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EX-32.2 - EXHIBIT 32.2 - FIRST KEYSTONE CORPv444834_ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - FIRST KEYSTONE CORPv444834_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - FIRST KEYSTONE CORPv444834_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - FIRST KEYSTONE CORPv444834_ex31-1.htm

 

UNITED STATES

 

SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

FORM 10Q

 

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

 

For the quarterly period ended June 30, 2016

 

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, 5,645,997 shares as of August 3, 2016

 

 

 

 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

(Dollars in thousands, except per share data)  June 30,   December 31, 
   2016   2015 
ASSETS          
Cash and due from banks  $8,586   $7,474 
Interest-bearing deposits in other banks   672    1,534 
Total cash and cash equivalents   9,258    9,008 
Time deposits with other banks   1,482    1,482 
Investment securities available-for-sale   385,089    385,241 
Investment securities held-to-maturity (fair value 2016- $21; 2015 - $27)   20    26 
Restricted investment in bank stocks   6,622    5,742 
Loans   516,998    516,610 
Allowance for loan losses   (7,219)   (6,739)
Net loans   509,779    509,871 
Premises and equipment, net   19,697    20,113 
Accrued interest receivable   3,932    4,086 
Cash surrender value of bank owned life insurance   22,229    21,900 
Investments in low-income housing partnerships   1,465    1,553 
Goodwill   19,133    19,133 
Foreclosed assets held for resale   1,280    1,472 
Deferred income taxes       692 
Other assets   3,330    3,170 
TOTAL ASSETS  $983,316   $983,489 
LIABILITIES          
Deposits:          
Non-interest bearing  $109,113   $107,391 
Interest bearing   575,358    613,207 
Total deposits   684,471    720,598 
Short-term borrowings   99,638    80,539 
Long-term borrowings   75,175    70,232 
Accrued interest payable   441    382 
Deferred income taxes   2,709     
Other liabilities   3,546    3,300 
TOTAL LIABILITIES   865,980    875,051 
STOCKHOLDERS’ EQUITY          
Preferred stock, par value $2.00 per share; authorized 1,000,000 shares in 2016 and 2015; issued 0 in 2016 and 2015        
Common stock, par value $2.00 per share; authorized 20,000,000 shares in 2016 and 2015; issued 5,879,109 in 2016 and 5,853,317 in 2015; outstanding 5,645,997 in 2016 and 5,620,205 in 2015   11,758    11,707 
Surplus   34,450    33,830 
Retained earnings   68,251    66,622 
Accumulated other comprehensive income   8,633    2,035 
Treasury stock, at cost, 233,112 shares in 2016 and 2015   (5,756)   (5,756)
TOTAL STOCKHOLDERS’ EQUITY   117,336    108,438 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY  $983,316   $983,489 

 

See accompanying notes to consolidated financial statements.

 

2

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2016 AND 2015

(Unaudited)

 

(Dollars in thousands, except per share data)  Three Months Ended   Six Months Ended 
   June 30,   June 30, 
INTEREST INCOME  2016   2015   2016   2015 
Interest and fees on loans  $5,468   $5,372   $10,924   $10,692 
Interest and dividend income on investment securities:                    
Taxable   1,436    1,657    2,944    3,348 
Tax-exempt   940    733    1,862    1,404 
Dividends   16    15    31    30 
Dividend income on restricted investment in bank stocks   64    72    124    276 
Interest on interest-bearing deposits in other banks   8    8    16    16 
Total interest income   7,932    7,857    15,901    15,766 
INTEREST EXPENSE                    
Interest on deposits   825    776    1,679    1,528 
Interest on short-term borrowings   90    66    161    130 
Interest on long-term borrowings   370    387    755    763 
Total interest expense   1,285    1,229    2,595    2,421 
Net interest income   6,647    6,628    13,306    13,345 
Provision for loan losses   284    213    567    425 
Net interest income after provision for loan losses   6,363    6,415    12,739    12,920 
NON-INTEREST INCOME                    
Trust department   230    240    430    454 
Service charges and fees   446    423    861    822 
Bank owned life insurance income   165    165    329    329 
ATM fees and debit card income   331    310    643    593 
Gains on sales of mortgage loans   55    133    157    314 
Net investment securities gains   380    603    394    1,095 
Impairment charges on equity securities       (14)       (14)
Other   59    133    152    257 
Total non-interest income   1,666    1,993    2,966    3,850 
NON-INTEREST EXPENSE                    
Salaries and employee benefits   2,587    2,847    5,373    5,691 
Occupancy, net   379    406    789    874 
Furniture and equipment   128    144    264    291 
Computer expense   235    149    461    383 
Professional services   149    158    302    312 
Pennsylvania shares tax   188    190    377    366 
FDIC insurance   163    129    317    253 
ATM and debit card fees   167    172    306    297 
Data processing fees   135    180    268    341 
Foreclosed assets held for resale expense   61    42    112    49 
Advertising   96    107    163    180 
Other   726    872    1,422    1,642 
Total non-interest expense   5,014    5,396    10,154    10,679 
Income before income tax expense   3,015    3,012    5,551    6,091 
Income tax expense   524    582    884    1,212 
NET INCOME  $2,491   $2,430   $4,667   $4,879 
PER SHARE DATA                    
Net income per share:                    
Basic  $0.44   $0.44   $0.83   $0.88 
Diluted   0.44    0.44    0.83    0.88 
Dividends per share   0.27    0.27    0.54    0.54 

 

See accompanying notes to consolidated financial statements.

 

3

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

 

(Dollars in thousands)  Three Months Ended 
   June 30, 
   2016   2015 
Net Income  $2,491   $2,430 
           
Other comprehensive income (loss):          
Unrealized net holding gains (losses) on available-for-sale investment securities arising during the period, net of income taxes of $1,391 and $(1,721), respectively   2,687    (3,331)
           
Less reclassification adjustment for net gains included in net income, net of income taxes of $(129) and $(205), respectively (a) (c)   (251)   (398)
           
Less reclassification adjustment for impairment charge on equity securities included in net income, net of income taxes of $0 and $5, respectively (b) (c)       9 
           
Total other comprehensive income (loss)   2,436    (3,720)
           
Total Comprehensive Income (Loss)  $4,927   $(1,290)

_______________________

(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.

 

(Dollars in thousands)  Six Months Ended 
   June 30, 
   2016   2015 
Net Income  $4,667   $4,879 
           
Other comprehensive income (loss):          
Unrealized net holding gains (losses) on available-for-sale investment securities arising during the period, net of income taxes of $3,536 and $(1,005), respectively   6,858    (1,929)
           
Less reclassification adjustment for net gains included in net income, net of income taxes of $(134) and $(372), respectively (a) (c)   (260)   (723)
           
Less reclassification adjustment for impairment charge on equity securities included in net income, net of income taxes of $0 and $5, respectively (b) (c)       9 
           
Total other comprehensive income (loss)   6,598    (2,643)
           
Total Comprehensive Income  $11,265   $2,236 

_______________________

(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

SIX MONTHS ENDED JUNE 30, 2016 AND 2015

(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, 2016   5,853,317   $11,707   $33,830   $66,622   $2,035   $(5,756)  $108,438 
Net Income                  4,667              4,667 
Other comprehensive income, net of taxes                       6,598         6,598 
Issuance of common stock under dividend reinvestment plan   25,792    51    620                   671 
Dividends - $0.54 per share                 (3,038)             (3,038)
Balance at June 30, 2016   5,879,109   $11,758   $34,450   $68,251   $8,633   $(5,756)  $117,336 
                                    
Balance at January 1, 2015   5,802,521   $11,605   $32,674   $63,485   $4,330   $(5,823)  $106,271 
Net Income                  4,879              4,879 
Other comprehensive loss, net of taxes                       (2,643)        (2,643)
Issuance of common stock under dividend reinvestment plan and exercise of employee stock options   24,391    49    551              58    658 
Dividends - $0.54 per share                   (3,011             (3,011
Balance at June 30, 2015   5,826,912   $11,654   $33,225   $65,353   $1,687   $(5,765)  $106,154 

 

See accompanying notes to consolidated financial statements.

 

5

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30, 2016 AND 2015

(Unaudited)

(Dollars in thousands)

   2016   2015 
OPERATING ACTIVITIES          
Net income  $4,667   $4,879 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for loan losses   567    425 
Depreciation and amortization   677    784 
Net premium amortization on investment securities   1,900    1,324 
Deferred income tax expense       113 
Gains on sales of mortgage loans   (157)   (297)
Gains on sales of mortgage loans held for investment transferred to held for sale       (17)
Proceeds from sales of mortgage loans originated for resale   4,621    11,079 
Originations of mortgage loans originated for resale   (6,483)   (8,853)
Gains on sales of investment securities   (394)   (1,095)
Impairment charges on equity securities       14 
Net losses on sales of foreclosed real estate held for resale, including write-downs   37    33 
Decrease (increase) in accrued interest receivable   154    (692)
Earnings on investment in bank owned life insurance   (329)   (329)
Losses on disposals of premises and equipment       30 
Increase in other assets   (118)   (1,201)
Increase in accrued interest payable   59    31 
Increase (decrease) in other liabilities   238    (2,135)
NET CASH PROVIDED BY OPERATING ACTIVITIES   5,439    4,093 
INVESTING ACTIVITIES          
Proceeds from sales of investment securities available-for-sale   27,408    79,740 
Proceeds from maturities and redemptions of investment securities available-for-sale   6,808    12,727 
Purchases of investment securities available-for-sale   (25,571)   (102,185)
Proceeds from maturities and redemptions of investment securities held-to-maturity   6    1,023 
Net change in restricted investment in bank stocks   (880)   (937)
Net decrease (increase) in loans   1,512    (17,512)
Proceeds from sales of mortgage loans held for investment transferred to held for sale       491 
Purchases of premises and equipment   (208)   (122)
Proceeds from sales of foreclosed assets held for resale   230     
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES   9,305    (26,775)
FINANCING ACTIVITIES          
Net (decrease) increase in deposits   (36,127)   4,539 
Net increase in short-term borrowings   19,099    15,339 
Proceeds from long-term borrowings   10,000    5,000 
Repayment of long-term borrowings   (5,057)   (53)
Common stock issued   629    589 
Proceeds from issuance of treasury stock       32 
Dividends paid   (3,038)   (3,011)
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES   (14,494)   22,435 
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS   250    (247)
CASH AND CASH EQUIVALENTS, BEGINNING   9,008    7,967 
CASH AND CASH EQUIVALENTS, ENDING  $9,258   $7,720 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION          
Interest paid  $2,536   $2,390 
Income taxes paid   1,730    1,330 
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES          
Purchased securities settling after quarter end       1,920 
Loans transferred to foreclosed assets held for resale   75    226 
Loans transferred (from) to held for sale portfolio   (171)   491 
Common stock subscription receivable   42    37 

 

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 six month periods ended June 30, 2016, are not necessarily indicative of the results for the year ending December 31, 2016. 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, 2015.

 

The Corporation has evaluated events and transactions occurring subsequent to the consolidated balance sheet date of June 30, 2016 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. In July 2016, the Corporation anticipates approximately $449,000 in tax-free claims income from life insurance proceeds as the result of the death benefit which will be paid on a life insurance policy covering one of our former employees that remained an insured person by our bank-owned life insurance program following her separation of employment.

 

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

 

Except as disclosed below, there were no new accounting pronouncements affecting the Corporation during the six months ended June 30, 2016 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 August 2015, the FASB issued an update ASU 2015-14 which 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. In March 2016, the FASB issued an update ASU 2016-08 which updates the new revenue standard by clarifying the principal versus agent implementation guidance, but does not change the core principle of the new standard. In April 2016, the FASB issued an update ASU 2016-10. The ASU updates the standard by identifying performance obligations and licenses of intellectual property, which clarifies the guidance surrounding licensing arrangements and the identification of performance obligations. In May 2016, the FASB issued an update ASU 2016-12 which articulates narrow-scope improvements and practical expedients. The Corporation is currently evaluating the impact of these ASUs on its consolidated financial statements.

 

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10) – Recognition and Measurement of Financial Assets and Financial Liabilities. The guidance addresses certain aspects of recognition, measurement, presentation and disclosure of financial instruments. In particular, the guidance revises an entity’s accounting related to (1) the classification and measurement of investments in equity securities and (2) the presentation of certain fair value changes for financial liabilities measured at fair value. The guidance also amends certain disclosure requirements associated with fair value of financial instruments. For public business entities, the guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Entities should apply the amendments by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The adoption of this update is not expected to have a material impact on the Corporation’s consolidated financial position or results of operations.

 

7

 

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (i) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (ii) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Public business entities should apply the amendments in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted for all public business entities upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The Corporation is in the process of evaluating the impact of this guidance and anticipates an impact to the consolidated financial statements with regard to the Corporation’s operating lease agreements.

  

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The ASU requires that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset. This is in contrast to existing guidance whereby credit losses generally are not recognized until they are incurred. For public companies, this update will be effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early application will be permitted for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.  The Corporation is currently assessing the impact that this guidance will have on its consolidated financial statements.

 

NOTE 3INVESTMENT SECURITIES

 

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

 

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

 

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

 

8

 

 

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 June 30, 2016 and December 31, 2015:

 

   Available-for-Sale Securities 
(Dollars in thousands)      Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
June 30, 2016:  Cost   Gains   Losses   Value 
U.S. Treasury securities  $1,015   $5   $   $1,020 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed   112,802    1,596    (194)   114,204 
Other   11,541    74    (24)   11,591 
Obligations of state and political subdivisions   201,749    10,828        212,577 
Corporate debt securities   43,623    388    (342)   43,669 
Marketable equity securities   1,194    834        2,028 
Total  $371,924   $13,725   $(560)  $385,089 

 

   Held-to-Maturity Securities 
(Dollars in thousands)      Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
June 30, 2016:  Cost   Gains   Losses   Value 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed  $20   $1   $   $21 
Total  $20   $1   $   $21 

 

   Available-for-Sale Securities 
(Dollars in thousands)      Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
December 31, 2015:  Cost   Gains   Losses   Value 
U.S. Treasury securities  $1,022   $   $(1)  $1,021 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed   113,847    37    (1,410)   112,474 
Other   21,554    117    (79)   21,592 
Obligations of state and political subdivisions   195,297    5,425    (408)   200,314 
Corporate debt securities   49,162    10    (1,339)   47,833 
Marketable equity securities   1,194    813        2,007 
Total  $382,076   $6,402   $(3,237)  $385,241 

 

   Held-to-Maturity Securities 
(Dollars in thousands)      Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
December 31, 2015:  Cost   Gains   Losses   Value 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed  $26   $1   $   $27 
Total  $26   $1   $   $27 

 

Securities Available-for-Sale with an aggregate fair value of $255,220,000 at June 30, 2016 and $326,872,000 at December 31, 2015, and securities Held-to-Maturity with an aggregate book value of $20,000 at June 30, 2016 and $26,000 at December 31, 2015, were pledged to secure public funds, trust funds, securities sold under agreements to repurchase, FHLB advances and other balances of $191,148,000 at June 30, 2016 and $219,576,000 at December 31, 2015.

 

9

 

 

The amortized cost, estimated fair value and weighted average yield of debt and equity securities, by contractual maturity, are shown below at June 30, 2016. 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)

 

   June 30, 2016 
   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  $    $    $902    $   $    $  
Fair value           908             
Weighted average yield           6.29%            
                               
1 - 5 Years:                              
Amortized cost   1,015    30,977    42,696    12,639        20 
Fair value   1,020    31,593    44,250    12,722        21 
Weighted average yield   0.96%   2.06%   2.80%   2.38%       2.55%
                               
5 - 10 Years:                              
Amortized cost       16,821    72,677    30,984         
Fair value       17,166    76,116    30,947         
Weighted average yield       2.06%   3.29%   2.76%        
                               
After 10 Years:                              
Amortized cost       76,545    85,474        1,194     
Fair value       77,036    91,303        2,028     
Weighted average yield       1.67%   4.58%       5.16%    
                               
Total:                              
Amortized cost  $1,015   $124,343   $201,749   $43,623   $1,194   $20 
Fair value   1,020    125,795    212,577    43,669    2,028    21 
Weighted average yield   0.96%   1.82%   3.75%   2.65%   5.16%   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 June 30, 2016. 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 June 30, 2016 and 2015 were $20,374,000 and $31,966,000, respectively. Gross gains realized on these sales were $380,000 and $603,000, respectively. There were no losses realized on these sales for the three months ended June 30, 2016 and 2015. Impairment losses realized on Available-for-Sale equity securities for the three months ended June 30, 2016 and 2015 were $0 and $14,000, respectively.

 

Proceeds from sales of investments in Available-for-Sale debt and equity securities for the six months ended June 30, 2016 and 2015 were $27,408,000 and $79,740,000, respectively. Gross gains realized on these sales were $435,000 and $1,151,000, respectively. Gross losses on these sales were $41,000 and $56,000, respectively. Impairment losses realized on Available-for-Sale equity securities for the six months ended June 30, 2016 and 2015 were $0 and $14,000, respectively.

 

There were no proceeds from sales of investments in Held-to-Maturity debt equity securities during the three or six month periods ended June 30, 2016 or 2015. Therefore, there were no gains or losses realized during these periods.

 

10

 

 

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 June 30, 2016 or December 31, 2015.

 

11

 

 

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 June 30, 2016 and December 31, 2015:

 

June 30, 2016

 

(Dollars in thousands)  Less Than 12 Months   12 Months or More   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
  Value   Loss   Value   Loss   Value   Loss 
Available-for-Sale:                        
U.S. Treasury securities  $   $   $   $   $   $ 
Obligations of U.S. Government                              
Corporations and Agencies:                              
Mortgage-backed   11,375    (78)   7,751    (116)   19,126    (194)
Other   3,676    (24)           3,676    (24)
Obligations of state and political subdivisions                        
Corporate debt securities   4,467    (30)   13,464    (312)   17,931    (342)
Marketable equity securities                        
   $19,518   $(132)  $21,215   $(428)  $40,733   $(560)

 

December 31, 2015

 

(Dollars in thousands)  Less Than 12 Months   12 Months or More   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Loss   Value   Loss   Value   Loss 
Available-for-Sale:                              
U.S. Treasury securities  $1,021   $(1)  $   $   $1,021   $(1)
Obligations of U.S. Government                              
Corporations and Agencies:                              
Mortgage-backed   86,618    (1,177)   11,234    (233)   97,852    (1,410)
Other   12,962    (79)           12,962    (79)
Obligations of state and political subdivisions   26,163    (258)   8,105    (150)   34,268    (408)
Corporate debt securities   27,527    (531)   19,433    (808)   46,960    (1,339)
Marketable equity securities                        
   $154,291   $(2,046)  $38,772   $(1,191)  $193,063   $(3,237)

 

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 8 securities with a one year or less unrealized loss position or any of their 10 securities with a greater than one year unrealized loss position as of June 30, 2016, 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 and 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.

 

13

 

 

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 thirty 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. Home equity term loans are secured by the borrower’s primary residence and typically have a maximum loan-to-value of eighty percent and a maximum term of fifteen years. In general, 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 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 10 days or more. Delinquent notices are generated automatically when a loan is 10 or 15 days past-due depending on loan type. 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.

 

14

 

 

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.

 

15

 

 

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 Sheets. As of June 30, 2016 and December 31, 2015, the amount of the reserve for unfunded lending commitments was $192,000 and $184,000, respectively.

 

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 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.

 

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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 and 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.

 

17

 

 

The following table presents the classes of the loan portfolio summarized by risk rating as of June 30, 2016 and December 31, 2015:

 

   Commercial and     
(Dollars in thousands)  Industrial   Commercial Real Estate 
   June 30,   December 31,   June 30,   December 31, 
   2016   2015   2016   2015 
Grade:                      
1-6  Pass  $74,932   $80,730   $243,888   $242,546 
7     Special Mention   4,331    4,194    9,216    3,890 
8     Substandard           10,031    12,238 
9     Doubtful                
Add (deduct): Unearned discount and                
  Net deferred loan fees and costs   136    150    389    344 
Total loans  $79,399   $85,074   $263,524   $259,018 

 

   Residential Real Estate     
   Including Home Equity   Consumer Loans 
   June 30,   December 31,   June 30,   December 31, 
   2016   2015   2016   2015 
Grade:                    
1-6  Pass  $165,568   $163,690   $6,198   $5,764 
7     Special Mention   1,063    1,667    17    26 
8     Substandard   1,119    1,245    5    4 
9     Doubtful                
Add (deduct): Unearned discount and   (10)   (15)        
  Net deferred loan fees and costs   15    41    100    96 
Total loans  $167,755   $166,628   $6,320   $5,890 

 

   Total Loans 
   June 30,   December 31, 
   2016   2015 
Grade:          
1-6  Pass  $490,586   $492,730 
7     Special Mention   14,627    9,777 
8     Substandard   11,155    13,487 
9     Doubtful        
Add (deduct):  Unearned discount and   (10)   (15)
  Net deferred loan fees and costs   640    631 
Total loans  $516,998   $516,610 

 

Commercial and Industrial and Commercial Real Estate include loans categorized as tax-free in the amounts of $40,186,000 and $2,877,000 at June 30, 2016 and $43,817,000 and $2,992,000 at December 31, 2015. Loans held for sale amounted to $3,755,000 at June 30, 2016 and $1,929,000 at December 31, 2015.

 

18

 

 

The activity in the allowance for loan losses, by loan class, 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 June 30, 2016:                              
Allowance for Loan Losses:                              
Beginning balance  $731   $3,983   $1,749   $101   $448   $7,012 
Charge-offs   (2)   (57)   (25)           (84)
Recoveries   4            3        7 
Provision   (31)   88    (27)   2    252    284 
Ending Balance  $702   $4,014   $1,697   $106   $700   $7,219 

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
As of and for the six month period ended June 30, 2016:                              
Allowance for Loan Losses:                              
Beginning balance  $725   $3,983   $1,777   $96   $158   $6,739 
Charge-offs   (2)   (57)   (25)   (23)       (107)
Recoveries   4        12    4        20 
Provision   (25)   88    (67)   29    542    567 
Ending Balance  $702   $4,014   $1,697   $106   $700   $7,219 
Ending balance: individually evaluated for impairment  $   $393   $19   $   $   $412 
Ending balance: collectively evaluated for impairment  $702   $3,621   $1,678   $106   $700   $6,807 
                               
Loans Receivable:                              
Ending Balance  $79,399   $263,524   $167,755   $6,320   $   $516,998 
Ending balance: individually evaluated for impairment  $478   $11,993   $858   $      $13,329 
Ending balance: collectively evaluated for impairment  $78,921   $251,531   $166,897   $6,320   $   $503,669 

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
As of and for the three month period ended June 30, 2015:                              
Allowance for Loan Losses:                              
Beginning balance  $687   $3,019   $1,852   $90   $837   $6,485 
Charge-offs       (94)   (49)   (1)       (144)
Recoveries   3    42        1        46 
Provision   16    172    64    (1)   (38)   213 
Ending Balance  $706   $3,139   $1,867   $89   $799   $6,600 

 

19

 

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
As of and for the six month period ended June 30, 2015:                              
Allowance for Loan Losses:                              
Beginning balance  $542   $3,176   $1,928   $107   $637   $6,390 
Charge-offs   (2)   (137)   (108)   (15)       (262)
Recoveries   3    42        2        47 
Provision   163    58    47    (5)   162    425 
Ending Balance  $706   $3,139   $1,867   $89   $799   $6,600 
Ending balance: individually evaluated for impairment  $   $24   $66   $   $   $90 
Ending balance: collectively evaluated for impairment  $706   $3,115   $1,801   $89   $799   $6,510 
                               
Loans Receivable:                              
Ending Balance  $78,077   $256,184   $162,463   $5,448   $   $502,172 
Ending balance: individually evaluated for impairment  $414   $9,174   $1,029   $2   $   $10,619 
Ending balance: collectively evaluated for impairment  $77,663   $247,010   $161,434   $5,446   $   $491,553 

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
As of and for the twelve months ended December 31, 2015:                              
Allowance for Loan Losses:                              
Beginning balance  $542   $3,176   $1,928   $107   $637   $6,390 
Charge-offs   (2)   (1,759)   (210)   (45)       (2,016)
Recoveries   22    59    1    6        88 
Provision   163    2,507    58    28    (479)   2,277 
Ending Balance  $725   $3,983   $1,777   $96   $158   $6,739 
Ending balance: individually evaluated for impairment  $   $309   $31   $      $340 
Ending balance: collectively evaluated for impairment  $725   $3,674   $1,746   $96   $158   $6,399 
                               
Loans Receivable:                              
Ending Balance  $85,074   $259,018   $166,628   $5,890   $   $516,610 
Ending balance: individually evaluated for impairment  $399   $12,057   $911   $   $   $13,367 
Ending balance: collectively evaluated for impairment  $84,675   $246,961   $165,717   $5,890   $   $503,243 

 

Of the $1,280,000 in foreclosed assets held for resale at June 30, 2016, $105,000 was secured by residential real estate, $50,000 was secured by land, and $1,125,000 was secured by commercial real estate. Of the $1,472,000 in foreclosed assets held for resale at December 31, 2015, $256,000 was secured by residential real estate, $50,000 was secured by land, and $1,166,000 was secured by commercial real estate. At June 30, 2016 and December 31, 2015, all foreclosed assets were 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 $266,000 at June 30, 2016 and $221,000 at December 31, 2015. These balances were not included in foreclosed assets held for resale at June 30, 2016 or December 31, 2015.

 

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”).

 

20

 

 

The outstanding balance of TDRs as of June 30, 2016 and December 31, 2015 was $11,091,000 and $11,096,000, respectively. The small decrease in TDRs at June 30, 2016 as compared to December 31, 2015 is attributable to large principal payments and paydowns made on existing TDRs net against smaller loans modified as TDRs during the six months ended June 30, 2016. There were $18,000 and $31,000 in unfunded commitments on TDRs at June 30, 2016 and December 31, 2015, respectively.

 

During the three months ended June 30, 2016, three loans with a combined post modification balance of $114,000 were classified as TDRs, as compared to the same period in 2015, when three loans with a combined post modification balance of $308,000 were classified as TDRs. The loan modifications for the three months ended June 30, 2016 consisted of two term modifications and one payment modification. The loan modifications for the three months ended June 30, 2015 consisted of two term modifications and one payment modification.

 

During the six months ended June 30, 2016, seven loans with a combined post modification balance of $542,000 were classified as TDRs, as compared to the same period in 2015, when five loans with a combined post modification balance of $4,558,000 were classified as TDRs. The loan modifications for the six months ended June 30, 2016 consisted of five term modifications and two payment modifications. The loan modifications for the six months ended June 30, 2015 consisted of three term modifications and two payment modifications.

 

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

 

(Dollars in thousands)

   June 30,   December 31, 
   2016   2015 
Non-accrual TDRs  $300   $477 
Accruing TDRs   10,791    10,619 
Total  $11,091   $11,096 

 

At June 30, 2016, five Commercial Real Estate loans classified as TDRs with a combined recorded investment of $748,000 were not in compliance with the terms of their restructure, compared to June 30, 2015 when five Commercial Real Estate loans classified as TDRs with a combined recorded investment of $6,393,000 were not in compliance with the terms of their restructure. The significant decrease in TDRs not in compliance with the terms of their restructure at June 30, 2016 as compared to June 30, 2015 is largely due to the proper measures being taken to bring two loans totaling $5,639,000 into compliance with the terms of their restructure. One loan to a student housing holding company in the amount of $4,226,000 was not in compliance with the terms of its restructure at June 30, 2015, but proper measures were taken to bring the loan into compliance with restructure terms by June 30, 2016. A purchased participation loan in the amount of $1,413,000 to a distributor of recreational vehicles was not in compliance with the terms of its restructure at June 30, 2015. A piece of property related to this loan, valued at $925,000, was moved to foreclosed assets held for resale at December 31, 2015, and proper measures were taken to bring the remainder of the loan into compliance with restructure terms by June 30, 2016.

 

During the three months ended June 30, 2016, no loans that were modified as TDRs within the preceding twelve months had experienced payment defaults, as compared to the same period in 2015 when one Commercial Real Estate loan totaling $4,226,000 that was modified as a TDR within the preceding twelve months had experienced a payment default. During the six months ended June 30, 2016, no loans that were modified as TDRs within the preceding twelve months had experienced payment defaults, as compared to the same period in 2015 when two Commercial Real Estate loans totaling $4,446,000 that were modified as TDRs within the preceding twelve months had experienced payment defaults. The significant decrease in defaulted TDRs at June 30, 2016 as compared to June 30, 2015 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 payment default during the second quarter of 2015.

 

21

 

 

The following table presents information regarding the loan modifications categorized as TDRs during the three and six months ended June 30, 2016 and June 30, 2015:

 

(Dollars in thousands)  Three Months Ended June 30, 2016 
       Pre-Modification   Post-Modification     
   Number   Outstanding Recorded   Outstanding Recorded   Recorded 
   of Contracts   Investment   Investment   Investment 
Commercial and Industrial   1   $18   $18   $18 
Commercial Real Estate   2    96    96    95 
Total   3   $114   $114   $113 

 

(Dollars in thousands)  Three Months Ended June 30, 2015 
       Pre-Modification   Post-Modification     
   Number   Outstanding Recorded   Outstanding Recorded   Recorded 
   of Contracts   Investment   Investment   Investment 
Commercial and Industrial      $   $   $ 
Commercial Real Estate   3    354    308    308 
Total   3   $354   $308   $308 

 

(Dollars in thousands)  Six Months Ended June 30, 2016 
       Pre-Modification   Post-Modification     
   Number   Outstanding Recorded   Outstanding Recorded   Recorded 
   of Contracts   Investment   Investment   Investment 
Commercial and Industrial   4   $86   $86   $81 
Commercial Real Estate   3    456    456    209 
Total   7   $542   $542   $290 

 

(Dollars in thousands)  Six Months Ended June 30, 2015 
       Pre-Modification   Post-Modification     
   Number   Outstanding Recorded   Outstanding Recorded   Recorded 
   of Contracts   Investment   Investment   Investment 
Commercial and Industrial   1   $23   $23   $22 
Commercial Real Estate   4    4,580    4,535    4,533 
Total   5   $4,603   $4,558   $4,555 

 

The following table provides detail regarding the types of loan modifications made for loans categorized as TDRs during the three and six months ended June 30, 2016 and June 30, 2015 with the total number of each type of modification performed.

 

   Three Months Ended June 30, 2016   Six Months Ended June 30, 2016 
   Rate   Term   Payment   Number   Rate   Term   Payment   Number 
   Modification   Modification   Modification   Modified   Modification   Modification   Modification   Modified 
Commercial and Industrial       1        1        3    1    4 
Commercial Real Estate       1    1    2        2    1    3 
Total       2    1    3        5    2    7 

 

   Three Months Ended June 30, 2015   Six Months Ended June 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       2    1    3        2    2    4 
Total       2    1    3        3    2    5 

 

22

 

 

The recorded investment, unpaid principal balance, and the related allowance of the Corporation’s impaired loans are summarized below for the periods ended June 30, 2016 and December 31, 2015.

 

(Dollars in thousands)  June 30, 2016   December 31, 2015 
       Unpaid           Unpaid     
   Recorded   Principal   Related   Recorded   Principal   Related 
   Investment   Balance   Allowance   Investment   Balance   Allowance 
With no related allowance recorded:                              
Commercial and Industrial  $478   $478    $   $399   $399   $ 
Commercial Real Estate   6,781    8,020        7,853    9,524     
Residential Real Estate   434    603        475    657     
                               
With an allowance recorded:                              
Commercial Real Estate   5,212    6,567    393    4,204    4,204    309 
Residential Real Estate   424    424    19    436    436    31 
Total  $13,329   $16,092   $412   $13,367   $15,220   $340 
                               
Total consists of:                              
Commercial and Industrial  $478   $478    $   $399   $399   $ 
Commercial Real Estate  $11,993   $14,587   $393   $12,057   $13,728   $309 
Residential Real Estate  $858   $1,027   $19   $911   $1,093   $31 

______________________

At June 30, 2016 and December 31, 2015, $11,091,000 and $11,096,000 of loans classified as TDRs were included in impaired loans with a total allocated allowance of $256,000 and $309,000, 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 six months ended June 30, 2016 and 2015.

 

(Dollars in thousands)  For the Three Months Ended   For the Three Months Ended 
   June 30, 2016   June 30, 2015 
   Average   Interest   Average   Interest 
   Recorded   Income   Recorded   Income 
   Investment   Recognized   Investment   Recognized 
With no related allowance recorded:                    
Commercial and Industrial  $472   $5   $416   $5 
Commercial Real Estate   6,913    83    8,943    141 
Residential Real Estate   423        441     
Consumer           3     
                     
With an allowance recorded:                    
Commercial Real Estate   5,179    37    257     
Residential Real Estate   424        547     
Total  $13,411   $125   $10,607   $146 
                     
Total consists of:                    
Commercial and Industrial  $472   $5   $416   $5 
Commercial Real Estate  $12,092   $120   $9,200   $141 
Residential Real Estate  $847   $   $988   $ 
Consumer  $   $   $3   $ 

 _____________________

Of the $125,000 and $146,000 in interest income recognized on impaired loans for the three months ended June 30, 2016 and 2015, respectively, no interest income was recognized with respect to non-accrual loans.

 

23

 

 

(Dollars in thousands)  For the Six Months Ended   For the Six Months Ended 
   June 30, 2016   June 30, 2015 
   Average   Interest   Average   Interest 
   Recorded   Income   Recorded   Income 
   Investment   Recognized   Investment   Recognized 
With no related allowance recorded:                    
Commercial and Industrial  $447   $10   $410   $9 
Commercial Real Estate   6,904    171    7,599    247 
Residential Real Estate   422        414     
Consumer           3     
                     
With an allowance recorded:                    
Commercial Real Estate   5,176    74    259     
Residential Real Estate   428        553     
Total  $13,377   $255   $9,238   $256 
                     
Total consists of:                    
Commercial and Industrial  $447   $10   $410   $9 
Commercial Real Estate  $12,080   $245   $7,858   $247 
Residential Real Estate  $850   $   $967   $ 
Consumer  $   $   $3   $ 

_____________________

Of the $255,000 and $256,000 in interest income recognized on impaired loans for the six months ended June 30, 2016 and 2015, respectively, no interest income was recognized with respect to non-accrual loans.

 

Loans receivable on non-accrual status, foreclosed assets held for resale and loans past-due 90 days or more and still accruing, as of June 30, 2016 and December 31, 2015 were as follows:

 

(Dollars in thousands)        
   June 30,   December 31, 
   2016   2015 
Commercial Real Estate  $1,680   $1,837 
Residential Real Estate   858    911 
Total non-accrual loans   2,538    2,748 
Foreclosed assets held for resale   1,280    1,472 
Loans past-due 90 days or more and still accruing   431    166 
Total non-performing assets  $4,249   $4,386 

 

The following tables present the classes of the loan portfolio summarized by the past-due status at June 30, 2016 and December 31, 2015:

 

(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 
June 30, 2016:                            
Commercial and Industrial  $638   $63   $   $701   $78,698   $79,399   $ 
Commercial Real Estate   1,357    627    1,901    3,885    259,639    263,524    398 
Residential Real Estate   974    26    848    1,848    165,907    167,755    33 
Consumer   11            11    6,309    6,320     
Total  $2,980   $716   $2,749   $6,445   $510,553   $516,998   $431 

  

24

 

 

(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, 2015:                                   
Commercial and Industrial  $34   $   $   $34   $85,040   $85,074   $ 
Commercial Real Estate   316    3    1,484    1,803    257,215    259,018     
Residential Real Estate   1,288    491    1,049    2,828    163,800    166,628    166 
Consumer   20            20    5,870    5,890     
Total  $1,658   $494   $2,533   $4,685   $511,925   $516,610   $166 

 

At June 30, 2016, commitments to lend additional funds with respect to impaired loans consisted of three irrevocable letters of credit totaling $2,204,000. One irrevocable letter of credit in the amount of $2,185,000 was associated with a loan to a developer of a residential sub-division. Two irrevocable letters of credit totaling $19,000 were associated with a loan to a community recreation facility. At December 31, 2015, the only commitment to lend additional funds with respect to impaired loans was an irrevocable letter of credit in the amount of $2,185,000 associated with a loan to a developer of a residential sub-division.

 

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.

 

25

 

 

The following table presents the short-term borrowings subject to an enforceable master netting arrangement or repurchase agreements as of June 30, 2016 and December 31, 2015.

 

(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 
June 30, 2016                              
Repurchase agreements (a)  $24,029   $   $24,029   $(24,029)  $   $ 
                               
December 31, 2015                              
Repurchase agreements (a)  $20,779   $   $20,779   $(20,779)  $   $ 

______________________

(a) As of June 30, 2016 and December 31, 2015, the fair value of securities pledged in connection with repurchase agreements was $27,713,000 and $27,510,000, respectively.

 

The following table presents the remaining contractual maturity of the master netting arrangement or repurchase agreements as of June 30, 2016:

 

(Dollars in thousands)  Remaining Contractual Maturity of the Agreements 
   Overnight           Greater     
   and   Up to   30 -90   than     
  Continuous   30 days   Days   90 Days   Total 
June 30, 2016:                    
Repurchase agreements and repurchase-to-maturity transactions:                         
U.S. Treasury and/or agency securities  $24,029   $   $   $   $24,029 
Total  $24,029   $   $   $   $24,029 

 

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.

 

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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 June 30, 2016 and December 31, 2015, were as follows:

 

(Dollars in thousands)

   June 30, 2016   December 31, 2015 
Financial instruments whose contract amounts represent credit risk:          
Commitments to extend credit  $85,194   $72,552 
Financial standby letters of credit  $452   $475 
Performance standby letters of credit  $4,660   $4,692 

 

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.

 

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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 June 30, 2016 and December 31, 2015, investments measured at fair value on a recurring basis and the valuation methods used are as follows:

 

(Dollars in thousands)

 

June 30, 2016                
   Level 1   Level 2   Level 3   Total 
Available-for-Sale Securities:                
U.S. Treasury securities  $   $1,020   $   $1,020 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed       114,204        114,204 
Other       11,591        11,591 
Obligations of state and political subdivisions       212,577        212,577 
Corporate debt securities       43,669        43,669 
Marketable equity securities   2,028            2,028 
Total  $2,028   $383,061   $   $385,089 

 

(Dollars in thousands)

 

December 31, 2015

   Level 1   Level 2   Level 3   Total 
Available-for-Sale Securities:                    
U.S. Treasury securities  $   $1,021   $   $1,021 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgaged-backed       112,474        112,474 
Other       21,592        21,592 
Obligations of state and political subdivisions       200,314        200,314 
Corporate debt securities       47,833        47,833 
Marketable equity securities   2,007            2,007 
Total  $2,007   $383,234   $   $385,241 

 

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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 2016 or 2015.

 

Financial Assets Measured at Fair Value on a Non-recurring Basis

 

At June 30, 2016 and December 31, 2015, impaired loans measured at fair value on a non-recurring basis that are collateral dependent and the valuation methods used are as follows:

 

(Dollars in thousands)

   Level 1   Level 2   Level 3   Total 
Assets at June 30, 2016                    
Impaired loans:                    
Commercial Real Estate  $   $   $5,289   $5,289 
Residential Real Estate           549    549 
Total impaired loans  $   $   $5,838   $5,838 

 

(Dollars in thousands)

   Level 1   Level 2   Level 3   Total 
Assets at December 31, 2015                    
Impaired loans:                    
Commercial Real Estate  $   $   $1,665   $1,665 
Residential Real Estate           631    631 
Total impaired loans  $   $   $2,296   $2,296 

 

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 2016 and 2015.

 

Nonfinancial Assets Measured at Fair Value on a Non-recurring Basis

 

At June 30, 2016, 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 June 30, 2016                    
Foreclosed assets held for resale:                    
Commercial Real Estate  $   $   $200