized.

With the adoption of CECL on January 1, 2023, the previous concept of other-than-temporary impairment for AFS securities has been eliminated. Under CECL, credit losses on AFS debt securities are recognized in (Allowance for Credit Losses) ACL for investments, through the provision for credit losses, rather than through a direct write-down of the security. In evaluating AFS securities for credit losses, Management considers factors such as delinquency, guarantees, invest grade rating, and specific conditions related to a specific security or industry. If an impaired debt security is sold, any previous ACL on that security is charged-off and any incremental loss will be recognized through earnings. Any improvement in expected credit losses will be recognized by reducing the ACL.

For HTM securities an estimate of current expected credit loss must be established at the time of purchase with changes in estimated credit loss recognized in the ACL through the provision for credit losses.

30


Prior to January 1, 2023, declines in the fair value of securities was recorded under the other-than-temporary impairment concept more fully described in the Corporation’s report on Form 10-K as of December 31, 2022.

Realized securities gains and losses are computed using the specific identification method. Gains or losses on the disposition of debt investment securities are recorded on the trade date, based on the net proceeds and the adjusted carrying amount of the specific security sold. Equity investments are carried at fair value with changes in fair value recognized in net income.

Allowance for Credit Losses – Loans

The ACL for loans is established through provisions for credit losses charged against income. Loans deemed to be uncollectible are charged against the ACL, and subsequent recoveries, if any, are credited to the ACL.

The ACL for loans is an estimate of the losses expected to be realized over the life of the loan portfolio. The ACL is determined for two distinct categories of loans: 1) loans evaluated individually for expected credit losses (specific reserve), and 2) loans evaluated collectively for expected credit losses (pooled reserve). Management’s periodic evaluation of the adequacy of the ACL for loans is based on the Bank’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, borrowers’ actual or perceived financial and managerial strengths, and other relevant factors. This evaluation is inherently subjective, as it requires material assumptions and estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans.

Loans evaluated individually for credit losses are primarily commercial purpose loans that do not share similar characteristics with those loans evaluated in the pool. These loans may exhibit performance characteristics where it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. All commercial purpose loans greater than $250 thousand and rated Substandard (7), Doubtful (8) or on nonaccrual status may be considered for individual evaluation. Impairment is measured on a loan-by-loan basis by one of the following methods: the fair value of the collateral if the loan is collateral dependent, the present value of expected future cash flows discounted at the loan’s effective interest rate or the loan’s obtainable market price. Commercial purpose loans with a balance less than $250 thousand, and consumer purpose loans are not evaluated individually for a specific reserve but are included in the pooled reserve calculation. Loans that are evaluated for a specific reserve, but not needing a specific reserve are not included in the pooled reserve calculation.

The Corporation has elected to exclude accrued interest receivable from the measurement of the ACL. When a loan is placed on nonaccrual status, any outstanding accrued interest is reversed against income. In addition, ASC 326 made changes to the accounting for available-for-sale debt securities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available-for-sale debt securities management does not intend to sell or believes that it is more likely than not they will be required to sell.

The pooled reserve represents the ACL for pools of homogenous loans, not evaluated individually. The pooled reserve is calculated using a quantitative and qualitative component for the loan pools.

The following inputs are used to calculate the quantitative component for the pool:

Segregating loans into homogeneous pools by the FRB Call Code which is primarily a collateral-based and secondarily a purpose-based segmentation.

The average remaining life of each pool is calculated using the weighted average remaining maturity method (WARM). The WARM method produces an estimated remaining balance by pool, by year, until maturity.

Using third party data, the Bank determines a reasonable and supportable economic forecast that it believes is likely to exist for the next four quarters.

A historical credit loss rate is calculated for each pool, using the average historical loss, by FRB Call Code, for a peer group of Pennsylvania community banks over the last eight quarters. The historical loss rate is calculated over a historical period the Bank believes best represents a period that will be similar to the next four quarters.

The historical peer credit loss rate is applied to each WARM bucket though the initial four quarter forecast period.

At the end of the forecast period, the credit loss rate applied to each WARM bucket reverts to the peer group historical loss rate for the respective pool.

Collectively these estimated losses represent the quantitative component of the pooled reserve.

The qualitative component for the pool utilizes a risk matrix comprised of eight risk factors and assigns a risk level to each factor. The risk factors consider changes in: lending policy, procedures and practice; economic conditions; nature and volume of loans; experience of lending team; volume of past due loans; quality of the loan review system; concentrations

31


of credit; and other external factors. The risk factors are weighted to reflect Management’s estimate of how the factor affects potential losses. The risk levels within each factor are measured in basis points and range from minimal risk to very high risk and are determined independently for commercial loans, residential mortgage loans and consumer loans.

The ACL for pooled loans is the sum of the quantitative and qualitative loss estimates.

Allowance for Credit Losses – Unfunded Commitments

The ACL for unfunded commitments is recorded in other liabilities on the consolidated balance sheet. The ACL represents management’s estimate of expected losses from unfunded commitments and is determined by estimating future usage of the commitments, based on historical usage. The estimated loss is calculated in a manner similar to that used for the ACL for loans, previously described. The ACL is increased or decreased through the provision for credit losses.

There were no other changes to the critical accounting policies disclosed in the 2022 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 2022 Annual Report on Form 10-K for a more detailed disclosure of the critical accounting policies.

Results of Operations

Summary

Franklin Financial Services Corporation reported consolidated earnings of $3.9 million ($0.88 per diluted share) for the third quarter of 2023 compared to $4.6 million ($1.05 per diluted share) for the same period in 2022. Year-to-date 2023 net income was $10.1 million ($2.31 per diluted share) compared to $11.2 million ($2.52 per diluted share) for the same nine-month period in 2022, a decrease of 9.7%.

A summary of operating results for the third quarter and year-to-date 2023 are as follows:

Net income for the third quarter of 2023 was $3.9 million ($0.88 per diluted share) compared to $3.0 million ($0.68 per diluted share) for the second quarter of 2023 (an increase of 22.9%), and $4.6 million ($1.05 per diluted share) for the third quarter of 2022 (a decrease of 16.7%).

For the third quarter of 2023, the provision for credit losses was $875 thousand compared to $524 thousand for the second quarter of 2023 and $0 for the third quarter of 2022.   

Net income year-to-date for 2023 was $10.1 million ($2.31 per diluted share) compared to $11.2 million ($2.52 per diluted share) for the same period in 2022, a decrease of 9.7%. As compared to the prior year-to-date results, 2023 was affected by a loss of $1.1 million on securities sales, a lease termination expense of $495 thousand and an increase of $1.9 million in the provision for credit losses. 

Total net loans increased 5.4% from the end of the second quarter of 2023 and 14.9% from December 31, 2022. 

Total deposits increased 3.6% from the end of the second quarter of 2023, and 1.0% from December 31, 2022.  Borrowings from the Federal Reserve and FHLB totaled $110.0 million at September 30, 2023. 

For the year-to-date period, Return on Average Assets (ROA) was 0.78%, Return on Average Equity (ROE) was 11.25% and the Net Interest Margin (NIM) was 3.33%, compared to ROA of 0.83%, ROE of 11.12% and NIM of 2.96% for the same period in 2022.

On October 19, 2023, the Board of Directors declared a $0.32 per share regular quarterly cash dividend for the fourth quarter of 2023 to be paid on November 22, 2023 to shareholders of record at the close of business on November 3, 2023. 


32


Key performance ratios as of, or for the three months ended September 30, 2023 and 2022 and the year ended December 31, 2022 are listed below:

September 30,

September 30,

December 31,

(Dollars in thousands, except per share)

2023

2022

2022

Balance Sheet Highlights

Total assets

$

1,827,910 

$

1,847,162 

$

1,699,579 

Investment and equity securities

458,662 

492,467 

487,247 

Loans, net

1,191,322 

1,033,518 

1,036,866 

Deposits

1,567,414 

1,704,983 

1,551,448 

Shareholders' equity

114,769 

108,151 

114,197 

Summary of Operations

Interest income

$

55,247 

$

39,454 

$

56,449 

Interest expense

15,509 

2,471 

4,863 

Net interest income

39,738 

36,983 

51,586 

Provision for credit losses - loans

1,857 

Provision for credit losses - unfunded commitments

79 

650 

Net interest income after provision for loan losses

37,802 

36,983 

50,936 

Noninterest income

10,766 

11,639 

15,250 

Noninterest expense

36,864 

35,496 

48,691 

Income before income taxes

11,704 

13,126 

17,495 

Federal income tax expense

1,577 

1,905 

2,557 

Net income

$

10,127 

$

11,221 

$

14,938 

Performance Measurements

Return on average assets*

0.78%

0.83%

0.83%

Return on average equity*

11.25%

11.12%

11.64%

Return on average tangible equity (1)*

12.13%

11.89%

12.52%

Efficiency ratio (1)

70.24%

71.34%

71.21%

Net interest margin*

3.33%

2.96%

3.11%

Shareholders' Value (per common share)

Diluted earnings per share

$

2.31

$

2.52

$

3.36

Basic earnings per share

2.31

2.53

3.38

Regular cash dividends declared

0.96

0.96

1.28

Book value

26.31

24.60

26.01

Tangible book value (1)

24.24

22.55

23.96

Market value

28.50

31.56

36.10

Market value/book value ratio

108.32%

128.29%

138.79%

Market value/tangible book value ratio

117.55%

139.95%

150.67%

Price/earnings multiple*

9.25

9.39

10.74

Current quarter dividend yield

4.49%

4.06%

3.55%

Dividend payout ratio year-to-date

41.45%

37.91%

37.88%

Safety and Soundness

Average equity/average assets

6.98%

7.49%

7.17%

Risk-based capital ratio (Total)

14.34%

17.34%

17.21%

Leverage ratio (Tier 1)

9.10%

8.59%

8.95%

Common equity ratio (Tier 1)

11.70%

14.29%

14.22%

Nonperforming loans / gross loans

0.02%

0.53%

0.01%

Nonperforming assets/total assets

0.01%

0.30%

0.01%

Allowance for credit losses as a % of loans

1.29%

1.43%

1.35%

Net loans (charged-off) recovered / average loans*

0.00%

-0.01%

-0.15%

Assets under Management

Trust assets under management (fair value)

$

963,805 

$

810,954 

$

904,317 

Held at third-party brokers (fair value)

126,394 

104,127 

116,398 

*Year-to-date annualized

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

33


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. Non-GAAP financial measures should be viewed in addition to, and not as an alternative for, our reported results prepared in accordance with GAAP. In the event of such a disclosure or release, the Securities and Exchange Commission’s Regulation G requires: (i) the presentation of the most directly comparable financial measure calculated and presented in accordance with GAAP and (ii) a reconciliation of the differences between the non-GAAP financial measure presented and the most directly comparable financial measure calculated and presented in accordance with GAAP. The following table shows the calculation of the non-GAAP measurements as of, or for the first nine months ended September 30, 2023 and 2022 and the year ended December 31, 2022.

(Dollars in thousands, except per share)

September 30, 2023

December 31, 2022

September 30, 2022

Return on Tangible Equity (non-GAAP)

Net income

$

10,127

$

14,938

$

11,221

Average shareholders' equity

120,351

128,283

134,898

Less average intangible assets

(9,016)

(9,016)

(9,016)

Average tangible equity (non-GAAP)

111,335

119,267

125,882

Return on average tangible equity (non-GAAP)*

12.13%

12.52%

11.89%

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

Shareholders' equity

$

114,769

$

114,197

$

108,151

Less intangible assets

(9,016)

(9,016)

(9,016)

Tangible book value (non-GAAP)

105,753

105,181

99,135

Shares outstanding (in thousands)

4,362

4,390

4,396

Tangible book value per share (non-GAAP)

$

24.24

$

23.96

$

22.55

Efficiency Ratio

Noninterest expense

$

36,864

$

48,691

$

35,496

Net interest income

39,738

51,586

36,983

Plus tax equivalent adjustment to net interest income

835

1,381

1,055

Plus noninterest income, net of securities transactions

11,910

15,410

11,719

Total revenue

52,483

68,377

49,757

Efficiency ratio (Noninterest expense/total revenue)

70.24%

71.21%

71.34%

* 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.

34


Comparison of the three months ended September 30, 2023 to the three months ended September 30, 2022:

Tax equivalent net interest income decreased $441 thousand to $14.0 million in the third quarter of 2023 compared to $14.4 million for the same period in 2022. The balance sheet volume change decreased tax-equivalent net interest income $1.1 million, which was partially offset by an increase of $637 thousand due to interest rate changes.


35


The following table presents average balances, tax-equivalent (T/E) interest income, and yields earned or rates paid on the assets or liabilities. Loans are classified by type of collateral and residential loans include commercial purpose loans and nonaccrual loans are included in the average loan balance used to calculate the yield. All nontaxable interest income has been adjusted to a tax-equivalent basis using a tax rate of 21%.

For the Three Months Ended September 30,

2023

2022

Average

Income or

Average

Average

Income or

Average

(Dollars in thousands)

balance

expense

yield/rate

balance

expense

yield/rate

Interest-earning assets:

Interest-earning obligations in other banks

$

56,133 

$

720 

5.09%

$

181,609 

$

1,022 

2.23%

Investment securities:

Taxable

406,761 

3,849 

3.75%

429,336 

2,733 

2.52%

Tax exempt

50,474 

344 

2.70%

84,624 

659 

3.09%

Investments

457,235 

4,193 

3.64%

513,959 

3,392 

2.62%

Loans:

Residential real estate 1-4 family:

First liens

179,698 

2,059 

4.55%

140,126 

1,414 

4.00%

Junior liens and lines of credit

72,460 

1,045 

5.72%

74,374 

644 

3.44%

Residential real estate - construction

19,058 

333 

6.93%

21,073 

230 

4.33%

Commercial real estate

650,470 

8,827 

5.38%

563,255 

6,185 

4.36%

Commercial

244,524 

3,102 

5.03%

245,173 

2,396 

3.88%

Consumer

6,387 

137 

8.51%

5,798 

107 

7.32%

Loans

1,172,597 

15,503 

5.25%

1,049,799 

10,976 

4.15%

Total interest-earning assets

1,685,965 

$

20,416 

4.80%

1,745,367 

$

15,390 

3.50%

Other assets

96,225 

92,531 

Total assets

$

1,782,190 

$

1,837,898 

Interest-bearing liabilities:

Deposits:

Interest-bearing checking

$

455,299 

$

501 

0.44%

$

575,766 

$

206 

0.14%

Money Management

578,408 

3,818 

2.62%

601,941 

426 

0.28%

Savings

113,797 

44 

0.15%

130,842 

19 

0.06%

Time

94,448 

764 

3.21%

61,688 

66 

0.42%

Total interest-bearing deposits

1,241,952 

5,127 

1.64%

1,370,237 

717 

0.21%

Subordinated notes

19,647 

264 

5.37%

19,609 

263 

5.36%

Federal Reserve Bank borrowings

70,000 

789 

4.47%

-

FHLB advances

18,261 

267 

5.82%

-

Total interest-bearing liabilities

1,349,860 

6,447 

1.90%

1,389,846 

980 

0.28%

Noninterest-bearing deposits

297,190 

313,781 

Other liabilities

14,835 

10,659 

Shareholders' equity

120,305 

123,612 

Total liabilities and shareholders' equity

$

1,782,190 

$

1,837,898 

T/E net interest income/Net interest margin

13,969 

3.29%

14,410 

3.28%

Tax equivalent adjustment

(262)

(347)

Net interest income

$

13,707 

$

14,063 

Net Interest Spread

2.90%

3.22%

Cost of Funds

1.55%

0.23%

Cost of Deposits

1.32%

0.17%

Provision for Credit Losses

For the third quarter of 2023, the provision for credit losses was $875 thousand allocated between the provision for loans of $866 thousand and the provision for unfunded commitments of $9 thousand. The provision for loan loss expense

36


for the third quarter of 2022 was $0. The ACL ratio for loans was 1.29% at September 30, 2023 compared to 1.35% at December 31, 2022. The ACL for unfunded commitments was $2.0 million compared to $1.5 million at December 31, 2022. For more information refer to the Loan Quality and Allowance for Credit Losses discussion in the Financial Condition section.

Noninterest Income

For the third quarter of 2023, noninterest income increased $350 thousand from the same period in 2022. Investment and trust income increased from asset management fees. Debit card income increased but was offset by a decrease in gains on sale of loans as the volume of mortgages sold decreased. The increase in other income was due in part to a state sales tax refund of $107 thousand.

The following table presents a comparison of noninterest expense for the three months ended September 30, 2023 and 2022:

For the Three Months Ended

September 30,

Change

(Dollars in thousands)

2023

2022

Amount

%

Noninterest Income

Investment and trust services fees

$

1,783

$

1,661

$

122

7.3

Loan service charges

235

177

58

32.8

Gain on sale of loans

33

183

(150)

(82.0)

Deposit service charges and fees

649

629

20

3.2

Other service charges and fees

472

443

29

6.5

Debit card income

568

497

71

14.3

Increase in cash surrender value of life insurance

114

109

5

4.6

Net losses on sales of debt securities

(15)

15

NA

Change in fair value of equity securities

7

(61)

68

(111.5)

Other

152

40

112

280.0

Total noninterest income

$

4,013

$

3,663

$

350

9.6

Noninterest Expense

Noninterest expense for the third quarter of 2023 was flat compared to the same period in 2022. Data processing costs increased due to the timing of several annual invoices. Other expenses increased due to small increases across multiple line items.

The following table presents a comparison of noninterest expense for the three months ended September 30, 2023 and 2022:

For the Three Months Ended

(Dollars in thousands)

September 30,

Change

Noninterest Expense

2023

2022

Amount

%

Salaries and benefits

$

6,982

$

7,050

$

(68)

(1.0)

Net occupancy

1,093

1,124

(31)

(2.8)

Marketing and advertising

531

433

98

22.6

Legal and professional

588

581

7

1.2

Data processing

1,300

1,146

154

13.4

Pennsylvania bank shares tax

174

335

(161)

(48.1)

FDIC insurance

230

197

33

16.8

ATM/debit card processing

320

359

(39)

(10.9)

Telecommunications

103

114

(11)

(9.6)

Nonservice pension

(29)

69

(98)

(142.0)

Lease termination

NA

Other

906

792

114

14.4

Total noninterest expense

$

12,198

$

12,200

$

(2)

(0.0)

37


Provision for Income Taxes

For the third quarter of 2023, the Corporation recorded a Federal income tax expense of $788 thousand compared to $895 thousand for the same quarter in 2022. The effective tax rate for the third quarter of 2023 was 17.0% compared to 16.2% for the same period in 2022. The federal statutory tax rate is 21% for 2023 and 2022.

Comparison of the nine months ended September 30, 2023 to the nine months ended September 30, 2022:

Tax equivalent net interest income increased $2.5 million to $40.6 million in the first nine months of 2023 compared to $38.0 million for the same period in 2022. A change in rates contributed $4.1 million to the increase which was offset by a balance sheet volume change of $1.6 million.

The following table presents average balances, tax-equivalent (T/E) interest income, and yields earned or rates paid on the assets or liabilities. Loans are classified by type of collateral and residential loans include commercial purpose loans and nonaccrual loans are included in the average loan balance used to calculate the yield. All nontaxable interest income has been adjusted to a tax-equivalent basis using a tax rate of 21%.

For the Nine Months Ended September 30,

2023

2022

Average

Income or

Average

Average

Income or

Average

(Dollars in thousands)

balance

expense

yield/rate

balance

expense

yield/rate

Interest-earning assets:

Interest-earning obligations in other banks

$

54,935 

$

1,934 

4.71%

$

176,523 

$

1,542 

1.17%

Investment securities:

Taxable

404,126 

10,645 

3.52%

428,572 

6,753 

2.11%

Tax exempt

56,590 

1,184 

2.80%

88,558 

1,980 

2.99%

Investments

460,716 

11,829 

3.43%

517,130 

8,733 

2.26%

Loans:

Residential real estate 1-4 family:

First liens

165,206 

5,482 

4.44%

138,241 

4,124 

3.99%

Junior liens and lines of credit

72,769 

2,976 

5.47%

72,932 

1,543 

2.83%

Residential real estate - construction

20,648 

924 

5.98%

20,720 

701 

4.52%

Commercial real estate

607,870 

23,720 

5.22%

543,412 

16,657 

4.10%

Commercial

240,742 

8,828 

4.90%

243,113 

6,901 

3.80%

Consumer

6,240 

389 

8.33%

5,918 

307 

6.94%

Loans

1,113,475 

42,319 

5.08%

1,024,336 

30,233 

3.95%

Total interest-earning assets

1,629,126 

$

56,082 

4.60%

1,717,989 

$

40,509 

3.15%

Other assets

96,178 

83,627 

Total assets

$

1,725,304 

$

1,801,614 

Interest-bearing liabilities:

Deposits:

Interest-bearing checking

$

457,230 

$

1,342 

0.39%

$

541,865 

$

508 

0.13%

Money Management

566,649 

9,872 

2.33%

594,796 

917 

0.21%

Savings

120,248 

137 

0.15%

127,936 

55 

0.06%

Time

80,369 

1,583 

2.63%

66,176 

205 

0.41%

Total interest-bearing deposits

1,224,496 

12,934 

1.41%

1,330,773 

1,684 

0.17%

Subordinated notes

19,637 

790 

5.35%

19,600 

787 

5.34%

Federal Reserve Bank borrowings

45,531 

1,518 

4.46%

-

FHLB advances

6,154 

267 

5.80%

-

Total interest-bearing liabilities

1,295,818 

15,509 

1.60%

1,350,373 

2,471 

0.24%

Noninterest-bearing deposits

294,542 

306,358 

Other liabilities

14,593 

9,985 

Shareholders' equity

120,351 

134,898 

Total liabilities and shareholders' equity

$

1,725,304 

$

1,801,614 

T/E net interest income/Net interest margin

40,573 

3.33%

38,038 

2.96%

Tax equivalent adjustment

(835)

(1,055)

Net interest income

$

39,738 

$

36,983 

Net Interest Spread

3.00%

2.91%

Cost of Funds

1.30%

0.20%

Cost of Deposits

1.14%

0.14%

38


Provision for Credit Losses

For the first nine months of 2023, the provision for credit losses was $1.9 million allocated between the provision for loans of $1.9 million and the provision for unfunded commitments of $79 thousand. The provision for loan loss expense for the first nine months of 2022 was $0. The ACL ratio for loans was 1.29% at September 30, 2023 compared to 1.35% at December 31, 2022. The ACL for unfunded commitments was $2.0 million compared to $1.5 million at December 31, 2022. For more information refer to the Loan Quality and Allowance for Credit Losses discussion in the Financial Condition section.

Noninterest Income

For the first nine months of 2023, noninterest income decreased $873 thousand from the same period in 2022. Debit card income increased but was offset by a decrease in gains on sale of loans as the volume of mortgages sold decreased. Losses on the sale of investment securities of $1.1 million were taken as part of a portfolio restructuring.

The following table presents a comparison of noninterest income for the nine months ended September 30, 2023 and 2022:

For the Nine Months Ended

September 30,

Change

(Dollars in thousands)

2023

2022

Amount

%

Noninterest Income

Investment and trust services fees

$

5,576

$

5,407

$

169

3.1

Loan service charges

658

533

125

23.5

Gain on sale of loans

150

692

(542)

(78.3)

Deposit service charges and fees

1,848

1,885

(37)

(2.0)

Other service charges and fees

1,334

1,293

41

3.2

Debit card income

1,618

1,393

225

16.2

Increase in cash surrender value of life insurance

333

326

7

2.1

Net losses on sales of debt securities

(1,119)

(34)

(1,085)

3,191.2

Change in fair value of equity securities

(25)

(46)

21

(45.7)

Other

393

190

203

106.8

Total noninterest income

$

10,766

$

11,639

$

(873)

(7.5)

Noninterest Expense

Noninterest expense for the first nine months of 2023 increased $1.4 million compared to the same period in 2022. Salary expense increased primarily due to a highly competitive labor market, while net occupancy increased from costs associated with the new headquarters and operations center that was put in service in July 2022. A lease termination expense was recorded in the second quarter of 2023 for $495 thousand. The lease termination was a long-term real estate lease held for a new community banking office that will not be constructed.


39


The following table presents a comparison of noninterest expense for the first nine months ended September 30, 2023 and 2022:

For the Nine Months Ended

(Dollars in thousands)

September 30,

Change

Noninterest Expense

2023

2022

Amount

%

Salaries and employee benefits

$

21,202

$

20,403

$

799

3.9

Net occupancy

3,315

3,077

238

7.7

Marketing and advertising

1,600

1,391

209

15.0

Legal and professional

1,593

1,580

13

0.8

Data processing

3,478

3,544

(66)

(1.9)

Pennsylvania bank shares tax

571

813

(242)

(29.8)

FDIC insurance

610

550

60

10.9

ATM/debit card processing

920

1,065

(145)

(13.6)

Telecommunications

300

313

(13)

(4.2)

Nonservice pension

(88)

207

(295)

(142.5)

Lease termination

495

495

NA

Other

2,868

2,553

315

12.3

Total noninterest expense

$

36,864

$

35,496

$

1,368

3.9

Provision for Income Taxes

For the first nine months of 2023, the Corporation recorded a Federal income tax expense of $1.6 million compared to $1.9 million for the same period in 2022. The effective tax rate for the first nine months of 2023 was 13.5% and reflects the benefit of a $280 thousand tax credit recorded during the first nine months of 2023. Without the tax credit, the effective rate would have been 15.9% compared to 14.5% for the first nine months of 2022. The federal statutory tax rate is 21% for 2023 and 2022.

Financial Condition

Cash and Cash Equivalents:

Cash and cash equivalents totaled $74.0 million at September 30, 2023, an increase of $9.1 million from the prior year-end balance of $64.9 million. Short-term interest-earning deposits are held primarily at the Federal Reserve ($53.4 million).

Investment Securities:

AFS Securities: At September 30, 2023, the AFS securities portfolio had an amortized cost of $525.5 million, a decrease of $22.8 million from the prior year-end, and had a fair value of $458.3 million, a decrease of $28.6 million from the prior year-end. The Bank sold $41.2 million of securities taking advantage of higher market interest rates while restructuring the AFS portfolio. The AFS portfolio had a net unrealized loss of $67.3 million at September 30, 2023 compared to a net unrealized loss of $61.5 million at the prior year-end. This change was due to an increase in long-term interest rates over the period despite the Bank realizing $1.1 million of losses during the year due to restructuring of the portfolio. The AFS portfolio averaged $457.2 million with a tax-equivalized yield of 3.64% for the three months ended September 30, 2023. This compares to an average of $514.0 million and a tax-equivalized yield of 2.62% for the same period in 2022. The weighted average life of the AFS portfolio is 5.1 years and the effective duration is 4.57%.

The AFS portfolio held $83.7 million, or 16% of the total portfolio, of securities issued by the U.S. Treasury and another $147.1 million, or 28% of the total portfolio, of mortgage and asset-backed securities issued by a U.S. Government Agency or a government sponsored entity and securitized by pools of residential mortgages and other loan assets.

Municipal bond holdings in the AFS portfolio were $161.7 million, or 31% of the total portfolio. The municipal bond holdings are well diversified geographically (154 issuers) and are comprised primarily of general obligation bonds (68%). Many municipal bonds have credit enhancements in the form of private bond insurance or other credit support. The largest geographic municipal bond exposures are in the states of Texas (15%), California (13%), Pennsylvania (12%), and Michigan (10%). The average rating of the municipal holdings from Moody’s is AA. No securities in the portfolio are rated below investment grade.

The corporate bond holdings in the AFS portfolio were $26.3 million, or 5% of the total portfolio, comprised predominantly of 46 fixed rate community bank issued subordinated notes totaling $22.1 million. All of the subordinated

40


notes are unrated. The Bank monitors the credit of the issuers of the subordinated notes on a quarterly basis. The remaining corporate bond holdings consist of five trust preferred securities and are investment grade rated.

The non-agency mortgage and asset-backed securities portfolio was $106.8 million, or 20% of the total portfolio, at September 30, 2023, an increase of $36.0 million from the prior year-end. The majority of these securities, $84.7 million, are investment grade rated while the remaining $22.1 million of securities in this portfolio are unrated. Many of the securities in this portfolio have credit enhancements in the form of subordination and overcollateralization.

Impairment in the AFS securities portfolio, measured by gross unrealized losses, were $67.3 million at September 30, 2023 compared to $61.5 million at December 31, 2022. The Bank believes it will be able to collect all interest and principal due on impaired securities and the decline in fair value below amortized cost is due to changing interest rates and not due to credit related factors; therefore, the Bank has no allowance for credit loss for these investments. The Bank does not have the intent to sell and does not believe it will more likely than not be required to sell, any of these securities prior to a recovery of their fair value to amortized cost.

Restricted Stock at Cost: The Bank held $2.3 million of restricted stock at September 30, 2023. 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.

See Note 4 of the accompanying financial statements for additional information on Investment Securities.

Loans:

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

Total residential real estate loans increased by $40.9 million over year-end 2022. For the first nine months of 2023, the Bank originated $10.7 million of mortgages held for sale and sold $10.2 million through third party brokerage agreements. 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: This category contains loans for the vertical construction of 1-4 family residential properties. The largest component of this category represents loans to residential real estate developers ($11.3 million), while loans for individuals to construct personal residences totaled $9.8 million at September 30, 2023. 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.

Commercial real estate (CRE): This category includes commercial, industrial, farm and agricultural loans and land development loans, where real estate serves as the primary collateral for the loans. Total commercial real estate loans increased to $671.2 million from $566.7 million at the end of 2022. The largest sectors (by collateral) in the commercial real estate category are: apartment buildings ($112.2 million), office buildings ($82.9 million), hotels & motels ($81.6 million), shopping centers ($69.3 million), and development land ($54.6 million). Within the office building portfolio, approximately 27.4% of total office building exposure is to owner occupied properties. The majority of the Bank’s hotel exposure is located along the Interstate 81 (I-81) corridor through south-central Pennsylvania. The portfolio is comprised of properties operating under 12 flagged brands and 3 independent operators.

Also included in CRE are real estate construction loans totaling $120.0 million. At September 30, 2023, the Bank had $52.3 million in real estate construction loans funded with an interest reserve and capitalized $1.2 million of interest in 2023 from these reserves on active projects for 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

41


of the project. This monitoring process includes at a minimum, the submission of invoices and American Institute of Architects (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: This category includes commercial, industrial, farm, agricultural, and municipal loans. Commercial loans increased $13.5 million to $249.1 million at September 30, 2023, compared to $235.6 million at the end of 2022. At September 30, 2023, the balance of PPP loans was $68 thousand, down from $179 thousand at year-end. At September 30, 2023, the Bank had approximately $117.1 million in tax-free loans. The largest sectors (by industry) in the commercial category are: public administration ($45.3 million), utilities ($41.3 million), real estate rental and leasing ($25.9 million), manufacturing ($23.2 million) and retail trade ($19.1 million).

Participations: The Bank may supplement its own commercial loan production by purchasing loan participations. These participations are primarily located in south-central Pennsylvania. At September 30, 2023, the outstanding commercial participations were $86.2 million, or 8.6%, of commercial purpose loans and 7.1% of total gross loans compared to $70.6 million at December 31, 2022, or 8.0%, of commercial purpose loans and 6.7% of total gross loans. The Bank’s total exposure (including outstanding balances and unfunded commitments) to purchased participations is $122.4 million, compared to $90.0 million at December 31, 2022. The commercial loan participations are comprised of $23.0 million of Commercial loans and $63.2 million of CRE loans, reported in the respective loan class.

Consumer loans: This category had a balance of $6.4 million at September 30, 2023, compared to $6.2 million at prior year-end and is comprised primarily of installment loans and personal lines of credit.


42


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

September 30,

December 31,

Change

(Dollars in thousands)

2023

2022

Amount

%

Residential Real Estate 1-4 Family

Consumer first liens

$

124,289

$

82,795

$

41,494

50.1

Commercial first lien

62,942

61,702

1,240

2.0

Total first liens

187,231

144,497

42,734

29.6

Consumer junior liens and lines of credit

68,141

69,561

(1,420)

(2.0)

Commercial junior liens and lines of credit

3,685

4,127

(442)

(10.7)

Total junior liens and lines of credit

71,826

73,688

(1,862)

(2.5)

Total residential real estate 1-4 family

259,057

218,185

40,872

18.7

Residential real estate - construction

Consumer

11,264

13,908

(2,644)

(19.0)

Commercial

9,820

10,485

(665)

(6.3)

Total residential real estate construction

21,084

24,393

(3,309)

(13.6)

Commercial real estate

671,182

566,662

104,520

18.4

Commercial

249,119

235,602

13,517

5.7

Total commercial

920,301

802,264

118,037

14.7

Consumer

6,408

6,199

209

3.4

1,206,850

1,051,041

155,809

14.8

Less: Allowance for credit losses

(15,528)

(14,175)

(1,353)

9.5

Net Loans

$

1,191,322

$

1,036,866

$

154,456

14.9

Loan Quality:

Management monitors loan performance on a monthly basis and performs a quarterly evaluation of the adequacy of the Allowance for Credit Loss for loans (ACL). The Bank begins enhanced monitoring of all loans rated 6–OAEM or worse and obtains a new appraisal or asset valuation for any loans 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 ACL, 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. Management monitors the adequacy of the ACL on an ongoing basis and reports its adequacy quarterly to the Board Enterprise Risk Management Committee of the Board of Directors. Management believes the ACL at September 30, 2023 is adequate.

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 $10.4 million at September 30, 2023 compared to $11.6 million at December 31, 2022. The watch list includes both performing and nonperforming loans. Included in the watchlist total are $213 thousand of nonaccrual loans. The credit composition of the watch list (loans rated 6, 7, or 8), by primary collateral is shown in Note 6 of the accompanying financial statements.

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

43


all loans 90-days or more past due, nonaccrual loans, or impaired loans. Further, it is the Bank’s policy to discontinue accruing interest on loans that are not adequately secured and in the process of collection. Upon determination of nonaccrual status, the Bank subtracts any current year accrued and unpaid interest from its income, and any prior year accrued and unpaid interest from the allowance for loan losses. Management continually monitors the status of nonperforming loans, the value of any collateral and potential of risk of loss. Nonaccrual loans are rated no better than 7-Substandard.

The Bank’s Loan Management Committee reviews these loans and risk ratings on a quarterly basis in order to proactively identify and manage problem loans. In addition, a committee meets monthly to discuss possible workout strategies for 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 Board Enterprise Risk Management Committee of the Board of Directors. The Bank also uses an external loan review consultant to assist with internal loan review with a goal of reviewing up to 80% 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 September 30, 2023, the Bank had loans of $14.2 million (7.6% of total risk-based capital) that exceeded the supervisory limit, compared to 7.2% at year-end 2022.

Loan quality, as measured by nonaccrual loans, had a balance of $213 thousand at September 30, 2023 compared to $120 thousand at December 31, 2022 and the nonperforming loan to total loans ratio was 0.02% at September 30, 2023 compared to 0.01% and December 31, 2022. Loans past due 90-days or more, but still accruing, totaled $14 thousand at September 30, 2023.

In addition to monitoring nonaccrual loans, the Bank also closely monitors loans to borrowers experiencing financial difficulty 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.

Modifications to borrowers experiencing financial difficulty may include interest rate reductions, principal or interest forgiveness, forbearances, term extensions, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral.

Allowance for Credit Losses:

Allowance for Credit Losses – Loans

The ACL for loans is established through provisions for credit losses charged against income. Loans deemed to be uncollectible are charged against the ACL, and subsequent recoveries, if any, are credited to the ACL.

The ACL for loans is an estimate of the losses expected to be realized over the life of the loan portfolio. The ACL is determined for two distinct categories of loans: 1) loans evaluated individually for expected credit losses (specific reserve), and 2) loans evaluated collectively for expected credit losses (pooled reserve). Management’s periodic evaluation of the adequacy of the ACL for loans is based on the Bank’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, borrowers’ actual or perceived financial and managerial strengths, and other relevant factors. This evaluation is inherently subjective, as it requires material assumptions and estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on loans evaluated individually.

Loans evaluated individually for credit losses are primarily commercial purpose loans that do not share similar characteristics with those loans evaluated in the pool. These loans may exhibit performance characteristics where it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. All commercial purpose loans greater than $250 thousand and rated Substandard (7), Doubtful (8) or on nonaccrual status may be considered for individual evaluation. Impairment is measured on a loan-by-loan basis by one of the following methods: the fair value of the collateral if the loan is collateral dependent, the present value of expected future cash flows discounted at the loan’s effective interest rate or the loan’s obtainable market price. Commercial purpose loans with a balance less than $250 thousand, and consumer purpose loans are not evaluated individually for a specific reserve but are included in the pooled reserve calculation. Loans that are evaluated for a specific reserve, but not needing a specific reserve are not included in the pooled reserve calculation.

The Corporation has elected to exclude accrued interest receivable from the measurement of the ACL. When a loan is placed on nonaccrual status, any outstanding accrued interest is reversed against income.

44


The pooled reserve represents the ACL for pools of homogenous loans, not evaluated individually. The pooled reserve is calculated using a quantitative and qualitative component for the loan pools.

The following inputs are used to calculate the quantitative component for the loan pool:

Segregating loans into homogeneous pools by the FRB Call Code which is primarily a collateral-based and secondarily a purpose-based segmentation.

The average remaining life of each pool is calculated using the weighted average remaining maturity method (WARM). The WARM method produces an estimated remaining balance by pool, by year, until maturity.

Using third party data, the Bank determines a reasonable and supportable economic forecast that it believes is likely to exist for the next four quarters.

A historical credit loss rate is calculated for each pool, using the average historical loss, by FRB Call Code, for a peer group of Pennsylvania community banks over the last eight quarters. The historical loss rate is calculated over a historical period the Bank believes best represents a period that will be similar to the next four quarters.

The historical peer credit loss rate is applied to each WARM bucket though the initial four quarter forecast period.

At the end of the forecast period, the credit loss rate applied to each WARM bucket reverts to the peer group historical loss rate for the respective pool.

Collectively these estimated losses represent the quantitative component of the pooled reserve.

The qualitative component for the pool utilizes a risk matrix comprised of eight risk factors and assigns a risk level to each factor. The risk factors give consideration to changes in: lending policy, procedures and practice; economic conditions; nature and volume of loans; experience of lending team; volume of past due loans; quality of the loan review system; concentrations of credit; and other external factors. The risk factors are weighted to reflect Management’s estimate of how the factor affects potential losses. The risk levels within each factor are measured in basis points and range from minimal risk to very high risk and are determined independently for commercial loans, residential mortgage loans and consumer loans.

The ACL for pooled loans is the sum of the quantitative and qualitative loss estimates.

Allowance for Credit Losses – Unfunded Commitments

The ACL for unfunded commitments is recorded in other liabilities on the consolidated balance sheet. The ACL represents management’s estimate of expected losses from unfunded commitments and is determined by estimating future usage of the commitments, based on historical usage. The estimated loss is calculated in a manner similar to that used for the ACL for loans, previously described. The ACL is increased or decreased through the provision for credit losses.

45


The following table shows the allocation of the allowance for credit losses and other loan performance ratios, by class, as of September 30, 2023 and December 31, 2022:

(Dollars in thousands)

Residential Real Estate 1-4 Family

Junior Liens &

Commercial

First Liens

Lines of Credit

Construction

Real Estate

Commercial

Consumer

Unallocated

Total

2023

Loans at September 30, 2023

$

187,231 

$

71,826 

$

21,084 

$

671,182 

$

249,119 

$

6,408 

$

$

1,206,850 

Average Loans through September 30, 2023

165,206 

72,769 

20,648 

607,870 

240,742 

6,240 

1,113,475 

Nonaccrual Loans at September 30, 2023

98 

115 

213 

Allowance for Credit Loss at September 30, 2023

1,201 

418 

242 

10,207 

3,370 

90 

15,528 

YTD Net (Charge-offs)/Recoveries at September 30, 2023

46 

(21)

32 

Loans/Total Gross Loans at September 30, 2023

16%

6%

2%

56%

21%

1%

100%

Nonaccrual Loans/Total Gross Loans at September 30, 2023

0.05%

0.00%

0.00%

0.00%

0.05%

0.00%

0.02%

Allowance for Credit Loss/Gross Loans at September 30, 2023

0.64%

0.58%

1.15%

1.52%

1.35%

1.40%

1.29%

Net (Charge-offs) Recoveries/Average Loans at September 30, 2023*

0.00%

0.00%

0.22%

0.00%

0.00%

-0.34%

0.00%

Allowance for Credit Loss/Nonaccrual Loans at September 30, 2023

7290.14%

2022

Loans at December 31, 2022

$

144,497 

$

73,688 

$

24,393 

$

566,662 

$

235,602 

$

6,199 

$

$

1,051,041 

Average Loans for 2022

139,577 

73,200 

21,737 

550,772 

241,395 

5,938 

1,032,619 

Nonaccrual Loans at December 31, 2022

120 

120 

Allowance for Loan Losses at December 31, 2022

459 

234 

343 

7,493 

4,846 

133 

667 

14,175 

Net Recoveries/(Charge-offs) for 2022

28 

(1,450)

(45)

(76)

(1,541)

Loans/Total Gross Loans at December 31, 2022

14%

7%

2%

54%

22%

1%

100%

Nonaccrual Loans/Total Gross Loans at December 31, 2022

0.08%

0.00%

0.00%

0.00%

0.00%

0.00%

0.01%

Allowance for Loan Loss/Gross Loans at December 31, 2022

0.32%

0.32%

1.41%

1.32%

2.06%

2.15%

1.35%

Net Recoveries(Charge-offs)/Average Loans for 2022

0.02%

0.00%

0.00%

-0.26%

-0.02%

-1.28%

-0.15%

Allowance for Loan Loss/Nonaccrual Loans at December 31, 2022

11812.50%

*Annualized

Deposits:

Total deposits increased $16.0 million during the first nine months of 2023 to $1.567 billion. Interest-bearing checking decreased by $30.6 million primarily in municipal deposits and savings decreased by $18.6 million, while the Bank’s Money Management increased $16.3 million. Time deposits increased $52.9 million as customers shifted to higher rate products. The Bank also added $8.6 million of brokered CDs, during the first nine months of 2023.

As of September 30, 2023, the Bank had deposits of $233.5 million placed in the IntraFi Network deposit program ($142.1 million in interest-bearing checking and $91.4 million in money management) and $6.5 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. Only reciprocal deposits that exceed 20% of liabilities are considered brokered deposits. At September 30, 2023, the Bank’s reciprocal deposits were 14.0% of total liabilities compared to 12.7% at year-end 2022.

The Bank estimates that approximately 91% of its deposits are FDIC insured or collateralized as of September 30, 2023.


46


The following table presents a summary of deposits for the periods ended:

September 30,

December 31,

Change

(Dollars in thousands)

2023

2022

Amount

%

Noninterest-bearing checking

$

295,181

$

299,231

$

(4,050)

(1.4)

Interest-bearing checking

465,897

496,533

(30,636)

(6.2)

Money management

585,872

569,585

16,287

2.9

Savings

110,158

128,709

(18,551)

(14.4)

Total interest-bearing checking and savings

1,161,927

1,194,827

(32,900)

(2.8)

Time deposits

110,306

57,390

52,916

92.2

Total deposits

$

1,567,414

$

1,551,448

$

15,966

1.0

Overdrawn deposit accounts reclassified as loans

$

120

$

103

Borrowings:

At September 30, 2023, the Bank had $70.0 million borrowed from the Federal Reserve’s Bank Term Funding Program (BTFP) to temporarily support its liquidity position and $40.0 million in short-term borrowing from the Federal Home Loan Bank of Pittsburgh (FHLB). The BTFP borrowing is comprised of $50.0 million with a rate of 4.38% due March 22, 2024, and $20.0 million with a rate of 4.71% due May 10, 2024. At September 30, 2023, the fair value of debt securities pledged for the BTFP was $79.8 million. The FHLB borrowings have a blended rate of 5.80% and are due during the third quarter of 2024.

On August 4, 2020, the Corporation completed the sale of a subordinated debt note offering. The Corporation sold $15.0 million of subordinated debt notes with a maturity date of September 1, 2030. These notes are noncallable for 5 years and carry a fixed interest rate of 5.00% per year for 5 years and then convert to floating rate of SOFR plus 4.93% per year for the remainder of the term. The notes can be redeemed at par beginning 5 years prior to maturity. The Corporation also sold $5.0 million of subordinated debt notes with a maturity date of September 1, 2035. These notes are noncallable for 10 years and carry a fixed interest rate of 5.25% per year for 10 years and then convert to floating rate of SOFR plus 4.92% per year for the remainder of the term. The notes can be redeemed at par beginning 5 years prior to maturity. The notes are structured to qualify as Tier 2 capital for the Corporation and any funds it invests in the Bank qualify as Tier 1 capital at the Bank. The Corporation paid an issuance fee of 2% of the total issue that will be amortized to maturity date of each issue on a pro-rata basis. The proceeds are intended to be used for general corporate purposes.

Shareholders’ Equity:

Total shareholders’ equity increased $572 thousand to $114.8 million as of September 30, 2023 from December 31, 2022. Retained earnings increased $6.0 million in 2023 and accumulated other comprehensive income (AOCI) decreased $4.5 million as the fair value of the investment portfolio decreased during 2023. The increase in retained earnings was from net earnings of $10.1 million partially offset by cash dividends of $4.2 million. The Corporation’s Dividend Reinvestment Plan (DRIP) added $306 thousand in new capital from optional cash contributions and $781 thousand from the reinvestment of quarterly dividends. The Corporation’s dividend payout ratio was 41.45% for the first nine months of 2023 compared to 37.91% for the first nine months of 2022.

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 third quarter of 2023, the Corporation paid a $0.32 per share dividend, compared to $0.32 paid in the second quarter of 2023. On October 19, 2023, the Board of Directors declared a $0.32 per share regular quarterly dividend for the fourth quarter of 2023, which will be paid on November 22, 2023.

On December 15, 2022, the Board of Directors authorized the 2022 Repurchase Plan for the repurchase of up to 150,000 shares of the Corporation’s $1.00 par value common stock at market prices in open market or privately negotiated transactions beginning December 22, 2022 and expiring on December 21, 2023. A total of 85,906 shares have been repurchased under the current plan. The Corporation is monitoring the market and intends to repurchase shares when and if the opportunity arises in accordance with applicable law, regulations and plan authorizations.

Capital adequacy for the Bank is currently defined by regulatory agencies through the use of several minimum required ratios. The capital ratios to be considered “well capitalized” 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%. In addition, a capital conservation buffer of 2.5% is applicable to all of the capital ratios except for the Tier 1 Leverage ratio. The capital conservation buffer is equal to the lowest value of the three applicable capital ratios less the regulatory minimum for each respective capital measurement. The Bank’s capital conservation buffer at September 30, 2023 was 6.28% compared to the

47


regulatory buffer of 2.5%. Compliance with the capital conservation buffer is required in order to avoid limitations to certain capital distributions and is in addition to the minimum required capital requirements. As of September 30, 2023, the Bank was “well capitalized.”

In 2019, the Community Bank Leverage Ratio (CBLR) was approved by federal banking agencies as an optional capital measure available to Qualifying Community Banking Organizations (QCBO). If a bank qualifies as a QCBO and maintains a CBLR of 9% or greater, the bank would be considered “well-capitalized” for regulatory capital purposes and exempt from complying with the risk-based capital rule described above. The CBLR rule took effect January 1, 2020 and banks could opt-in through an election in the first quarter 2020 regulatory filing. The Bank met the criteria of a QCBO but did not opt-in to the CBLR.

The consolidated asset limit on small bank holding companies is $3.0 billion and a company with assets under that limit is not subject to the consolidated capital rules but may file reports that include capital amounts and ratios. The Corporation has elected to file those reports.

The following table summarizes the regulatory capital requirements and results as of September 30, 2023 and December 31, 2022 for the Corporation and the Bank:

Regulatory Ratios

Adequately

Well

September 30,

December 31,

Capitalized

Capitalized

(Dollars in thousands)

2023

2022

Minimum

Minimum

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

Franklin Financial Services Corporation

12.43%

14.22%

N/A

N/A

Farmers & Merchants Trust Company

13.03%

14.63%

4.50%

6.50%

Tier 1 Risk-based Capital Ratio (2)

Franklin Financial Services Corporation

12.43%

14.22%

N/A

N/A

Farmers & Merchants Trust Company

13.03%

14.63%

6.00%

8.00%

Total Risk-based Capital Ratio (3)

Franklin Financial Services Corporation

15.16%

17.21%

N/A

N/A

Farmers & Merchants Trust Company

14.28%

15.88%

8.00%

10.00%

Tier 1 Leverage Ratio (4)

Franklin Financial Services Corporation

9.10%

8.95%

N/A

N/A

Farmers & Merchants Trust Company

9.53%

9.21%

4.00%

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, Huntingdon, and Dauphin Counties, Pennsylvania and Washington County, Maryland. This area is diverse in demographic and economic makeup. County populations range from a low of approximately 15,000 in Fulton County to over 280,000 in Dauphin County. Unemployment in the Bank’s market area ranged from 1.9% in Washington County, MD to 4.3% in Huntingdon County, as of the end of July 2023. The market area has a diverse economic base and local industries include warehousing, truck & rail shipping centers, light and heavy manufacturers, healthcare, higher education institutions, farming and agriculture, and a varied service sector. The Corporation’s primary market area 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.

Impact of Inflation

The impact of inflation upon financial institutions such as the Corporation differs from its effect upon other commercial

48


enterprises. 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 and how such changes affect market rates and the Corporation. Although inflation (and inflation expectations) may affect the interest rate environment, it is not possible to measure with any precision the effect of inflation on the Corporation.

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 its 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 ($179.5 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 the Bank. There are no current indicators that lead the Bank to believe the FHLB would discontinue its lending function or restrict the Bank’s ability to borrow. If either of these events would occur, it would have a negative effect on the Bank, and it is unlikely that the Bank could replace the level of FHLB funding in a short time. The Bank has established credit at the Federal Reserve Discount Window and at correspondent banks.

The following table shows the Bank’s available liquidity at September 30, 2023.

(Dollars in thousands)

Liquidity Source

Capacity

Outstanding

Available

Federal Home Loan Bank

$

451,460

$

40,000

$

411,460

Federal Reserve Bank Discount Window

55,126

55,126

Fed Bank Term Funding Program

86,765

70,000

16,765

Correspondent Banks

56,000

56,000

Total

$

649,351

$

110,000

$

539,351


49


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. At September 30, 2023, the ACL-unfunded commitments was $2.0 million compared to $1.5 million at December 31, 2022. The ACL-unfunded commitments is reported in Other Liabilities on the Consolidated Balance Sheet.

September 30,

December 31,

(Dollars in thousands)

2023

2022

Financial instruments whose contract amounts represent credit risk

Commercial commitments to extend credit

$

318,116

$

275,867

Consumer commitments to extend credit (secured)

101,059

93,124

Consumer commitments to extend credit (unsecured)

4,970

5,247

$

424,145

$

374,238

Standby letters of credit

$

28,341

$

30,734

ACL - Unfunded Commitments*

$

1,965

$

1,475

*Reported in Other Liabilities on the Consolidated Balance Sheet

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, except as reported, from those reported in the Corporation’s 2022 Annual Report on Form 10-K.

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

Item 3. Quantitative and Qualitative Disclosures about Market Risk

There were no material changes in the Corporation’s exposure to market risk during the nine months ended September 30, 2023. For more information on market risk refer to the Corporation’s 2022 Annual Report on Form 10-K.

Item 4. Controls and Procedures

Evaluation of Controls and Procedures

The Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon the evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer concluded that as of September 30, 2023, the Corporation’s disclosure controls and procedures are effective. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in the Corporation’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. There were no changes in the Corporation’s internal control over financial reporting during the quarterly period ended September 30, 2023, 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.


50


Part II – OTHER INFORMATION

Item 1. Legal Proceedings

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

In management’s opinion, there are no other legal 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 to the Corporation’s financial condition or results of operations. No material proceedings are pending or are known to be threatened or contemplated against us by any governmental authorities.

Item 1A. Risk Factors

There were no material changes in the Corporation’s risk factors during the three months ended September 30, 2023 except as described below. For more information, refer to the Corporation’s 2022 Annual Report on Form 10-K.

Negative Developments Affecting the Banking Industry, Including Bank Failures or Concerns Regarding Liquidity, Have Eroded Customer Confidence in the Banking System and May Have a Material Adverse Effect on the Corporation.

During March and April 2023, three significant bank failures occurred (Silicon Valley Bank, Signature Bank, and First Republic Bank). This was and continues to be accompanied by financial instability at various additional banks. These bank failures and bank instabilities have created and may continue to create market and other risks, for all financial institutions and banks, including the Corporation. These risks include, but are not limited to:

1.Market risk and loss of confidence in the financial services sector, and/or specific banks;

2.Deterioration of securities and loan portfolios;

3.Deposit volatility and reductions with higher volumes and occurring over shorter periods of time;

4.Increased liquidity demand and utilization of sources of liquidity; and

5.Interest rate volatility and abrupt, sudden and greater than usual rate changes.

These factors individually, or in any combination, could materially and adversely affect:

1.Financial condition;

2.Operations and results thereof; and

3.Stock price.

In addition, the previously mentioned bank failures and instabilities may result in an increase of FDIC deposit insurance premiums and/or result in special FDIC deposit insurance assessments, which also may adversely affect the Corporation’s financial condition, operations, results thereof or stock price.

The Corporation cannot predict the impact, timing or duration of such events.

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

On December 15, 2022, the Board of Directors authorized the 2022 Repurchase Plan for the repurchase of up to 150,000 shares of the Corporation’s $1.00 par value common stock at market prices in open market or privately negotiated transactions beginning December 22, 2022 and expiring on December 21, 2023. No shares were repurchased during the third quarter of 2023.

Item 3. Defaults by the Company on its Senior Securities

None

Item 4. Mine Safety Disclosures

Not Applicable


51


Item 5. Other Information

None

Item 6.   Exhibits

Exhibits

3.1

Amended and Restated Articles of Incorporation of the Corporation (Filed as Exhibit 3.1 to Quarterly Report on Form 10-Q for the quarter ended September 30, 2020 and incorporated herein by reference).

3.2

Bylaws of the Corporation. (Filed on Form 8-K, as Exhibit 99 with the commission on September 2, 2022 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)

104

Cover Page Interactive Data File (the cover page XBRL tags are imbedded in the XBRL document)


52


FRANKLIN FINANCIAL SERVICES CORPORATION

and SUBSIDIARIES

SIGNATURES

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

Franklin Financial Services Corporation

November 14, 2023

/s/ Timothy G. Henry

Timothy G. Henry

Chief Executive Officer and President

(Principal Executive Officer)

November 14, 2023

/s/ Mark R. Hollar

Mark R. Hollar

Treasurer and Chief Financial Officer

(Principal Financial and Accounting Officer)

53