Attached files

file filename
EXCEL - IDEA: XBRL DOCUMENT - FIRST KEYSTONE CORPFinancial_Report.xls
EX-31.2 - EXHIBIT 31.2 - FIRST KEYSTONE CORPv392153_ex31-2.htm
EX-32.2 - EXHIBIT 32.2 - FIRST KEYSTONE CORPv392153_ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - FIRST KEYSTONE CORPv392153_ex32-1.htm
EX-31.1 - EXHIBIT 31.1 - FIRST KEYSTONE CORPv392153_ex31-1.htm

 

UNITED STATES

 

SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

FORM 10Q

 

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

 

For the quarterly period ended September 30, 2014

 

or

 

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

 

For the transition period from ________ to ________

 

Commission File Number: 2-88927

 

FIRST KEYSTONE CORPORATION
(Exact name of registrant as specified in its charter)

 

Pennsylvania   23-2249083
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
     
111 West Front Street, Berwick, PA   18603
(Address of principal executive offices)   (Zip Code)

 

Registrant’s telephone number, including area code: (570) 752-3671

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x No ¨

 

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

  Large accelerated filer ¨ Accelerated filer x
  Non-accelerated filer ¨ Smaller reporting company ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes ¨ No x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date:

 

Common Stock, $2 Par Value, 5,555,318 shares as of November 4, 2014.

 

 
 

 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

(Dollars in thousands, except per share data)  September 30,   December 31, 
   2014   2013 
ASSETS          
Cash and due from banks  $7,677   $8,257 
Interest-bearing deposits in other banks   1,058    22,366 
Total cash and cash equivalents   8,735    30,623 
Investment securities available-for-sale   341,063    353,698 
Investment securities held-to-maturity (fair value 2014 - $1,065;  2013 - $1,083)   1,060    1,072 
Restricted investment in bank stocks   7,116    4,761 
Loans   485,261    446,518 
Allowance for loan losses   (6,490)   (6,519)
Net loans   478,771    439,999 
Premises and equipment, net   21,083    21,516 
Accrued interest receivable   3,405    3,616 
Cash surrender value of bank owned life insurance   21,070    20,556 
Investments in low-income housing partnerships   1,170    1,289 
Goodwill   19,133    19,133 
Core deposit intangible, net   190    395 
Foreclosed assets held for resale   217    480 
Deferred income taxes   56    2,080 
Other assets   2,616    2,296 
TOTAL ASSETS  $905,685   $901,514 
LIABILITIES          
Deposits:          
Non-interest bearing  $96,984   $85,156 
Interest bearing   559,115    604,919 
Total deposits   656,099    690,075 
Short-term borrowings   76,850    68,233 
Long-term borrowings   65,364    40,429 
Accrued interest payable   401    392 
Other liabilities   2,997    6,034 
TOTAL LIABILITIES   801,711    805,163 
STOCKHOLDERS’ EQUITY          
Preferred stock, par value $2.00 per share; authorized 1,000,000 shares in 2014 and 2013; issued 0 in 2014 and 2013        
Common stock, par value $2.00 per share; authorized 20,000,000 shares in 2014 and 2013; issued 5,790,467 in 2014 and 5,756,474 in 2013; outstanding 5,555,318 in 2014 and 5,521,325 in 2013   11,581    11,513 
Surplus   32,404    31,626 
Retained earnings   62,211    59,089 
Accumulated other comprehensive income (loss)   3,601    (54)
Treasury stock, at cost, 235,149 in 2014 and 2013   (5,823)   (5,823)
TOTAL STOCKHOLDERS’ EQUITY   103,974    96,351 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY  $905,685   $901,514 

 

See accompanying notes to consolidated financial statements.

 

1
 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013

(Unaudited)

 

(Dollars in thousands, except per share data)  Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2014   2013   2014   2013 
INTEREST INCOME                    
Interest and fees on loans  $5,258   $5,182   $15,284   $15,488 
Interest and dividend income on investment securities:                    
Taxable   1,912    1,670    5,920    4,944 
Tax-exempt   560    790    1,800    2,839 
Dividends   18    15    50    44 
Dividend income on restricted investment in bank stocks   67    10    169    18 
Interest on interest bearing deposits in other banks       1    1    3 
Total interest income   7,815    7,668    23,224    23,336 
INTEREST EXPENSE                    
Interest on deposits   684    920    2,241    2,716 
Interest on short-term borrowings   71    34    159    83 
Interest on long-term borrowings   325    293    913    923 
Total interest expense   1,080    1,247    3,313    3,722 
Net interest income   6,735    6,421    19,911    19,614 
Provision for loan losses   100    133    433    733 
Net interest income after provision for loan losses   6,635    6,288    19,478    18,881 
NON-INTEREST INCOME                    
Trust department   216    213    711    625 
Service charges and fees   460    353    1,171    1,030 
Bank owned life insurance income   165    171    514    518 
ATM fees and debit card income   284    258    833    744 
Gains on sales of mortgage loans   68    77    148    517 
Net investment securities gains   163    264    1,963    2,944 
Other   146    61    395    236 
Total non-interest income   1,502    1,397    5,735    6,614 
NON-INTEREST EXPENSE                    
Salaries and employee benefits   2,927    2,822    8,569    8,250 
Occupancy, net   384    368    1,279    1,145 
Furniture and equipment   130    131    437    491 
Computer expense   273    264    816    766 
Professional services   147    134    444    375 
Pennsylvania shares tax   159    204    476    612 
FDIC insurance   142    108    379    317 
ATM and debit card fees   155    129    446    384 
Data processing fees   102        298     
Foreclosed assets held for resale expense   4    45    126    19 
Advertising   139    108    447    279 
FHLB prepayment penalties               345 
Other   700    654    2,236    1,988 
Total non-interest expense   5,262    4,967    15,953    14,971 
Income before income tax expense   2,875    2,718    9,260    10,524 
Income tax expense   492    563    1,823    1,971 
NET INCOME  $2,383   $2,155   $7,437   $8,553 
PER SHARE DATA                    
Net income per share:                    
Basic  $0.43   $0.39   $1.34   $1.56 
Diluted   0.43    0.39    1.34    1.56 
Dividends per share   0.26    0.26    0.78    0.78 

See accompanying notes to consolidated financial statements.

 

2
 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

 

(Dollars in thousands)    
   Three Months Ended 
   September 30, 
   2014   2013 
         
Net Income  $2,383   $2,155 
           
Other comprehensive loss:          
Unrealized net holding losses on available-for-sale investment securities arising during the period, net of income taxes of $(100) and $(777), respectively   (174)   (1,540)
Less reclassification adjustment for net gains included in net income, net of income taxes of $(55) and $(90), respectively (a) (b)   (108)   (174)
Total other comprehensive loss   (282)   (1,714)
Total Comprehensive Income  $2,101   $441 

 

 

(a) Gross amounts are included in net investment securities gains on the Consolidated Statements of Income in non-interest income.

(b) Income tax amounts are included in income tax expense on the Consolidated Statements of Income.

 

(Dollars in thousands)    
   Nine Months Ended 
   September 30, 
   2014   2013 
         
Net Income  $7,437   $8,553 
           
Other comprehensive income (loss):          
Unrealized net holding gains (losses) on available-for-sale investment securities arising during the period, net of income taxes of $2,538 and $(4,567), respectively   4,951    (8,945)
Less reclassification adjustment for net gains included in net income, net of income taxes of $(667) and $(1,001), respectively (a) (b)   (1,296)   (1,943)
Total other comprehensive income (loss)   3,655    (10,888)
Total Comprehensive Income (Loss)  $11,092   $(2,335)

 

 

(a) Gross amounts are included in net investment securities gains on the Consolidated Statements of Income in non-interest income.

(b) Income tax amounts are included in income tax expense on the Consolidated Statements of Income.

 

See accompanying notes to consolidated financial statements.

 

3
 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013

(Unaudited)

 

(Dollars in thousands, except per share data)                   
                   Accumulated         
                   Other       Total 
   Common Stock       Retained   Comprehensive   Treasury   Stockholders’ 
   Shares   Amount   Surplus   Earnings   Income (Loss)   Stock   Equity 
Balance at January 1, 2014   5,756,474   $11,513   $31,626   $59,089   $(54)  $(5,823)  $96,351 
Net Income                  7,437              7,437 
Other comprehensive income, net of taxes                       3,655         3,655 
Issuance of common stock under dividend reinvestment plan   33,993    68    778                   846 
Dividends - $0.78 per share                  (4,315)             (4,315)
Balance at September 30, 2014   5,790,467   $11,581   $32,404   $62,211   $3,601   $(5,823)  $103,974 
                                    
Balance at January 1, 2013   5,717,400   $11,435   $30,725   $54,532   $12,528   $(5,890)  $103,330 
Net Income                  8,553              8,553 
Other comprehensive loss, net of taxes                       (10,888)        (10,888)
Issuance of common stock under dividend reinvestment plan   28,988    58    672              51    781 
Dividends - $0.78 per share                  (4,283)             (4,283)
Balance at September 30, 2013   5,746,388   $11,493   $31,397   $58,802   $1,640   $(5,839)  $97,493 

 

See accompanying notes to consolidated financial statements.

 

4
 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013

(Unaudited)

(Dollars in thousands)        
   2014   2013 
OPERATING ACTIVITIES          
Net income  $7,437   $8,553 
Adjustments to reconcile net income to net cash provided by operating activities:         
Provision for loan losses   433    733 
Depreciation and amortization   1,213    1,129 
Net premium amortization on investment securities   1,207    1,333 
Deferred income tax expense (benefit)   155    (274)
Gains on sales of mortgage loans   (148)   (517)
Proceeds from sales of mortgage loans originated for resale   6,000    22,737 
Originations of mortgage loans originated for resale   (8,077)   (22,576)
Gains on sales of investment securities   (1,963)   (2,944)
Losses (gains) on sales of foreclosed real estate held for resale, including write-downs   36    (70)
Decrease in accrued interest receivable   211    192 
Earnings on investment in bank owned life insurance   (514)   (518)
Losses on disposals of premises and equipment       138 
(Increase) decrease in other assets   (300)   1,058 
Increase in accrued interest payable   9    609 
Decrease in other liabilities   (3,041)   (239)
NET CASH PROVIDED BY OPERATING ACTIVITIES   2,658    9,344 
           
INVESTING ACTIVITIES          
Proceeds from sales of investment securities available-for-sale   138,218    56,944 
Proceeds from maturities and redemptions of investment securities available-for-sale   31,087    30,215 
Purchases of investment securities available-for-sale   (150,390)   (120,964)
Proceeds from maturities and redemptions of investment securities held-to-maturity   12    1,012 
Net change in restricted investment in bank stocks   (2,355)   1,403 
Net increase in loans   (37,178)   (13,251)
Purchases of premises and equipment   (516)   (2,540)
Proceeds from sales of foreclosed assets held for resale   489    468 
NET CASH USED IN INVESTING ACTIVITIES   (20,633)   (46,713)
           
FINANCING ACTIVITIES          
Net (decrease) increase in deposits   (33,976)   57,249 
Net increase (decrease) in short-term borrowings   8,617    (30,516)
Proceeds from long-term borrowings   30,000    10,000 
Repayment of long-term borrowings   (5,065)   (7,067)
Common stock issued   826    722 
Proceeds from issuance of treasury stock       33 
Dividends paid   (4,315)   (4,283)
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES   (3,913)   26,138 
           
DECREASE IN CASH AND CASH EQUIVALENTS   (21,888)   (11,231)
CASH AND CASH EQUIVALENTS, BEGINNING   30,623    20,920 
CASH AND CASH EQUIVALENTS, ENDING  $8,735   $9,689 
           
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION          
Interest paid  $3,304   $3,819 
Income taxes paid   1,755    968 
Loans transferred to foreclosed assets held for resale   262    420 

 

See accompanying notes to consolidated financial statements.

 

5
 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 1 ― BASIS OF PRESENTATION AND ACCOUNTING POLICIES

 

The consolidated financial statements include the accounts of First Keystone Corporation (the “Corporation”) and its wholly owned subsidiary, First Keystone Community Bank (the “Bank”). All significant intercompany accounts and transactions have been eliminated.

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete consolidated financial statements. In the opinion of management, all adjustments considered necessary for fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2014, are not necessarily indicative of the results for the year ending December 31, 2014. For further information, refer to the consolidated financial statements and notes thereto included in First Keystone Corporation’s Annual Report on Form 10-K for the year ended December 31, 2013.

 

For comparative purposes, the September 30, 2013 and December 31, 2013 balances have been reclassified to conform to the 2014 presentation. Such reclassifications had no impact on net income.

 

The Corporation has evaluated events and transactions occurring subsequent to the consolidated balance sheet date of September 30, 2014 for items that should potentially be recognized or disclosed in these consolidated financial statements. The evaluation was conducted through the date these consolidated financial statements were issued.

 

NOTE 2 ― RECENT ACCOUNTING STANDARDS UPDATES (“ASU”)

 

Except as disclosed below, there were no new accounting pronouncements affecting the Corporation during the three and nine months ended September 30, 2014 that were not already adopted by the Corporation in previous periods.

 

In January 2014, the Financial Accounting Standards Board (“FASB”) issued ASU 2014-01, Investments – Equity Method and Joint Ventures (Topic 323). The ASU provides guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for the low-income housing tax credit. This ASU is effective for annual periods and interim reporting periods within those annual periods beginning after December 15, 2014, and will be applied retrospectively to all periods presented. The Corporation is currently evaluating the impact of this ASU on its consolidated financial statements.

 

In January 2014, the FASB issued ASU 2014-04, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40). The ASU clarifies that a creditor is considered to have physical possession of residential real estate that is collateral for a residential mortgage loan when it obtains legal title to the collateral or a deed in lieu of foreclosure or similar legal agreement is completed. Consequently, the creditor should reclassify the loan to other real estate owned at that time. The new guidance is intended to resolve the diversity in current practice as to when a creditor should reclassify a loan to other real estate on the balance sheet. This ASU is effective for annual periods beginning after December 15, 2014, and interim periods within those annual periods after December 15, 2015. The Corporation is currently evaluating the impact of this ASU on its consolidated financial statements.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes the revenue requirements in Revenue Recognition (Topic 605). This ASU requires entities to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. The ASU is effective is effective for annual reporting periods beginning after December 31, 2016, including interim periods within the reporting period. Early application is not permitted. The Corporation is currently evaluating the impact of this ASU on its consolidated financial statements.

 

6
 

 

In September 2014, the FASB issued ASU No. 2014-11, Transfers and Servicing (Topic 860). The ASU provides guidance on accounting for repurchase-to-maturity transactions and certain linked repurchase financings. This guidance will result in accounting for both types of arrangements as secured borrowings on the balance sheet. Additionally, the ASU introduces new disclosures to (i) increase transparency about the types of collateral pledged in secured borrowing transactions and (ii) enable users to better understand transactions in which the transferor retains substantially all of the exposure to the economic return on the transferred financial asset throughout the term of the transaction. This ASU is effective for annual periods beginning after December 15, 2014, and for interim periods beginning after March 15, 2015. The Corporation is currently evaluating the impact of this ASU on its consolidated financial statements.

 

In August 2014, the FASB issued ASU 2014-14, Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure. The ASU addresses the classification of certain foreclosed mortgage loans held by creditors that are either fully or partially guaranteed under government programs, whereby creditors will reclassify these loans to “other receivables” upon foreclosure. The ASU is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The Corporation is currently evaluating the impact of this ASU on its consolidated financial statements.

 

NOTE 3INVESTMENT SECURITIES

 

The Corporation classifies its investment securities as either “Held-to-Maturity” or “Available-for-Sale” at the time of purchase. Investment securities are accounted for on a trade date basis. Debt securities are classified as Held-to-Maturity when the Corporation has the ability and positive intent to hold the securities to maturity. Investment securities classified as Held-to-Maturity are carried at cost adjusted for amortization of premium and accretion of discount to maturity.

 

Debt securities not classified as Held-to-Maturity and equity securities are included in the Available-for-Sale category and are carried at fair value. The amount of any unrealized gain or loss, net of the effect of deferred income taxes, is reported as accumulated other comprehensive income (loss) in the Consolidated Balance Sheets and Consolidated Statements of Changes in Stockholders’ Equity. Management’s decision to sell Available-for-Sale securities is based on changes in economic conditions controlling the sources and applications of funds, terms, availability of and yield of alternative investments, interest rate risk and the need for liquidity.

 

The cost of debt securities classified as Held-to-Maturity or Available-for-Sale is adjusted for amortization of premiums and accretion of discounts to expected maturity. Such amortization and accretion, as well as interest and dividends, are included in interest and dividend income from investment securities. Realized gains and losses are included in net investment securities gains and losses. The cost of investment securities sold, redeemed or matured is based on the specific identification method.

 

The amortized cost, related estimated fair value, and unrealized gains and losses for investment securities classified as “Available-For-Sale” or “Held-to-Maturity” were as follows at September 30, 2014 and December 31, 2013:

 

   Available-for-Sale Securities 
(Dollars in thousands)      Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
September 30, 2014:  Cost   Gains   Losses   Value 
U.S. Treasury securities  $11,351   $   $(56)  $11,295 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed   150,485    753    (749)   150,489 
Other   17,122    285        17,407 
Obligations of state and political subdivisions   118,568    5,734    (676)   123,626 
Corporate debt securities   36,461    173    (788)   35,846 
Marketable equity securities   1,533    887    (20)   2,400 
Total  $335,520   $7,832   $(2,289)  $341,063 

 

7
 

 

   Held-to-Maturity Securities 
(Dollars in thousands)      Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
September 30, 2014:  Cost   Gains   Losses   Value 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed  $60   $1   $   $61 
Other   1,000    4        1,004 
Total  $1,060   $5   $   $1,065 

 

   Available-for-Sale Securities 
(Dollars in thousands)      Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
December 31, 2013:  Cost   Gains   Losses   Value 
U.S. Treasury securities  $   $   $   $ 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed   122,661    598    (2,035)   121,224 
Other   32,107    238    (60)   32,285 
Obligations of state and political subdivisions   147,112    4,136    (2,859)   148,389 
Corporate debt securities   50,266    416    (1,417)   49,265 
Marketable equity securities   1,533    1,004    (2)   2,535 
Total  $353,679   $6,392   $(6,373)  $353,698 

 

   Held-to-Maturity Securities 
(Dollars in thousands)      Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
December 31, 2013:  Cost   Gains   Losses   Value 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed  $72   $3   $   $75 
Other   1,000    8        1,008 
Total  $1,072   $11   $   $1,083 

 

Securities Available-for-Sale with an aggregate fair value of $217,744,000 at September 30, 2014 and $242,839,000 at December 31, 2013, and securities Held-to-Maturity with an aggregate book value of $1,060,000 at September 30, 2014 and $1,072,000 at December 31, 2013, were pledged to secure public funds, trust funds, securities sold under agreements to repurchase, FHLB advances and other balances of $168,052,000 at September 30, 2014 and $178,814,000 at December 31, 2013.

 

8
 

 

The amortized cost, estimated fair value and weighted average yield of debt and equity securities, by contractual maturity, are shown below at September 30, 2014. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

(Dollars in thousands)

 

   September 30, 2014 
   Available-For-Sale   Held-To-Maturity 
       U.S. Government   Obligations           U.S. Government 
       Corporations &   of State   Corporate   Marketable   Corporations & 
   U.S. Treasury   Agencies   & Political   Debt   Equity   Agencies 
   Securities   Obligations1   Subdivisions2   Securities   Securities3   Obligations1 
Within 1 Year:                              
Amortized cost  $   $   $2,004   $3,525   $   $ 
Fair value           2,042    3,568         
Weighted average yield           3.74%   3.03%        
                               
1 - 5 Years:                              
Amortized cost   11,351        8,860    2,591        1,060 
Fair value   11,295        9,246    2,653        1,065 
Weighted average yield   1.50%       4.03%   1.98%       0.84%
                               
5 - 10 Years:                              
Amortized cost       2,115    42,806    30,345         
Fair value       2,190    43,317    29,625         
Weighted average yield       2.94%   3.62%   2.55%        
                               
After 10 Years:                              
Amortized cost       165,492    64,898        1,533     
Fair value       165,706    69,021        2,400     
Weighted average yield       2.41%   6.03%       4.35%    
                               
Total:                              
Amortized cost  $11,351   $167,607   $118,568   $36,461   $1,533   $1,060 
Fair value   11,295    167,896    123,626    35,846    2,400    1,065 
Weighted average yield   1.50%   2.42%   4.97%   2.56%   4.35%   0.84%

 

 

1Mortgage-backed securities are allocated for maturity reporting at their original maturity date.

2Average yields on tax-exempt obligations of state and political subdivisions have been computed on a tax-equivalent basis using a 34% tax rate.

3Marketable equity securities are not considered to have defined maturities and are included in the after ten year category.

 

9
 

 

There were no aggregate investments with a single issuer (excluding the U.S. Government and its agencies) which exceeded ten percent of consolidated stockholders’ equity at September 30, 2014. The quality rating of the obligations of state and political subdivisions are generally investment grade, as rated by Moody’s, Standard and Poor’s or Fitch. The typical exceptions are local issues which are not rated, but are secured by the full faith and credit obligations of the communities that issued these securities.

 

Proceeds from sales of investments in Available-for-Sale debt and equity securities for the three months ended September 30, 2014 and 2013 were $18,016,000 and $29,133,000, respectively. Gross gains realized on these sales were $235,000 and $333,000, respectively. Gross losses on these sales were $72,000 and $69,000, respectively. There were no other-than-temporary impairment losses during the three months ended September 30, 2014 or 2013.

 

Proceeds from sales of investments in Available-for-Sale debt and equity securities for the nine months ended September 30, 2014 and 2013 were $138,218,000 and $56,944,000, respectively. Gross gains realized on these sales were $2,557,000 and $3,159,000, respectively. Gross losses on these sales were $594,000 and $215,000, respectively. There were no other-than-temporary impairment losses during the nine months ended September 30, 2014 or 2013.

 

There were no proceeds from sales of investments in Held-to-Maturity debt and equity securities during the three or nine month periods ended September 30, 2014 or 2013. Therefore, there were no gains or losses realized during these periods.

 

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. Investment securities classified as available-for-sale or held-to-maturity are generally evaluated for OTTI under FASB ASC 320, Investments - Debt and Equity Securities. In determining OTTI under the FASB ASC 320 model, management considers many factors, including (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

 

When other-than-temporary impairment occurs on debt securities, the amount of the other-than-temporary impairment recognized in earnings depends on whether an entity intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss. If an entity intends to sell or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the other-than-temporary impairment shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the other-than-temporary impairment shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is determined based on the present value of cash flows expected to be collected, and the realized loss is recognized in net investment securities gains on the Consolidated Statements of Income. The amount of the total other-than-temporary impairment related to the other factors shall be recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the other-than-temporary impairment recognized in earnings shall become the new amortized cost basis of the investment.

 

The fair market value of the equity securities tends to fluctuate with the overall equity markets as well as the trends specific to each institution. The equity securities portfolio is reviewed in a similar manner as that of the debt securities with greater emphasis placed on the length of time the market value has been less than the carrying value and the financial sector outlook. The Corporation also reviews dividend payment activities, levels of non-performing assets and loan loss reserves. The starting point for the equity analysis is the length and severity of market value decline. The realized loss is recognized in net investment securities gains on the Consolidated Statements of Income. The amount of the total other-than-temporary impairment is recognized in other comprehensive income, net of applicable taxes.

 

The Corporation and its investment advisors monitor the entire portfolio monthly with particular attention given to securities in a continuous loss position of at least ten percent for over twelve months. Based on the factors described above, management did not consider any securities to be other-than-temporarily impaired at September 30, 2014 and December 31, 2013.

 

10
 

 

In accordance with disclosures required by FASB ASC 320-10-50, Investments - Debt and Equity Securities, the summary below shows the gross unrealized losses and fair value of the Corporation’s investments, aggregated by investment category, that individual securities have been in a continuous unrealized loss position for less than 12 months or 12 months or more as of September 30, 2014 and December 31, 2013:

 

September 30, 2014

 

(Dollars in thousands)  Less Than 12 Months   12 Months or More   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
Available-for-Sale:  Value   Loss   Value   Loss   Value   Loss 
U.S. Treasury securities  $11,295   $(56)  $   $   $11,295   $(56)
Obligations of U.S. Government                              
Corporations and Agencies:                              
Mortgage-backed   54,841    (156)   22,169    (593)   77,010    (749)
Other                        
Obligations of state and political subdivisions   227        21,973    (676)   22,200    (676)
Corporate debt securities   14,778    (472)   13,286    (316)   28,064    (788)
Marketable equity securities   30    (20)           30    (20)
   $81,171   $(704)  $57,428   $(1,585)  $138,599   $(2,289)

 

December 31, 2013

 

(Dollars in thousands)  Less Than 12 Months   12 Months or More   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
Available-for-Sale:  Value   Loss   Value   Loss   Value   Loss 
U.S. Treasury securities  $   $   $   $   $   $ 
Obligations of U.S. Government                              
Corporations and Agencies:                              
Mortgage-backed   98,760    (2,035)           98,760    (2,035)
Other   4,956    (60)           4,956    (60)
Obligations of state and political subdivisions   48,853    (2,859)           48,853    (2,859)
Corporate debt securities   26,099    (1,417)           26,099    (1,417)
Marketable equity securities   21    (2)           21    (2)
   $178,689   $(6,373)  $   $   $178,689   $(6,373)

 

The Corporation invests in various forms of agency debt including mortgage backed securities and callable debt. The mortgage-backed securities are issued by FHLMC (“Federal Home Loan Mortgage Corporation”), FNMA (“Federal National Mortgage Association”) or GNMA (“Government National Mortgage Association”). The municipal securities consist of general obligations and revenue bonds. The marketable equity securities consist of stocks in other bank holding companies. The fair market value of the above securities is influenced by market interest rates, prepayment speeds on mortgage securities, bid offer spreads in the market place and credit premiums for various types of agency debt. These factors change continuously and therefore the market value of these securities may be higher or lower than the Corporation’s carrying value at any measurement date. Management does not believe any of their 55 debt securities in an unrealized loss position as of September 30, 2014 represents an other-than-temporary impairment, as these unrealized losses relate principally to changes in interest rates subsequent to the acquisition of the specific securities.

 

NOTE 4LOANS AND ALLOWANCE FOR LOAN LOSSES

 

Loans are stated at their outstanding unpaid principal balances, net of deferred fees or costs, unearned income and the allowance for loan losses. Interest on loans is recognized as income over the term of each loan, generally, by the accrual method. Loan origination fees and certain direct loan origination costs have been deferred with the net amount amortized using the straight line method or the interest method over the contractual life of the related loans as an interest yield adjustment.

 

11
 

 

Residential mortgage loans held for resale are carried at the lower of cost or market on an aggregate basis determined by independent pricing from appropriate federal or state agency investors. These loans are sold without recourse.

 

Past-Due Loans — Generally, a loan is considered to be past-due when scheduled loan payments are in arrears 15 days or more. Delinquent notices are generated automatically when a loan is 15 days past-due. Collection efforts continue on past-due loans that have not been brought current, when it is believed that some chance exists for improvement in the status of the loan. Past-due loans are continually evaluated with the determination for charge-off being made when no reasonable chance remains that the status of the loan can be improved.

 

Charge-Offs Commercial Real Estate and Commercial and Industrial loans are charged off in whole or in part when they become sufficiently delinquent based upon the terms of the underlying loan contract and when a collateral deficiency exists. Because all or part of the contractual cash flows are not expected to be collected, the loan is considered to be impaired, and the Bank estimates the impairment based on its analysis of the cash flows and collateral estimated at fair value less cost to sell.

 

Residential Real Estate and Consumer loans are charged off when they become sufficiently delinquent based upon the terms of the underlying loan contract and when the value of the underlying collateral is not sufficient to support the loan balance and a loss is expected. At that time, the amount of estimated collateral deficiency, if any, is charged off for loans secured by collateral, and all other loans are charged off in full. Loans with collateral are charged down to the estimated fair value of the collateral less cost to sell.

 

Loans in which the borrower is in bankruptcy are considered on a case by case basis and are either charged off or reaffirmed by the borrower.

 

Non-Accrual Loans — Generally, a loan is classified as non-accrual and the accrual of interest on such a loan is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan may currently be performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on non-accrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against interest income. Certain non-accrual loans may continue to perform; that is, payments are still being received. Generally, the payments are applied to principal. These loans remain under constant scrutiny, and if performance continues, interest income may be recorded on a cash basis based on management's judgment as to collectability of principal.

 

Impaired Loans — A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the original loan agreement. Under current accounting standards, the allowance for loan losses related to impaired loans is based on discounted cash flows using the loan’s effective interest rate or the fair value of the collateral for certain collateral dependent loans.

 

Troubled Debt Restructurings (“TDRs”) — The restructuring of a loan is considered a “troubled debt restructuring” if both the following conditions are met: (i) the borrower is experiencing financial difficulties, and (ii) the Bank has granted a concession. The most common concessions granted include one or more modifications to the terms of the debt, such as (a) a reduction in the interest rate for the remaining life of the debt, (b) an extension of the maturity date at an interest rate lower than the current market rate for new debt with similar risk, (c) a temporary period of interest-only payments, and (d) a reduction in the contractual payment amount for either a short period or remaining term of the loan. A less common concession is the forgiveness of a portion of the principal.

 

The determination of whether a borrower is experiencing financial difficulties takes into account not only the current financial condition of the borrower, but also the potential financial condition of the borrower were a concession not granted. Similarly, the determination of whether a concession has been granted is very subjective in nature. For example, simply extending the term of a loan at its original interest rate or even at a higher interest rate could be interpreted as a concession unless the borrower could readily obtain similar credit terms from a different lender.

 

Loans modified in a troubled debt restructuring may or may not be placed on non-accrual status until the Bank determines the future collection of principal and interest is reasonably assured, which generally requires that the borrower demonstrates a period of performance according to the restructured terms of six months. Loans classified as troubled debt restructurings are designated as impaired.

 

12
 

 

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

 

The allowance for loan losses is maintained at a level estimated by management to be adequate to absorb potential loan losses. Management’s periodic evaluation of the adequacy of the allowance for loan losses is based on the Corporation’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions, and other relevant factors. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change.

 

The Corporation is subject to periodic examination by its federal and state examiners, and may be required by such regulators to recognize additions to the allowance for loan losses based on their assessment of credit information available to them at the time of their examinations.

 

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are individually classified as impaired. Select loans are not aggregated for collective impairment evaluation, as such; all loans are subject to individual impairment evaluation should the facts and circumstances pertinent to a particular loan suggest that such evaluation is necessary. Factors considered by management in determining impairment include payment status and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. If a loan is impaired, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from collateral. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loans may be reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Corporation determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.

 

The general component covers all other loans not identified as impaired and is based on historical losses adjusted for current factors. The historical loss component of the allowance is determined by losses recognized by portfolio segment over the preceding eight quarters. In calculating the historical component of our allowance, loans are aggregated into one of four portfolio segments: Commercial and Industrial, Commercial Real Estate, Residential Real Estate and Consumer. Risk factors impacting loans in each of the portfolio segments include broad deterioration of property values, reduced consumer and business spending as a result of continued high unemployment and reduced credit availability and lack of confidence in a sustainable recovery. Actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: the concentration of special mention, substandard and doubtful loans as a percentage of total loans, levels of loan concentration within the portfolio segment or division of a portfolio segment, broad economic conditions, delinquency trends, volume trends and terms, and policy and management changes.

 

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

 

The Bank utilizes a risk grading matrix as a tool for managing credit risk in the loan portfolio and assigns an asset quality rating (risk grade) to all retail Residential Real Estate and retail Consumer, Commercial and Industrial, and Commercial Real Estate borrowings. An asset quality rating is assigned using the guidance provided in the Bank’s loan policy. Primary responsibility for assigning the asset quality rating rests with the lender. The asset quality rating is validated periodically by both an internal and external loan review process.

 

The commercial loan grading system focuses on a borrower’s financial strength and performance, experience and depth of management, primary and secondary sources of repayment, the nature of the business and the outlook for the particular industry. Primary emphasis will be on the financial condition and trends. The grade also reflects current economic and industry conditions; as well as other variables such as liquidity, cash flow, revenue/earnings trends, management strengths or weaknesses, quality of financial information, and credit history.

 

13
 

 

The retail loan grading system for Residential Real Estate and Consumer loans focuses on the borrower’s credit score and credit history, debt-to-income ratio and income sources, collateral position and loan-to-value ratio, as well as other variables such as current economic conditions, and individual strengths and weaknesses.

 

Risk grade characteristics are as follows:

 

Risk Grade 1 – MINIMAL RISK through Risk Grade 6 – MANAGEMENT ATTENTION (Pass Grade Categories)

 

Risk is evaluated via examination of several attributes including but not limited to financial trends, strengths and weaknesses, likelihood of repayment when considering both cash flow and collateral, sources of repayment, leverage position, management expertise, and repayment history.

 

At the low-risk end of the rating scale, a risk grade of 1 - Minimal Risk is the grade reserved for loans with exceptional credit fundamentals and virtually no risk of default or loss. Loan grades then progress through escalating ratings of 2 through 6 based upon risk. Risk Grade 2 - Modest Risk are loans with sufficient cash flows; Risk Grade 3 - Average Risk are loans with key balance sheet ratios slightly above the borrower’s peers; Risk Grade 4 - Acceptable Risk are loans with key balance sheet ratios usually near the borrower’s peers, but one or more ratios may be higher; and Risk Grade 5 – Marginally Acceptable are loans with strained cash flow, increasing leverage and/or weakening markets. Risk Grade 6 - Management Attention are loans with weaknesses resulting from declining performance trends and the borrower’s cash flows may be temporarily strained. Loans in this category are performing according to terms, but present some type of potential concern.

 

Risk Grade 7 − SPECIAL MENTION (Non-Pass Category)

 

Generally, these loans or assets are currently protected, but are “Potentially Weak”. They constitute an undue and unwarranted credit risk but not to the point of justifying a classification of substandard.

 

Assets in this category are currently protected but have potential weakness which may, if not checked or corrected, weaken the asset or inadequately protect the Bank’s credit position at some future date. No loss of principal or interest is envisioned; however, they constitute an undue credit risk that may be minor but is unwarranted in light of the circumstances surrounding a specific asset. Risk is increasing beyond that at which the loan originally would have been granted. Historically, cash flows are inconsistent; financial trends show some deterioration. Liquidity and leverage are above industry averages. Financial information could be incomplete or inadequate. A Special Mention asset has potential weaknesses that deserve management’s close attention.

 

Risk Grade 8 − SUBSTANDARD (Non-Pass Category)

 

Generally, these assets are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have “well-defined” weaknesses that jeopardize the full liquidation of the debt.

 

They are characterized by the distinct possibility that the Bank will sustain some loss if the aggregate amount of substandard assets is not fully covered by the liquidation of the collateral used as security. Substandard loans are inadequately protected by current sound net worth, paying capacity of the borrower, or pledged collateral, and have a high probability of payment default, or they have other well-defined weaknesses. Such assets require more intensive supervision by Bank Management.

 

Risk Grade 9 − DOUBTFUL (Non-Pass Category)

 

Generally, loans graded doubtful have all the weaknesses inherent in a substandard loan with the added factor that the weaknesses are pronounced to a point where the basis of current information, conditions, and values, collection or liquidation in full is highly improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors that may work to strengthen the asset, its classification is deferred until, for example, a proposed merger, acquisition, liquidation procedures, capital injection, perfection of liens on additional collateral and/or refinancing plans are completed. Loans are graded doubtful if they contain weaknesses so serious that collection or liquidation in full is questionable.

 

14
 

 

The credit quality indicators by loan segment are summarized below at September 30, 2014 and December 31, 2013:

 

   Commercial and     
(Dollars in thousands)  Industrial   Commercial Real Estate 
   September 30,   December 31,   September 30,   December 31, 
   2014   2013   2014   2013 
Grade:                    
1-6   Pass  $69,132   $60,614   $235,466   $219,925 
7      Special Mention   56    65    8,278    1,717 
8      Substandard   31    21    5,608    3,782 
9      Doubtful                
Add (deduct): Unearned discount and                
Net deferred loan fees and costs   141    122    21    (19)
Total loans  $69,360   $60,822   $249,373   $225,405 

 

   Residential Real Estate         
   Including Home Equity   Consumer Loans 
   September 30,   December 31,   September 30,   December 31, 
   2014   2013   2014   2013 
Grade:                    
1-6   Pass  $159,379   $153,292   $5,072   $5,612 
7      Special Mention   525    180    21    2 
8      Substandard   1,199    931    11     
9      Doubtful           10     
Add (deduct): Unearned discount and           (57)   (87)
Net deferred loan fees and costs   278    272    90    89 
Total loans  $161,381   $154,675   $5,147   $5,616 

 

   Total Loans 
   September 30,   December 31, 
   2014   2013 
Grade:          
1-6   Pass  $469,049   $439,443 
7      Special Mention   8,880    1,964 
8      Substandard   6,849    4,734 
9      Doubtful   10     
Add (deduct): Unearned discount and   (57)   (87)
Net deferred loan fees and costs   530    464 
Total loans  $485,261   $446,518 

 

Commercial and Industrial and Commercial Real Estate include loans categorized as tax free loans in the amounts of $33,754,000 and $3,296,000 at September 30, 2014 and $27,299,000 and $3,945,000 at December 31, 2013, respectively. Loans held for sale amounted to $2,216,000 at September 30, 2014 and $0 at December 31, 2013.

 

15
 

 

The activity in the allowance for loan losses, by loan segment, is summarized below for the periods indicated.

 

As of and for the three month period ended September 30, 2014:

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
Allowance for Loan Losses:                              
Beginning balance  $743   $3,450   $1,619   $51   $614   $6,477 
Charge-offs   (100)       (6)   (21)       (127)
Recoveries   3    34    1    2        40 
Provision   (123)   (108)   262    89    (20)   100 
Ending Balance  $523   $3,376   $1,876   $121   $594   $6,490 

 

As of and for the nine month period ended September 30, 2014:

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
Allowance for Loan Losses:                              
Beginning balance  $776   $3,320   $1,565   $53   $805   $6,519 
Charge-offs   (107)   (237)   (180)   (36)       (560)
Recoveries   24    59    12    3        98 
Provision   (170)   234    479    101    (211)   433 
Ending Balance  $523   $3,376   $1,876   $121   $594   $6,490 
Ending balance: individually                              
evaluated for impairment  $   $28   $17   $   $   $45 
Ending balance: collectively                              
evaluated for impairment  $523   $3,348   $1,859   $121   $594   $6,445 
                               
Financing Receivables:                              
Ending Balance  $69,360   $249,373   $161,381   $5,147   $   $485,261 
Ending balance: individually                              
evaluated for impairment  $340   $5,573   $1,173   $6   $   $7,092 
Ending balance: collectively                              
evaluated for impairment  $69,020   $243,800   $160,208   $5,141   $   $478,169 

 

16
 

 

As of and for the three month period ended September 30, 2013:

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
Allowance for Loan Losses:                              
Beginning balance  $700   $2,835   $1,447   $76   $872   $5,930 
Charge-offs   (12)       (50)   (8)       (70)
Recoveries           1    6        7 
Provision   109    3    165        (144)   133 
Ending Balance  $797   $2,838   $1,563   $74   $728   $6,000 

 

As of and for the nine month period ended September 30, 2013:

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
Allowance for Loan Losses:                              
Beginning balance  $573   $2,837   $1,524   $80   $758   $5,772 
Charge-offs   (12)   (175)   (321)   (30)       (538)
Recoveries   19        5    9        33 
Provision   217    176    355    15    (30)   733 
Ending Balance  $797   $2,838   $1,563   $74   $728   $6,000 
Ending balance: individually                              
evaluated for impairment  $   $177   $15   $   $   $192 
Ending balance: collectively                              
evaluated for impairment  $797   $2,661   $1,548   $74   $728   $5,808 
                               
Financing Receivables:                              
Ending Balance  $62,249   $225,486   $152,045   $5,872   $   $445,652 
Ending balance: individually                              
evaluated for impairment  $24   $5,282   $888   $   $   $6,194 
Ending balance: collectively                              
evaluated for impairment  $62,225   $220,204   $151,157   $5,872   $   $439,458 

 

As of December 31, 2013:

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
Allowance for Loan Losses:                              
Ending Balance  $776   $3,320   $1,565   $53   $805   $6,519 
Ending balance: individually                              
evaluated for impairment  $   $125   $15   $   $   $140 
Ending balance: collectively                              
evaluated for impairment  $776   $3,195   $1,550   $53   $805   $6,379 
                               
Financing Receivables:                              
Ending Balance  $60,822   $225,405   $154,675   $5,616   $   $446,518 
Ending balance: individually                              
evaluated for impairment  $21   $5,022   $931   $   $   $5,974 
Ending balance: collectively                              
evaluated for impairment  $60,801   $220,383   $153,744   $5,616   $   $440,544 

 

From time to time, the Bank may agree to modify the contractual terms of a borrower’s loan. In cases where the modifications represent a concession to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring (“TDR”).

 

17
 

 

The outstanding balance of TDRs as of September 30, 2014 and December 31, 2013 was $4,698,000 and $3,961,000, respectively. The increase in TDRs was attributable to deterioration in the respective borrowers’ financial position, and in some cases a declining collateral value, along with the Bank’s proactive monitoring of the loan portfolio. As of September 30, 2014 and December 31, 2013, there were no unfunded commitments on any TDRs.

 

During the three months ended September 30, 2014, four loans with a combined post modification balance of $888,000 were classified as TDRs, as compared to the same period in 2013, when three loans with a combined post modification balance of $811,000 were classified as TDRs. The loan modifications for the three months ended September 30, 2014 consisted of one term modification and three payment modifications. The loan modifications for the three months ended September 30, 2013 consisted of one interest rate modification, one term modification, and one payment modification.

 

During the nine months ended September 30, 2014, thirteen loans with a combined post modification balance of $1,810,000 were classified as TDRs, as compared to the same period in 2013, when twelve loans with a combined post modification balance of $4,305,000 were classified as TDRs. The loan modifications for the nine months ended September 30, 2014 consisted of one interest rate modification, four term modifications, and eight payment modifications. The loan modifications for the nine months ended September 30, 2013 consisted of three interest rate modifications, two term modifications, and seven payment modifications.

 

The following table presents the unpaid balance of TDRs at the dates indicated:

 

(Dollars in thousands)

   September 30,   December 31, 
   2014   2013 
Non-accrual TDRs  $1,641   $1,538 
Accruing TDRs   3,057    2,423 
Total  $4,698   $3,961 

 

At September 30, 2014, four Commercial Real Estate loans classified as TDRs with a combined recorded investment of $1,573,000 were not in compliance with the terms of their restructure, compared to September 30, 2013 when four Commercial Real Estate loans classified as TDRs with a combined recorded investment of $1,735,000 were not in compliance with the terms of their restructure.

 

The following table presents information regarding the loan modifications categorized as TDRs during the three and nine months ended September 30, 2014 and September 30, 2013:

 

(Dollars in thousands, except number of contracts)

 

   Three Months Ended September 30, 2014 
      Pre-Modification   Post-Modification     
   Number   Outstanding Recorded   Outstanding Recorded   Recorded 
   of Contracts   Investment   Investment   Investment 
Commercial and Industrial       $    $   $  
Commercial Real Estate   4    801    888    887 
Consumer                
Total   4   $801   $888   $887 

 

18
 

 

(Dollars in thousands, except number of contracts)

 

   Three Months Ended September 30, 2013 
      Pre-Modification   Post-Modification     
   Number   Outstanding Recorded   Outstanding Recorded   Recorded 
   of Contracts   Investment   Investment   Investment 
Commercial and Industrial      $   $   $ 
Commercial Real Estate   3    806    811    808 
Consumer                
Total   3   $806   $811   $808 

 

(Dollars in thousands, except number of contracts)

 

   Nine Months Ended September 30, 2014 
      Pre-Modification   Post-Modification     
   Number   Outstanding Recorded   Outstanding Recorded   Recorded 
   of Contracts   Investment   Investment   Investment 
Commercial and Industrial   2   $327   $327   $326 
Commercial Real Estate   10    1,389    1,476    1,080 
Consumer   1    7    7    6 
Total   13   $1,723   $1,810   $1,412 

 

(Dollars in thousands, except number of contracts)

 

   Nine Months Ended September 30, 2013 
      Pre-Modification   Post-Modification     
   Number   Outstanding Recorded   Outstanding Recorded   Recorded 
   of Contracts   Investment   Investment   Investment 
Commercial and Industrial       $    $   $  
Commercial Real Estate   12    4,445    4,305    4,128 
Consumer                
Total   12   $4,445   $4,305   $4,128 

 

The following table provides detail regarding the types of loan modifications made for loans categorized as TDRs during the three and nine months ended September 30, 2014 and September 30, 2013 with the total number of each type of modification performed.

 

   Three Months Ended September 30, 2014   Nine Months Ended September 30, 2014 
   Rate   Term   Payment   Number   Rate   Term   Payment   Number 
   Modification   Modification   Modification   Modified   Modification   Modification   Modification   Modified 
Commercial and Industrial                           2    2 
Commercial Real Estate       1    3    4    1    4    5    10 
Consumer                           1    1 
Total       1    3    4    1    4    8    13 

 

   Three Months Ended September 30, 2013   Nine Months Ended September 30, 2013 
   Rate   Term   Payment   Number   Rate   Term   Payment   Number 
   Modification   Modification   Modification   Modified   Modification   Modification   Modification   Modified 
Commercial and Industrial                                
Commercial Real Estate   1    1    1    3    3    2    7    12 
Consumer                                
Total   1    1    1    3    3    2    7    12 

 

19
 

 

The recorded investment, unpaid principal balance, and the related allowance of the Corporation’s impaired loans are summarized below for the periods ended September 30, 2014 and December 31, 2013.

 

(Dollars in thousands)  September 30, 2014   December 31, 2013 
      Unpaid           Unpaid     
   Recorded   Principal   Related   Recorded   Principal   Related 
   Investment   Balance   Allowance   Investment   Balance   Allowance 
With no related allowance recorded:                              
Commercial and Industrial  $340   $486   $   $21   $167   $ 
Commercial Real Estate   5,288    5,850        4,810    5,503     
Residential Real Estate   1,107    1,272        868    1,176     
Consumer   6    6                 
                               
With an allowance recorded:                              
Commercial and Industrial                        
Commercial Real Estate   285    299    28    212    212    125 
Residential Real Estate   66    66    17    63    63    15 
Consumer                        
Total  $7,092   $7,979   $45   $5,974   $7,121   $140 
                               
Total consists of:                              
Commercial and Industrial  $340   $486   $   $21   $167   $ 
Commercial Real Estate  $5,573   $6,149   $28   $5,022   $5,715   $125 
Residential Real Estate  $1,173   $1,338   $17   $931   $1,239   $15 
Consumer  $6   $6   $   $   $   $ 

______________________

At September 30, 2014 and December 31, 2013, $4,698,000 and $3,961,000 of loans classified as TDRs were included in impaired loans with a total allocated allowance of $2,000 and $0, respectively. The recorded investment represents the loan balance reflected on the Consolidated Balance Sheets net of any charge-offs. The unpaid balance is equal to the gross amount due on the loan.

 

20
 

 

The average recorded investment and interest income recognized for the Corporation’s impaired loans are summarized below for the three and nine month periods ended September 30, 2014 and 2013.

 

(Dollars in thousands)  For the Three Months Ended   For the Three Months Ended 
   September 30, 2014   September 30, 2013 
   Average   Interest   Average   Interest 
   Recorded   Income   Recorded   Income 
   Investment   Recognized   Investment   Recognized 
With no related allowance recorded:                    
Commercial and Industrial  $341   $   $26   $ 
Commercial Real Estate   5,213    20    4,544    42 
Residential Real Estate   1,123        798    1 
Consumer   7             
                     
With an allowance recorded:                    
Commercial Real Estate   171    8    277    4 
Residential Real Estate   33    2    63     
Total  $6,888   $30   $5,708   $47 
                     
Total consists of:                    
Commercial and Industrial  $341   $   $26   $ 
Commercial Real Estate  $5,384   $28   $4,821   $46 
Residential Real Estate  $1,156   $2   $861   $1 
Consumer  $7   $   $   $ 

 

(Dollars in thousands)  For the Nine Months Ended   For the Nine Months Ended 
   September 30, 2014   September 30, 2013 
   Average   Interest   Average   Interest 
   Recorded   Income   Recorded   Income 
   Investment   Recognized   Investment   Recognized 
With no related allowance recorded:                    
Commercial and Industrial  $184   $13   $30   $ 
Commercial Real Estate   5,037    86    3,694    96 
Residential Real Estate   865        693    1 
Consumer   5             
                     
With an allowance recorded:                    
Commercial Real Estate   101    8    281    4 
Residential Real Estate   17    2    66     
Total  $6,209   $109   $4,764   $101 
                     
Total consists of:                    
Commercial and Industrial  $184   $13   $30   $ 
Commercial Real Estate  $5,138   $94   $3,975   $100 
Residential Real Estate  $882   $2   $759   $1 
Consumer  $5   $   $   $ 

 

21
 

 

Financing receivables on non-accrual status, loans past-due 90 days or more and still accruing, and foreclosed assets held for resale as of September 30, 2014 and December 31, 2013 were as follows:

 

(Dollars in thousands)

   September 30,   December 31, 
   2014   2013 
Commercial and Industrial  $14   $21 
Commercial real estate   2,848    2,599 
Residential real estate   1,173    931 
Total non-accrual loans   4,035    3,551 
Foreclosed assets held for resale   217    480 
Loans past-due 90 days or more and still accruing   89    318 
Total non-performing assets  $4,341   $4,349 

  

The following tables present the classes of the loan portfolio summarized by the past-due status at September 30, 2014 and December 31, 2013:

 

(Dollars in thousands)

                           90 Days 
                           Or Greater 
           90 Days           Total   Past Due 
   30-59 Days   60-89 Days   or Greater   Total       Financing   and Still 
   Past Due   Past Due   Past Due   Past Due   Current   Receivables   Accruing 
September 30, 2014:                                   
Commercial and Industrial  $62   $51   $14   $127   $69,233   $69,360    $ 
Commercial Real Estate   933    316    2,655    3,904    245,469    249,373    63 
Residential Real Estate   1,653    181    708    2,542    158,839    161,381    26 
Consumer   32    6        38    5,109    5,147     
Total  $2,680   $554   $3,377   $6,611   $478,650   $485,261   $89 

 

(Dollars in thousands)

                           90 Days 
                           Or Greater 
           90 Days           Total   Past Due 
   30-59 Days   60-89 Days   or Greater   Total       Financing   and Still 
   Past Due   Past Due   Past Due   Past Due   Current   Receivables   Accruing 
December 31, 2013:                                   
Commercial and Industrial  $7   $7   $40   $54   $60,768   $60,822   $19 
Commercial Real Estate   875    653    1,367    2,895    222,510    225,405    180 
Residential Real Estate   1,751    248    926    2,925    151,750    154,675    119 
Consumer   30    12        42    5,574    5,616     
Total  $2,663   $920   $2,333   $5,916   $440,602   $446,518   $318 

  

At September 30, 2014 and December 31, 2013, there were no commitments to lend additional funds with respect to impaired loans.

 

NOTE 5BORROWINGS

 

Short-term borrowings include federal funds purchased, securities sold under agreements to repurchase, Federal Discount Window, and Federal Home Loan Bank (“FHLB”) advances, which generally represent overnight or less than 30-day borrowings.

 

22
 

 

Securities Sold Under Agreements to Repurchase (“Repurchase Agreements”)

 

The Corporation enters into agreements under which it sells securities subject to an obligation to repurchase the same or similar securities. Under these arrangements, the Corporation may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Corporation to repurchase the assets.

 

As a result, these repurchase agreements are accounted for as collateralized financing agreements (i.e., secured borrowings) and not as a sale and subsequent repurchase of securities. The obligation to repurchase the securities is reflected as a liability on the Corporation’s Consolidated Balance Sheets, while the securities underlying the repurchase agreements remain in the respective investment securities asset accounts. In other words, there is not offsetting or netting of the investment securities assets with the repurchase agreement liabilities. In addition, as the Corporation does not enter into reverse repurchase agreements, there is no such offsetting to be done with the repurchase agreements.

 

The right of setoff for a repurchase agreement resembles a secured borrowing, whereby the collateral would be used to settle the fair value of the repurchase agreement should the Corporation be in default (e.g., fails to make an interest payment to the counterparty). The collateral is held by a correspondent bank in the counterparty’s custodial account. The counterparty has the right to sell or repledge the investment securities.

 

The following table presents the short-term borrowings subject to an enforceable master netting arrangement or repurchase agreements as of September 30, 2014 and December 31, 2013.

 

(Dollars in thousands)      Gross   Net Amounts             
       Amounts   of Liabilities             
       Offset   Presented             
   Gross   in the   in the             
   Amounts of   Consolidated   Consolidated       Cash     
   Recognized   Balance   Balance   Financial   Collateral   Net 
   Liabilities   Sheet   Sheet   Instruments   Pledge   Amount 
September 30, 2014                              
Repurchase agreements (a)  $15,990   $   $15,990   $(15,990)  $   $ 
                               
December 31, 2013                              
Repurchase agreements (a)  $16,261   $   $16,261   $(16,261)  $   $ 

______________________

(a) As of September 30, 2014 and December 31, 2013, the fair value of securities pledged in connection with repurchase agreements was $22,947,000 and $26,575,000, respectively.

 

Long-term borrowings are comprised of advances from FHLB and a capital lease assumed as a result of the acquisition of Pocono Community Bank. Under terms of a blanket agreement, collateral for the FHLB loans is certain qualifying assets of the Corporation’s banking subsidiary. The principal assets are real estate mortgages and certain investment securities.

 

NOTE 6COMMITMENTS AND CONTINGENCIES

 

In the normal course of business, there are various pending legal actions and proceedings that are not reflected in the consolidated financial statements. Management does not believe the outcome of these actions and proceedings will have a material effect on the consolidated financial position or results of operations of the Corporation.

 

NOTE 7 FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND CONCENTRATIONS OF CREDIT RISK

 

The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract or notional amounts of those instruments reflect the extent of involvement the Corporation has in particular classes of financial instruments. The Corporation does not engage in trading activities with respect to any of its financial instruments with off-balance sheet risk.

 

23
 

 

The Corporation’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments.

 

The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

 

The Corporation may require collateral or other security to support financial instruments with off-balance sheet credit risk.

 

The contract or notional amounts at September 30, 2014 and December 31, 2013, were as follows:

 

(Dollars in thousands)

   September 30, 2014   December 31, 2013 
Financial instruments whose contract amounts represent credit risk:        
Commitments to extend credit  $85,014   $73,700 
Financial standby letters of credit  $561   $418 
Performance standby letters of credit  $6,832   $4,449 

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses that may require payment of a fee. Since some of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Corporation evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, owner-occupied income-producing commercial properties, and residential real estate.

 

Standby letters of credit are conditional commitments issued by the Corporation to guarantee payment to a third party when a customer either fails to repay an obligation or fails to perform some non-financial obligation. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Corporation may hold collateral to support standby letters of credit for which collateral is deemed necessary.

 

The Corporation grants commercial, agricultural, real estate mortgage and consumer loans to customers primarily in the counties of Columbia, Luzerne, Montour and Monroe, Pennsylvania. The concentrations of credit by type of loan are set forth in Note 4 – Loans and Allowance for Loan Losses. It is management’s opinion that the loan portfolio was well balanced and diversified at September 30, 2014, to the extent necessary to avoid any significant concentration of credit risk. However, it is the debtor’s ability to honor their contracts, which may be influenced by the region’s economy.

 

NOTE 8FAIR VALUE MEASUREMENTS

 

Fair value measurement and disclosure guidance defines fair value as the price that would be received to sell the asset or transfer the liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. This guidance provides additional information on determining when the volume and level of activity for the asset or liability has significantly decreased. The guidance also includes information on identifying circumstances when a transaction may not be considered orderly.

 

Fair value measurement and disclosure guidance provides a list of factors that a reporting entity should evaluate to determine whether there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability. When the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability, further analysis of the information from that market is needed and significant adjustments to the related prices may be necessary to estimate fair value in accordance with the fair value measurement and disclosure guidance.

 

24
 

 

This guidance clarifies that when there has been a significant decrease in the volume and level of activity for the asset or liability, some transactions may not be orderly. In those situations, the entity must evaluate the weight of the evidence to determine whether the transaction is orderly. The guidance provides a list of circumstances that may indicate that a transaction is not orderly. A transaction price that is not associated with an orderly transaction is given little, if any, weight when estimating fair value.

 

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own belief about the assumptions market participants would use in pricing the asset or liability based upon the best information available in the circumstances. Fair value measurement and disclosure guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

Level 1 Inputs: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

 

Level 2 Inputs: Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability;

 

Level 3 Inputs: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

 

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth as follows.

 

Financial Assets Measured at Fair Value on a Recurring Basis

 

At September 30, 2014 and December 31, 2013, investments measured at fair value on a recurring basis and the valuation methods used are as follows:

 

(Dollars in thousands)

 

September 30, 2014

   Level 1   Level 2   Level 3   Total 
Available-for-Sale Securities:                    
U.S. Treasury securities  $   $11,295   $   $11,295 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgaged-backed       150,489        150,489 
Other       17,407        17,407 
Obligations of state and political subdivisions       123,626        123,626 
Corporate debt securities       35,846        35,846 
Marketable equity securities   2,400            2,400 
Total  $2,400   $338,663   $   $341,063 

 

25
 

 

(Dollars in thousands)

 

December 31, 2013                
   Level 1   Level 2   Level 3   Total 
Available-for-Sale Securities:                    
U.S. Treasury securities  $   $   $   $ 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgaged-backed       121,224        121,224 
Other       32,285        32,285 
Obligations of state and political subdivisions       148,389        148,389 
Corporate debt securities       49,265        49,265 
Marketable equity securities   2,535            2,535 
Total  $2,535   $351,163   $   $353,698 

 

The estimated fair values of equity securities classified as Level 1 are derived from quoted market prices in active markets; these assets consist mainly of stocks held in other banks. The estimated fair values of all debt securities classified as Level 2 are obtained from nationally-recognized third-party pricing agencies. The estimated fair values are derived primarily from cash flow models, which include assumptions for interest rates, credit losses, and prepayment speeds. The significant inputs utilized in the cash flow models are based on market data obtained from sources independent of the Corporation (observable inputs), and are therefore classified as Level 2 within the fair value hierarchy. The Corporation does not have any Level 3 inputs for investments. There were no transfers between Level 1 and Level 2 during 2014 or 2013.

 

Financial Assets Measured at Fair Value on a Nonrecurring Basis

 

At September 30, 2014 and December 31, 2013, impaired loans measured at fair value on a non-recurring basis and the valuation methods used are as follows:

 

(Dollars in thousands)

   Level 1   Level 2   Level 3   Total 
Assets at September 30, 2014                    
Impaired loans:                    
Commercial and Industrial  $   $   $14   $14 
Commercial Real Estate           2,030    2,030 
Residential Real Estate           423    423 
Total impaired loans  $   $   $2,467   $2,467 

 

(Dollars in thousands)

   Level 1   Level 2   Level 3   Total 
Assets at December 31, 2013                    
Impaired loans:                    
Commercial and Industrial  $   $   $21   $21 
Commercial Real Estate           656    656 
Residential Real Estate           621    621 
Total impaired loans  $   $   $1,298   $1,298 

 

The Bank’s impaired loan valuation procedure for any loans greater than $250,000 requires an appraisal to be obtained and reviewed annually at year end. A quarterly collateral evaluation is performed which may include a site visit, property pictures and discussions with realtors and other similar business professionals to ascertain current values. For impaired loans less than $250,000 upon classification and annually at year end, the Bank completes a Certificate of Inspection, which includes an onsite inspection, insured values, tax assessed values, recent sales comparisons and a review of the previous evaluations. These assets are included as Level 3 fair values, based upon the lowest level that is significant to the fair value measurements. The fair value consists of the impaired loan balances less the valuation allowance and/or charge-offs. There were no transfers between valuation levels in 2014 and 2013.

 

26
 

Nonfinancial Assets Measured at Fair Value on a Nonrecurring Basis

 

At September 30, 2014 and December 31, 2013, there were no nonfinancial assets measured at fair value on a nonrecurring basis.

 

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

  

(Dollars in thousands)

   Quantitative Information about Level 3 Fair Value Measurements 
   Fair Value            Weighted 
   Estimate   Valuation Technique  Unobservable Input  Range  Average 
Assets at September 30, 2014                 
Impaired loans  $2,467   Appraisal of collateral1,3  Appraisal adjustments2  (0%) – (63%)   (38)%

 

(Dollars in thousands)

   Quantitative Information about Level 3 Fair Value Measurements 
   Fair Value            Weighted 
   Estimate   Valuation Technique  Unobservable Input  Range  Average 
Assets at December 31, 2013                 
Impaired loans  $1,298   Appraisal of collateral1,3  Appraisal adjustments2  (10%) – (35%)   (23)%

_______________________

1Fair value is generally determined through independent appraisals of the underlying collateral, as defined by Bank regulators.

2Appraisals may be adjusted downward by management for qualitative factors such as economic conditions and estimated liquidation expenses. The typical range of appraisal adjustments are presented as a percent of the appraisal value.

3Includes qualitative adjustments by management and estimated liquidation expenses.

 

Fair Value of Financial Instruments

 

(Dollars in thousands)

   Carrying   Fair Value Measurements at September 30, 2014 
   Amount   Level 1   Level 2   Level 3   Total 
FINANCIAL ASSETS:                    
Cash and due from banks  $7,677   $7,677   $   $   $7,677 
Interest-bearing deposits in other banks   1,058        1,058        1,058 
Investment securities available-for-sale   341,063    2,400    338,663        341,063 
Investment securities held-to-maturity   1,060        1,065        1,065 
Restricted investment in bank stocks   7,116        7,116        7,116 
Net loans   478,771            483,398    483,398 
Mortgage servicing rights   480            480    480 
Accrued interest receivable   3,405        3,405        3,405 
                          
FINANCIAL LIABILITIES:                         
Deposits   656,099        656,756        656,756 
Short-term borrowings   76,850        76,850        76,850 
Long-term borrowings   65,364        66,452        66,452 
Accrued interest payable   401        401        401 
                          
OFF-BALANCE SHEET FINANCIAL  INSTRUMENTS                    

 

 

27
 

(Dollars in thousands)

   Carrying   Fair Value Measurements at December 31, 2013 
   Amount   Level 1   Level 2   Level 3   Total 
FINANCIAL ASSETS:                         
Cash and due from banks  $8,257   $8,257   $   $   $8,257 
Interest-bearing deposits in other banks   22,366        22,366        22,366 
Investment securities available-for-sale   353,698    2,535    351,163        353,698 
Investment securities held-to-maturity   1,072        1,083        1,083 
Restricted investment in bank stocks   4,761        4,761        4,761 
Net loans   439,999            443,844    443,844 
Mortgage servicing rights   521            521    521 
Accrued interest receivable   3,616        3,616        3,616 
                          
FINANCIAL LIABILITIES:                         
Deposits   690,075        690,771        690,771 
Short-term borrowings   68,233        68,233        68,233 
Long-term borrowings   40,429        41,288        41,288 
Accrued interest payable   392        392        392 
                          
OFF-BALANCE SHEET FINANCIAL  INSTRUMENTS                    

 

The preceding information should not be interpreted as an estimate of the fair value of the entire Corporation since a fair value calculation is only provided for a limited portion of the Corporation’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Corporation’s disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair values of the Corporation’s financial instruments at September 30, 2014 and December 31, 2013:

 

Cash and Due From Banks, Interest-Bearing Deposits in Other Banks, Restricted Investment in Bank Stocks, Accrued Interest Receivable and Accrued Interest Payable

 

The fair values are equal to the current carrying values.

 

Investment Securities

 

The fair value of investment securities are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1) or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying on the securities’ relationship to other benchmark quoted prices.

 

Loans

 

Fair values are estimated for categories of loans with similar financial characteristics. Loans were segregated by type such as Commercial and Industrial, Commercial and Residential Real Estate mortgages and Consumer. For estimation purposes, each loan category was further segmented into fixed and adjustable rate interest terms.

 

The fair value of each category of performing loans is calculated by discounting future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

 

Fair value for impaired loans is based on management’s estimate of future cash flows discounted using a rate commensurate with the risk associated with the estimated future cash flows or based on the value of the collateral if repayment is expected solely from collateral. The assumptions used by management are judgmentally determined using information regarding each specific borrower.

 

Mortgage Servicing Rights

 

The fair value of servicing rights is based on the present value of estimated future cash flows on pools of mortgages stratified by rate and maturity date.

 

28
 

 

Deposits

 

The fair value of deposits with no stated maturity, such as demand deposits, savings accounts and money market accounts, is equal to the amount payable on demand at September 30, 2014 and December 31, 2013.

 

Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on similar term borrowings, to a schedule of aggregated expected monthly maturities on time deposits.

 

Short-Term and Long-Term Borrowings

 

The fair values of short-term borrowings are equal to the current carrying values, and long-term borrowings are estimated using discounted cash flow analyses based on the Corporation’s incremental borrowing rate for similar instruments.

 

Off-Balance Sheet Financial Instruments

 

The fair values for the Corporation’s off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.

 

NOTE 9EARNINGS PER SHARE

 

Basic earnings per share (“EPS”) is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Corporation. Potential common shares that may be issued by the Corporation relate solely to outstanding stock options and are determined using the treasury stock method. The following table sets forth the computation of basic and diluted earnings per share.

 

(In thousands, except earnings per share)  Three Months Ended 
   September 30, 
   2014   2013 
Net income  $2,383   $2,155 
Weighted-average common shares outstanding   5,544    5,501 
Basic earnings per share  $0.43   $0.39 
           
Weighted-average common shares outstanding   5,544    5,501 
Common stock equivalents due to effect of stock options   5    5 
Total weighted-average common shares and equivalents   5,549    5,506 
Diluted earnings per share  $0.43   $0.39 

 

(In thousands, except earnings per share)  Nine Months Ended 
   September 30, 
   2014   2013 
Net income  $7,437   $8,553 
Weighted-average common shares outstanding   5,533    5,470 
Basic earnings per share  $1.34   $1.56 
           
           
Weighted-average common shares outstanding   5,533    5,470 
Common stock equivalents due to effect of stock options   5    5 
Total weighted-average common shares and equivalents   5,538    5,475 
Diluted earnings per share  $1.34   $1.56 
29
 

 

Item 2. First Keystone Corporation Management’s Discussion and Analysis of Financial Condition and Results of Operation

  

This quarterly report contains certain forward-looking statements, which are included pursuant to the “safeharbor” provisions of the Private Securities Litigation Reform Act of 1995, and reflect management’s beliefs and expectations based on information currently available. These forward-looking statements are inherently subject to significant risks and uncertainties, including changes in general economic and financial market conditions, the Corporation’s ability to effectively carry out its business plans and changes in regulatory or legislative requirements. Other factors that could cause or contribute to such differences are changes in competitive conditions, and pending or threatened litigation. Although management believes the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially.

 

CRITICAL ACCOUNTING ESTIMATES

 

The Corporation has chosen accounting policies that it believes are appropriate to accurately and fairly report its operating results and financial position, and the Corporation applies those accounting policies in a consistent manner. The Significant Accounting Policies are summarized in Note 1 to the consolidated financial statements included in the 2013 Annual Report on Form 10-K. There have been no changes to the Critical Accounting Estimates since the Corporation filed its Annual Report on Form 10-K for the year ended December 31, 2013.

 

RESULTS OF OPERATIONS

 

Quarter ended September 30, 2014 compared to quarter ended September 30, 2013

 

First Keystone Corporation realized earnings for the three months ended September 30, 2014 of $2,383,000, an increase of $228,000, or 10.6% from the three months ended September 30, 2013. The increase in net income for the three months ended September 30, 2014 was primarily due to an increase in net interest income and non-interest income offset by an increase in non-interest expense.

 

On a per share basis, for the three months ended September 30, 2014, net income was $0.43 versus $0.39 in the three months ended September 30, 2013. Cash dividends amounted to $0.26 per share for the three months ended September 30, 2014 and 2013.

 

NET INTEREST INCOME

 

The major source of operating income for the Corporation is net interest income, defined as interest income less interest expense. For the three months ended September 30, 2014, interest income amounted to $7,815,000, an increase of $147,000 or 1.9% from the three months ended September 30, 2013, while interest expense amounted to $1,080,000 for the three months ended September 30, 2014, a decrease of $167,000, or 13.4% from the three months ended September 30, 2013. As a result, net interest income increased $314,000 or 4.9% for the three months ended September 30, 2014 to $6,735,000 from $6,421,000 for the same period in 2013.

 

The Corporation’s net interest margin for the three months ended September 30, 2014 was 3.45% compared to 3.66% for the same period in 2013. The decrease in net interest margin was a result of the unprecedented continuing low interest rate environment.

 

PROVISION FOR LOAN LOSSES

 

The provision for loan losses for the three months ended September 30, 2014 and September 30, 2013 was $100,000 and $133,000, respectively. The decrease in the provision for loan losses resulted from the Bank’s analysis of the current loan portfolio, including historic losses, past-due trends, current economic conditions, and other relevant factors. Net charge-offs for the three months ended September 30, 2014 and 2013 were $87,000 and $63,000, respectively. See Allowance for Loan Losses on page 35 for further discussion.

 

30
 

NON-INTEREST INCOME

 

Total non-interest income was $1,502,000 for the three months ended September 30, 2014, as compared to $1,397,000 for the same period in 2013, an increase of $105,000, or 7.5%. Service charges and fee income increased by $107,000 or 30.3%. This increase was primarily the result of an increase in the Bank’s overdraft fee implemented during the second quarter. The increase in ATM fees and debit card income was primarily driven by the Bank’s new Kasasa rewards checking program, which encourages customers to use their debit card more often. The primary component of other income is Retail Non-Deposit income, which increased $77,000 or 171.1% as compared to the third quarter of 2013, and was due to an increase in sales activity in this area.

 

Net gains on sales of investment securities decreased $101,000 to $163,000 as compared to the three months ended September 30, 2013. The Bank has taken gains and losses in the portfolio to reduce market risk and protect from further changes in value in the face of increases in long-term interest rates.

 

Excluding net investment securities gains, non-interest income was $1,339,000 for the three months ended September 30, 2014, an increase of $206,000 or 18.2% from the third quarter of 2013.

 

NON-INTEREST EXPENSE

 

Total non-interest expense was $5,262,000 for the quarter ended September 30, 2014, as compared to $4,967,000 for the quarter ended September 30, 2013. Non-interest expense increased $295,000, or 5.9%.

 

Expenses associated with employees (salaries and employee benefits) continue to be the largest category of non-interest expense. Salaries and benefits amounted to $2,927,000, or 55.6% of total non-interest expense for the three months ended September 30, 2014, as compared to 56.8% for the same three months of 2013. Net occupancy, furniture and equipment, and computer expense amounted to $787,000 for the quarter ended September 30, 2014, an increase of $24,000, or 3.1%. All other non-interest expenses amounted to $1,548,000 for the three months ended September 30, 2014, an increase of $166,000, or 12.0% as compared to the same three months of 2013.

 

The overall increase in non-interest expense related primarily to expenses associated with our new Dallas and Shickshinny offices along with the opening of our new administrative facility in Berwick. In addition, the Corporation experienced increased costs related to data processing expenses. In the second quarter of 2014, the Bank began to incur data processing costs as a result of the planned outsourcing of its core processing system for data security, disaster recovery and system efficiency goals. Advertising expenses were also higher due to the rollout of the Bank’s new suite of rewards checking products called Kasasa in the first quarter of 2014.

 

INCOME TAXES

 

Effective tax planning has helped produce favorable net income. Income tax expense amounted to $492,000 for the three months ended September 30, 2014, as compared to $563,000 for the three months ended September 30, 2013, a decrease of $71,000. The effective total income tax rate was 17.1% for the third quarter of 2014 as compared to 20.7% for the third quarter of 2013. The decrease in the effective tax rate was due to the utilization of tax credits from the low-income housing partnerships.

 

Nine months ended September 30, 2014 compared to nine months ended September 30, 2013

 

First Keystone Corporation realized earnings for the nine months ended September 30, 2014 of $7,437,000, a decrease of $1,116,000, or 13.0% from the nine months ended September 30, 2013. The decrease in net income for the first nine months of 2014 was due to several factors, including a decrease in non-interest income and an increase in non-interest expense, offset by a decrease in the provision for loan losses.

 

On a per share basis, for the nine months ended September 30, 2014, net income was $1.34 versus $1.56 in the first nine months of 2013. Cash dividends amounted to $0.78 per share in the first nine months of 2014 and 2013.

 

Year-to-date net income annualized as of September 30, 2014, amounted to a return on average common equity of 9.72%, a return on average tangible equity net of goodwill of 11.97% and a return on average assets of 1.11%. For the nine months ended September 30, 2013, these measures were 11.14%, 13.69%, and 1.39%, respectively, on an annualized basis.

 

31
 

NET INTEREST INCOME

 

For the nine months ended September 30, 2014, interest income amounted to $23,224,000, a decrease of $112,000 or 0.5% from the same nine month period in 2013, while interest expense amounted to $3,313,000 for the nine months ended September 30, 2014, a decrease of $409,000, or 11.0% from the nine months ended September 30, 2013. As a result, net interest income increased $297,000 or 1.5% for the nine months ended September 30, 2014 to $19,911,000 from $19,614,000 for the same period in 2013.

 

Our net interest margin for the nine months ended September 30, 2014 was 3.45% compared to 3.81% for the nine months ended September 30, 2013. The decrease in the net interest margin was a result of the unprecedented continuing low interest rate environment.

 

PROVISION FOR LOAN LOSSES

 

The provision for loan losses for the nine months ended September 30, 2014 was $433,000 as compared to $733,000 for the nine months ended September 30, 2013. The decrease in the provision for loan losses resulted from the Bank’s analysis of the current loan portfolio, including historic losses, past-due trends, current economic conditions, and other relevant factors. Net charge-offs for the nine months ended September 30, 2014 and 2013 were $462,000 and $505,000, respectively. See Allowance for Loan Losses on page 35 for further discussion.

 

NON-INTEREST INCOME

 

Total non-interest income was $5,735,000 for the nine months ended September 30, 2014, as compared to $6,614,000 for the nine months ended September 30, 2013, a decrease of $879,000, or 13.3%. Service charges and fee income increased $141,000 or 13.7%. This increase was primarily the result of an increase in the Bank’s overdraft fee implemented during the second quarter. The increase in ATM fees and debit card income of $89,000 was primarily driving by the Bank’s new Kasasa rewards checking program, which encourages customers to use their debit cared more often. The primary component of other income is Retail Non-Deposit income, which increased $143,000 or 75.3% as compared to the first nine months of 2013, and was due to an increase in sales activity in this area. While Trust Department income, service charges and fees and ATM and debit card fees increased, they were not large enough to offset the $369,000 reduction in gains on sales of mortgage loans.

 

Net gains on sales of investment securities decreased $981,000 to $1,963,000 as compared to the nine months ended September 30, 2013. The Bank has taken gains and losses in the portfolio to reduce market risk and protect from further changes in value in the face of increases in long-term interest rates.

 

Excluding net investment securities gains, non-interest income was $3,772,000 for the first nine months of 2014, an increase of $102,000, or 2.8% from the first nine months of 2013.

 

NON-INTEREST EXPENSE

 

Total non-interest expense was $15,953,000 for the nine months ended September 30, 2014, as compared to $14,971,000 for the nine months ended September 30, 2013. Non-interest expense increased $982,000, or 6.6%.

 

Expenses associated with employees (salaries and employee benefits) continue to be the largest category of non-interest expense. Salaries and benefits amounted to $8,569,000, or 53.7% of total non-interest expense for the nine months ended September 30, 2014, as compared to 55.1% for the nine months of 2013. Net occupancy, furniture and equipment, and computer expense amounted to $2,532,000 for the nine months ended September 30, 2014, an increase of $130,000, or 5.4%. All other non-interest expenses amounted to $4,852,000 for the nine months ended September 30, 2014, an increase of $533,000, or 12.3% as compared to the same nine months ended September 30, 2013.

 

The overall increase in non-interest expense related primarily to expenses associated with our new Dallas and Shickshinny offices along with the opening of our new administrative facility in Berwick. In addition, the Corporation experienced increased costs related to data processing, collections and foreclosed real estate expenses. In the second quarter of 2014, the Bank began to incur data processing costs as a result of the planned outsourcing of its core processing system for data security, disaster recovery and system efficiency goals. Advertising expenses were also higher due to the rollout of the Bank’s new suite of rewards checking products called Kasasa in the first quarter of 2014. These increases were offset by the FHLB prepayment penalties incurred during the nine months ended September 30, 2013. Prepayment penalties were incurred when term borrowings with the FHLB were prepaid.

32
 

INCOME TAXES

 

Income tax expense amounted to $1,823,000 for the nine months ended September 30, 2014, as compared to $1,971,000 for the nine months ended September 30, 2013, a decrease of $148,000. The effective total income tax rate was 19.7% for the nine months ended September 30, 2014 as compared to 18.7% for the nine months ended September 30, 2013. The increase in the effective tax rate was due to the sales of tax-free municipal securities during the past year and the impact of the tax credits from the low-income housing partnerships. The Corporation looks to maximize its tax-exempt income derived from both tax-free loans and tax-free municipal securities.

 

FINANCIAL CONDITION

 

SUMMARY

 

Total assets increased to $905,685,000 as of September 30, 2014, an increase of $4,171,000, or 0.5% from year-end 2013. As of September 30, 2014, total deposits amounted to $656,099,000, a decrease of 4.9% from year-end 2013.

 

Total loans increased by $38,743,000 or 8.7%. Loan demand appears to be increasing as the Bank has seen an increase in loan originations.

 

Total cash and cash equivalents decreased compared to year-end 2013 due to reductions in balances held at correspondent banks.

 

The Corporation continues to maintain and manage its asset growth. The Corporation’s strong equity capital position provides an opportunity to further leverage its asset growth. Total borrowings increased in the first nine months of 2014 by $33,552,000 to $142,214,000 from $108,662,000 as of December 31, 2013. Borrowings increased to support increased loan balances and replace decreased deposit balances.

 

SEGMENT REPORTING

 

Currently, management measures the performance and allocates the resources of the Corporation as a single segment.

 

EARNING ASSETS

 

Earning assets are defined as those assets that produce interest income. By maintaining a healthy asset utilization rate, i.e., the volume of earning assets as a percentage of total assets, the Corporation maximizes income. The earning asset ratio (average interest earning assets divided by average total assets) equaled 91.8% at September 30, 2014, compared to 91.5% at September 30, 2013. This indicates that the management of earning assets is a priority and non-earning assets, primarily cash and due from banks, fixed assets and other assets, are maintained at minimal levels. The primary earning assets are loans and investment securities.

 

Our primary earning asset, total loans, increased to $485,261,000 as of September 30, 2014, up $38,743,000, or 8.7% since year-end 2013. The loan portfolio continues to be diversified. Overall asset quality has remained consistent with non-performing assets decreasing slightly since year-end 2013. Total non-performing assets were $4,341,000 as of September 30, 2014, a decrease of $8,000, or 0.2% from $4,349,000 reported in non-performing assets as of December 31, 2013. Total allowance for loan losses to total non-performing assets was 149.5% as of September 30, 2014 and 149.9% at December 31, 2013.

 

In addition to loans, another primary earning asset is our overall investment portfolio, which decreased in size from December 31, 2013, to September 30, 2014. Available-for-sale securities amounted to $341,063,000 as of September 30, 2014, a decrease of $12,635,000 from year-end 2013. Interest-bearing deposits in other banks decreased as of September 30, 2014, to $1,058,000 from $22,366,000 at year-end 2013.

 

LOANS

 

Total loans increased to $485,261,000 as of September 30, 2014 as compared to $446,518,000 as of December 31, 2013. The table on page 15 provides data relating to the composition of the Corporation’s loan portfolio on the dates indicated. Total loans increased by $38,743,000 or 8.7%.

33
 

Increasing demand for borrowing by both individuals and businesses accounted for the 8.7% increase in the loan portfolio from December 31, 2013 to September 30, 2014. The Commercial and Industrial portfolio increased $8,538,000 to $69,360,000 as of September 30, 2014 as compared to $60,822,000 as of December 31, 2013. The increase in the Commercial and Industrial portfolio (which includes tax free Commercial and Industrial loans) was attributed to new loan originations totaling $17,946,000, which were offset by loan payoffs of $5,191,000, as well as regular principal payments. The Commercial Real Estate portfolio (which includes tax free Commercial Real Estate loans) increased $23,968,000 to $249,373,000 as of September 30, 2014, as compared to $225,405,000 at December 31, 2013. The increase was mainly attributed to new loan originations totaling $40,572,000, which were offset by loan payoffs of $10,566,000, combined with typical amortizations in the loan portfolio. The Residential Real Estate portfolio increased $6,706,000 to $161,381,000 as of September 30, 2014, as compared to $154,675,000 at December 31, 2013. The increase was the result of new originations, and to a lesser extent, refinances held in the Bank’s portfolio. The Corporation continued to originate and sell certain long-term fixed rate residential mortgage loans which conform to secondary market requirements. The Corporation derives ongoing income from the servicing of mortgages sold in the secondary market. The Corporation continues its efforts to lend to creditworthy borrowers despite the continued slow economic conditions.

 

Management believes that the loan portfolio is well diversified. The total commercial portfolio was $318,733,000. Of the total commercial portfolio, $249,373,000 or 51.4% of total loans is secured by commercial real estate.

 

The largest relationship is comprised of various real estate entities with a mutual owner who began real estate investment and development activities in 1989. The relationship had outstanding loan balances and unused commitments of $13,339,000 at September 30, 2014. The individual owns a diverse mix of real estate entities which specialize in construction/development projects, leasing of commercial office space, and rental of multi-tenant residential units. This relationship is comprised of $7,889,000 in long term debt, a construction mortgage of $4,450,000, and a $1,000,000 line of credit. The relationship is well secured by first lien mortgages on income producing commercial and residential real estate, plus collateral pledge of cash accounts and marketable securities.

 

The second largest relationship is comprised of several first lien mortgages relating to office and professional rental properties and a planned residential community. The principal and related companies have been involved in real estate development since 1974 and have successfully developed residential communities, medical office facilities, and professional office facilities. The entire relationship is secured by a combination of first lien mortgages and marketable securities. At September 30, 2014, the relationship had outstanding loan balances and unused commitments of $10,065,000 after participation shares sold of $633,000. The debt is comprised of $2,429,000 in long term debt, $5,450,000 in lines of credit, and a $2,186,000 letter of credit.

 

The third largest relationship consists of a real estate development/holding company that was established in 2006 to construct a multi-tenant medical complex, as well as the medical-related entities that operate out of the complex. The relationship had outstanding loan balances and unused commitments of $9,131,000 at September 30, 2014. The debt is comprised of approximately $8,414,000 in term debt, $450,000 in lines of credit, and $267,000 in available credit on a real estate term loan. The relationship is well secured by business assets, undeveloped land, and commercial and residential real estate.

 

The fourth largest relationship consists of a municipality founded in 1816 consisting of 35 square miles. According to township officials, the population has been increasing steadily since 2001 and is currently in excess of 11,000 people. In 2012, the township completed its $74,000,000 sewer expansion project. The relationship had outstanding balances and unused commitments of $8,377,000 at September 30, 2014. The debt consists of $8,348,000 in term debt and available credit of $29,000 on a tax free loan. The loans are secured by project receivables and the full faith, credit, and taxing power of the township.

 

The fifth largest relationship is a real estate development company and its related entities, specializing in the design, construction, and management of multi-tenant residential housing. The company was established in the late 1980s with its primary market being the Corporation’s immediate central market area. The relationship had outstanding loan balances and unused commitments of $8,174,000 at September 30, 2014. The debt consists of approximately $5,762,000 in term debt secured by various real estate holdings and $2,412,000 in lines of credit. The loans are secured primarily by income producing multi-tenant real estate.

 

Each of the relationships is located within the Corporation’s market area.

 

34
 

All of the loans are performing as agreed; however, one loan is graded special mention. The property securing each of the loans was appraised at the time the loan was originated. Appraisals are ordered independently of the loan approval process from appraisers on an approved list. All appraisals are reviewed internally for conformity with accepted standards of the Bank.

 

All loan relationships in excess of $1,500,000 are reviewed internally and through an external loan review process on an annual basis. Such review is based upon analysis of current financial statements of the borrower, co-borrowers/guarantors, payment history, and economic conditions.

 

Overall, the portfolio risk profile as measured by loan grade is considered low risk, as $469,049,000 or 96.7% of total loans are graded Pass; $8,880,000 or 1.9% are graded Special Mention; $6,849,000 or 1.4% are graded Substandard; and $10,000 or 0.0% are graded Doubtful. The rating is intended to represent the best assessment of risk available at a given point in time, based upon a review of the borrower’s financial statements, credit analysis, payment history with the Bank, credit history and lender knowledge of the borrower. See Note 4 — Loans and Allowance for Loan Losses for risk grading tables.

 

Overall, non-pass grades increased to $15,739,000 at September 30, 2014, as compared to $6,698,000 at December 31, 2013. Commercial and Industrial non-pass grades increased to $87,000 as of September 30, 2014 as compared to $86,000 as of December 31, 2013. Commercial Real Estate non-pass grades increased to $13,886,000 as of September 30, 2014 as compared to $5,499,000 as of December 31, 2013. The Residential Real Estate and Consumer loan non-pass grades increased to $1,766,000 as of September 30, 2014 as compared to $1,113,000 as of December 31, 2013.

 

The increase in Commercial Real Estate non-pass grade loans was mainly the result of the downgrade of twelve loans. One loan of $4,957,000 is with a real estate development company. The weak real estate market has hindered the process of the development plans and expected sales have not materialized. However, the borrower remains strong and continues to perform. One loan of $2,773,000 is with a real estate development company for a multi-tenant housing project that has completed construction but has a very low occupancy rate. Despite the low occupancy rate, the borrower continues to perform. Two of the downgraded loans, totaling $827,000 are with a single individual for an amusement and recreation facility that has experienced significant losses due to flood damage. The facility was renovated and re-opened and is experiencing a weak recovery. Eight of the downgraded loans, totaling $620,000 are with a single individual for various multi-tenant housing projects. Unpaid real estate taxes and municipal liens have had a negative impact on the relationship. Despite the circumstances, the borrower continues to perform.

 

The Corporation continues to internally underwrite each of its loans to comply with prescribed policies and approval levels established by its Board of Directors.

 

Total Loans

 

(Dollars in thousands)  September 30,   December 31, 
   2014   2013 
Commercial and Industrial  $69,360   $60,822 
Commercial Real Estate   249,373    225,405 
Residential Real Estate   161,381    154,675 
Consumer   5,147    5,616 
Total loans  $485,261   $446,518 

 

ALLOWANCE FOR LOAN LOSSES

 

The allowance for loan losses constitutes the amount available to absorb losses within the loan portfolio. As of September 30, 2014, the allowance for loan losses was $6,490,000 as compared to $6,519,000 as of December 31, 2013. The allowance for loan losses is established through a provision for loan losses charged to expenses. Loans are charged against the allowance for possible loan losses when management believes that the collectability of the principal is unlikely. The risk characteristics of the loan portfolio are managed through the various control processes, including credit evaluations of individual borrowers, periodic reviews, and diversification by industry. Risk is further mitigated through the application of lending procedures such as the holding of adequate collateral and the establishment of contractual guarantees.

 

35
 

Management performs a quarterly analysis to determine the adequacy of the allowance for loan losses. The methodology in determining adequacy incorporates specific and general allocations together with a risk/loss analysis on various segments of the portfolio according to an internal loan review process. This assessment results in an allocated allowance. Management maintains its loan review and loan classification standards consistent with those of its regulatory supervisory authority.

 

Management considers, based upon its methodology, that the allowance for loan losses is adequate to cover foreseeable future losses. However, there can be no assurance that the allowance for loan losses will be adequate to cover significant losses, if any, that might be incurred in the future.

 

The Analysis of Allowance for Loan Losses table contains an analysis of the allowance for loan losses indicating charge-offs and recoveries for the nine month periods ended September 30, 2014 and 2013. For the first nine months of 2014, net charge-offs as a percentage of average loans was 0.10% as compared to 0.12% for the nine month period ended September 30, 2013. Net charge-offs amounted to $462,000 for the first nine months of 2014 as compared to $505,000 for the first nine months of 2013. The decrease in net charge-offs in the first nine months of 2014 as compared to the first nine months of 2013 related primarily to decreased losses in Commercial and Residential Real Estate loans. During the first nine months of 2014, $417,000 in Commercial and Residential Real Estate loans were charged off as compared to $496,000 for the first nine months of 2013.

 

For the first nine months of 2014, the provision for loan losses was $433,000 as compared to $733,000 for the first nine months of 2013. The provision, net of charge-offs and recoveries, decreased the quarter end Allowance for Loan Losses to $6,490,000 of which 8.1% was attributed to the Commercial and Industrial component; 52.0% attributed to the Commercial Real Estate component; 28.9% attributed to the Residential Real Estate component (primarily residential mortgages); 1.9% attributed to the Consumer component; and 9.1% being the unallocated component (refer to the activity in Note 4 – Loans and Allowance for Loan Losses on page 16). The Corporation determined that the provision for loan losses made during the current quarter was sufficient to maintain the allowance for loan losses at a level necessary for the probable losses inherent in the loan portfolio as of September 30, 2014.

 

Analysis of Allowance for Loan Losses

 

(Dollars in thousands)  September 30,   September 30, 
   2014   2013 
Balance at beginning of the nine month period  $6,519   $5,772 
Charge-offs:          
Commercial and Industrial   107    12 
Real Estate – Commercial and Residential   417    496 
Consumer   36    30 
    560    538 
Recoveries:          
Commercial and Industrial   24    19 
Real Estate – Commercial and Residential   71    5 
Consumer   3    9 
    98    33 
           
Net charge-offs   462    505 
Additions charged to operations