PEOPLES FINANCIAL SERVICES CORP. - Quarter Report: 2017 March (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

☒Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the quarterly period ended March 31, 2017

◻Transition report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

for the transition period from

001-36388

(Commission File Number)

PEOPLES FINANCIAL SERVICES CORP.

(Exact name of registrant as specified in its charter)

Pennsylvania	23-2391852
(State of incorporation)	(IRS Employer ID Number)

150 North Washington Avenue, Scranton, PA	18503
(Address of principal executive offices)	(Zip code)

(570) 346-7741

(Registrant’s telephone number, including area code)

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

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

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


Large accelerated filer	◻	Accelerated filer	☒

Non-accelerated filer	◻	Smaller reporting company	◻
Emerging growth company	◻		

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

Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act. Yes ◻ No ☒

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of the registrant’s common stock, as of the latest practicable date: 7,396,163 at April 30, 2017.

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PEOPLES FINANCIAL SERVICES CORP.

FORM 10-Q

For the Quarter Ended March 31, 2017


Contents		Page No.

PART I.	FINANCIAL INFORMATION:

Item 1.	Financial Statements (Unaudited)

	Consolidated Balance Sheets at March 31, 2017 and December 31, 2016	3

	Consolidated Statements of Income and Comprehensive Income for the Three months ended March 31, 2017 and 2016	4

	Consolidated Statements of Changes in Stockholders’ Equity for the Three months ended March 31, 2017 and 2016	5

	Consolidated Statements of Cash Flows for the Three months ended March 31, 2017 and 2016	6

	Notes to Consolidated Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	39

Item 4.	Controls and Procedures	39

PART II	OTHER INFORMATION

Item 1.	Legal Proceedings	40

Item 1A.	Risk Factors	40

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	40

Item 3.	Defaults upon Senior Securities	40

Item 4.	Mine Safety Disclosures	40

Item 5.	Other Information	40

Item 6.	Exhibits	40

	Signatures	41

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Peoples Financial Services Corp.

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(Dollars in thousands, except share data)


	March 31, 2017		December 31, 2016
Assets:
Cash and due from banks:
Cash and due from banks	$	31,511	$	39,496
Interest-bearing deposits in other banks		304		445
Total cash and due from banks		31,815		39,941
Investment securities:
Available-for-sale		264,644		259,410
Held-to-maturity: Fair value March 31, 2017, $10,359; December 31, 2016, $10,714		10,180		10,517
Total investment securities		274,824		269,927
Loans, net		1,559,867		1,532,965
Less: allowance for loan losses		16,969		15,961
Net loans		1,542,898		1,517,004
Loans held for sale		444
Premises and equipment, net		34,967		33,260
Accrued interest receivable		5,604		6,228
Goodwill		63,370		63,370
Intangible assets, net		3,944		4,211
Other assets		65,640		65,501
Total assets	$	2,023,506	$	1,999,442

Liabilities:
Deposits:
Noninterest-bearing	$	358,538	$	353,686
Interest-bearing		1,257,006		1,235,071
Total deposits		1,615,544		1,588,757
Short-term borrowings		77,475		82,700
Long-term debt		57,615		58,134
Accrued interest payable		457		462
Other liabilities		13,096		12,771
Total liabilities		1,764,187		1,742,824

Stockholders’ equity:
Common stock, par value $2.00, authorized 25,000,000 shares, issued and outstanding 7,396,163 shares at March 31, 2017 and 7,394,143 shares at December 31, 2016		14,792		14,788
Capital surplus		134,884		134,871
Retained earnings		113,621		111,114
Accumulated other comprehensive loss		(3,978)		(4,155)
Total stockholders’ equity		259,319		256,618
Total liabilities and stockholders’ equity	$	2,023,506	$	1,999,442

See notes to consolidated financial statements

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Peoples Financial Services Corp.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)

(Dollars in thousands, except per share data)


For the Three Months Ended March 31,	2017		2016
Interest income:
Interest and fees on loans:
Taxable	$	15,541	$	14,346
Tax-exempt		726		751
Interest and dividends on investment securities:
Taxable		697		687
Tax-exempt		794		875
Dividends		12		10
Interest on interest-bearing deposits in other banks		29		17
Total interest income		17,799		16,686

Interest expense:
Interest on deposits		1,434		1,283
Interest on short-term borrowings		174		77
Interest on long-term debt		348		360
Total interest expense		1,956		1,720
Net interest income		15,843		14,966
Provision for loan losses		1,200		1,200
Net interest income after provision for loan losses		14,643		13,766

Noninterest income:
Service charges, fees and commissions		1,572		1,444
Merchant services income		1,015		914
Commission and fees on fiduciary activities		508		482
Wealth management income		319		412
Mortgage banking income		179		204
Life insurance investment income		189		193
Net gain on sale of investment securities available-for-sale				242
Total noninterest income		3,782		3,891

Noninterest expense:
Salaries and employee benefits expense		6,275		5,332
Net occupancy and equipment expense		2,394		2,437
Merchant services expense		730		632
Amortization of intangible assets		268		305
Other expenses		2,689		2,912
Total noninterest expense		12,356		11,618
Income before income taxes		6,069		6,039
Income tax expense		1,269		1,157
Net income		4,800		4,882

Other comprehensive income:
Unrealized gain on investment securities available-for-sale		273		995
Reclassification adjustment for net gain on sales included in net income				(242)
Other comprehensive income		273		753
Income tax related to other comprehensive income		96		264
Other comprehensive income, net of income taxes		177		489
Comprehensive income	$	4,977	$	5,371

Per share data:
Net income:
Basic	$	0.65	$	0.66
Diluted	$	0.65	$	0.66
Average common shares outstanding:
Basic		7,394,143		7,403,510
Diluted		7,394,143		7,403,510
Dividends declared	$	0.31	$	0.31

See notes to consolidated financial statements

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Peoples Financial Services Corp.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)

(Dollars in thousands, except per share data)


							Accumulated
							Other
	Common		Capital		Retained		Comprehensive
	Stock		Surplus		Earnings		Loss		Total
Balance, January 1, 2017	$	14,788	$	134,871	$	111,114	$	(4,155)	$	256,618
Stock based compensation				17						17
Net income						4,800				4,800
Other comprehensive income, net of income taxes								177		177
Dividends declared: $0.31 per share						(2,293)				(2,293)
Common stock grants awarded, net of unearned compensation of $81: 2,020 shares		4		(4)
Balance, March 31, 2017	$	14,792	$	134,884	$	113,621	$	(3,978)	$	259,319

Balance, January 1, 2016	$	14,821	$	135,371	$	100,701	$	(2,125)	$	248,768
Stock based compensation				18						18
Net income						4,882				4,882
Other comprehensive income, net of income taxes								489		489
Dividends declared: $0.31 per share						(2,295)				(2,295)
Shares retired: 11,308 shares		(22)		(395)						(417)
Balance, March 31, 2016	$	14,799	$	134,994	$	103,288	$	(1,636)	$	251,445

See notes to consolidated financial statements

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Peoples Financial Services Corp.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(Dollars in thousands, except per share data)


For the Three Months Ended March 31,	2017		2016
Cash flows from operating activities:
Net income	$	4,800	$	4,882
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation of premises and equipment		451		392
Amortization of deferred loan costs		211		169
Amortization of intangibles		268		305
Net accretion of purchase accounting adjustments on tangible assets				(275)
Amortization of loss on investment tax credits		117		125
Provision for loan losses		1,200		1,200
Net gain on sale of other real estate owned		(1)		(11)
Loans originated for sale		(5,141)		(5,268)
Proceeds from sale of loans originated for sale		4,734		5,394
Net gain on sale of loans originated for sale		(37)		(204)
Net amortization of investment securities		759		1,041
Net gain on sale of investment securities available-for-sale				(242)
Life insurance investment income		(189)		(193)
Stock based compensation		17		18
Net change in:
Accrued interest receivable		624		341
Other assets		(580)		(583)
Accrued interest payable		(5)		(54)
Other liabilities		308		(404)
Net cash provided by operating activities		7,536		6,633
Cash flows from investing activities:
Proceeds from sales of investment securities available-for-sale				10,271
Proceeds from repayments of investment securities:
Available-for-sale		9,285		10,453
Held-to-maturity		331		418
Purchases of investment securities:
Available-for-sale		(14,999)
Net redemption (purchase) of restricted equity securities		270		(798)
Net increase in lending activities		(27,349)		(69,321)
Investment in low income housing investment tax credits				(2,050)
Purchases of premises and equipment		(2,158)		(1,646)
Purchase of investment in life insurance				(1,500)
Proceeds from sale of other real estate owned		208		83
Net cash used in investing activities		(34,412)		(54,090)
Cash flows from financing activities:
Net increase in deposits		26,787		19,798
Repayment of long-term debt		(519)		(573)
Net (decrease) increase in short-term borrowings		(5,225)		22,025
Retirement of common stock				(417)
Cash dividends paid		(2,293)		(2,295)
Net cash provided by financing activities		18,750		38,538
Net decrease in cash and cash equivalents		(8,126)		(8,919)
Cash and cash equivalents at beginning of period		39,941		32,917
Cash and cash equivalents at end of period	$	31,815	$	23,998

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Peoples Financial Services Corp.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(Dollars in thousands, except per share data)


For the Three Months Ended March 31,	2017		2016
Supplemental disclosures:
Cash paid during the period for:
Interest	$	1,961	$	1,931
Income taxes
Noncash items:
Transfers of loans to other real estate	$	50	$	524

See notes to consolidated financial statements

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

1. Summary of significant accounting policies:

Nature of operations:

Peoples Financial Services Corp., a bank holding company incorporated under the laws of Pennsylvania, provides a full range of financial services through its wholly-owned subsidiary, Peoples Security Bank and Trust Company (“Peoples Bank”), including its subsidiary, Peoples Advisors, LLC (collectively, the “Company” or “Peoples”). The Company services its retail and commercial customers through twenty-six full-service community banking offices located within the Lackawanna, Lehigh, Luzerne, Monroe, Montgomery, Northampton, Susquehanna, Wayne and Wyoming Counties of Pennsylvania and Broome County of New York.

Basis of presentation:

The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP’) for interim financial information and with the instructions to Form 10-Q and Article 10-01 of Regulation S-X. In the opinion of management, all normal recurring adjustments necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. All significant intercompany balances and transactions have been eliminated in consolidation. Prior-period amounts are reclassified when necessary to conform to the current year’s presentation. These reclassifications did not have any effect on the operating results or financial position of the Company. The operating results and financial position of the Company for the three months ended and as of March 31, 2017, are not necessarily indicative of the results of operations and financial position that may be expected in the future.

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates that are particularly susceptible to material change in the near term relate to the determination of the allowance for loan losses, fair value of financial instruments, the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, the valuation of deferred tax assets, determination of other-than-temporary impairment losses on securities, impairment of goodwill and fair value of assets acquired and liabilities assumed in business combinations. Actual results could differ from those estimates. For additional information and disclosures required under GAAP, reference is made to the Company’s Annual Report on Form 10-K for the period ended December 31, 2016.

Recent accounting standards:

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” The updated standard is a new comprehensive revenue recognition model that requires revenue to be recognized in a manner that depicts the transfer of goods or services to a customer at an amount that reflects the consideration expected to be received in exchange for those goods or services. In August 2015, the FASB issued ASU 2015-14 which deferred the effective date of ASU 2014-09 by one year. During 2016, the FASB issued ASU Nos. 2016-10, 2016-12 and 2016-20 that provide additional guidance related to the identification of performance obligations within a contract, assessing collectability, contract costs, and other technical corrections and improvements. ASU 2014-09 will become effective for the Company for the annual period beginning after December 15, 2017 and for interim periods within the annual period. ASU 2014-09 allows for either full retrospective or modified retrospective adoption. The Company has not selected a transition method. The Company has completed an evaluation of its revenue-producing contracts and determined they are primarily agreements that are not within the scope of this standard. As a result, the Company does not expect the adoption of this standard to have a material impact to the Company’s reported revenues and interest income. The Company is continuing to evaluate the impact on other revenue and income sources.

In January 2016, the FASB issued Accounting Standards Update ("ASU") No. 2016-01, “Financial Instruments – Overall.” The guidance in this ASU among other things, (1) requires equity investments with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (2) simplifies the impairment assessment of equity

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (3) eliminates the requirement for public businesses entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (4) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (5) requires an entity to present separately in other comprehensive income the portion of the change in fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (6) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (7) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities. The guidance in this ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is in the process of evaluating the impact of the adoption of this guidance on the Company’s financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases”. From the lessee's perspective, the new standard establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for a lessess. From the lessor's perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating. A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing. If the lessor doesn’t convey risks and rewards or control, an operating lease results. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. A modified retrospective transition approach is required for lessors for sales-type, direct financing, and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company’s initial findings conclude that the new pronouncement will not have a significant impact on its consolidated financial statements as the current projected minimum lease payments under existing lease contracts subject to the new pronouncement are less than one percent of its current assets.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU will have a significant impact on the Company’s calculation and accounting for its Allowance for Loan Losses as well as credit losses related to investment securities available-for-sale. A summary of significant provisions of this ASU is as follows:

			The ASU requires that a financial asset (or a group of financial assets) measured at amortized cost basis be presented, net of a valuation allowance for credit losses, at an amount expected to be collected on the financial asset(s), and that the income statement include the measurement of credit losses for newly recognized financial assets as well as changes in expected losses on previously recognized financial assets. The provisions of this ASU require measurement of expected credit losses based on relevant information including past events, historical experience, current conditions, and reasonable and supportive forecasts that affect the collectability of the asset. The provisions of this ASU differ from current U.S. GAAP in that current U.S. GAAP generally delays recognition of the full amount of credit losses until the loss is probable of occurring.
			The amendments in the Update retain many of the disclosure requirements related to credit quality in current U.S. GAAP, updated to reflect the change from an incurred loss methodology to an expected credit loss methodology. In addition, the Update requires that disclosure of credit quality indicators in relation to the amortized cost of financing receivables, a current requirement, be further disaggregated by year of origination.



This ASU requires that credit losses on available-for-sale debt securities be presented as an allowance rather than as a write-down, and limits the amount of the allowance for credit losses to the amount by which the fair value is below amortized cost. For purchased investment securities available-for-sale with a more-than-insignificant

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

amount of credit deterioration since origination, the ASU requires an allowance be determined in a manner similar to other investment securities available-for-sale; however, the initial allowance would be added to the purchase price, with only subsequent changes in the allowance recorded in credit loss expense, and interest income recognized at the effective rate excluding the discount embedded in the purchase price related to estimated credit losses at acquisition.



This ASU will be effective for the Company for interim and annual periods beginning in the first quarter of 2020. Earlier adoption is permitted beginning in the first quarter of 2019. The Company will record the effect of implementing this ASU through a cumulative-effect adjustment through retained earnings as of the beginning of the reporting period in which Topic 326 is effective.

The Company cannot yet determine the magnitude of any such one-time cumulative adjustment or of the overall impact of the new standard on our financial condition or results of operations; however, it is anticipated that the allowance will increase upon adoption and that the increased allowance level will decrease regulatory capital and ratios..

In June 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) –Classification of Certain Cash Receipts and Cash Payments. This Update provides clarification regarding eight specific cash flow issues with the objective of reducing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. For the Company, the amendments in this Update are effective beginning in the first quarter 2018. The amendments in this Update should be applied using a retroactive transition method to each period presented. The Company anticipates there will be no adjustments to the Consolidated Statements of Cash Flows, as previously reported, as a result of the clarifications provided in the Update.

In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350) to simplify the accounting for goodwill impairment. This guidance, among other things, removes step 2 of the goodwill impairment test thus eliminating the need to determine the fair value of individual assets and liabilities of the reporting unit. Upon adoption of this ASU, goodwill impairment will be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. This may result in more or less impairment being recognized than under current guidance. This Update will become effective for the Company’s annual and interim goodwill impairment tests beginning in the first quarter of 2020.

2. Other comprehensive income (loss):

The components of other comprehensive loss and their related tax effects are reported in the Consolidated Statements of Income and Comprehensive Income. The accumulated other comprehensive loss included in the Consolidated Balance Sheets relates to net unrealized gains and losses on investment securities available-for-sale and benefit plan adjustments.

The components of accumulated other comprehensive loss included in stockholders’ equity at March 31, 2017 and December 31, 2016 is as follows:


	March 31, 2017		December 31, 2016
Net unrealized gain on investment securities available-for-sale	$	826	$	553
Income tax		289		193
Net of income taxes		537		360
Benefit plan adjustments		(6,946)		(6,946)
Income tax		(2,431)		(2,431)
Net of income taxes		(4,515)		(4,515)
Accumulated other comprehensive loss	$	(3,978)	$	(4,155)

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

Other comprehensive income (loss) and related tax effects for the three months ended March 31, 2017 and 2016 is as follows:


Three Months Ended March 31,	2017		2016
Unrealized gain on investment securities available-for-sale	$	273	$	995
Net gain on the sale of investment securities available-for-sale(1)				(242)
Other comprehensive income gain before taxes		273		753
Income tax expense		96		264
Other comprehensive income	$	177	$	489

(1)Represents amounts reclassified out of accumulated comprehensive loss and included in gains on sale of investment securities on the consolidated statements of income and comprehensive income.

3. Earnings per share:

Basic earnings per share represent income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options, and are determined using the treasury stock method.

There were no shares considered anti-dilutive for the three month periods ended March 31, 2017 and 2016.


	2017				2016
For the Three Months Ended March 31	Basic		Diluted		Basic		Diluted
Net Income	$	4,800	$	4,800	$	4,882	$	4,882
Average common shares outstanding		7,394,143		7,394,143		7,403,510		7,403,510
Earnings per share	$	0.65	$	0.65	$	0.66	$	0.66

4. Investment securities:

The amortized cost and fair value of investment securities aggregated by investment category at March 31, 2017 and December 31, 2016 are summarized as follows:


			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
March 31, 2017	Cost		Gains		Losses		Value
Available-for-sale:
U.S. Treasury securities	$	20,050	$	1	$	156	$	19,895
U.S. Government-sponsored enterprises		83,677		72		1,277		82,472
State and municipals:
Taxable		14,663		604				15,267
Tax-exempt		105,894		2,104		461		107,537
Mortgage-backed securities:
U.S. Government agencies		19,321		47		36		19,332
U.S. Government-sponsored enterprises		20,213		46		118		20,141
Total	$	263,818	$	2,874	$	2,048	$	264,644
Held-to-maturity:
Tax-exempt state and municipals	$	6,861	$	86	$	83	$	6,864
Mortgage-backed securities:
U.S. Government agencies		64						64
U.S. Government-sponsored enterprises		3,255		176				3,431
Total	$	10,180	$	262	$	83	$	10,359

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)


			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
December 31, 2016	Cost		Gains		Losses		Value
Available-for-sale:
U.S. Treasury securities	$	7,570			$	132	$	7,438
U.S. Government-sponsored enterprises		82,314	$	79		1,480		80,913
State and municipals:
Taxable		14,698		566		39		15,225
Tax-exempt		110,931		2,309		640		112,600
Mortgage-backed securities:
U.S. Government agencies		21,041		48		47		21,042
U.S. Government-sponsored enterprises		22,303		48		159		22,192
Total	$	258,857	$	3,050	$	2,497	$	259,410
Held-to-maturity:
Tax-exempt state and municipals	$	6,862	$	72	$	67	$	6,867
Mortgage-backed securities:
U.S. Government agencies		68		1				69
U.S. Government-sponsored enterprises		3,587		191				3,778
Total	$	10,517	$	264	$	67	$	10,714

The maturity distribution of the fair value, which is the net carrying amount, of the debt securities classified as available-for-sale at March 31, 2017, is summarized as follows:


	Fair
March 31, 2017	Value
Within one year	$	39,613
After one but within five years		118,950
After five but within ten years		49,157
After ten years		17,451
		225,171
Mortgage-backed securities		39,473
Total	$	264,644

The maturity distribution of the amortized cost and fair value, of debt securities classified as held-to-maturity at March 31, 2017, is summarized as follows:


	Amortized		Fair
March 31, 2017	Cost		Value
Within one year
After one but within five years
After five but within ten years
After ten years	$	6,861	$	6,864
		6,861		6,864
Mortgage-backed securities		3,319		3,495
Total	$	10,180	$	10,359

Securities with a carrying value of $142,335 and $144,750 at March 31, 2017 and December 31, 2016, respectively, were pledged to secure public deposits and certain other deposits as required or permitted by law.

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

Securities and short-term investment activities are conducted with a diverse group of government entities, corporations and state and local municipalities. The counterparty’s creditworthiness and type of collateral is evaluated on a case-by-case basis. At March 31, 2017 and December 31, 2016, there were no significant concentrations of credit risk from any one issuer, with the exception of U.S. Government agencies and sponsored enterprises that exceeded 10.0 percent of stockholders’ equity.

The fair value and gross unrealized losses of investment securities with unrealized losses for which an other-than-temporary impairment (“OTTI”) has not been recognized at March 31, 2017 and December 31, 2016, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, are summarized as follows:


	Less Than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
March 31, 2017	Value		Losses		Value		Losses		Value		Losses
U.S. Treasury securities	$	17,411	$	156					$	17,411	$	156
U.S. Government-sponsored enterprises		62,591		1,277						62,591		1,277
State and municipals:
Taxable
Tax-exempt		51,467		544						51,467		544
Mortgage-backed securities:
U.S. Government agencies		5,769		23	$	1,337	$	13		7,106		36
U.S. Government-sponsored enterprises		13,832		66		2,380		52		16,212		118
Total	$	151,070	$	2,066	$	3,717	$	65	$	154,787	$	2,131


	Less Than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
December 31, 2016	Value		Losses		Value		Losses		Value		Losses
U.S. Treasury securities	$	7,438	$	132					$	7,438	$	132
U.S. Government-sponsored enterprises		59,460		1,480						59,460		1,480
State and municipals:
Taxable		1,035		39						1,035		39
Tax-exempt		55,166		707	$	226				55,392		707
Mortgage-backed securities:
U.S. Government agencies		5,917		27		1,496	$	20		7,413		47
U.S. Government-sponsored enterprises		16,412		85		2,712		74		19,124		159
Total	$	145,428	$	2,470	$	4,434	$	94	$	149,862	$	2,564

The Company had 150 investment securities, consisting of 93 tax-exempt state and municipal obligations, six U.S. Treasury securities, 23 U.S. Government-sponsored enterprise securities, and 28 mortgage-backed securities that were in unrealized loss positions at March 31, 2017. Of these securities, eight mortgage-backed securities were in a continuous unrealized loss position for twelve months or more. Management does not consider the unrealized losses on the debt securities, as a result of changes in interest rates, to be OTTI based on historical evidence that indicates the cost of these securities is recoverable within a reasonable period of time in relation to normal cyclical changes in the market rates of interest. Moreover, because there has been no material change in the credit quality of the issuers or other events or circumstances that may cause a significant adverse impact on the fair value of these securities, and management does not intend to sell these securities and it is unlikely that the Company will be required to sell these securities before recovery of their amortized cost basis, which may be maturity, the Company does not consider the unrealized losses to be OTTI at March 31, 2017. There was no OTTI recognized for the three months ended March 31, 2017 and 2016.

The Company had 163 investment securities, consisting of 107 tax-exempt state and municipal obligations, two taxable state and municipal obligation, two U.S. Treasury securities, 22 U.S. Government-sponsored enterprise securities and 30 mortgage-backed securities that were in unrealized loss positions at December 31, 2016. Of these securities, nine

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

mortgage-backed securities and two tax-exempt state and municipal securities were in a continuous unrealized loss position for twelve months or more.

5. Loans, net and allowance for loan losses:

The major classifications of loans outstanding, net of deferred loan origination fees and costs at March 31, 2017 and December 31, 2016 are summarized as follows. Net deferred loan costs were $494 and $579 at March 31, 2017 and December 31, 2016.


		March 31, 2017		December 31, 2016
Commercial	$	431,164	$	408,814
Real estate:
Commercial		703,194		700,144
Residential		286,389		289,781
Consumer		139,120		134,226
Total	$	1,559,867	$	1,532,965

The changes in the allowance for loan losses account by major classification of loan for the three months ended March 31, 2017 and 2016 are summarized as follows:


			Real estate
March 31, 2017	Commercial		Commercial		Residential		Consumer		Unallocated		Total
Allowance for loan losses:
Beginning Balance January 1, 2017	$	3,799	$	5,847	$	4,707	$	1,608	$		$	15,961
Charge-offs				(125)		(15)		(171)				(311)
Recoveries		7		33		22		57				119
Provisions		323		536		264		77				1,200
Ending balance	$	4,129	$	6,291	$	4,978	$	1,571	$		$	16,969

			Real estate
March 31, 2016	Commercial		Commercial		Residential		Consumer		Unallocated		Total
Allowance for loan losses:
Beginning Balance January 1, 2016	$	3,042	$	4,245	$	4,082	$	1,583	$	23	$	12,975
Charge-offs		(3)		(55)				(65)				(123)
Recoveries		2		16		25		63				106
Provisions		281		410		252		65		192		1,200
Ending balance	$	3,322	$	4,616	$	4,359	$	1,646	$	215	$	14,158

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

The allocation of the allowance for loan losses and the related loans by major classifications of loans at March 31, 2017 and December 31, 2016 is summarized as follows:


			Real estate
March 31, 2017	Commercial		Commercial		Residential		Consumer		Unallocated	Total
Allowance for loan losses:
Ending balance	$	4,129	$	6,291	$	4,978	$	1,571	$	$	16,969
Ending balance: individually evaluated for impairment		404		513		484		23			1,424
Ending balance: collectively evaluated for impairment		3,725		5,778		4,494		1,548			15,545
Ending balance: loans acquired with deteriorated credit quality	$		$		$		$		$	$
Loans receivable:
Ending balance	$	431,164	$	703,194	$	286,389	$	139,120	$	$	1,559,867
Ending balance: individually evaluated for impairment		2,311		3,849		3,359		207			9,726
Ending balance: collectively evaluated for impairment		428,476		698,008		282,996		138,913			1,548,393
Ending balance: loans acquired with deteriorated credit quality	$	377	$	1,337	$	34	$		$	$	1,748



			Real estate
December 31, 2016	Commercial		Commercial		Residential		Consumer		Unallocated	Total
Allowance for loan losses:
Ending balance	$	3,799	$	5,847	$	4,707	$	1,608	$	$	15,961
Ending balance: individually evaluated for impairment		225		1,197		520					1,942
Ending balance: collectively evaluated for impairment		3,574		4,650		4,187		1,608			14,019
Ending balance: loans acquired with deteriorated credit quality	$		$		$		$		$	$
Loans receivable:
Ending balance	$	408,814	$	700,144	$	289,781	$	134,226	$	$	1,532,965
Ending balance: individually evaluated for impairment		1,724		5,820		3,543		155			11,242
Ending balance: collectively evaluated for impairment		406,127		692,987		286,201		134,071			1,519,386
Ending balance: loans acquired with deteriorated credit quality	$	963	$	1,337	$	37	$		$	$	2,337

The Company segments 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, public information,

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

and current economic trends, among other factors. Loans are individually analyzed for credit risk by classifying them within the Company’s internal risk rating system. The Company’s risk rating classifications are defined as follows:

Pass- A loan to borrowers with acceptable credit quality and risk that is not adversely classified as Substandard, Doubtful, Loss nor designated as Special Mention.

Special Mention- A loan that has potential weaknesses that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the institution’s credit position at some future date. Special Mention loans are not adversely classified since they do not expose the Company to sufficient risk to warrant adverse classification.

Substandard- A loan that is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected.

Doubtful – A loan classified as Doubtful has all the weaknesses inherent in one classified Substandard with the added characteristic that the weaknesses make the collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loss- A loan classified as Loss is considered uncollectible and of such little value that its continuance as bankable loan is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future.

The following tables present the major classification of loans summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within the Company’s internal risk rating system at March 31, 2017 and December 31, 2016:


			Special
March 31, 2017	Pass		Mention		Substandard		Doubtful	Total
Commercial	$	422,506	$	4,698	$	3,960	$	$	431,164
Real estate:
Commercial		680,231		10,409		12,554			703,194
Residential		279,384		205		6,800			286,389
Consumer		138,853		—		267			139,120
Total	$	1,520,974	$	15,312	$	23,581	$	$	1,559,867


			Special
December 31, 2016	Pass		Mention		Substandard		Doubtful	Total
Commercial	$	398,867	$	6,222	$	3,725	$	$	408,814
Real estate:
Commercial		674,914		10,392		14,838			700,144
Residential		282,737		233		6,811			289,781
Consumer		133,983				243			134,226
Total	$	1,490,501	$	16,847	$	25,617	$	$	1,532,965

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

Information concerning nonaccrual loans by major loan classification at March 31, 2017 and December 31, 2016 is summarized as follows:


		March 31, 2017		December 31, 2016
Commercial	$	1,532	$	934
Real estate:
Commercial		4,701		7,016
Residential		2,821		3,003
Consumer		207		155
Total	$	9,261	$	11,108

The major classifications of loans by past due status are summarized as follows:


					Greater								Loans > 90
	30-59 Days		60-89 Days		than 90		Total Past						Days and
March 31, 2017	Past Due		Past Due		Days		Due		Current		Total Loans		Accruing
Commercial	$	440	$	33	$	1,532	$	2,005	$	429,159	$	431,164
Real estate:
Commercial		1,257		779		4,809		6,845		696,349		703,194	$	108
Residential		2,766		904		2,945		6,615		279,774		286,389		124
Consumer		864		168		437		1,469		137,651		139,120		230
Total	$	5,327	$	1,884	$	9,723	$	16,934	$	1,542,933	$	1,559,867	$	462


					Greater								Loans > 90
	30-59 Days		60-89 Days		than 90		Total Past						Days and
December 31, 2016	Past Due		Past Due		Days		Due		Current		Total Loans		Accruing
Commercial	$	249	$	75	$	934	$	1,258	$	407,556	$	408,814
Real estate:
Commercial		4,782		527		7,016		12,325		687,819		700,144
Residential		2,100		354		3,561		6,015		283,766		289,781	$	558
Consumer		962		259		441		1,662		132,564		134,226		286
Total	$	8,093	$	1,215	$	11,952	$	21,260	$	1,511,705	$	1,532,965	$	844

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

The following tables summarize information concerning impaired loans as of and for the three months ended March 31, 2017 and March 31, 2016, and as of and for the year ended, December 31, 2016 by major loan classification:


							For the Quarter Ended
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
March 31, 2017	Investment		Balance		Allowance		Investment		Recognized
With no related allowance:
Commercial	$	765	$	1,386			$	1,585	$	4
Real estate:
Commercial		3,715		4,368				3,039		4
Residential		2,349		2,533				2,277		4
Consumer		184		184				170
Total		7,013		8,471				7,071		12
With an allowance recorded:
Commercial		1,923		1,923	$	404		1,103		13
Real estate:
Commercial		1,471		1,471		513		3,132		6
Residential		1,044		1,044		484		1,210		4
Consumer		23		23		23		12
Total		4,461		4,461		1,424		5,457		23
Commercial		2,688		3,309		404		2,688		17
Real estate:
Commercial		5,186		5,839		513		6,171		10
Residential		3,393		3,577		484		3,487		8
Consumer		207		207		23		182
Total	$	11,474	$	12,932	$	1,424	$	12,528	$	35


							For the Year Ended
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
December 31, 2016	Investment		Balance		Allowance		Investment		Recognized
With no related allowance:
Commercial	$	2,404	$	3,213			$	1,461	$	48
Real estate:
Commercial		2,364		3,018				4,300		71
Residential		2,205		2,388				2,133		35
Consumer		155		155				147
Total		7,128		8,774				8,041		154
With an allowance recorded:
Commercial		283		283	$	225		859
Real estate:
Commercial		4,793		4,793		1,197		2,366		2
Residential		1,375		1,376		520		1,185		7
Consumer								50
Total		6,451		6,452		1,942		4,460		9
Commercial		2,687		3,496		225		2,320		48
Real estate:
Commercial		7,157		7,811		1,197		6,666		73
Residential		3,580		3,764		520		3,318		42
Consumer		155		155				197
Total	$	13,579	$	15,226	$	1,942	$	12,501	$	163

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)


							For the Quarter Ended
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
March 31, 2016	Investment		Balance		Allowance		Investment		Recognized
With no related allowance:
Commercial	$	1,173	$	2,383			$	1,263	$	17
Real estate:
Commercial		3,162		3,832				2,947		32
Residential		2,216		2,399				2,632		1
Consumer		89		89				60
Total		6,640		8,703				6,902		50
With an allowance recorded:
Commercial		1,141		1,141	$	1,040		968
Real estate:
Commercial		3,028		3,028		541		2,836
Residential		992		992		533		1,455		2
Consumer		89		89		89		103
Total		5,250		5,250		2,203		5,362		2
Commercial		2,314		3,524		1,040		2,231		17
Real estate:
Commercial		6,190		6,860		541		5,783		32
Residential		3,208		3,391		533		4,087		3
Consumer		178		178		89		163
Total	$	11,890	$	13,953	$	2,203	$	12,264	$	52

Included in the commercial loan and commercial and residential real estate categories are troubled debt restructurings that are classified as impaired. Troubled debt restructurings totaled $2,226 at March 31, 2017, $1,909 at December 31, 2016 and $2,834 at March 31, 2016.

Troubled debt restructured loans are loans with original terms, interest rate, or both, that have been modified as a result of a deterioration in the borrower’s financial condition and a concession has been granted that the Company would not otherwise consider. Unless on nonaccrual, interest income on these loans is recognized when earned, using the interest method. The Company offers a variety of modifications to borrowers that would be considered concessions. The modification categories offered generally fall within the following categories:

Rate Modification - A modification in which the interest rate is changed to a below market rate.

Term Modification - A modification in which the maturity date, timing of payments or frequency of payments is changed.

Interest Only Modification - A modification in which the loan is converted to interest only payments for a period of time.

Payment Modification - A modification in which the dollar amount of the payment is changed, other than an interest only modification described above.

Combination Modification - Any other type of modification, including the use of multiple categories above.

There was one loan modified as a troubled debt restructuring for the three months ended March 31, 2017, in the amount of $345. There was one loan modified as a troubled debt restructuring for the three months ended March 31, 2016, in the amount of $75. During the three months ended March 31, 2017, there were no payment defaults on restructured loans; there were two payment defaults on restructured residential real estate loans during the three months ended March 31, 2016 totaling $208.

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

6. Other assets:

The components of other assets at March 31, 2017, and December 31, 2016 are summarized as follows:


		March 31, 2017		December 31, 2016
Other real estate owned	$	236	$	393
Investment in residential housing program		8,194		8,312
Mortgage servicing rights		698		698
Bank owned life insurance		33,261		33,073
Restricted equity securities		6,781		7,051
Other assets		16,470		15,974
Total	$	65,640	$	65,501

7. Fair value estimates:

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosure under GAAP. Fair value estimates are calculated without attempting to estimate the value of anticipated future business and the value of certain assets and liabilities that are not considered financial. Accordingly, such assets and liabilities are excluded from disclosure requirements.

In accordance with FASB ASC 820, “Fair Value Measurements and Disclosures,” fair value is the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets. In many cases, these values cannot be realized in immediate settlement of the instrument.

Current fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction that is not a forced liquidation or distressed sale between participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

In accordance with GAAP, the Company groups its assets and liabilities generally measured at fair value into three levels based on market information or other fair value estimates in which the assets and liabilities are traded or valued and the reliability of the assumptions used to determine fair value. These levels include:

Level 1: Unadjusted quoted prices of identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

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

The following methods and assumptions were used by the Company to calculate fair values and related carrying amounts of financial instruments:

Cash and cash equivalents: The carrying values of cash and cash equivalents as reported on the balance sheet approximate fair value.

Investment securities: The fair values of U.S. Treasury securities and marketable equity securities are based on quoted market prices from active exchange markets. The fair values of debt securities are based on pricing from a matrix pricing model.

Loans held for sale: The fair values of loans held for sale are based upon current delivery prices in the secondary mortgage market.

Net loans: For adjustable-rate loans that re-price frequently and with no significant credit risk, fair values are based on carrying values. The fair values of other non-impaired loans are estimated using discounted cash flow analysis, using interest rates currently offered in the market for loans with similar terms to borrowers of similar credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis determined by the loan review function or underlying collateral values, where applicable.

Loans acquired in connection with business combinations are recorded at their acquisition date fair value. In order to record the loans at fair value, management made three different types of fair value adjustments. A market rate adjustment was made to adjust for the movement in market interest rates, irrespective of credit adjustments, compared to the stated rates of the acquired loans. A credit adjustment was made on pools of homogeneous loans representing the changes in credit quality of the underlying borrowers from the loan inception to the acquisition date. The credit adjustment on distressed loans represents the portion of the loan balance that has been deemed uncollectible based on the management’s expectations of future cash flows for each respective loan.

Mortgage servicing rights: To determine the fair value, the Company estimates the present value of future cash flows incorporating assumptions such as cost of servicing, discount rates, prepayment speeds and default rates.

Accrued interest receivable: The carrying value of accrued interest receivable as reported on the balance sheet approximates fair value.

Restricted equity securities: The carrying values of restricted equity securities approximate fair value, due to the lack of marketability for these securities.

Deposits: The fair values of noninterest-bearing deposits and savings, NOW and money market accounts are the amounts payable on demand at the reporting date. The fair value estimates do not include the benefit that results from such low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market. The carrying values of adjustable-rate, fixed-term time deposits approximate their fair values at the reporting date. For fixed-rate time deposits, the present value of future cash flows is used to estimate fair values. The discount rates used are the current rates offered for time deposits with similar maturities.

The fair value assigned to the core deposit intangible asset represents the future economic benefit of the potential cost savings from acquiring core deposits in the 2013 Penseco merger compared to the cost of obtaining alternative funding such as brokered deposits from market sources. Management utilized an income valuation approach to present value the estimated future cash savings in order to determine the fair value of the intangible asset.

Short-term borrowings: The carrying values of short-term borrowings approximate fair value.

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

Long-term debt: The fair value of fixed-rate long-term debt is based on the present value of future cash flows. The discount rate used is the current rate offered for long-term debt with the same maturity.

Accrued interest payable: The carrying value of accrued interest payable as reported on the balance sheet approximates fair value.

Off-balance sheet financial instruments:

The majority of commitments to extend credit, unused portions of lines of credit and standby letters of credit carry current market interest rates if converted to loans. Because such commitments are generally unassignable of either the Company or the borrower, they only have value to the Company and the borrower. None of the commitments are subject to undue credit risk. The estimated fair values of off-balance sheet financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of off-balance sheet financial instruments was not material at March 31, 2017 and December 31, 2016.

Assets and liabilities measured at fair value on a recurring basis at March 31, 2017 and December 31, 2016 are summarized as follows:


	Fair Value Measurement Using
			Quoted Prices in		Significant		Significant
			Active Markets for		Other Observable		Unobservable
			Identical Assets		Inputs		Inputs
March 31, 2017	Amount		(Level 1)		(Level 2)		(Level 3)
U.S. Treasury securities	$	19,895	$	19,895			$
U.S. Government-sponsored enterprises		82,472			$	82,472
State and Municipals:
Taxable		15,267				15,267
Tax-exempt		107,537				107,537
Mortgage-backed securities:
U.S. Government agencies		19,332				19,332
U.S. Government-sponsored enterprises		20,141				20,141
Total	$	264,644	$	19,895	$	244,749	$


	Fair Value Measurement Using
			Quoted Prices in		Significant		Significant
			Active Markets for		Other Observable		Unobservable
			Identical Assets		Inputs		Inputs
December 31, 2016	Amount		(Level 1)		(Level 2)		(Level 3)
U.S. Treasury securities	$	7,438	$	7,438			$
U.S. Government-sponsored enterprises		80,913			$	80,913
State and Municipals:
Taxable		15,225				15,225
Tax-exempt		112,600				112,600
Mortgage-backed securities:
U.S. Government agencies		21,042				21,042
U.S. Government-sponsored enterprises		22,192				22,192
Total	$	259,410	$	7,438	$	251,972	$

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

Assets and liabilities measured at fair value on a nonrecurring basis at March 31, 2017 and December 31, 2016 are summarized as follows:

Fair Value Measurement Using

Quoted Prices in

Significant

Active Markets for

Other Observable

Unobservable

Identical Assets

Inputs

March 31, 2017

Amount

(Level 1)

(Level 2)

(Level 3)

Impaired loans

2,474

Other real estate owned

236

Fair Value Measurement Using

Quoted Prices in

Significant Other

Significant

Active Markets for

Observable

Unobservable

Identical Assets

Inputs

December 31, 2016

Amount

(Level 1)

(Level 2)

(Level 3)

Impaired loans

3,193

Other real estate owned

371

Fair values of impaired loans are based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent.

The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which the Company has utilized Level 3 inputs to determine fair value:


	Quantitative Information about Level 3 Fair Value Measurements
	Fair Value				Range
March 31, 2017	Estimate		Valuation Techniques	Unobservable Input	(Weighted Average)
Impaired loans	$	2,474	Appraisal of collateral	Appraisal adjustments	3.7% to 97.0% (63.0)%
				Liquidation expenses	3.0% to 6.0% (4.9)%
Other real estate owned	$	236	Appraisal of collateral	Appraisal adjustments	20.0% to 40.0% (34.9)%
				Liquidation expenses	3.0% to 6.0% (5.0)%


	Quantitative Information about Level 3 Fair Value Measurements
	Fair Value				Range
December 31, 2016	Estimate		Valuation Techniques	Unobservable Input	(Weighted Average)
Impaired loans	$	3,193	Appraisal of collateral	Appraisal adjustments	18.0% to 97.0% (74.5)%
				Liquidation expenses	3.0% to 6.0% (5.3)%
Other real estate owned	$	371	Appraisal of collateral	Appraisal adjustments	25.0% to 54.6% (43.1)%
				Liquidation expenses	3.0% to 6.0% (5.0)%

Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various Level 3 Inputs which are not identifiable.

Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

The carrying and fair values of the Company’s financial instruments at March 31, 2017 and December 31, 2016 and their placement within the fair value hierarchy are as follows:


					Fair Value Hierarchy
					Quoted
					Prices in
					Active		Significant
					Markets for		Other		Significant
					Identical		Observable		Unobservable
	Carrying		Fair		Assets		Inputs		Inputs
March 31, 2017	Value		Value		(level 1)		(level 2)		(Level 3)
Financial assets:
Cash and cash equivalents	$	31,815	$	31,815	$	31,815
Investment securities:
Available-for-sale		264,644		264,644		19,895	$	244,749
Held-to-maturity		10,180		10,359				10,359
Loans held for sale		444		453				453
Net loans		1,542,898		1,529,464					$	1,529,464
Accrued interest receivable		5,604		5,604				5,604
Mortgage servicing rights		698		1,587				1,587
Restricted equity securities		6,781		6,781				6,781
Total	$	1,863,064	$	1,850,707
Financial liabilities:
Deposits	$	1,615,544	$	1,614,470			$	1,614,470
Short-term borrowings		77,475		77,475				77,475
Long-term debt		57,615		58,484				58,484
Accrued interest payable		457		457				457
Total	$	1,751,091	$	1,750,886


					Fair Value Hierarchy
					Quoted
					Prices in
					Active		Significant
					Markets for		Other		Significant
					Identical		Observable		Unobservable
	Carrying		Fair		Assets		Inputs		Inputs
December 31, 2016	Value		Value		(level 1)		(level 2)		(Level 3)
Financial assets:
Cash and cash equivalents	$	39,941	$	39,941	$	39,941
Investment securities:
Available-for-sale		259,410		259,410	$	7,438	$	251,972
Held-to-maturity		10,517		10,714				10,714
Loans held for sale
Net loans		1,517,004		1,507,936					$	1,507,936
Accrued interest receivable		6,228		6,228				6,228
Mortgage servicing rights		698		1,587				1,587
Restricted equity securities		7,051		7,051				7,051
Total	$	1,840,849	$	1,832,867
Financial liabilities:
Deposits	$	1,588,757	$	1,587,701			$	1,587,701
Short-term borrowings		82,700		82,700				82,700
Long-term debt		58,134		58,987				58,987
Accrued interest payable		462		462				462
Total	$	1,730,053	$	1,729,850

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

8. Employee benefit plans:

The Company provides an Employee Stock Ownership Plan (“ESOP”) and a Retirement Profit Sharing Plan. The Company also maintains a Supplemental Executive Retirement Plan (“SERP”), an Employees’ Pension Plan, which is currently frozen, and a Postretirement Plan Life Insurance plan which was curtailed in 2013.

For the three months ended March 31, salaries and employee benefits expense includes approximately $296 in 2017 and $274 in 2016 relating to the employee benefit plans.

Components of net periodic benefit cost are as follows:



	Pension Benefits
Three Months Ended March 31,	2017	2016
Components of net periodic pension cost:
Interest cost	$	$	166
Expected return on plan assets			(223)
Amortization of unrecognized net gain			52
Net periodic other benefit cost	$	$	(5)

The 2008 long-term incentive plan (“2008 Plan”) allows for eligible participants to be granted equity awards. The plan was a legacy plan of Penseco Financial Services Corporation. Under the 2008 Plan the Compensation Committee of the board of directors has broad authority with respect to awards granted under the 2008 Plan, including, without limitation, the authority to:

Designate the individuals eligible to receive awards under the 2008 Plan.

Determine the size, type and date of grant for individual awards, provided that awards approved by the Committee are not effective unless and until ratified by the board of directors.

Interpret the 2008 Plan and award agreements issued with respect to individual participants.

Persons eligible to receive awards under the 2008 Plan include directors, officers, employees, consultants and other service providers of the Company and its subsidiaries, except that incentive stock option may be granted only to individuals who are employees on the date of grant.

As of March 31, 2017, there were 120,116 shares of the Company’s common stock available for grant as awards pursuant to the 2008 Plan. If any outstanding awards are forfeited by the holder or canceled by the Company, the underlying shares would be available for regrant to others.

The 2008 Plan authorizes grants of stock options, stock appreciation rights, dividend equivalents, performance awards, restricted stock and restricted stock units.

During the three months ended March 31, 2017, the Company awarded 2,020 shares of non-performance-based restricted stock, bringing the total of nonvested restricted stock awards to 14,382 shares, and 7,071 performance-based restricted stock units under the 2008 Plan. During the three months ended March 31, 2016, the Company did not make any awards under the 2008 Plan.

The non-performance restricted stock grants made during the three months ended March 31, 2017 vest equally over three years from the grant date. Grants of restricted stock made in prior periods cliff vest after five years. The performance-based restricted stock units vest three years after the grant date and include conditions based on the Company’s three-

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Peoples Financial Services Corp.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

year cumulative diluted earnings per share and three-year average return on equity that determines the number of restricted stock units that may vest.

The Company expenses the fair value of all-share based compensation over the requisite service period commencing at grant date. The fair value of restricted stock is expensed on a straight-line basis. The Company periodically assesses the probability of achievement of the performance criteria and adjusts the amount of compensation expense accordingly. Compensation is recognized over the vesting period and adjusted for the probability of achievement of the performance criteria. The Company classifies share-based compensation for employees within “salaries and employee benefits expense” on the Consolidated Statements of Income and Comprehensive Income.

The Company did not recognize any compensation expense for the three months ended March 31, 2017 and 2016, respectively for awards granted under the 2008 Plan. As of March 31, 2017, the Company had $365 of unrecognized compensation expense associated with awards. That cost is expected to be recognized over a weighted average vesting period of 3 years.

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Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

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

The following discussion and analysis should be read in conjunction with the unaudited consolidated interim financial statements contained in Part I, Item 1 of this report, and with our audited consolidated financial statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” presented in our Annual Report on Form 10-K for the year ended December 31, 2016.

Cautionary Note Regarding Forward-Looking Statements:

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to risks and uncertainties. These statements are based on assumptions and may describe future plans, strategies and expectations of Peoples Financial Services Corp. and its direct and indirect subsidiaries. These forward-looking statements are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions. All statements in this report, other than statements of historical facts, are forward-looking statements.

Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Important factors that could cause our actual results to differ materially from those in the forward-looking statements include, but are not limited to: risks associated with business combinations; changes in interest rates; economic conditions, particularly in our market area; legislative and regulatory changes and the ability to comply with the significant laws and regulations governing the banking and financial services business; monetary and fiscal policies of the U.S. government, including policies of the U.S. Department of Treasury and the Federal Reserve System; credit risk associated with lending activities and changes in the quality and composition of our loan and investment portfolios; demand for loan and other products; deposit flows; competition; changes in the values of real estate and other collateral securing the loan portfolio, particularly in our market area; changes in relevant accounting principles and guidelines; inability of third party service providers to perform; and our ability to prevent, detect and respond to cyberattacks. Additional factors that may affect our results are discussed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016, and in reports we file with the Securities and Exchange Commission from time to time.

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, Peoples Financial Services Corp. does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.

Notes to the Consolidated Financial Statements referred to in the Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) are incorporated by reference into the MD&A. Certain prior period amounts may have been reclassified to conform with the current year’s presentation. Any reclassifications did not have any effect on the operating results or financial position of the Company.

Critical Accounting Policies:

Disclosure of our significant accounting policies are included in Note 1 to the consolidated financial statements of the Annual Report on Form 10-K for the year ended December 31, 2016. Some of these policies are particularly sensitive requiring significant judgments, estimates and assumptions.

Operating Environment:

The Federal Open Market Committee (“FOMC”), as telegraphed, increased the overnight rate 25 basis points during the first quarter of 2017 as well as projected two more rate hikes for 2017. In doing so, the FOMC cited improvement in labor markets and the move in recent quarters to the committee’s long-term desired 2 percent level. The initial reading of first quarter 2017 gross domestic product (“GDP”), the value of all goods and services produced in the Nation, came in at an annualized rate of 0.7%, down from the final reading of 2.1% in the fourth quarter of 2016 while the consumer price index (“CPI”) increased only moderately for the 12 months ended March 31, 2017 at 2.4% from 2.1% for the 12 months ended December 31, 2016. Moreover, the core personal consumption expenditure price index, which ignores food and energy, averaged 2.0% for the 12 months ended March 31, 2017. In fact, the consumer was a major factor in

Table of Contents

Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

the slowdown in GDP for the first quarter of 2017. Personal consumption fell from 3.5% in the fourth quarter of 2016 to just 0.3% in the first quarter of 2017.

Review of Financial Position:

Total assets increased $24,064, or 4.9% annualized, to $2,023,506 at March 31, 2017, from $1,999,442 at December 31, 2016. Loans, net increased to $1,559,867 at March 31, 2017, compared to $1,532,965 at December 31, 2016, an increase of $26,902 or 7.1% annualized. The increase in loans, net during 2017 has been funded through an increase in deposits. Deposits increased $26,787 or 6.8% annualized in the first quarter of 2017. Interest-bearing deposits increased $21,935 while noninterest-bearing deposits increased $4,852. Total stockholders’ equity increased $2,701 or at an annual rate of 4.3%, from $256,618 at year-end 2016 to $259,319 at March 31, 2017. For the three months ended March 31, 2017, total assets averaged $2,004,553, an increase of $152,910 from $1,851,643 for the same period of 2016.

Investment Portfolio:

The majority of the investment portfolio is classified as available-for-sale, which allows for greater flexibility in using the investment portfolio for liquidity purposes by allowing securities to be sold when market opportunities occur. Investment securities available-for-sale totaled $264,644 at March 31, 2017, an increase of $5,234, or 2.0% from $259,410 at December 31, 2016. The increase was the result of current balance sheet strategy aimed at increasing the level of investment securities held for liquidity purposes. Investment securities held-to-maturity totaled $10,180 at March 31, 2017, a decrease of $337 or 3.2% from $10,517 at December 31, 2016 due to payments received from mortgage backed holdings.

For the three months ended March 31, 2017, the investment portfolio averaged $274,940, a decrease of $12,267 or 4.3% compared to $287,207 for the same period last year. The tax-equivalent yield on the investment portfolio increased 3 basis points to 2.89% for the three months ended March 31, 2017, from 2.86% for the comparable period of 2016.

Securities available-for-sale are carried at fair value, with unrealized gains or losses net of deferred income taxes reported in the accumulated other comprehensive income (loss) component of stockholders’ equity. We reported net unrealized gains, included as a separate component of stockholders’ equity of $537, net of deferred income taxes of $289, at March 31, 2017, and $360, net of deferred income taxes of $193, at December 31, 2016.

Our Asset/Liability Committee (“ALCO”) reviews the performance and risk elements of the investment portfolio quarterly. Through active balance sheet management and analysis of the securities portfolio, we endeavor to maintain sufficient liquidity to satisfy depositor requirements and meet the credit needs of our customers.

Loan Portfolio:

Loan growth was strong in the three month period ended March 31, 2017. Loans, net increased to $1,559,867 at March 31, 2017 from $1,532,965 at December 31, 2016, an increase of $26,902 or 7.1% annualized. The growth reflected increases in commercial loans, commercial real estate loans and consumer loans, partially offset by a decrease in residential real estate loans. Commercial loans increased $22,350, or 22.2% annualized, to $431,164 at March 31, 2017 compared to $408,814 at December 31, 2016. Commercial real estate loans increased $3,050 or 1.8% annualized, to $703,194 at March 31, 2017 compared to $700,144 at December 31, 2016. Consumer loans increased $4,894, or 14.8% on an annualized basis, to $139,120 at March 31, 2017 compared to $134,226 at December 31, 2016. The primary contributor to the growth in consumer loans was our indirect loan portfolio which increased $5,961.

Residential real estate loans decreased $3,392, or 4.7% on an annualized basis, to $286,389 at March 31, 2017 compared to $289,781 at December 31, 2016. The majority of residential real estate loans originated are sold into the secondary market instead of being carried in the portfolio to mitigate interest rate risk in the current low rate environment.

For the three months ended March 31, 2017, loans, net averaged $1,534,765, an increase of $153,948 or 11.1% compared to $1,380,817 for the same period of 2016. The tax-equivalent yield on the loan portfolio was 4.40% for the three months ended March 31, 2017, a 12 basis point decrease from the comparable period last year. The tax-equivalent yield on the loan portfolio increased 7 basis points for the first quarter of 2017 as compared to 4.33% for the fourth quarter of 2016.

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Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

In addition to the risks inherent in our loan portfolio, in the normal course of business, we are also a party to financial instruments with off-balance sheet risk to meet the financing needs of our customers. These instruments include legally binding commitments to extend credit, unused portions of lines of credit and commercial letters of credit made under the same underwriting standards as on-balance sheet instruments, and may involve, to varying degrees, elements of credit risk and interest rate risk (“IRR”) in excess of the amount recognized in the financial statements.

Unused commitments at March 31, 2017, totaled $369,695, consisting of $338,753 in unfunded commitments of existing loan facilities and $30,942 in standby letters of credit. Due to fixed maturity dates, specified conditions within these instruments, and the ultimate needs of our customers, many will expire without being drawn upon. We believe that amounts actually drawn upon can be funded in the normal course of operations and therefore, do not represent a significant liquidity risk to us. In comparison, unused commitments at December 31, 2016 totaled $324,713, consisting of $293,662 in unfunded commitments of existing loans and $31,051 in standby letters of credit.

Asset Quality:

National, Pennsylvania, New York and market area unemployment rates at March 31, 2017 and 2016, are summarized as follows:


	2017		2016
United States	4.7	%	4.9	%
New York (statewide)	4.8		5.2
Pennsylvania (statewide)	5.3		5.6
Broome County	6.3		6.1
Bucks County	4.5		4.8
Lackawanna County	5.6		6.0
Lehigh County	5.4		5.5
Luzerne County	6.6		6.8
Monroe County	6.3		6.5
Montgomery County	4.0		4.2
Northampton County	5.4		5.4
Susquehanna County	6.0		6.9
Wayne County	6.6		7.0
Wyoming County	6.4	%	7.4	%

The employment conditions improved for the Nation, Pennsylvania, and New York and in all but two of the eleven counties representing our market areas in Pennsylvania and New York from one year ago. Unemployment rates remained elevated relative to historical as well as national and state levels within many of our market areas.

Our asset quality improved in the first quarter of 2017. Nonperforming assets decreased $2,068 or 14.5% to $12,144 at March 31, 2017, from $14,212 at December 31, 2016. We experienced a decrease in nonaccrual and restructured loans, accruing loans past due 90 days or more and other real estate owned. As a percentage of loans, net and foreclosed assets, nonperforming assets equaled 0.78% at March 31, 2017 compared to 0.93% at December 31, 2016.

Loans on nonaccrual status decreased $1,847 to $9,261 at March 31, 2017 from $11,108 at December 31, 2016. The majority of the decrease from year end was due to a decrease of $2,315 in commercial real estate loans. Nonaccrual commercial loans increased $598, residential real estate loans decreased $182, and nonaccrual consumer loans increased $52. Accruing loans past due 90 days or more showed a decrease of $382 to $462 at March 31, 2017 from $844 at December 31, 2016 and other real estate owned decreased $157 to $236 at March 31, 2017 from $393 at December 31, 2016.

Generally, maintaining a high loan to deposit ratio is our primary goal in order to maximize profitability. However, this objective is superseded by our attempts to ensure that asset quality remains strong. We continued our efforts to maintain sound underwriting standards for both commercial and consumer credit. Most commercial lending is done primarily with locally owned small businesses.

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Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

We maintain the allowance for loan losses at a level we believe adequate to absorb probable credit losses related to specifically identified loans, as well as probable incurred loan losses inherent in the remainder of the loan portfolio as of the balance sheet date. The allowance for loan losses is based on past events and current economic conditions. We employ the Federal Financial Institutions Examination Council Interagency Policy Statement, as amended December 13, 2006, and GAAP in assessing the adequacy of the allowance account. Under GAAP, the adequacy of the allowance account is determined based on the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 310, “Receivables,” for loans specifically identified to be individually evaluated for impairment and the requirements of FASB ASC 450, “Contingencies,” for large groups of smaller-balance homogeneous loans to be collectively evaluated for impairment.

We follow our systematic methodology in accordance with procedural discipline by applying it in the same manner regardless of whether the allowance is being determined at a high point or a low point in the economic cycle. Each quarter, credit administration identifies those loans to be individually evaluated for impairment and those loans collectively evaluated for impairment utilizing a standard criteria. We consistently use loss experience from the latest twelve quarters in determining the historical loss factor for each pool collectively evaluated for impairment. Qualitative factors are evaluated in the same manner each quarter and are adjusted within a relevant range of values based on current conditions. For additional disclosure related to the allowance for loan losses refer to the note entitled, “Loans, net and Allowance for Loan Losses,” in the Notes to Consolidated Financial Statements to this Quarterly Report.

The allowance for loan losses increased $1,008 to $16,969 at March 31, 2017, from $15,961 at the end of 2016. For the three months ended March 31, 2017, net charge-offs were $192 or 0.05% of average loans outstanding, a $175 increase compared to $17 or 0.01% of average loans outstanding in the same period of 2016.

Deposits:

We attract the majority of our deposits from within our ten county market area that stretches from Montgomery County in Pennsylvania to Broome County in the Southern Tier of New York State through the offering of various deposit instruments including demand deposit accounts, NOW accounts, money market deposit accounts, savings accounts, and time deposits, including certificates of deposit and IRA’s. For the three months ended March 31, 2017, total deposits increased to $1,615,544 from $1,588,757 at December 31, 2016. Interest-bearing deposits increased $21,935 and noninterest-bearing deposits increased $4,852. Interest-bearing transaction accounts, including NOW and money market accounts, increased $13,682, or 9.9% annualized, to $569,010 at March 31, 2017, from $555,328 at December 31, 2016. savings accounts increased $8,750, or 9.0% annualized to $402,783 as of March 31, 2017 from $394,033 at December 31, 2016 and time deposits less than $100 increased $36, or 0.1% annualized, to $164,186 at March 31, 2017, from $164,150 at December 31, 2016. Time deposits $100 or more decreased $495, or 1.7% annualized to $121,028 at March 31, 2017 from $121,523 at year end 2016.

For the three months ended March 31, 2017 interest-bearing deposits averaged $1,244,021 in 2017 compared to $1,159,159 in 2016, an increase of $84,862, or 7.3%. The cost of interest-bearing deposits was 0.47% in 2017 compared to 0.45% for the same period last year. For the first three months, the overall cost of interest-bearing liabilities including the cost of borrowed funds, was 0.57% in 2017 and 0.54% in 2016.

Borrowings:

The Bank utilizes borrowings as a secondary source of liquidity for its asset/liability management. Advances are available from the Federal Home Loan Bank of Pittsburgh (“FHLB”) provided certain standards related to credit worthiness have been met. Repurchase and term agreements are also available from the FHLB.

Total short-term borrowings at March 31, 2017, totaled $77,475 compared to $82,700 at December 31, 2016, a decrease of $5,225. Long-term debt was $57,615 at March 31, 2017, compared to $58,134 at year end 2016. Cash and due from bank balances were used to reduce our short-term borrowing whereas the decline in long-term debt was a product of monthly contractual amortized payments made during the three months ended March 31, 2017.

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Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

Market Risk Sensitivity:

Market risk is the risk to our earnings or financial position resulting from adverse changes in market rates or prices, such as interest rates, foreign exchange rates or equity prices. Our exposure to market risk is primarily “IRR” associated with our lending, investing and deposit-gathering activities. During the normal course of business, we are not exposed to foreign exchange risk or commodity price risk. Our exposure to IRR can be explained as the potential for change in our reported earnings and/or the market value of our net worth. Variations in interest rates affect earnings by changing net interest income and the level of other interest-sensitive income and operating expenses. Interest rate changes also affect the underlying economic value of our assets, liabilities and off-balance sheet items. These changes arise because the present value of future cash flows, and often the cash flows themselves, change with interest rates. The effects of the changes in these present values reflect the change in our underlying economic value and provide a basis for the expected change in future earnings related to interest rates. IRR is inherent in the role of banks as financial intermediaries. However, a bank with a high degree of IRR may experience lower earnings, impaired liquidity and capital positions, and most likely, a greater risk of insolvency. Therefore, banks must carefully evaluate IRR to promote safety and soundness in their activities.

As a result of economic uncertainty and a prolonged era of historically low market rates, it has become challenging to manage IRR. Due to these factors, IRR and effectively managing it are very important to both bank management and regulators. Bank regulations require us to develop and maintain an IRR management program, overseen by the Board of Directors and senior management, that involves a comprehensive risk management process in order to effectively identify, measure, monitor and control risk. Should bank regulatory agencies identify a material weakness in our risk management process or high exposure relative to our capital, bank regulatory agencies may take action to remedy these shortcomings. Moreover, the level of IRR exposure and the quality of our risk management process is a determining factor when evaluating capital adequacy.

The ALCO, comprised of members of our Board of Directors, senior management and other appropriate officers, oversees our IRR management program. Specifically, ALCO analyzes economic data and market interest rate trends, as well as competitive pressures, and utilizes computerized modeling techniques to reveal potential exposure to IRR. This allows us to monitor and attempt to control the influence these factors may have on our rate-sensitive assets (“RSA”) and rate-sensitive liabilities (“RSL”), and overall operating results and financial position. One such technique utilizes a static gap model that considers repricing frequencies of RSA and RSL in order to monitor IRR. Gap analysis attempts to measure our interest rate exposure by calculating the net amount of RSA and RSL that reprice within specific time intervals. A positive gap occurs when the amount of RSA repricing in a specific period is greater than the amount of RSL repricing within that same time frame and is indicated by a RSA/RSL ratio greater than 1.0. A negative gap occurs when the amount of RSL repricing is greater than the amount of RSA and is indicated by a RSA/RSL ratio of less than 1.0. A positive gap implies that earnings will be impacted favorably if interest rates rise and adversely if interest rates fall during the period. A negative gap tends to indicate that earnings will be affected inversely to interest rate changes.

Our cumulative one-year RSA/RSL ratio equaled 1.69% at March 31, 2017. Given the length of time that market rates have been at historical lows and the potential for rates to increase in the future, the focus of ALCO has been to create a positive static gap position. With regard to RSA, we predominantly offer medium- term, fixed-rate loans as well as adjustable rate loans. With respect to RSL, we offer longer term promotional certificates of deposit in an attempt to increase duration. The current position at March 31, 2017, indicates that the amount of RSA repricing within one year would exceed that of RSL, thereby causing net interest income to increase as market rates increase. However, these forward-looking statements are qualified in the aforementioned section entitled “Forward-Looking Discussion” in this Management’s Discussion and Analysis.

Static gap analysis, although a standard measuring tool, does not fully illustrate the impact of interest rate changes on future earnings. First, market rate changes normally do not equally or simultaneously affect all categories of assets and liabilities. Second, assets and liabilities that can contractually reprice within the same period may not do so at the same time or to the same magnitude. Third, the interest rate sensitivity table presents a one-day position. Variations occur daily as we adjust our rate sensitivity throughout the year. Finally, assumptions must be made in constructing such a table.

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Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

As the static gap report fails to address the dynamic changes in the balance sheet composition or prevailing interest rates, we utilize a simulation model to enhance our asset/liability management. This model is used to create pro forma net interest income scenarios under various interest rate shocks. Model results at March 31, 2017, produced results similar to those indicated by the one-year static gap position. In addition, parallel and instantaneous shifts in interest rates under various interest rate shocks resulted in changes in net interest income that were well within ALCO policy limits. We will continue to monitor our IRR throughout 2017 and endeavor to employ deposit and loan pricing strategies and direct the reinvestment of loan and investment repayments in order to manage our IRR position.

Financial institutions are affected differently by inflation than commercial and industrial companies that have significant investments in fixed assets and inventories. Most of our assets are monetary in nature and change correspondingly with variations in the inflation rate. It is difficult to precisely measure the impact inflation has on us, however we believe that our exposure to inflation can be mitigated through asset/liability management.

Liquidity:

Liquidity management is essential to our continuing operations and enables us to meet financial obligations as they come due, as well as to take advantage of new business opportunities as they arise. Financial obligations include, but are not limited to, the following:

Funding new and existing loan commitments;

Payment of deposits on demand or at their contractual maturity;

Repayment of borrowings as they mature;

Payment of lease obligations; and

Payment of operating expenses.

These obligations are managed daily, thus enabling us to effectively monitor fluctuations in our liquidity position and to adapt that position according to market influences and balance sheet trends. Future liquidity needs are forecasted and strategies are developed to ensure adequate liquidity at all times.

Historically, core deposits have been the primary source of liquidity because of their stability and lower cost, in general, than other types of funding. Providing additional sources of funds are loan and investment payments and prepayments and the ability to sell both available for sale securities and mortgage loans held for sale. We believe liquidity is adequate to meet both present and future financial obligations and commitments on a timely basis.

We employ a number of analytical techniques in assessing the adequacy of our liquidity position. One such technique is the use of ratio analysis to determine the extent of our reliance on noncore funds to fund our investments and loans maturing after March 31, 2017. Our noncore funds at March 31, 2017, were comprised of time deposits in denominations of $100 or more and other borrowings. These funds are not considered to be a strong source of liquidity because they are very interest rate sensitive and are considered to be highly volatile. At March 31, 2017, our net noncore funding dependence ratio, the difference between noncore funds and short-term investments to long-term assets, was 13.8%, while our net short-term noncore funding dependence ratio, noncore funds maturing within one-year, less short-term investments to long-term assets equaled 6.3%. Comparatively, our overall noncore dependence ratio at year-end 2016 was 14.4% and our net short-term noncore funding dependence ratio was 6.5%, indicating that our reliance on noncore funds has decreased.

The Consolidated Statements of Cash Flows present the changes in cash and cash equivalents from operating, investing and financing activities. Cash and cash equivalents, consisting of cash on hand, cash items in the process of collection, deposit balances with other banks and federal funds sold, decreased $8,126 during the three months ended March 31, 2017. Cash and cash equivalents decreased $8,919 for the same period last year. For the three months ended March 31, 2017, net cash inflows of $7,536 from operating activities and $18,750 from financing activities were more than offset by net cash outflows of $34,412 from investing activities. For the same period of 2016, net cash inflows of $6,633 from

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Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

operating activities and $38,538 from financing activities were more than offset by net cash outflows of $54,090 from investing activities.

Operating activities provided net cash of $7,536 for the three months ended March 31, 2017, and $6,633 for the corresponding three months of 2016. Net income, adjusted for the effects of gains and losses along with noncash transactions such as depreciation and the provision for loan losses, is the primary source of funds from operations.

Investing activities primarily include transactions related to our lending activities and investment portfolio. Investing activities used net cash of $34,412 for the three months ended March 31, 2017, compared to using net cash $54,090 for the same period of 2016. In 2017 and 2016, an increase in lending activities was the primary factor causing the net cash outflow from investing activities.

Financing activities provided net cash of $18,750 for the three months ended March 31, 2017, and provided net cash of $38,538 for the corresponding three months of 2016. Deposit gathering is our predominant financing activity. Deposits increased for the three months ended March 31, 2017 and 2016. The net increase in deposits totaled $26,787 in the three months ended March 31, 2017. Comparatively, deposits increased $19,798 for the same period of 2016. We continued to attract deposits from new markets and customers as well as existing customers, including municipalities and school districts. Another source of financing is our short term borrowings which decreased $5,225 in the three months ended March 31, 2017 compared to an increase of $22,025 in the first quarter of 2016.

We believe that our future liquidity needs will be satisfied through maintaining an adequate level of cash and cash equivalents, by maintaining readily available access to traditional funding sources, and through proceeds received from the investment and loan portfolios. The current sources of funds will enable us to meet all cash obligations as they come due.

Capital:

Stockholders’ equity totaled $259,319 or $35.07 per share at March 31, 2017, compared to $256,618 or $34.71 per share at December 31, 2016. Net income of $4,800 for the three months ended March 31, 2017 was the primary factor leading to the improved capital position. Stockholders’ equity was also affected by cash dividends declared of $2,293, stock based compensation of $17, and other comprehensive income resulting from market value fluctuations in the investment portfolio of $177.

Dividends declared equaled $0.31 per share for the first quarter of 2017 and 2016. The dividend payout ratio was 47.7% for the three months ended March 31, 2017 and 47.0% for the same period of 2016. The merger agreement pursuant to which we merged with Penseco in 2013 contemplates that, unless 80 percent of our board of directors determines otherwise, we will pay a quarterly cash dividend in an amount no less than $0.31 per share through 2018, provided that sufficient funds are legally available, and that Peoples and Peoples Bank remain “Well-capitalized” in accordance with applicable regulatory guidelines. It is the intention of the Board of Directors to continue to pay cash dividends in the future. However, these decisions are affected by operating results, financial and economic decisions, capital and growth objectives, appropriate dividend restrictions and other relevant factors.

In July 2013, the Board of Directors of the FRB approved the Basel III interim final rule (“Basel III”) which is intended to strengthen the quality and increase the required level of regulatory capital for a more stable and resilient banking system. The changes include: (i) a new regulatory capital measure, Common Equity Tier 1 (“CET1”), which is limited to capital elements of the highest quality; (ii) a new definition and increase of tier 1 capital which is now comprised of CET1 and Additional Tier 1; (iii) changes in calculation of some risk-weighted assets and off-balance sheet exposure; and (iv) a capital conservation buffer that will limit capital distributions, stock redemptions, and certain discretionary bonus payments if the institution does not maintain capital in excess of the minimum capital requirements. These new capital rules took effect for our Bank on January 1, 2015 and reporting began with the quarter ended March 31, 2015. Under the final capital rules that became effective on January 1, 2015, there was a requirement for a CET1 capital conservation buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not maintain this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases

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Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement is being phased in over three years beginning in 2016.

The adequacy of capital is reviewed on an ongoing basis with reference to the size, composition and quality of resources and regulatory guidelines. We seek to maintain a level of capital sufficient to support existing assets and anticipated asset growth, maintain favorable access to capital markets, and preserve high quality credit ratings. At March 31, 2017, the Bank’s Tier 1 capital to total average assets was 9.89% as compared to 9.88% at December 31, 2016. The Bank’s Tier 1 capital to risk weighted asset ratio was 11.96% and the total capital to risk weighted asset ratio was 13.02% at March 31, 2017. These ratios were 12.14% and 13.16% at December 31, 2016. The Bank’s common equity Tier 1 to risk weighted asset ratio was 11.96% at March 31, 2017 compared to 12.14% at December 31, 2016. The Bank was deemed to be well-capitalized under regulatory standards at March 31, 2017. Additionally, as of March 31, 2017, the Bank would meet all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis as if all such requirements were currently in effect.

Review of Financial Performance:

Net income for the first quarter of 2017 equaled $4,800 or $0.65 per share compared to $4,882 or $0.66 per share for the first quarter of 2016. Return on average assets (“ROA”) measures our net income in relation to total assets. Our ROA was 0.97% for the first quarter of 2017 compared to 1.06% for the same period of 2016. Return on average equity (“ROE”) indicates how effectively we can generate net income on the capital invested by stockholders. Our ROE was 7.51% for the first quarter of 2017 compared to 7.85% for the comparable period in 2016. There were no gains on sale of investment securities for the three months ended March 31, 2017 while gains on sale of investment securities were $242 for the same period in 2016.

Net Interest Income:

Net interest income is the fundamental source of earnings for commercial banks. Fluctuations in the level of net interest income can have the greatest impact on net profits. Net interest income is defined as the difference between interest revenue, interest and fees earned on interest-earning assets, and interest expense, the cost of interest-bearing liabilities supporting those assets. The primary sources of earning assets are loans and investment securities, while interest-bearing deposits, short-term and long-term borrowings comprise interest-bearing liabilities. Net interest income is impacted by:

Variations in the volume, rate and composition of earning assets and interest-bearing liabilities;

Changes in general market rates; and

The level of nonperforming assets.

Changes in net interest income are measured by the net interest spread and net interest margin. Net interest spread, the difference between the average yield earned on earning assets and the average rate incurred on interest-bearing liabilities, illustrates the effects changing interest rates have on profitability. Net interest margin, net interest income as a percentage of earning assets, is a more comprehensive ratio, as it reflects not only the spread, but also the change in the composition of interest-earning assets and interest-bearing liabilities. Tax-exempt loans and investments carry pre-tax yields lower than their taxable counterparts. Therefore, in order to make the analysis of net interest income more comparable, tax-exempt income and yields are reported herein on a tax-equivalent basis using the prevailing federal statutory tax rate of 35.0% in 2017 and 2016.

For the three months ended March 31, tax-equivalent net interest income increased $821 to $16,662 in 2017 from $15,841 in 2016. The net interest spread decreased to 3.60% for the three months ended March 31, 2017 from 3.68% for the three months ended March 31, 2016. The tax-equivalent net interest margin decreased to 3.73% for the first quarter of 2017 from 3.81% for the comparable period of 2016. The tax-equivalent net interest margin for the fourth quarter of 2016 was 3.67%. Loan accretion in the first quarter of 2017 related to loans acquired in the 2013 Penseco merger was $187, resulting in an increase in the tax-equivalent net interest margin of 4 basis points. Comparatively, loan accretion recognized on these loans in the first quarter of 2016 was $215 resulting in an increase in the tax-equivalent net interest margin of 5 basis points. Without such loan accretion, the tax equivalent net interest margin for the three months ended March 31 would have been 3.69% in 2017 and 3.76% in 2016.

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Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

For the three months ended March 31, tax-equivalent interest income on earning assets increased $1,057, to $18,618 in 2017 as compared to $17,561 in 2016. The overall yield on earning assets, on a fully tax-equivalent basis, decreased 5 basis points for the three months ended March 31, 2017 to 4.17% as compared to 4.22% for the three months ended March 31, 2016. The decrease in the yield on earning assets resulted from loans being originated or renewed at market rates, which are lower than those maturing and amortizing. The overall yield earned on loans decreased 12 basis points for the first quarter of 2017 to 4.40% from 4.52% for the first quarter of 2016. Average loans increased to $1,534,765 for the quarter ended March 31, 2017 compared to $1,380,817 for the same period in 2016. The resulting tax-equivalent interest earned on loans was $16,658 for the three month period ended March 31, 2017 compared to $15,501 for the same period in 2016, an increase of $1,157.

Total interest expense increased $236, to $1,956 for the three months ended March 31, 2017 from $1,720 for the three months ended March 31, 2016. An unfavorable volume variance caused the increase. An increase in the average volume of interest bearing liabilities of $111,220 coupled with the 3 basis point increase to the cost of funds comparing the three months ended March 31, 2017 and 2016 caused the increase.

The average balances of assets and liabilities, corresponding interest income and expense and resulting average yields or rates paid are summarized as follows. Averages for earning assets include nonaccrual loans. Investment averages include available-for-sale securities at amortized cost. Income on investment securities and loans is adjusted to a tax equivalent basis using the prevailing federal statutory tax rate of 35%.

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Management’s Discussion and Analysis

(Dollars in thousands, except per share data)


	Three months ended
	March 2017						March 2016
	Average		Interest Income/		Yield/		Average		Interest Income/		Yield/
	Balance		Interest		Rate		Balance		Interest		Rate
Assets:
Earning assets:
Loans:
Taxable	$	1,429,323	$	15,541	4.41	%	$	1,276,491	$	14,346	4.52	%
Tax-exempt		105,442		1,117	4.30			104,326		1,155	4.45
Investments:
Taxable		159,593		737	1.87			159,584		697	1.76
Tax-exempt		115,347		1,222	4.30			127,623		1,346	4.24
Interest-bearing deposits		349		1	1.16			4,686		17	1.46
Federal funds sold
Total earning assets		1,810,054		18,618	4.17	%		1,672,710		17,561	4.22	%
Less: allowance for loan losses		16,361						13,410
Other assets		210,860						192,343
Total assets	$	2,004,553		18,618			$	1,851,643		17,561
Liabilities and Stockholders’ Equity:
Interest-bearing liabilities:
Money market accounts	$	240,756		272	0.46	%	$	206,602		177	0.34	%
NOW accounts		321,755		338	0.43			293,002		278	0.38
Savings accounts		398,273		125	0.13			389,230		175	0.18
Time deposits less than $100		160,537		416	1.05			165,389		435	1.06
Time deposits $100 or more		122,700		283	0.94			104,936		218	0.84
Short-term borrowings		82,002		174	0.86			53,436		77	0.58
Long-term debt		57,856		348	2.44			60,064		360	2.41
Total interest-bearing liabilities		1,383,879		1,956	0.57			1,272,659		1,720	0.54
Noninterest-bearing deposits		346,567						313,908
Other liabilities		14,872						15,755
Stockholders’ equity		259,235						249,321
Total liabilities and stockholders’ equity	$	2,004,553		1,956			$	1,851,643		1,720
Net interest income/spread			$	16,662	3.60	%			$	15,841	3.68	%
Net interest margin					3.73	%					3.81	%
Tax-equivalent adjustments:
Loans			$	391					$	404
Investments				428						471
Total adjustments			$	819					$	875

Provision for Loan Losses:

We evaluate the adequacy of the allowance for loan losses account on a quarterly basis utilizing our systematic analysis in accordance with procedural discipline. We take into consideration certain factors such as composition of the loan portfolio, volumes of nonperforming loans, volumes of net charge-offs, prevailing economic conditions and other relevant factors when determining the adequacy of the allowance for loan losses account. We make monthly provisions to the allowance for loan losses account in order to maintain the allowance at the appropriate level indicated by our evaluations. Based on our most current evaluation, we believe that the allowance is adequate to absorb any known and inherent losses in the portfolio as of March 31, 2017.

For the three months ended March 31, the provision for loan losses totaled $1,200 in both 2017 and 2016.

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Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

Noninterest Income:

For the three months ended March 31, 2017, noninterest income totaled $3,782, a decrease of $109 or 2.8% from $3,891 for the comparable period of 2016. Service charges, fees and commissions increased $128, or 8.9% to $1,572 through three months in 2017 from $1,444 for the same period in 2016. Merchant services income increased $101 to $1,015 for the three months ended March 31, 2017 from $914 for the same period last year as a result of an increase in the number of merchant accounts serviced. Income generated from commissions and fees on fiduciary activities increased $26 to $508 for the three months ended March 31, 2017 in comparison to $482 for the same period in 2016 due to additional executor fees generated in 2017. Income generated from our wealth management division decreased $93 to $319 through the first three months of 2017 in comparison to $412 over that same period in 2016 due to servicer conversion fees generated in 2016 which were not replicated in the current period. Mortgage banking income decreased $25 to $179 for the first three months of 2017 compared to $204 for the comparable period in 2016 as the volume of loans originated for sale declined. Life insurance investment income decreased $4 to $189 for the three months ended March 31, 2017 from $193 for the same period in 2016. There were no gains recognized from the sale of investment securities available-for-sale in the first quarter of 2017 compared to $242 for the three months ended March 31, 2016.

Noninterest Expenses:

In general, noninterest expense is categorized into three main groups: employee-related expenses, occupancy and equipment expenses and other expenses. Employee-related expenses are costs associated with providing salaries, including payroll taxes and benefits, to our employees. Occupancy and equipment expenses, the costs related to the maintenance of facilities and equipment, include depreciation, general maintenance and repairs, real estate taxes, rental expense offset by any rental income, and utility costs. Other expenses include general operating expenses such as advertising, contractual services, insurance, including FDIC assessment, other taxes and supplies. Several of these costs and expenses are variable while the remainder are fixed. We utilize budgets and other related strategies in an effort to control the variable expenses.

For the first quarter, noninterest expense increased $738 or 6.4% to $12,356 in 2017 from $11,618 in 2016. Personnel costs increased 17.7%, net occupancy and equipment costs decreased 1.8%, merchant services expense increased 15.5% and other expenses decreased by 7.7% comparing year-to-date 2017 and 2016.

Salaries and employee benefits expense, which comprise the majority of noninterest expense, totaled $6,275 for the first quarter of 2017, an increase of $943 or 17.7% when compared to the first quarter of 2016. Costs related to our build out of our expansion plan in the Lehigh Valley and King of Prussia, as well as standard merit increases, contributed to the increase. Further, the year ago period included a one-time credit of $208 to offset salary and employee benefits for mortgage servicing rights retained by the bank.

We experienced a $43 or 1.8% decrease in net occupancy and equipment expense comparing $2,394 for the first quarter of 2017 and $2, 437 for the same period in 2015. Mild winter conditions led to a decrease in heating costs as well as a decrease in costs associated with snow removal during the first part of 2017 when compared to the first three months of 2016. Additionally, certain cost containment measures have been implemented to curtail occupancy and equipment expenditures.

Merchant services expense increased $98 or 15.5% to $730 for the three months ended March 31, 2017 from $632 for the same period in 2016. The increase is due to higher volumes and correlates directly to the increase in merchant services income for the quarter ended March 31, 2017 when compared to the same year ago period.

For the three months ended March 31, other expenses decreased $223 or 7.7% to $2,689 from $2,912 comparing 2017 to 2016. FDIC assessments decreased $141, or 52.6% when comparing the first quarter of 2017 to the same period in 2016.

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Peoples Financial Services Corp.

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

Income Taxes:

We recorded income tax expense of $1,269 or 20.9% of pre-tax income, and $1,157 or 19.2% of pre-tax income for the three months ended March 31, 2017 and 2016. The three months ended March 31, 2017 includes before tax investment tax credits of $270 compared to $306 for that same period last year.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Market risk is the risk to our earnings and/or financial position resulting from adverse changes in market rates or prices, such as interest rates, foreign exchange rates or equity prices. Our exposure to market risk is primarily interest rate risk (“IRR”), which arises from our lending, investing and deposit gathering activities. Our market risk sensitive instruments consist of non-derivative financial instruments, none of which are entered into for trading purposes. During the normal course of business, we are not exposed to foreign exchange risk or commodity price risk. Our exposure to IRR can be explained as the potential for change in reported earnings and/or the market value of net worth. Variations in interest rates affect the underlying economic value of assets, liabilities and off-balance sheet items. These changes arise because the present value of future cash flows, and often the cash flows themselves, change with interest rates. The effects of the changes in these present values reflect the change in our underlying economic value, and provide a basis for the expected change in future earnings related to interest rates. Interest rate changes affect earnings by changing net interest income and the level of other interest-sensitive income and operating expenses. IRR is inherent in the role of banks as financial intermediaries.

A bank with a high degree of IRR may experience lower earnings, impaired liquidity and capital positions, and most likely, a greater risk of insolvency. Therefore, banks must carefully evaluate IRR to promote safety and soundness in their activities.

The projected impacts of instantaneous changes in interest rates on our net interest income and economic value of equity at March 31, 2017, based on our simulation model, as compared to our ALCO policy limits are summarized as follows:


	March 31, 2017
	% Change in
Changes in Interest Rates (basis points)	Net Interest Income		Economic Value of Equity
	Metric	Policy	Metric	Policy
+400	4.4	(20.0)	6.4	(40.0)
+300	3.7	(20.0)	5.6	(30.0)
+200	2.6	(10.0)	4.2	(20.0)
+100	1.5	(10.0)	3.3	(10.0)
Static
(100)	(5.0)	(10.0)	(9.4)	(10.0)

Our simulation model creates pro forma net interest income scenarios under various interest rate shocks. Given instantaneous and parallel shifts in general market rates of plus 100 basis points, our projected net interest income for the 12 months ending March 31, 2017, would increase at 1.5 percent from model results using current interest rates. Additional disclosures about market risk are included in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2016, under the heading “Market Risk Sensitivity,” and are incorporated into this Item 3 by reference. There were no material changes in our market risk from December 31, 2016.

Item 4. Controls and Procedures.

(a) Evaluation of disclosure controls and procedures.

At March 31, 2017, the end of the period covered by this Quarterly Report on Form 10-Q, the Chief Executive Officer (“CEO”) and Interim Principal Financial and Accounting Officer (“IPFAO”) evaluated the effectiveness of the Company’s disclosure controls and procedures as defined in Rule 13a-15(e) under the Exchange Act. Based upon that evaluation, the CEO and IPFAO concluded that the disclosure controls and procedures, at March 31, 2017, were effective to provide reasonable assurance that information required to be disclosed in the Company’s reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules

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and forms, and to provide reasonable assurance that information required to be disclosed in such reports is accumulated and communicated to the CEO and IPFAO to allow timely decisions regarding required disclosure.

(b) Changes in internal control.

There were no changes made in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

The nature of the Company’s business generates a certain amount of litigation involving matters arising out of the ordinary course of business. In the opinion of management, there were no legal proceedings that had or might have a material effect on the consolidated results of operations, liquidity, or the financial position of the Company during the three-months ended March 31, 2017 and through the date of this quarterly report on Form 10-Q.

Item 1A. Risk Factors.

There have been no material changes from the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

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

None.

Item 3. Defaults upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

None.

Item 6. Exhibits.


10.1	Peoples Security Bank and Trust Company Employee Stock Ownership Plan restated effective January 1, 2015, as amended.

31.1	Chief Executive Officer certification pursuant to Rule 13a-14(a)/15d-14(a).

31.2	Interim Principal Financial and Accounting Officer certification pursuant to Rule 13a-14(a)/15d-14(a).

32	Chief Executive Officer and Interim Principal Financial and Accounting Officer certifications pursuant to Section 1350.

101+	Interactive Data File

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+	As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.

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.

	Peoples Financial Services Corp.
	(Registrant)

Date: May 5, 2017	/s/ Craig W. Best
	Craig W. Best
	President and Chief Executive Officer
	(Principal Executive Officer)

Date: May 5, 2017	/s/ John R. Anderson, III
	John R. Anderson, III
	Interim Principal Financial and Accounting Officer
	(Interim Principal Financial Officer and Principal Accounting Officer)

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EXHIBIT INDEX

Item Number	Description	Page

10.1	Peoples Security Bank and Trust Company Employee Stock Ownership Plan restated effective January 1, 2015, as amended.

31.1	CEO Certification Pursuant to Rule 13a-14 (a) /15d-14 (a).	43

31.2	IPFAO Certification Pursuant to Rule 13a-14 (a) /15d-14 (a).	44

32	CEO and IPFAO Certifications Pursuant to Section 1350.	45

101	The following materials from Peoples Financial Services Corp. Quarterly Report on Form 10-Q for the period ended March 31, 2017, formatted in XBRL: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income and Comprehensive Income, (iii) the Consolidated Statements of Changes in Stockholders’ Equity, (iv) the Consolidated Statements of Cash Flows and (v) the Notes to the Consolidated Financial Statements.