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EX-31.2 - EXHIBIT 31.2 - FIRST KEYSTONE CORPv422760_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - FIRST KEYSTONE CORPv422760_ex31-1.htm
EX-32.2 - EXHIBIT 32.2 - FIRST KEYSTONE CORPv422760_ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - FIRST KEYSTONE CORPv422760_ex32-1.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, 2015

 

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, 5,606,938 shares as of November 4, 2015

 

   

 

 

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, 
   2015   2014 
ASSETS          
Cash and due from banks  $9,512   $7,543 
Interest-bearing deposits in other banks   488    424 
Total cash and cash equivalents   10,000    7,967 
Time deposits with other banks   1,482    1,482 
Investment securities available-for-sale   370,293    347,666 
Investment securities held-to-maturity (fair value 2015- $31 2014 - $1,060)   30    1,056 
Restricted investment in bank stocks   6,795    5,308 
Loans   519,909    487,461 
Allowance for loan losses   (7,234)   (6,390)
Net loans   512,675    481,071 
Premises and equipment, net   20,130    20,871 
Accrued interest receivable   3,990    3,313 
Cash surrender value of bank owned life insurance   21,734    21,236 
Investments in low-income housing partnerships   1,595    1,130 
Goodwill   19,133    19,133 
Core deposit intangible, net       122 
Foreclosed assets held for resale   256    55 
Other assets   3,429    1,943 
TOTAL ASSETS  $971,542   $912,353 
LIABILITIES          
Deposits:          
Non-interest bearing  $107,540   $96,530 
Interest bearing   613,997    565,032 
Total deposits   721,537    661,562 
Short-term borrowings   65,482    73,123 
Long-term borrowings   70,259    65,339 
Accrued interest payable   434    399 
Deferred income taxes   215    211 
Other liabilities   4,553    5,448 
TOTAL LIABILITIES   862,480    806,082 
STOCKHOLDERS’ EQUITY          
Preferred stock, par value $2.00 per share; authorized 1,000,000 shares in 2015 and 2014; issued 0 in 2015 and 2014        
Common stock, par value $2.00 per share; authorized 20,000,000 shares in 2015 and 2014; issued 5,840,050 in 2015 and 5,802,521 in 2014; outstanding 5,606,938 in 2015 and 5,567,372 in 2014   11,680    11,605 
Surplus   33,522    32,674 
Retained earnings   66,327    63,485 
Accumulated other comprehensive income   3,289    4,330 
Treasury stock, at cost, 233,112 shares in 2015 and 235,149 in 2014   (5,756)   (5,823)
TOTAL STOCKHOLDERS’ EQUITY   109,062    106,271 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY  $971,542   $912,353 

 

See accompanying notes to consolidated financial statements.

 

 2 

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2015 AND 2014

(Unaudited)

 

(Dollars in thousands, except per share data)  Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2015   2014   2015   2014 
INTEREST INCOME                    
Interest and fees on loans  $5,398   $5,258   $16,090   $15,284 
Interest and dividend income on investment securities:                    
Taxable   1,579    1,912    4,927    5,920 
Tax-exempt   808    560    2,212    1,800 
Dividends   15    18    45    50 
Dividend income on restricted investment in bank stocks   77    67    353    169 
Interest on interest-bearing deposits in other banks   8        24    1 
Total interest income   7,885    7,815    23,651    23,224 
INTEREST EXPENSE                    
Interest on deposits   779    684    2,307    2,241 
Interest on short-term borrowings   85    71    215    159 
Interest on long-term borrowings   390    325    1,153    913 
Total interest expense   1,254    1,080    3,675    3,313 
Net interest income   6,631    6,735    19,976    19,911 
Provision for loan losses   753    100    1,178    433 
Net interest income after provision for loan losses   5,878    6,635    18,798    19,478 
NON-INTEREST INCOME                    
Trust department   216    216    670    711 
Service charges and fees   469    460    1,291    1,171 
Bank owned life insurance income   169    165    498    514 
ATM fees and debit card income   310    284    903    833 
Gains on sales of mortgage loans   111    68    425    148 
Net investment securities gains   1,036    163    2,131    1,963 
Impairment charges on equity securities           (14)    
Other   121    146    378    395 
Total non-interest income   2,432    1,502    6,282    5,735 
NON-INTEREST EXPENSE                    
Salaries and employee benefits   2,741    2,927    8,432    8,569 
Occupancy, net   386    384    1,260    1,279 
Furniture and equipment   158    130    449    437 
Computer expense   217    273    600    816 
Professional services   139    147    451    444 
Pennsylvania shares tax   190    159    556    476 
FDIC insurance   137    142    390    379 
ATM and debit card fees   164    155    461    446 
Data processing fees   111    102    452    298 
Foreclosed assets held for resale expense   9    4    58    126 
Advertising   147    139    327    447 
Other   833    700    2,475    2,236 
Total non-interest expense   5,232    5,262    15,911    15,953 
Income before income tax expense   3,078    2,875    9,169    9,260 
Income tax expense   593    492    1,805    1,823 
NET INCOME  $2,485   $2,383   $7,364   $7,437 
PER SHARE DATA                    
Net income per share:                    
Basic  $0.44   $0.43   $1.32   $1.34 
Diluted   0.44    0.43    1.32    1.34 
Dividends per share   0.27    0.26    0.81    0.78 

 

See accompanying notes to consolidated financial statements.

 

 3 

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

(Dollars in thousands)  Three Months Ended 
   September 30, 
   2015   2014 
         
Net Income  $2,485   $2,383 
           
Other comprehensive income (loss):          
Unrealized net holding gains (losses) on available-for-sale investment securities arising during the period, net of income taxes of $1,181 and $(100), respectively   2,285    (174)
           
Less reclassification adjustment for net gains included in net income, net of income taxes of $(353) and $(55), respectively (a) (b)   (683)   (108)
           
Total other comprehensive income (loss)   1,602    (282)
           
Total Comprehensive Income   $4,087   $2,101 

_______________________

(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, 
   2015   2014 
         
Net Income  $7,364   $7,437 
           
Other comprehensive (loss) income:          
Unrealized net holding gains on available-for-sale investment securities arising during the period, net of income taxes of $176 and $2,538, respectively   356    4,951 
           
Less reclassification adjustment for net gains included in net income, net of income taxes of $(725) and $(667), respectively (a) (c)   (1,406)   (1,296)
           
Less reclassification adjustment for impairment charges on equity securities included in net income, net of income taxes of $5 and $0, respectively (b) (c)   9     
           
Total other comprehensive (loss) income   (1,041)   3,655 
           
Total Comprehensive Income  $6,323   $11,092 

_______________________

(a)Gross amounts are included in net investment securities gains on the Consolidated Statements of Income in non-interest income.
(b)Gross amounts are included in impairment charges on equity securities on the Consolidated Statements of Income in non-interest income.
(c)Income tax amounts are included in income tax expense on the Consolidated Statements of Income.

 

See accompanying notes to consolidated financial statements.

 

 4 

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

NINE MONTHS ENDED SEPTEMBER 30, 2015 AND 2014

(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, 2015   5,802,521   $11,605   $32,674   $63,485   $4,330   $(5,823)  $106,271 
Net Income                  7,364              7,364 
Other comprehensive loss, net of taxes                       (1,041)        (1,041)
Issuance of common stock under dividend reinvestment plan and exercise of employee stock options   37,529    75    848              67    990 
Dividends - $0.81 per share                  (4,522)             (4,522)
Balance at September 30, 2015   5,840,050   $11,680   $33,522   $66,327   $3,289   $(5,756)  $109,062 
                                    
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 

 

See accompanying notes to consolidated financial statements.

 

 5 

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2015 AND 2014

(Unaudited)

 

(Dollars in thousands)        
   2015   2014 
OPERATING ACTIVITIES          
Net income  $7,364   $7,437 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for loan losses   1,178    433 
Depreciation and amortization   1,126    1,213 
Net premium amortization on investment securities   2,103    1,207 
Deferred income tax expense   549    155 
Gains on sales of mortgage loans   (425)   (148)
Proceeds from sales of mortgage loans originated for resale   15,447    6,000 
Originations of mortgage loans originated for resale   (13,961)   (8,077)
Gains on sales of investment securities   (2,131)   (1,963)
Impairment charges on equity securities   14     
Losses on sales of foreclosed real estate held for resale, including write-downs   34    36 
(Increase) decrease in accrued interest receivable   (677)   211 
Earnings on investment in bank owned life insurance   (498)   (514)
Losses on disposals of premises and equipment   30     
Increase in other assets   (1,486)   (300)
Increase in accrued interest payable   35    9 
Decrease in other liabilities   (1,958)   (3,041)
NET CASH PROVIDED BY OPERATING ACTIVITIES   6,744    2,658 
INVESTING ACTIVITIES          
Proceeds from sales of investment securities available-for-sale   111,799    138,218 
Proceeds from maturities and redemptions of investment securities available-for-sale   17,006    31,087 
Purchases of investment securities available-for-sale   (151,941)   (150,390)
Proceeds from maturities and redemptions of investment securities held-to-maturity   1,026    12 
Net change in restricted investment in bank stocks   (1,487)   (2,355)
Net increase in loans   (34,035)   (37,178)
Purchases of premises and equipment   (232)   (516)
Purchases of investment in real estate venture   (590)    
Proceeds from sales of foreclosed assets held for resale   21    489 
NET CASH USED IN INVESTING ACTIVITIES   (58,433)   (20,633)
FINANCING ACTIVITIES          
Net increase (decrease) in deposits   59,975    (33,976)
Net (decrease) increase in short-term borrowings   (7,641)   8,617 
Proceeds from long-term borrowings   5,000    30,000 
Repayment of long-term borrowings   (80)   (5,065)
Common stock issued   953    826 
Proceeds from issuance of treasury stock   37     
Dividends paid   (4,522)   (4,315)
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES   53,722    (3,913)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS   2,033    (21,888)
CASH AND CASH EQUIVALENTS, BEGINNING   7,967    30,623 
CASH AND CASH EQUIVALENTS, ENDING  $10,000   $8,735 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION          
Interest paid  $3,640   $3,304 
Income taxes paid   2,047    1,755 
Purchased securities settling after quarter end   1,063     
Loans transferred to foreclosed assets held for resale   256    262 

 

See accompanying notes to consolidated financial statements.

 

 6 

 

 

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, 2015, are not necessarily indicative of the results for the year ending December 31, 2015. 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, 2014.

 

The Corporation has evaluated events and transactions occurring subsequent to the consolidated balance sheet date of September 30, 2015 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, 2015 that were not already adopted by the Corporation.

 

In May 2014, the Financial Accounting Standards Board (“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 for annual reporting periods beginning after December 31, 2016, including interim periods within the reporting period. Early application is not permitted. In July 2015, the FASB approved a one-year delay of the effective date of this standard. The deferral would require public entities to apply the standard for annual reporting periods beginning after December 15, 2017. Public companies would be permitted to elect to early adopt for annual reporting periods beginning after December 15, 2016. 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.

 

 7 

 

 

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, 2015 and December 31, 2014:

 

   Available-for-Sale Securities 
(Dollars in thousands)      Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
September 30, 2015:  Cost   Gains   Losses   Value 
U.S. Treasury securities  $1,026   $6   $   $1,032 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed   95,941    626    (299)   96,268 
Other   21,876    256    (46)   22,086 
Obligations of state and political subdivisions   195,845    5,048    (340)   200,553 
Corporate debt securities   49,350    31    (993)   48,388 
Marketable equity securities   1,194    772        1,966 
Total  $365,232   $6,739   $(1,678)  $370,293 

 

   Held-to-Maturity Securities 
(Dollars in thousands)      Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
September 30, 2015:  Cost   Gains   Losses   Value 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed  $30   $1   $   $31 
Total  $30   $1   $   $31 

 

   Available-for-Sale Securities 
(Dollars in thousands)      Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
December 31, 2014:  Cost   Gains   Losses   Value 
U.S. Treasury securities  $11,356   $24   $(2)  $11,378 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed   112,146    1,055    (487)   112,714 
Other   26,246    270    (6)   26,510 
Obligations of state and political subdivisions   151,565    6,127    (469)   157,223 
Corporate debt securities   38,499    112    (825)   37,786 
Marketable equity securities   1,208    867    (20)   2,055 
Total  $341,020   $8,455   $(1,809)  $347,666 

 

   Held-to-Maturity Securities 
(Dollars in thousands)      Gross    Gross     
   Amortized   Unrealized   Unrealized   Fair 
December 31, 2014:  Cost   Gains   Losses   Value 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed  $56   $2   $   $58 
Other   1,000    2        1,002 
Total  $1,056   $4   $   $1,060 

 

 8 

 

 

Securities Available-for-Sale with an aggregate fair value of $312,484,000 at September 30, 2015 and $222,847,000 at December 31, 2014, and securities Held-to-Maturity with an aggregate book value of $30,000 at September 30, 2015 and $1,056,000 at December 31, 2014, were pledged to secure public funds, trust funds, securities sold under agreements to repurchase, FHLB advances and other balances of $236,806,000 at September 30, 2015 and $155,895,000 at December 31, 2014.

 

The amortized cost, estimated fair value and weighted average yield of debt and equity securities, by contractual maturity, are shown below at September 30, 2015. 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, 2015 
   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  $   $   $550   $869   $   $ 
Fair value           565    885         
Weighted average yield           6.45%   3.15%        
                               
1 - 5 Years:                              
Amortized cost   1,026    15,127    20,586    12,155        30 
Fair value   1,032    15,271    21,077    12,031        31 
Weighted average yield   0.96%   1.83%   3.01%   2.30%       2.55%
                               
5 - 10 Years:                              
Amortized cost       40,740    91,445    36,326         
Fair value       41,077    92,800    35,472         
Weighted average yield       2.18%   3.13%   2.69%        
                               
After 10 Years:                              
Amortized cost       61,950    83,264        1,194     
Fair value       62,006    86,111        1,966     
Weighted average yield       1.65%   4.93%       4.95%    
                               
Total:                              
Amortized cost  $1,026   $117,817   $195,845   $49,350   $1,194   $30 
Fair value   1,032    118,354    200,553    48,388    1,966    31 
Weighted average yield   0.96%   1.86%   3.89%   2.60%   4.95%   2.55%

_______________________

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.

 

There were no aggregate investments with a single issuer (excluding the U.S. Government and U.S. Government Agencies and Corporations) which exceeded ten percent of consolidated stockholders’ equity at September 30, 2015. 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, 2015 and 2014 were $32,059,000 and $18,016,000, respectively. Gross gains realized on these sales were $1,036,000 and $235,000, respectively. Gross losses on these sales were $0 and $72,000, respectively. Impairment losses realized on Available-for-Sale equity securities for the three months ended September 30, 2015 and 2014 were $0 and $0, respectively.

 

 9 

 

 

Proceeds from sales of investments in Available-for-Sale debt and equity securities for the nine months ended September 30, 2015 and 2014 were $111,799,000 and $138,218,000, respectively. Gross gains realized on these sales were $2,186,000 and $2,557,000, respectively. Gross losses on these sales were $55,000 and $594,000, respectively. Impairment losses realized on Available-for-Sale equity securities for the nine months ended September 30, 2015 and 2014 were $14,000 and $0, respectively.

 

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, 2015 or 2014. 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 as impairment charges on securities 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 (loss), net of applicable taxes. The previous amortized cost basis less the other-than-temporary impairment recognized in earnings becomes 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 as impairment charges on securities on the Consolidated Statements of Income. The amount of the total other-than-temporary impairment is recognized in other comprehensive income (loss), net of applicable taxes. The previous cost basis less the other-than-temporary impairment recognized in earnings becomes the new cost basis of the investment.

 

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. As of June 30, 2015, we recognized other than temporary impairment on one equity security that was trading below cost basis. We have written down the value of the shares based upon market indications. In management’s opinion, the equity securities reflect a more accurate valuation of the shares after the impairment charge. Based on the factors described above, management did not consider any securities to be other-than-temporarily impaired at September 30, 2015. Management did not consider any securities to be other-than-temporarily impaired at December 31, 2014.

 

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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, 2015 and December 31, 2014:

 

September 30, 2015                        
                         
(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   17,464    (199)   11,801    (100)   29,265    (299)
Other   3,928    (46)           3,928    (46)
Obligations of state and political subdivisions   34,508    (213)   8,133    (127)   42,641    (340)
Corporate debt securities   26,913    (365)   19,080    (628)   45,993    (993)
Marketable equity securities                        
   $82,813   $(823)  $39,014   $(855)  $121,827   $(1,678)

 

December 31, 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  $6,030   $(2)  $   $   $6,030   $(2)
Obligations of U.S. Government                              
Corporations and Agencies:                              
Mortgage-backed   19,823    (230)   17,099    (257)   36,922    (487)
Other   7,154    (6)           7,154    (6)
Obligations of state and political subdivisions   21,459    (94)   18,273    (375)   39,732    (469)
Corporate debt securities   22,227    (542)   12,066    (283)   34,293    (825)
Marketable equity securities   30    (20)           30    (20)
   $76,723   $(894)  $47,438   $(915)  $124,161   $(1,809)

 

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 62 securities with a one year or less unrealized loss position or any of their 19 securities with a greater than one year unrealized loss position as of September 30, 2015, represent an other-than-temporary impairment, as these unrealized losses relate principally to changes in interest rates subsequent to the acquisition of the specific securities.

 

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NOTE 4LOANS AND ALLOWANCE FOR LOAN LOSSES

 

Loans

 

Net 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.

 

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.

 

The loans receivable portfolio is segmented into commercial, residential and consumer loans. Commercial loans consist of the following classes: Commercial and Industrial and Commercial Real Estate.

 

Commercial and Industrial Lending

 

The Corporation originates commercial and industrial loans primarily to businesses located in its primary market area and surrounding areas. These loans are used for various business purposes, which include short-term loans and lines of credit to finance machinery and equipment, inventory and accounts receivable. Generally, the maximum term for loans extended on machinery and equipment is based on the projected useful life of such machinery and equipment. Most business lines of credit are written on demand and are reviewed annually.

 

Commercial and industrial loans are generally secured with short-term assets; however, in many cases, additional collateral such as real estate is provided as additional security for the loan. Loan-to-value maximum thresholds have been established by the Corporation and are specific to the type of collateral. Collateral values may be determined using invoices, inventory reports, accounts receivable aging reports, business financial statements, collateral appraisals, etc. Commercial and industrial loans are typically secured by personal guarantees of the borrower.

 

In underwriting commercial and industrial loans, an analysis is performed to evaluate the borrower's character and capacity to repay the loan, the adequacy of the borrower's capital and collateral, as well as the conditions affecting the borrower. Evaluation of the borrower's past, present and future cash flows is also an important aspect of the Corporation's analysis of the borrower’s ability to repay.

 

Commercial and industrial loans generally present a higher level of risk than other types of loans due primarily to the effect of general economic conditions. Commercial and industrial loans are typically made on the basis of the borrower’s ability to make repayment from cash flows from the borrower’s primary business activities. As a result, the availability of funds for the repayment of commercial and industrial loans is dependent on the success of the business itself, which in turn, is likely to be dependent upon the general economic environment.

 

Commercial Real Estate Lending

 

The Corporation engages in commercial real estate lending in its primary market area and surrounding areas. The Corporation’s commercial real estate portfolio is secured primarily by commercial retail space, commercial office buildings, residential housing and hotels. Generally, commercial real estate loans have terms that do not exceed twenty years, have loan-to-value ratios of up to eighty percent of the value of the collateral property, and are typically secured by personal guarantees of the borrowers.

 

In underwriting these loans, the Corporation performs a thorough analysis of the financial condition of the borrower, the borrower’s credit history, and the reliability and predictability of the cash flow generated by the property securing the loan. The value of the property is determined by either independent appraisers or internal evaluations by Bank officers.

 

Commercial real estate loans generally present a higher level of risk than residential real estate secured loans. Repayment of loans secured by commercial real estate is typically dependent upon the successful operation of the related real estate project and/or the effect of the general economic conditions on income producing properties.

 

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Residential Real Estate Lending (Including Home Equity)

 

The Corporation’s residential real estate portfolio is comprised of one-to-four family residential mortgage loan originations, home equity term loans and home equity lines of credit. These loans are generated by the Corporation’s marketing efforts, its present customers, walk-in customers and referrals. These loans originate primarily within or with customers from the Corporation’s market area.

 

The Corporation’s one-to-four family residential mortgage originations are secured primarily by properties located in its primary market area and surrounding areas. The Corporation offers fixed-rate mortgage loans with terms up to a maximum of twenty years for both permanent structures and those under construction. Generally, the majority of the Corporation’s residential mortgage loans originate with a loan-to-value of eighty percent or less, or those with primary mortgage insurance at ninety-five percent or less. Generally, home equity term loans are secured by the borrower’s primary residence with a maximum loan-to-value of eighty percent and a maximum term of fifteen years. Generally, home equity lines of credit are secured by the borrower’s primary residence with a maximum loan-to-value of eighty percent and a maximum term of twenty years.

 

In underwriting one-to-four family residential mortgage loans, the Corporation evaluates the borrower’s ability to make monthly payments, the borrower’s repayment history and the value of the property securing the loan. The ability and willingness to repay is determined by the borrower’s employment history, current financial conditions and credit background. A majority of the properties securing residential real estate loans made by the Corporation are appraised by independent appraisers. The Corporation generally requires mortgage loan borrowers to obtain an attorney’s title opinion or title insurance and fire and property insurance, including flood insurance, if applicable.

 

Residential mortgage loans, home equity term loans and home equity lines of credit generally present a lower level of risk than consumer loans because they are secured by the borrower’s primary residence. Risk is increased when the Corporation is in a subordinate position, especially to another lender, for the loan collateral.

 

Consumer Lending

 

The Corporation offers a variety of secured and unsecured consumer loans, including vehicle loans, stock loans and loans secured by financial institution deposits. These loans originate primarily within or with customers from the Corporation’s market area.

 

Consumer loan terms vary according to the type and value of collateral and creditworthiness of the borrower. In underwriting personal loans, a thorough analysis is performed regarding the borrower’s willingness and financial ability to repay the loan as agreed. The ability to repay is determined by the borrower’s employment history, current financial condition and credit background.

 

Consumer loans may entail greater credit risk than residential real estate loans, particularly in the case of personal loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles or recreational equipment. In such cases, repossessed collateral for a defaulted personal loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, personal loan collections are dependent on the borrower’s continuing financial stability and therefore, are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

 

Delinquent 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.

 

Commercial and Industrial and Commercial Real Estate 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 or collateral estimated at fair value less cost to sell.

 

 13 

 

 

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.

 

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 well secured (or supported by a strong guarantee) and in the process of collection. 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.

 

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 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 and qualitative factors. The historical loss component of the allowance is determined by losses recognized by portfolio segment over a time period that management has determined represents the current credit cycle. Qualitative factors impacting each portfolio segment may include: delinquency trends, loan volume trends, Bank policy changes, management processes and oversight, economic trends (including change in consumer and business disposable incomes, unemployment and under-employment levels, and other conditions), concentrations by industry or product, internal and external loan review processes, collateral value and market conditions, and external factors including regulatory issues and competition.

 

 14 

 

 

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.

 

A reserve for unfunded lending commitments is provided for possible credit losses on off-balance sheet credit exposures. The reserve for unfunded lending commitments represents management’s estimate of losses inherent in its unfunded loan commitments and, if necessary, is recorded in other liabilities on the Consolidated Balance Sheet. As of September 30, 2015 and December 31, 2014, the amount of the reserve for unfunded lending commitments was $132,000 and $0.

 

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.

 

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 at inception or the fair value of the collateral for certain collateral dependent loans.

 

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 are considered impaired and 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.

 

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 Commercial and Industrial, Commercial Real Estate, Residential Real Estate and Consumer 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 is placed 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.

 

The 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.

 

 15 

 

 

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 have a high probability of payment default; are inadequately protected by the current sound net worth, paying capacity of the borrower, or pledged collateral; and may 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 whereby the basis of current information, conditions, and values, collection or liquidation in full is deemed to be 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 procedure, capital injection, perfection of liens on additional collateral and/or refinancing plan is completed. Loans are graded doubtful if they contain weaknesses so serious that collection or liquidation in full is questionable.

 

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The following table presents the classes of the loan portfolio summarized by risk rating as of September 30, 2015 and December 31, 2014:

 

   Commercial and     
(Dollars in thousands)  Industrial   Commercial Real Estate 
   September 30,   December 31,   September 30,   December 31, 
   2015   2014   2015   2014 
Grade:                    
1-6   Pass  $88,125   $64,459   $239,816   $237,404 
      Special Mention   159    47    3,900    11,008 
8       Substandard       21    15,796    5,472 
9       Doubtful                
Add (deduct): Unearned discount and                
   Net deferred loan fees and costs   142    129    311    38 
Total loans  $88,426   $64,656   $259,823   $253,922 

 

   Residential Real Estate         
   Including Home Equity   Consumer Loans 
   September 30,   December 31,   September 30,   December 31, 
   2015   2014   2015   2014 
Grade:                    
1-6   Pass  $162,943   $161,122   $5,761   $5,248 
7       Special Mention   1,115    520    28    21 
8       Substandard   1,680    1,640    4    9 
9       Doubtful                
Add (deduct): Unearned discount and   (20)       (1)   (40)
   Net deferred loan fees and costs   56    271    94    92 
Total loans  $165,774   $163,553   $5,886   $5,330 

 

   Total Loans 
   September 30,   December 31, 
   2015   2014 
Grade:          
1-6   Pass  $496,645   $468,233 
7       Special Mention   5,202    11,596 
8       Substandard   17,480    7,142 
9       Doubtful        
Add (deduct):  Unearned discount and   (21)   (40)
    Net deferred loan fees and costs   603    530 
Total loans  $519,909   $487,461 

 

Commercial and Industrial and Commercial Real Estate include loans categorized as tax-free in the amounts of $50,248,000 and $3,034,000, respectively at September 30, 2015 and $30,334,000 and $3,235,000 at December 31, 2014. Loans held for sale amounted to $1,723,000 at September 30, 2015 and $2,201,000 at December 31, 2014.

 

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

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
As of and for the three month period ended September 30, 2015:                              
Allowance for Loan Losses:                              
Beginning balance  $706   $3,139   $1,867   $89   $799   $6,600 
Charge-offs       (95)   (39)   (8)       (142)
Recoveries   4    17        2        23 
Provision   56    1,293    105    37    (738)   753 
Ending Balance  $766   $4,354   $1,933   $120   $61   $7,234 

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
As of and for the nine month period ended September 30, 2015:                              
Allowance for Loan Losses:                              
Beginning balance  $542   $3,176   $1,928   $107   $637   $6,390 
Charge-offs   (2)   (232)   (147)   (23)       (404)
Recoveries   7    59        4        70 
Provision   219    1,351    152    32    (576)   1,178 
Ending Balance  $766   $4,354   $1,933   $120   $61   $7,234 
Ending balance: individually evaluated for impairment  $   $1,243   $36   $   $   $1,279 
Ending balance: collectively evaluated for impairment  $766   $3,111   $1,897   $120   $61   $5,955 
                               
Loan Receivables:                              
Ending Balance  $88,426   $259,823   $165,774   $5,886   $   $519,909 
Ending balance: individually evaluated for impairment  $400   $11,620   $934   $   $   $12,954 
Ending balance: collectively evaluated for impairment  $88,026   $248,203   $164,840   $5,886   $   $506,955 

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
As of and for the three month period ended September 30, 2014:                              
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 

 

 18 

 

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
As of and for the nine month period ended September 30, 2014:                              
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 
                               
Loan 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 

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
As of December 31, 2014:                              
Allowance for Loan Losses:                              
Ending Balance  $542   $3,176   $1,928   $107   $637   $6,390 
Ending balance: individually evaluated for impairment  $   $38   $81   $   $   $119 
Ending balance: collectively evaluated for impairment  $542   $3,138   $1,847   $107   $637   $6,271 
                               
Loan Receivables:                              
Ending Balance  $64,656   $253,922   $163,553   $5,330   $   $487,461 
Ending balance: individually evaluated for impairment  $399   $5,350   $1,291   $4   $   $7,044 
Ending balance: collectively evaluated for impairment  $64,257   $248,572   $162,262   $5,326   $   $480,417 

 

As of September 30, 2015, the $256,000 in foreclosed assets held for resale was secured entirely by residential real estate and was held as the result of obtaining physical possession. At December 31, 2014, the $55,000 in foreclosed assets held for resale was secured entirely by commercial real estate, and there were no residential real estate properties held as the result of obtaining physical possession. Consumer mortgage loans secured by residential real estate for which the Bank has entered into formal foreclosure proceedings but for which physical possession of the property has yet to be obtained amounted to $215,000 at September 30, 2015 and $118,000 at December 31, 2014. These balances were not included in foreclosed assets held for resale at September 30, 2015 or December 31, 2014.

 

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”).

 

 19 

 

 

The outstanding balance of TDRs as of September 30, 2015 and December 31, 2014 was $8,851,000 and $4,708,000, 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. There were $48,000 and $0 in unfunded commitments on TDRs at September 30, 2015 and December 31, 2014, respectively.

 

During the three months ended September 30, 2015, two loans with a combined post modification balance of $992,000 were classified as TDRs, as compared to the same period in 2014, when four loans with a combined post modification balance of $888,000 were classified as TDRs. The loan modifications for the three months ended September 30, 2015 consisted of one term modification and one payment modification. The loan modifications for the three months ended September 30, 2014 consisted of one term modification and three payment modifications.

 

During the nine months ended September 30, 2015, seven loans with a combined post modification balance of $5,550,000 were classified as TDRs, as compared to the same period in 2014, when thirteen loans with a combined post modification balance of $1,810,000 were classified as TDRs. The loan modifications for the nine months ended September 30, 2015 consisted of four term modifications and three payment modifications. 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 following table presents the unpaid balance of TDRs at the dates indicated:

 

(Dollars in thousands)        
   September 30,   December 31, 
   2015   2014 
Non-accrual TDRs  $1,401   $1,638 
Accruing TDRs   7,450    3,070 
Total  $8,851   $4,708 

 

At September 30, 2015, five Commercial Real Estate loans classified as TDRs with a combined recorded investment of $2,133,000 were not in compliance with the terms of their restructure, compared to September 30, 2014 when 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.

 

During the three months ended September 30, 2015, two Commercial Real Estate loans totaling $178,000 that were modified as TDRs within the preceding twelve months had experienced payment defaults, as compared to the same period in 2014 when there were no payment defaults on loans that were modified as TDRs within the preceding twelve months. During the nine months ended September 30, 2015, three Commercial Real Estate loans totaling $4,404,000 that were modified as TDRs within the preceding twelve months had experienced payment defaults, as compared to the same period in 2014 when four Commercial Real Estate loans totaling $193,000 that were modified as TDRs within the preceding twelve months had experienced payment defaults. The significant increase in defaulted TDRs at September 30, 2015 as compared to September 30, 2014 is largely due to one loan in the amount of $4,226,000 to a student housing holding company, which was modified as a TDR in the first quarter of 2015 and experienced its subsequent default during the second quarter of 2015.

 

The following table presents information regarding the loan modifications categorized as TDRs during the three and nine months ended September 30, 2015 and September 30, 2014:

 

(Dollars in thousands, except number of contracts) 
     
   Three Months Ended September 30, 2015 
       Pre-Modification   Post-Modification     
   Number   Outstanding Recorded   Outstanding Recorded   Recorded 
   of Contracts   Investment   Investment   Investment 
Commercial and Industrial      $   $   $ 
Commercial Real Estate   2    815    992    1,001 
Consumer                
Total   2   $815   $992   $1,001 

 

(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 

 

 20 

 

 

(Dollars in thousands, except number of contracts)
     
   Nine Months Ended September 30, 2015 
       Pre-Modification   Post-Modification     
   Number   Outstanding Recorded   Outstanding Recorded   Recorded 
   of Contracts   Investment   Investment   Investment 
Commercial and Industrial   1   $23   $23   $21 
Commercial Real Estate   6    5,395    5,527    5,527 
Consumer                
Total   7   $5,418   $5,550   $5,548 

 

(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 

 

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, 2015 and September 30, 2014 with the total number of each type of modification performed.

 

   Three Months Ended September 30, 2015   Nine Months Ended September 30, 2015 
   Rate   Term   Payment   Number   Rate   Term   Payment   Number 
   Modification   Modification   Modification   Modified   Modification   Modification   Modification   Modified 
Commercial  and Industrial                       1        1 
Commercial Real Estate       1    1    2        3    3    6 
Consumer                                
Total       1    1    2        4    3    7 

 

   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 

 

 21 

 

 

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, 2015 and December 31, 2014.

 

(Dollars in thousands)  September 30, 2015   December 31, 2014 
       Unpaid           Unpaid     
   Recorded   Principal   Related   Recorded   Principal   Related 
   Investment   Balance   Allowance   Investment   Balance   Allowance 
With no related allowance recorded:                              
Commercial and Industrial  $400   $545   $   $399   $545   $ 
Commercial Real Estate   9,297    9,641        4,828    5,278     
Residential Real Estate   493    612        727    892     
Consumer               4    4     
                               
With an allowance recorded:                              
Commercial and Industrial                        
Commercial Real Estate   2,323    6,272    1,243    522    522    38 
Residential Real Estate   441    441    36    564    569    81 
Consumer                        
Total  $12,954   $17,511   $1,279   $7,044   $7,810   $119 
                               
Total consists of:                              
Commercial and Industrial  $400   $545   $   $399   $545   $ 
Commercial Real Estate  $11,620   $15,913   $1,243   $5,350   $5,800   $38 
Residential Real Estate  $934   $1,053   $36   $1,291   $1,461   $81 
Consumer  $   $   $   $4   $4   $ 

______________________

At September 30, 2015 and December 31, 2014, $8,851,000 and $4,708,000 of loans classified as TDRs were included in impaired loans with a total allocated allowance of $0 and $27,000, respectively. The recorded investment represents the loan balance reflected on the Consolidated Balance Sheets net of any charge-offs. The unpaid principal balance is equal to the gross amount due on the loan.

 

The average recorded investment and interest income recognized for the Corporation’s impaired loans are summarized below for the three and nine months ended September 30, 2015 and 2014.

 

(Dollars in thousands)  For the Three Months Ended   For the Three Months Ended 
   September 30, 2015   September 30, 2014 
   Average   Interest   Average   Interest 
   Recorded   Income   Recorded   Income 
   Investment   Recognized   Investment   Recognized 
With no related allowance recorded:                    
Commercial and Industrial  $407   $2   $341   $ 
Commercial Real Estate   9,235    59    5,213    20 
Residential Real Estate   499        1,123     
Consumer   1        7     
                     
With an allowance recorded:                    
Commercial Real Estate   1,162    45    171    8 
Residential Real Estate   441        33    2 
Total  $11,745   $106   $6,888   $30 
                     
Total consists of:                    
Commercial and Industrial  $407   $2   $341   $ 
Commercial Real Estate  $10,397   $104   $5,384   $28 
Residential Real Estate  $940   $   $1,156   $2 
Consumer  $1   $   $7   $ 

_____________________

Of the $106,000 and $30,000 in interest income recognized on impaired loans for the three months ended September 30, 2015 and 2014, respectively, $60,000 and $9,000 in interest income was recognized in respect to non-accrual loans.

 

 22 

 

 

(Dollars in thousands)  For the Nine Months Ended   For the Nine Months Ended 
   September 30, 2015   September 30, 2014 
   Average   Interest   Average   Interest 
   Recorded   Income   Recorded   Income 
   Investment   Recognized   Investment   Recognized 
With no related allowance recorded:                    
Commercial and Industrial  $407   $12   $184   $13 
Commercial Real Estate   8,218    305    5,037    86 
Residential Real Estate   449        865     
Consumer   2        5     
                     
With an allowance recorded:                    
Commercial Real Estate   581    45    101    8 
Residential Real Estate   445        17    2 
Total  $10,102   $362   $6,209   $109 
                     
Total consists of:                    
Commercial and Industrial  $407   $12   $184   $13 
Commercial Real Estate  $8,799   $350   $5,138   $94 
Residential Real Estate  $894   $   $882   $2 
Consumer  $2   $   $5   $ 

_____________________

Of the $362,000 and $109,000 in interest income recognized on impaired loans for the nine months ended September 30, 2015 and 2014, respectively, $60,000 and $10,000 in interest income was recognized in respect to non-accrual loans.

 

Loan receivables on non-accrual status, foreclosed assets held for resale and loans past-due 90 days or more and still accruing, as of September 30, 2015 and December 31, 2014 were as follows:

 

(Dollars in thousands)        
   September 30,   December 31, 
   2015   2014 
Commercial and Industrial  $   $5 
Commercial Real Estate   4,570    2,678 
Residential Real Estate   934    1,291 
Total non-accrual loans   5,504    3,974 
Foreclosed assets held for resale   256    55 
Loans past-due 90 days or more and still accruing   164    10 
Total non-performing assets  $5,924   $4,039 

 

The following tables present the classes of the loan portfolio summarized by the past-due status at September 30, 2015 and December 31, 2014:

 

(Dollars in thousands)               
                           90 Days 
                           Or Greater 
           90 Days               Past Due 
   30-59 Days   60-89 Days   or Greater   Total       Total   and Still 
   Past Due   Past Due   Past Due   Past Due   Current   Loans   Accruing 
September 30, 2015:                                   
Commercial and Industrial  $185   $24   $22   $231   $88,195   $88,426   $22 
Commercial Real Estate   561    403    4,520    5,484    254,339    259,823     
Residential Real Estate   1,381    216    1,045    2,642    163,132    165,774    142 
Consumer   17    13        30    5,856    5,886     
Total  $2,144   $656   $5,587   $8,387   $511,522   $519,909   $164 

 

 23 

 

 

(Dollars in thousands)
                           90 Days 
                           Or Greater 
           90 Days               Past Due 
   30-59 Days   60-89 Days   or Greater   Total       Total   and Still 
   Past Due   Past Due   Past Due   Past Due   Current   Loans   Accruing 
December 31, 2014:                                   
Commercial and Industrial  $72   $28   $5   $105   $64,551   $64,656   $ 
Commercial Real Estate   1,657    613    2,375    4,645    249,277    253,922     
Residential Real Estate   1,998    224    1,220    3,442    160,111    163,553    10 
Consumer   27    8        35    5,295    5,330     
Total  $3,754   $873   $3,600   $8,227   $479,234   $487,461   $10 

 

At September 30, 2015 and December 31, 2014, there were no commitments to lend additional funds with respect to impaired loans.

 

NOTE 5BORROWINGS

 

Short-Term Borrowings

 

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.

 

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.

 

 24 

 

 

The following table presents the short-term borrowings subject to an enforceable master netting arrangement or repurchase agreements as of September 30, 2015 and December 31, 2014.

 

(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, 2015                              
Repurchase agreements (a)  $22,882   $   $22,882   $(22,882)  $   $ 
                               
December 31, 2014                              
Repurchase agreements (a)  $16,730   $   $16,730   $(16,730)  $   $ 

______________________

(a) As of September 30, 2015 and December 31, 2014, the fair value of securities pledged in connection with repurchase agreements was $28,837,000 and $26,094,000, respectively.

 

The following table presents the remaining contractual maturity of the master netting arrangement or repurchase agreements as of September 30, 2015.

 

(Dollars in thousands)  Remaining Contractual Maturity of the Agreements 
   Overnight           Greater     
   and   Up to   30 -90   than     
   Continuous   30 days   Days   90 Days   Total 
September 30, 2015:                         
Repurchase agreements and repurchase-to-maturity transactions:                         
U.S. Treasury and /or agency securities  $22,882   $   $   $   $22,882 
Total  $22,882   $   $   $   $22,882 

 

Long-Term Borrowings

 

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 7FINANCIAL 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.

 

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.

 

 25 

 

 

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, 2015 and December 31, 2014, were as follows:

 

(Dollars in thousands)        
   September 30, 2015   December 31, 2014 
Financial instruments whose contract amounts represent credit risk:          
Commitments to extend credit  $83,658   $84,983 
Financial standby letters of credit  $475   $471 
Performance standby letters of credit  $5,102   $5,851 

 

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.

 

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.

 

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.

 

 26 

 

 

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, 2015 and December 31, 2014, investments measured at fair value on a recurring basis and the valuation methods used are as follows:

 

(Dollars in thousands)                
                 
September 30, 2015                
   Level 1   Level 2   Level 3   Total 
Available-for-Sale Securities:                    
U.S. Treasury securities  $   $1,032   $   $1,032 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed       96,268        96,268 
Other       22,086        22,086 
Obligations of state and political subdivisions       200,553        200,553 
Corporate debt securities       48,388        48,388 
Marketable equity securities   1,966            1,966 
Total  $1,966   $368,327   $   $370,293 

 

(Dollars in thousands)                
                 
December 31, 2014                
   Level 1   Level 2   Level 3   Total 
Available-for-Sale Securities:                    
U.S. Treasury securities  $   $11,378   $   $11,378 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgaged-backed       112,714        112,714 
Other       26,510        26,510 
Obligations of state and political subdivisions       157,223        157,223 
Corporate debt securities       37,786        37,786 
Marketable equity securities   2,055            2,055 
Total  $2,055   $345,611   $   $347,666 

 

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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 2015 or 2014.

 

Financial Assets Measured at Fair Value on a Nonrecurring Basis

 

At September 30, 2015 and December 31, 2014, 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, 2015                    
Impaired loans:                    
Commercial and Industrial  $   $   $   $ 
Commercial Real Estate           2,573    2,573 
Residential Real Estate           599    599 
Total impaired loans  $   $   $3,172   $3,172 

 

(Dollars in thousands)                
   Level 1   Level 2   Level 3   Total 
Assets at December 31, 2014                    
Impaired loans:                    
Commercial and Industrial  $   $   $3   $3 
Commercial Real Estate           2,073    2,073 
Residential Real Estate           856    856 
Total impaired loans  $   $   $2,932   $2,932 

 

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 2015 and 2014.

 

Nonfinancial Assets Measured at Fair Value on a Nonrecurring Basis

 

At September 30, 2015 and December 31, 2014 foreclosed assets held for resale 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, 2015               
Other foreclosed assets held for resale:                    
Commercial Real Estate  $   $   $   $ 
Total foreclosed assets held for resale  $   $   $   $ 

 

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(Dollars in thousands)                
   Level 1   Level 2   Level 3   Total 
Assets at December 31, 2014                
Other foreclosed assets held for resale:                    
Commercial Real Estate  $   $   $55   $55 
Total foreclosed assets held for resale  $   $   $55   $55 

 

The Bank’s foreclosed asset valuation procedure requires an appraisal, which considers the sales prices of similar properties in the proximate vicinity, to be completed periodically with the exception of those cases which the Bank has obtained a sales agreement. These assets are included as Level 3 fair values, based upon the lowest level that is significant to the fair value measurements. There were no transfers between valuation levels in 2015 and 2014.

 

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 
September 30, 2015                 
Impaired loans  $3,172   Appraisal of collateral1,3  Appraisal adjustments2  (0%) – (63%)   (33)%
Foreclosed assets held for resale  $   Appraisal of collateral1,3  Appraisal adjustments2  (0%) – (0%)   (0)%
                    
December 31, 2014                   
Impaired loans  $2,932   Appraisal of collateral1,3  Appraisal adjustments2  (0%) – (63%)   (37)%
Foreclosed assets held for resale  $55   Appraisal of collateral1,3  Appraisal adjustments2  (33%) – (46%)   (37)%

______________________

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, 2015 
   Amount   Level 1   Level 2   Level 3   Total 
FINANCIAL ASSETS:                         
Cash and due from banks  $9,512   $9,512   $   $   $9,512 
Interest-bearing deposits in other banks   488        488        488 
Time deposits with other banks   1,482        1,482        1,482 
Investment securities available-for-sale   370,293    1,966    368,327        370,293 
Investment securities held-to-maturity   30        31        31 
Restricted investment in bank stocks   6,795        6,795        6,795 
Net loans   512,675            519,951    519,951 
Mortgage servicing rights   494            494    494 
Accrued interest receivable   3,990        3,990        3,990 
                          
FINANCIAL LIABILITIES:                         
Deposits   721,537        722,521        722,521 
Short-term borrowings   65,482        65,482        65,482 
Long-term borrowings   70,259        72,301        72,301 
Accrued interest payable   434        434        434 
                          
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS                    

 

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(Dollars in thousands)                    
   Carrying   Fair Value Measurements at December 31, 2014 
   Amount   Level 1   Level 2   Level 3   Total 
FINANCIAL ASSETS:                         
Cash and due from banks  $7,543   $7,543   $   $   $7,543 
Interest-bearing deposits in other banks   424        424        424 
Time deposits with other banks   1,482        1,482        1,482 
Investment securities available-for-sale   347,666    2,055    345,611        347,666 
Investment securities held-to-maturity   1,056        1,060        1,060 
Restricted investment in bank stocks   5,308        5,308        5,308 
Net loans   481,071            485,468    485,468 
Mortgage servicing rights   481            481    481 
Accrued interest receivable   3,313        3,313        3,313 
                          
FINANCIAL LIABILITIES:                         
Deposits   661,562        661,819        661,819 
Short-term borrowings   73,123        73,123        73,123 
Long-term borrowings   65,339        66,739        66,739 
Accrued interest payable   399        399        399 
                          
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS                    

 

The following 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, 2015 and December 31, 2014:

 

Cash and Due From Banks, Interest-Bearing Deposits in Other Banks, Time Deposits with 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.

 

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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.

 

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, 2015 and December 31, 2014.

 

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, 
   2015   2014 
Net income  $2,485   $2,383 
Weighted-average common shares outstanding   5,594    5,544 
Basic earnings per share  $0.44   $0.43 
           
Weighted-average common shares outstanding   5,594    5,544 
Common stock equivalents due to effect of stock options   2    5 
Total weighted-average common shares and equivalents   5,596    5,549 
Diluted earnings per share  $0.44   $0.43 

 

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(In thousands, except earnings per share)  Nine Months Ended 
   September 30, 
   2015   2014 
Net income  $7,364   $7,437 
Weighted-average common shares outstanding   5,581    5,553 
Basic earnings per share  $1.32   $1.34 
           
Weighted-average common shares outstanding   5,581    5,553 
Common stock equivalents due to effect of stock options   2    5 
Total weighted-average common shares and equivalents   5,583    5,538 
Diluted earnings per share  $1.32   $1.34 

 

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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 2014 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, 2014.

 

RESULTS OF OPERATIONS

 

Quarter ended September 30, 2015 compared to quarter ended September 30, 2014

 

First Keystone Corporation realized earnings for the three months ended September 30, 2015 of $2,485,000, an increase of $102,000, or 4.3% from the third quarter of 2014. The increase in net income for the three months ended September 30, 2015 was primarily due to an increase in net investment securities gains.

 

On a per share basis, for the three months ended September 30, 2015, net income was $0.44 versus $0.43 in the three months ended September 30, 2014. Cash dividends amounted to $0.27 per share up from $0.26 in the three months ended September 30, 2014, an increase of 3.8%.

 

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, 2015, interest income amounted to $7,885,000, an increase of $70,000 or 0.9% from the three months ended September 30, 2014, while interest expense amounted to $1,254,000 for the three months ended September 30, 2015, an increase of $174,000, or 16.1% from the three months ended September 30, 2014. As a result, net interest income decreased $104,000 or 1.5% to $6,631,000 from $6,735,000 for the same period in 2014.

 

The Corporation’s net interest margin for the three months ended September 30, 2015 was 3.24% compared to 3.45% for the same period in 2014. 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, 2015 and September 30, 2014 was $753,000 and $100,000, respectively. The increase 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. One of the factors contributing to the increase in the provision for loan losses is a significant specific allocation on a non-performing originated participation loan assigned during the third quarter of 2015, included in the discussion of the Corporation’s largest impaired loan relationships in the Non-Performing Assets section on page 40. Net charge-offs for the three months ended September 30, 2015 and 2014 were $119,000 and $87,000, respectively. See Allowance for Loan Losses on page 38 for further discussion.

 

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NON-INTEREST INCOME

 

Total non-interest income was $2,432,000 for the three months ended September 30, 2015, as compared to $1,502,000 for the same period in 2014, an increase of $930,000, or 61.9%. Service charges and fee income increased by $9,000 or 2.0%. Gains on sales of mortgage loans increased $43,000 or 63.2% due to a favorable and stable rate environment for the Bank’s customers.

 

Net gains on sales of investment securities increased $873,000 to $1,036,000 for the three months ended September 30, 2015 as compared to the three months ended September 30, 2014. 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 $1,396,000 for the three months ended September 30, 2015, an increase of $57,000 or 4.3% from the three months ended September 30, 2014.

 

NON-INTEREST EXPENSE

 

Total non-interest expense was $5,232,000 for the three months ended September 30, 2015, as compared to $5,262,000 for the three months ended September 30, 2014. Non-interest expense decreased $30,000 or 0.6%.

 

Expenses associated with employees (salaries and employee benefits) continue to be the largest category of non-interest expense. Salaries and benefits amounted to $2,741,000 or 52.4% of total non-interest expense for the three months ended September 30, 2015, as compared to 55.6% for the three months ended September 30, 2014. Net occupancy, furniture and equipment, and computer expense amounted to $761,000 for the three months ended September 30, 2015, a decrease of $26,000 or 3.3%. The decrease was due to lower software maintenance costs as a result of the outsourcing of the Bank’s core processing system. Pennsylvania shares tax expense increased $31,000 or 19.5% as a result of an increase in total assets and total equity. Data processing expenses increased $9,000 or 8.8% to $111,000 for the three months ended September 30, 2015 as a result of the planned outsourcing of the Bank’s core processing system in 2014 for data security, disaster recovery and system efficiency goals. Foreclosed assets held for resale expense increased $5,000 or 125.0% due to the write down of three foreclosed properties in 2015. Advertising expense increased $8,000 or 5.8% as compared to the three months ended September 30, 2014, due to increased digital media advertising expenses. Other non-interest expense amounted to $833,000 for the three months ended September 30, 2015, an increase of $133,000 or 19.0% as compared to the three months ended September 30, 2014. The increase was due to higher fees for an enhanced internet and mobile banking platform, Kasasa rewards and success fees, and an increase in charitable donations.

 

INCOME TAXES

 

Effective tax planning has helped produce favorable net income. Income tax expense amounted to $593,000 for the three months ended September 30, 2015, as compared to $492,000 for the three months ended September 30, 2014, an increase of $101,000. The effective total income tax rate was 19.3% for the third quarter of 2015 as compared to 17.1% for the third quarter of 2014. The increase in the effective tax rate was due to an increase in net gains on sales of investment securities.

 

Nine months ended September 30, 2015 compared to nine months ended September 30, 2014

 

First Keystone Corporation realized earnings for the nine months ended September 30, 2015 of $7,364,000, a decrease of $73,000, or 1.0% from the nine months ended September 30, 2014. The decrease in net income for the nine months ended September 30, 2015 was primarily due to an increase in the provision for loan losses.

 

On a per share basis, for the nine months ended September 30, 2015, net income was $1.32 versus $1.34 in the nine months ended September 30, 2014. Cash dividends increased to $0.81 per share up from $0.78 in the first nine months ended September 30, 2014, an increase of 3.8%.

 

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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 first nine months of 2015, interest income amounted to $23,651,000, an increase of $427,000 or 1.8% from the first nine months of 2014, while interest expense amounted to $3,675,000 for the nine months ended September 30, 2015, an increase of $362,000, or 10.9% from the nine months ended September 30, 2014. As a result, net interest income increased $65,000 or 0.3% to $19,976,000 from $19,911,000 for the same period in 2014.

 

The Corporation’s net interest margin for the nine months ended September 30, 2015 was 3.27% compared to 3.45% for the same period in 2014. The decrease in net interest margin was a result of the unprecedented continuing low interest rate environment and the Bank’s reliance on short-term and long-term borrowings to support loan growth.

 

PROVISION FOR LOAN LOSSES

 

The provision for loan losses for the nine months ended September 30, 2015 and September 30, 2014 was $1,178,000 and $433,000, respectively. The increase 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. One of the factors contributing to the increase in the provision for loan losses is a significant specific allocation on a non-performing originated participation loan assigned during the third quarter of 2015, included in the discussion of the Corporation’s largest impaired loan relationships in the Non-Performing Assets section on page 40. Net charge-offs for the nine months ended September 30, 2015 and 2014 were $334,000 and $462,000, respectively. See Allowance for Loan Losses on page 38 for further discussion.

 

NON-INTEREST INCOME

 

Total non-interest income was $6,282,000 for the nine months ended September 30, 2015, as compared to $5,735,000 for the same period in 2014, an increase of $547,000, or 9.5%. Service charges and fee income increased by $120,000 or 10.2%. This increase was primarily the result of an increase in the Bank’s per item overdraft fee and certain other deposit account fees implemented during the second and third quarters of 2014. Gains on sales of mortgage loans increased $277,000 or 187.2% due to a favorable and stable rate environment for the Bank’s customers.

 

Net gains on sales of investment securities increased $168,000 to $2,131,000 for the nine months ended September 30, 2015 as compared to the nine months ended September 30, 2014. 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 $4,151,000 for the nine months ended September 30, 2015, an increase of $379,000 or 10.0% from the nine months ended September 30, 2014.

 

NON-INTEREST EXPENSE

 

Total non-interest expense was $15,911,000 for the nine months ended September 30, 2015, as compared to $15,953,000 for the nine months ended September 30, 2014. Non-interest expense decreased $42,000 or 0.3%.

 

Expenses associated with employees (salaries and employee benefits) continue to be the largest category of non-interest expense. Salaries and benefits amounted to $8,432,000 or 53.0% of total non-interest expense for the nine months ended September 30, 2015, as compared to 53.7% for the nine months ended September 30, 2014. Net occupancy, furniture and equipment, and computer expense amounted to $2,309,000 for the nine months ended September 30, 2015, a decrease of $223,000 or 8.8%. The decrease was due to lower software maintenance costs as a result of the outsourcing of the Bank’s core processing system. Pennsylvania shares tax expense increased $80,000 or 16.8% as a result of an increase in total assets and total equity. Data processing expenses increased $154,000 or 51.7% to $452,000 for the nine months ended September 30, 2015 as a result of the planned outsourcing of the Bank’s core processing system in 2014 for data security, disaster recovery and system efficiency goals. Foreclosed assets held for resale expense decreased $68,000 or 54.0% due to the sales of several foreclosed properties in 2014. Advertising expense decreased $120,000 or 26.8% as compared to the third quarter of 2014 as a result of the rollout of the Bank’s new suite of rewards checking products called Kasasa in February 2014.

 

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INCOME TAXES

 

Effective tax planning has helped produce favorable net income. Income tax expense amounted to $1,805,000 for the nine months ended September 30, 2015, as compared to $1,823,000 for the nine months ended September 30, 2014, a decrease of $18,000. The effective total income tax rate was 19.7% for the nine months ended September 30, 2015 and 2014.

 

FINANCIAL CONDITION

 

SUMMARY

 

Total assets increased to $971,542,000 as of September 30, 2015, an increase of $59,189,000, or 6.5% from year-end 2014. Total assets as of December 31, 2014 amounted to $912,353,000.

 

Total loans increased $32,448,000 or 6.7%. Loan demand grew in the nine months ended September 30, 2015 as the Bank has seen an increase in loan originations, primarily in the commercial and industrial portfolio.

 

Total deposits increased $59,975,000 or 9.1% to $721,537,000 as of September 30, 2015.

 

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 decreased in the first nine months of 2015 by $2,721,000 to $135,741,000 from $138,462,000 as of December 31, 2014. Borrowings decreased due to increased deposit balances.

 

Total stockholders’ equity increased to $109,062,000 at September 30, 2015, an increase of $2,791,000 or 2.6% from December 31, 2014.

 

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 92.3% at September 30, 2015, compared to 91.8% at September 30, 2014. 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 $519,909,000 as of September 30, 2015, up $32,448,000, or 6.7% since year-end 2014. The loan portfolio continues to be well diversified. Non-performing assets increased since year-end 2014, but overall asset quality has remained consistent. Total non-performing assets were $5,924,000 as of September 30, 2015, an increase of $1,885,000, or 46.7% from $4,039,000 reported in non-performing assets as of December 31, 2014. Total allowance for loan losses to total non-performing assets was 122.1% as of September 30, 2015 and 158.2% at December 31, 2014.

 

In addition to loans, another primary earning asset is our overall investment portfolio, which increased in size from December 31, 2014, to September 30, 2015. Available-for-sale securities amounted to $370,293,000 as of September 30, 2015, an increase of $22,627,000 from year-end 2014.

 

Interest-bearing deposits in other banks increased as of September 30, 2015, to $488,000 from $424,000 at year-end 2014. Time deposits with other banks were $1,482,000 at September 30, 2015 and December 31, 2014.

 

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LOANS

 

Total loans increased to $519,909,000 as of September 30, 2015 as compared to $487,461,000 as of December 31, 2014. The table on page 17 provides data relating to the composition of the Corporation’s loan portfolio on the dates indicated. Total loans increased by $32,448,000 or 6.7%.

 

Increasing demand for borrowing by businesses accounted for the 6.7% increase in the loan portfolio from December 31, 2014 to September 30, 2015. The Commercial and Industrial portfolio increased $23,770,000 to $88,426,000 as of September 30, 2015 as compared to $64,656,000 as of December 31, 2014. The increase in the Commercial and Industrial portfolio (which includes tax-free Commercial and Industrial loans) was attributed to new loan originations totaling $32,491,000, which were offset by loan payoffs of $5,369,000, as well as regular principal payments. The Commercial Real Estate portfolio (which includes tax-free Commercial Real Estate loans) increased $5,901,000 to $259,823,000 as of September 30, 2015, as compared to $253,922,000 at December 31, 2014. The increase was mainly attributed to new loan originations totaling $30,294,000, which were offset by loan payoffs of $11,717,000, combined with regular principal payments and typical amortizations in the loan portfolio. The Residential Real Estate portfolio increased $2,221,000 to $165,774,000 as of September 30, 2015, as compared to $163,553,000 at December 31, 2014. The increase was the result of new loan originations totaling $22,048,000 offset against payoffs of $11,837,000 and net loans sold of $4,146,000 combined with regular principal payments. Net loans sold in the Residential Real Estate portfolio for the nine months ended September 30, 2015 consisted of total loans sold during the nine months ended September 30, 2015 of $15,022,000 offset with loans opened and sold in the same quarter during any quarter of 2015 which amounted to $10,876,000. 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 $348,249,000. Of the total commercial portfolio, $259,823,000 or 50.0% 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 $11,125,000 at September 30, 2015. 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 $10,025,000 in long term debt and two lines of credit totaling $1,100,000. The relationship is well secured by first lien mortgages on income producing commercial and residential real estate, plus assignment of governmental leases and collateral pledge of cash accounts and marketable securities.

 

The second largest relationship consists of a hotel management company that has been in operation since 1987 and successfully owns and operates seven hotels. At September 30, 2015, the relationship consisted of outstanding loan balances and unused commitments totaling $8,668,000. The debt is comprised of $6,858,000 in long term debt and $1,810,000 in available credit on two real estate term loans. The relationship is secured by commercial real estate and business assets, as well as the assignment of leases and a life insurance policy.

 

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 $8,634,000 at September 30, 2015. The debt is comprised of $7,917,000 in term debt, $450,000 in lines of credit, and $267,000 in available credit on a real estate term loan. The relationship is secured by commercial real estate and business assets, as well as the assignment of leases and a life insurance policy.

 

The fourth largest relationship consists of a municipality founded in 1816 consisting of 35 square miles. The township completed a major expansion of its central sewage system in late 2012 due to increasing population growth among residential users and the addition of a large volume of business users, including pharmaceutical companies and recreational waterparks. The expansion was funded by grants, bond issues, and bank debt. At September 30, 2015, the relationship had outstanding balances and unused commitments of $8,521,000, which consisted entirely of term debt. The loans are secured by project receivables and the full faith, credit, and taxing power of the township.

 

The fifth largest relationship is comprised of multiple first and second lien mortgages relating to the purchase and improvements of several existing hotels. The principal and related owners/guarantors have extensive experience in the hotel industry, owning and operating hotels in various states for over twenty-five years. At September 30, 2015, the relationship had outstanding loan balances and unused commitments of $8,171,000. The debt is comprised of $8,116,000 in long term debt and two lines of credit totaling $55,000. The loans are secured by commercial real estate and business assets.

 

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

 

All of the loans are performing as agreed. 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 $496,645,000 or 95.6% of total loans are graded Pass; $5,202,000 or 1.0% are graded Special Mention; $17,480,000 or 3.4% are graded Substandard; and $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 $22,682,000 at September 30, 2015, as compared to $18,738,000 at December 31, 2014. Commercial and Industrial non-pass grades increased to $159,000 as of September 30, 2015 as compared to $68,000 as of December 31, 2014. Commercial Real Estate non-pass grades increased to $19,696,000 as of September 30, 2015 as compared to $16,480,000 as of December 31, 2014. The Residential Real Estate and Consumer loan non-pass grades increased to $2,827,000 as of September 30, 2015 as compared to $2,190,000 as of December 31, 2014.

 

The increase in Commercial Real Estate non-pass grades was mainly the result of the downgrade of two loans totaling $3,446,000 (combined with typical payment amortization and other normal fluctuations in the Commercial Real Estate non-pass grade portfolio segment). One of the downgraded loans totaling $2,499,000 is with a corporation that operates a licensed nursing home/long-term care facility. A decline in nursing home residents has led to decreased revenues and increased operating losses. However, despite the circumstances, the borrower continues to perform. One of the downgraded loans in the amount of $947,000 is with a corporation that owns and operates a golf course and banquet facility. Despite low liquidity and a weak debt-service coverage ratio, 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, 
   2015   2014 
Commercial and Industrial  $88,426   $64,656 
Commercial Real Estate   259,823    253,922 
Residential Real Estate   165,774    163,553 
Consumer   5,886    5,330 
Total loans  $519,909   $487,461 

 

ALLOWANCE FOR LOAN LOSSES

 

The allowance for loan losses constitutes the amount available to absorb losses within the loan portfolio. As of September 30, 2015, the allowance for loan losses was $7,234,000 as compared to $6,390,000 as of December 31, 2014. 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.

 

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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, 2015 and 2014. For the first nine months of 2015, net charge-offs as a percentage of average loans was 0.07% as compared to 0.10% for the nine month period ended September 30, 2014. Net charge-offs amounted to $334,000 for the first nine months of 2015 as compared to $462,000 for the nine months of 2014. The decrease in net charge-offs in the first nine months of 2015 as compared to the first nine months of 2014 related primarily to decreased charge-offs in Commercial and Industrial loans. During the first nine months of 2015, $2,000 in Commercial and Industrial loans were charged off as compared to $107,000 for the first nine months of 2014.

 

For the first nine months of 2015, the provision for loan losses was $1,178,000 as compared to $433,000 for the first nine months of 2014. The provision, net of charge-offs and recoveries, increased the quarter end Allowance for Loan Losses to $7,234,000 of which 10.6% was attributed to the Commercial and Industrial component; 60.2% attributed to the Commercial Real Estate component; 26.7% attributed to the Residential Real Estate component (primarily residential mortgages); 1.7% attributed to the Consumer component; and 0.8% being the unallocated component (refer to the activity in Note 4 – Loans and Allowance for Loan Losses on page 12). 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, 2015.

 

Analysis of Allowance for Loan Losses

 

(Dollars in thousands)  September 30,   September 30, 
   2015   2014 
Balance at beginning of the nine month period  $6,390   $6,519 
Charge-offs:          
Commercial and Industrial   2    107 
Commercial Real Estate   232    237 
Residential Real Estate   147    180 
Consumer   23    36 
    404    560 
Recoveries:          
Commercial and Industrial   7    24 
Commercial Real Estate   59    59 
Residential Real Estate       12 
Consumer   4    3 
    70    98 
           
Net charge-offs   334    462 
Additions charged to operations   1,178    433 
Balance at end of the nine month period  $7,234   $6,490 
           
Ratio of net charge-offs during the period to average loans outstanding during the period   0.07%   0.10%
Allowance for loan losses to average loans outstanding during the period   1.43%   1.40%

 

It is the policy of management and the Corporation’s Board of Directors to make a provision for both identified and unidentified losses inherent in its loan portfolio. A provision for loan losses is charged to operations based upon an evaluation of the potential losses in the loan portfolio. This evaluation takes into account such factors as portfolio concentrations, delinquency trends, trends of non-accrual and classified loans, economic conditions, and other relevant factors.

 

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The loan review process, which is conducted quarterly, is an integral part of the Bank’s evaluation of the loan portfolio. A detailed quarterly analysis to determine the adequacy of the Corporation’s allowance for loan losses is reviewed by the Board of Directors.

 

With the Bank’s manageable level of net charge-offs and the additions to the reserve from the provision out of operations, the allowance for loan losses as a percentage of average loans amounted to 1.43% at September 30, 2015 and 1.40% at September 30, 2014.

 

NON-PERFORMING ASSETS

 

The table on page 42 details the Corporation’s non-performing assets and impaired loans as of the dates indicated. 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 currently is 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 current period income. A modification of a loan constitutes a troubled debt restructuring (“TDR”) when a borrower is experiencing financial difficulty and the modification constitutes a concession that the Corporation would not otherwise consider. Modifications to loans classified as TDRs generally include reductions in contractual interest rates, principal deferments and extensions of maturity dates at a stated interest rate lower than the current market for a new loan with similar risk characteristics. While unusual, there may be instances of loan principal forgiveness. Foreclosed assets held for resale represent property acquired through foreclosure, or considered to be an in-substance foreclosure.

 

Total non-performing assets amounted to $5,924,000 as of September 30, 2015 as compared to $4,039,000 as of December 31, 2014. The economy, in particular, high unemployment/labor underutilization rate, weak job markets, unsettled fuel prices and energy costs, and the continued slowness in the housing industry had a direct effect on the Corporation’s non-performing assets. The Corporation is closely monitoring its Commercial Real Estate portfolio because of the current economic environment. In particular, vacancy rates are rising and rents and property values in some markets have fallen. Non-accrual loans totaled $5,504,000 as of September 30, 2015 as compared to $3,974,000 as of December 31, 2014. The increase in non-accrual loans, which was also the primary driver of the overall increase in non-performing assets, at September 30, 2015 as compared to December 31, 2014 is largely due to the addition of one loan in the amount of $2,323,000 to non-accrual status during the third quarter of 2015, combined with typical payment amortization and other normal fluctuations in the non-accrual portfolio segment. Foreclosed assets held for resale amounted to $256,000 at September 30, 2015 as compared to $55,000 at December 31, 2014. Loans past-due 90 days or more and still accruing interest amounted to $164,000 as of September 30, 2015 as compared to $10,000 as of December 31, 2014. At September 30, 2015, loans past-due 90 days or more and still accruing interest consisted of two Commercial and Industrial loans and three Residential Real Estate loans, which are all deemed to be well secured by collateral and in the process of collection. Non-performing assets to total loans was 1.1% at September 30, 2015 as compared to 0.8% at December 31, 2014. Non-performing assets to total assets was 0.6% at September 30, 2015 as compared to 0.4% at December 31, 2014. The allowance for loan losses to total non-performing assets was 122.1% as of September 30, 2015 as compared to 158.2% as of December 31, 2014. Additional detail can be found on page 42 in the Non-Performing Assets and Impaired Loans table and page 23 in the Loan Receivables on Non-Accrual Status table. Asset quality is a priority and the Corporation retains a full-time loan review officer to closely track and monitor overall loan quality, along with a full-time workout specialist to manage collection and liquidation efforts.

 

Potential problem loans are defined as performing substandard loans which are not deemed to be impaired. These loans have characteristics that cause management to have doubts regarding the ability of the borrower to perform under present loan repayment terms and which may result in reporting these loans as non-performing loans in the future. Potential problem loans amounted to $6,571,000 at September 30, 2015, compared to $2,477,000 at December 31, 2014.

 

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Impaired loans were $12,954,000 at September 30, 2015 and $7,044,000 at December 31, 2014. The largest impaired loan relationship at September 30, 2015 consisted of one performing loan to a student-housing holding company in the amount of $4,226,000, which was secured by commercial real estate. The loan was downgraded to substandard status and modified as a TDR during the first quarter of 2015 due to economic hardships experienced by the borrower. The decline in occupancy rates was attributed to the overall economic decline in students’ disposable income and an increase in enrollment in online courses. The discounted cash flow evaluation at September 30, 2015 resulted in a specific allocation of $0. At September 30, 2015, the second largest impaired loan relationship consisted of a non-performing originated participation loan to a student-housing holding company which was secured by commercial real estate. The Corporation’s participation share of the loan was $2,323,000. The loan was downgraded to substandard and placed on non-accrual status during the third quarter of 2015 due to the borrower’s inability to reach a break-even rental income, related to a significant decline in occupancy rates. The collateral evaluation of the participation at September 30, 2015 carried a value of $2,917,000, after considering estimated appraisal adjustments and costs to sell of 17% and considering the total participation outstanding note balance, resulting in the Corporation’s specific allocation of $1,243,000. The third largest impaired loan relationship at September 30, 2015 consisted of a non-performing purchased participation loan to a retailer of motorcycles, ATVs, and other motorized recreational vehicles, which was secured by commercial real estate. The Corporation’s participation share of the loan was $1,277,000. The collateral evaluation of the participation at September 30, 2015 carried a value of $5,091,000, after considering estimated appraisal adjustments and costs to sell of 40% and considering the total participation outstanding note balance, resulting in the Corporation’s specific allocation of $0. The estimated appraisal adjustments and cost to sell percentages are determined based on the market area in which the real estate securing the loan is located, among other factors, and therefore, can differ from one loan to another. Of the $12,954,000 in impaired loans at September 30, 2015, none were located outside the Corporation’s primary market area.

 

Loans categorized as TDRs carried an unpaid balance of $8,851,000 as of September 30, 2015 as compared to $4,708,000 as of December 31, 2014. The increase 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 resulting in the identification of additional loans classified as TDRs. Of the twenty-seven restructured loans at September 30, 2015, four loans are classified in the Commercial and Industrial portfolio, twenty-two loans are classified in the Commercial Real Estate portfolio, and one loan is classified in the Consumer portfolio. At September 30, 2015, five Commercial Real Estate loans classified as TDRs with a combined recorded investment of $2,133,000 were not in compliance with the terms of their restructure, compared to September 30, 2014 when 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. The troubled debt restructurings at September 30, 2015 consisted of ten term modifications beyond the original stated term, four interest rate modifications, and thirteen payment modifications. TDRs are separately identified for impairment disclosures, and if necessary, a specific allocation is established. As of September 30, 2015 and December 31, 2014, specific allocations of $0 and $27,000 were attributable to the TDRs.

 

During the three months ended September 30, 2015, two Commercial Real Estate loans totaling $178,000 that were modified as TDRs within the preceding twelve months had experienced payment defaults, as compared to the same period in 2014 when there were no payment defaults on loans that were modified as TDRs within the preceding twelve months. During the nine months ended September 30, 2015, three Commercial Real Estate loans totaling $4,404,000 that were modified as TDRs within the preceding twelve months had experienced payment defaults, as compared to the same period in 2014 when four Commercial Real Estate loans totaling $193,000 that were modified as TDRs within the preceding twelve months had experienced payment defaults. The significant increase in defaulted TDRs at September 30, 2015 as compared to September 30, 2014 is largely due to one loan in the amount of $4,226,000 to a student housing holding company, which was modified as a TDR in the first quarter of 2015 and experienced its subsequent default during the second quarter of 2015.

 

The Corporation’s non-accrual 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 non-accrual loans less than $250,000 upon classification and typically at year end, the Corporation completes a Certificate of Inspection, which includes the results of an onsite inspection, insured values, tax assessed values, recent sales comparisons and a review of the previous evaluations.

 

Improving loan quality is a priority. The Corporation actively works with borrowers to resolve credit problems and will continue its close monitoring efforts in 2015. Excluding the assets disclosed in the Non-Performing Assets and Impaired Loans tables below and the Troubled Debt Restructurings section in Note 4 — Loans and Allowance for Loan Losses, management is not aware of any information about borrowers’ possible credit problems which cause serious doubt as to their ability to comply with present loan repayment terms.

 

Should the economic climate no longer continue to be stable or deteriorate further, borrowers may experience difficulty, and the level of impaired loans and non-performing assets, charge-offs and delinquencies could rise and possibly require additional increases in the Corporation’s allowance for loan losses.

 

In addition, regulatory authorities, as an integral part of their examinations, periodically review the allowance for possible loan losses. They may require additions to allowances based upon their judgments about information available to them at the time of examination.

 

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A concentration of credit exists when the total amount of loans to borrowers, who are engaged in similar activities that are similarly impacted by economic or other conditions, exceed 10% of total loans. As of September 30, 2015 and December 31, 2014, management is of the opinion that there were no loan concentrations exceeding 10% of total loans.

 

(Dollars in thousands)  September 30,   December 31, 
   2015   2014 
Non-performing assets          
Non-accrual loans  $5,504   $3,974 
Foreclosed assets held for resale   256    55 
Loans past-due 90 days or more and still accruing interest   164    10 
Total non-performing assets  $5,924   $4,039 
           
Impaired loans          
Non-accrual loans  $5,504   $3,974 
Accruing TDRs   7,450    3,070 
Total impaired loans   12,954    7,044 
Allocated allowance for loan losses   (1,279)   (119)
Net investment in impaired loans  $11,675   $6,925 
           
Impaired loans with a valuation allowance  $2,764   $1,086 
Impaired loans without a valuation allowance   10,190    5,958 
Total impaired loans  $12,954   $7,044 
           
Allocated valuation allowance as a percent of impaired loans   9.9%   1.7%
Impaired loans to total loans   2.5%   1.4%
Non-performing assets to total loans   1.1%   0.8%
Non-performing assets to total assets   0.6%   0.4%
Allowance for loan losses to impaired loans   55.8%   90.7%
Allowance for loan losses to total non-performing assets   122.1%   158.2%

 

Real estate mortgages comprise 81.9% of the loan portfolio as of September 30, 2015, as compared to 85.6% as of December 31, 2014. Real estate mortgages consist of both residential and commercial real estate loans. The real estate loan portfolio is well diversified in terms of borrowers, collateral, interest rates, and maturities. Also, the residential real estate loan portfolio is largely comprised of fixed rate mortgages. The real estate loans are concentrated primarily in the Corporation’s market area and are subject to risks associated with the local economy. The commercial real estate loans typically reprice approximately every three to five years and are also concentrated in the Corporation’s market area. The Corporation’s loss exposure on its impaired loans continues to be mitigated by collateral positions on these loans. The allocated allowance for loan losses associated with impaired loans is generally computed based upon the related collateral value of the loans. The collateral values are determined by recent appraisals, but are generally discounted by management based on historical dispositions, changes in market conditions since the last valuation and management’s expertise and knowledge of the borrower and the borrower’s business.

 

DEPOSITS AND OTHER BORROWED FUNDS

 

Consumer and commercial retail deposits are attracted primarily by the Bank’s eighteen full service office locations and through its internet banking presence. The Bank offers a broad selection of deposit products and continually evaluates its interest rates and fees on deposit products. The Bank regularly reviews competing financial institutions interest rates, especially when establishing interest rates on certificates of deposit.

 

Total deposits increased $59,975,000 to $721,537,000 as of September 30, 2015 as non-interest bearing deposits increased by $11,010,000 and interest bearing deposits increased by $48,965,000 from year-end 2014. Total deposits increased due to the deposit of funds by a municipal depositor through normal, seasonal generation of tax revenues. The shift to core deposits and away from time deposits continued in the nine months ended September 30, 2015. Demand deposits and savings accounts increased, while certificates of deposit fell. Total short-term and long-term borrowings decreased to $135,741,000 as of September 30, 2015, from $138,462,000 at year-end 2014, a decrease of $2,721,000, or 2.0%. Total borrowings decreased due to increased deposit balances.

 

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CAPITAL STRENGTH

 

Normal increases in capital are generated by net income, less dividends paid out. During the first nine months of the year, net income less dividends paid increased capital by $2,842,000. Accumulated other comprehensive income derived from net unrealized gains on investment securities available-for-sale also impacts capital. At December 31, 2014, accumulated other comprehensive income was $4,330,000. Accumulated other comprehensive income stood at $3,289,000 at September 30, 2015, a decrease of $1,041,000. Fluctuations in interest rates have regularly impacted the gain/loss position in the Bank’s investment portfolio, as well as its decision to sell securities at a gain or loss. In order to protect the Bank from market risk in the event of further interest rate increases, the Bank chose to sell a portion of its securities during the first nine months of 2015 at an overall net gain of $2,131,000. These fluctuations from net unrealized gains on investment securities available-for-sale do not affect regulatory capital, as the Bank elected to opt-out of this item with the filing of the March 31, 2015 Call Report.

 

The Corporation held 233,112 and 235,149 shares of common stock as treasury stock at September 30, 2015 and December 31, 2014, respectively. This had an effect of reducing our total stockholders’ equity by $5,756,000 as of September 30, 2015 and $5,823,000 as of December 31, 2014.

 

Total stockholders’ equity was $109,062,000 as of September 30, 2015, and $106,271,000 as of December 31, 2014. Leverage ratio and risk based capital ratios remain very strong. As of September 30, 2015, the Bank’s Tier 1 leverage ratio was 8.61% compared to 8.63% as of December 31, 2014. Tier I risk based capital and total risk based capital ratios as of September 30, 2015, were 12.48% and 13.62%, respectively. The same ratios as of December 31, 2014 were 13.92% and 15.07%, respectively. In addition, the Bank’s Common Equity Tier 1 capital to risk-weighted assets ratio was 12.48% at September 30, 2015.

 

LIQUIDITY

 

The Corporation’s objective is to maintain adequate liquidity to meet funding needs at a reasonable cost and to provide contingency plans to meet unanticipated funding needs or a loss of funding sources, while minimizing interest rate risk. Adequate liquidity provides resources for credit needs of borrowers, for depositor withdrawals and for funding corporate operations.

 

Sources of liquidity are as follows:

 

· Growth in the core deposit base;

· Proceeds from sales or maturities of investment securities;

· Payments received on loans and mortgage-backed securities;

· Overnight correspondent bank borrowings on various credit lines; and,

· Borrowing capacity available from the FHLB.

 

Managing liquidity remains an important segment of asset/liability management. The overall liquidity position of the Corporation is maintained by an active asset/liability management committee. The Corporation believes that its core deposits are stable even in periods of changing interest rates. Liquidity and funds management are governed by policies and are measured on a monthly basis. These measurements indicate that liquidity generally remains stable and exceeds the Corporation’s minimum defined levels of adequacy. Other than the trends of continued competitive pressures and volatile interest rates, there are no known demands, commitments, events or uncertainties that will result in, or that are reasonably likely to result in, liquidity increasing or decreasing in any material way.

 

MARKET RISK

 

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates and equity prices. The Corporation’s market risk is composed primarily of interest rate risk. The Corporation’s interest rate risk results from timing differences in the repricing of assets, liabilities, off-balance sheet instruments, and changes in relationships between rate indices and the potential exercise of explicit or embedded options.

 

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Increases in the level of interest rates also may adversely affect the fair value of the Corporation’s securities and other earning assets. Generally, the fair value of fixed-rate instruments fluctuates inversely with changes in interest rates. As a result, increases in interest rates could result in decreases in the fair value of the Corporation’s interest-earning assets, which could adversely affect the Corporation’s results of operations if sold, or, in the case of interest-earning assets classified as available-for-sale, the Corporation’s stockholders’ equity, if retained. Under FASB ASC 320-10, Investment Debt and Equity Securities, changes in the unrealized gains and losses, net of taxes, on securities classified as available-for-sale are reflected in the Corporation’s stockholders’ equity. The Corporation does not own any trading assets.

 

Asset/Liability Management

 

The principal objective of asset/liability management is to manage the sensitivity of the net interest margin to potential movements in interest rates and to enhance profitability through returns from managed levels of interest rate risk. The Corporation actively manages the interest rate sensitivity of its assets and liabilities. Several techniques are used for measuring interest rate sensitivity. Interest rate risk arises from the mismatches in the repricing of assets and liabilities within a given time period, referred to as a rate sensitivity gap. If more assets than liabilities mature o