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EX-32.2 - EX-32.2 - FRANKLIN FINANCIAL SERVICES CORP /PA/fraf-20180930xex32_2.htm
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EX-31.2 - EX-31.2 - FRANKLIN FINANCIAL SERVICES CORP /PA/fraf-20180930xex31_2.htm
EX-31.1 - EX-31.1 - FRANKLIN FINANCIAL SERVICES CORP /PA/fraf-20180930xex31_1.htm

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

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

For the quarterly period ended September 30, 2018

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 0-12126

FRANKLIN FINANCIAL SERVICES CORPORATION

(Exact name of registrant as specified in its charter)



 

PENNSYLVANIA

25-1440803

(State or other jurisdiction of incorporation or organization) 

(I.R.S. Employer Identification No.)







 

20 South Main Street, Chambersburg, PA

17201-0819

(Address of principal executive offices)

(Zip Code)



(717) 264-6116

(Registrant's telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

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



Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes  No



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

Large accelerated filer      Accelerated filer      Non-accelerated filer      Smaller reporting company        Emerging growth company  



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



Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act)  Yes  No



There were 4,399,135 outstanding shares of the Registrant’s common stock as of October  31, 2018.

 


 

INDEX



               



 

 

Part I - FINANCIAL INFORMATION

 



 

 

Item 1

Financial Statements

 



Consolidated Balance Sheets as of September  30, 2018 and December 31, 2017 (unaudited)

1



Consolidated Statements of Income for the Three and Nine Months ended September  30, 2018 

2



and 2017 (unaudited)

 



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

3



September  30, 2018 and 2017 (unaudited)

 



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

3



ended September 30, 2018 and 2017 (unaudited)

 



Consolidated Statements of Cash Flows for the Nine Months ended September  30, 2018 

5



and 2017 (unaudited)

 



Notes to Consolidated Financial Statements (unaudited)

6



 

 

Item 2

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

26

Item 3

Quantitative and Qualitative Disclosures about Market Risk

46

Item 4

Controls and Procedures

46



 

 

Part II - OTHER INFORMATION 

 



 

 

Item 1

Legal Proceedings

46

Item 1A

Risk Factors

47

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

48

Item 3

Defaults Upon Senior Securities

48

Item 4

Mine Safety Disclosures

48

Item 5

Other Information

49

Item 6

Exhibits

49

SIGNATURE PAGE

50



 







 

 


 

Part I FINANCIAL INFORMATION

Item 1 Financial Statements

Consolidated Balance Sheets







 

 

 

 

 

 

 

 

 

 

 

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

September 30,

 

December 31,



2018

 

2017

Assets

 

 

 

 

 

Cash and due from banks

$

16,281 

 

$

21,433 

Interest-bearing deposits in other banks

 

28,496 

 

 

37,170 

Total cash and cash equivalents

 

44,777 

 

 

58,603 

Debt securities available for sale, at fair value

 

125,403 

 

 

126,971 

Equity securities

 

383 

 

 

365 

Restricted stock

 

452 

 

 

456 

Loans held for sale

 

1,072 

 

 

442 

Loans

 

970,983 

 

 

943,700 

Allowance for loan losses

 

(12,526)

 

 

(11,792)

Net Loans

 

958,457 

 

 

931,908 

Premises and equipment, net

 

13,267 

 

 

13,741 

Bank owned life insurance

 

23,366 

 

 

22,980 

Goodwill

 

9,016 

 

 

9,016 

Other real estate owned

 

2,665 

 

 

2,598 

Deferred tax asset, net

 

4,170 

 

 

5,803 

Other assets

 

11,596 

 

 

6,930 

Total assets

$

1,194,624 

 

$

1,179,813 



 

 

 

 

 

Liabilities

 

 

 

 

 

Deposits

 

 

 

 

 

Non-interest bearing checking

$

196,478 

 

$

196,853 

Money management, savings and interest checking

 

807,643 

 

 

774,857 

Time

 

67,736 

 

 

75,471 

Total deposits

 

1,071,857 

 

 

1,047,181 

Other liabilities

 

8,739 

 

 

17,488 

Total liabilities

 

1,080,596 

 

 

1,064,669 



 

 

 

 

 

Shareholders' equity

 

 

 

 

 

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

 

 

 

 

 

4,701,367 shares issued and 4,398,361 shares outstanding at September 30, 2018 and

 

 

 

 

 

4,689,099 shares issued and 4,354,788 shares outstanding at December 31, 2017

 

4,701 

 

 

4,689 

Capital stock without par value, 5,000,000 shares authorized with no

 

 

 

 

 

shares issued and outstanding

 

 —

 

 

 —

Additional paid-in capital

 

41,380 

 

 

40,396 

Retained earnings

 

81,330 

 

 

82,218 

Accumulated other comprehensive loss

 

(7,790)

 

 

(6,028)

Treasury stock, 303,006 shares at September 30, 2018 and 334,311 shares at

 

 

 

 

 

December 31, 2017, at cost

 

(5,593)

 

 

(6,131)

Total shareholders' equity

 

114,028 

 

 

115,144 

Total liabilities and shareholders' equity

$

1,194,624 

 

$

1,179,813 

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

1


 

Consolidated Statements of Income





 

 

 

 

 

 

 

 

 

 

 

 



 

For the Three Months Ended

 

For the Nine Months Ended

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

 

September 30,

 

September 30,



 

2018

 

2017

 

2018

 

2017

Interest income

 

 

 

 

 

 

 

 

 

 

 

 

Loans, including fees

 

$

10,565 

 

$

9,130 

 

$

30,268 

 

$

26,808 

Interest and dividends on investments:

 

 

 

 

 

 

 

 

 

 

 

 

Taxable interest

 

 

507 

 

 

509 

 

 

1,548 

 

 

1,558 

Tax exempt interest

 

 

293 

 

 

275 

 

 

862 

 

 

861 

Dividend income

 

 

 

 

 

 

15 

 

 

23 

Deposits and obligations of other banks

 

 

108 

 

 

147 

 

 

326 

 

 

297 

Total interest income

 

 

11,477 

 

 

10,063 

 

 

33,019 

 

 

29,547 

Interest expense

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

 

1,101 

 

 

629 

 

 

2,847 

 

 

1,785 

Short-term borrowings

 

 

21 

 

 

 —

 

 

24 

 

 

15 

Total interest expense

 

 

1,122 

 

 

629 

 

 

2,871 

 

 

1,800 

Net interest income

 

 

10,355 

 

 

9,434 

 

 

30,148 

 

 

27,747 

Provision for loan losses

 

 

250 

 

 

250 

 

 

9,579 

 

 

420 

Net interest income after provision for loan losses

 

 

10,105 

 

 

9,184 

 

 

20,569 

 

 

27,327 

Noninterest income

 

 

 

 

 

 

 

 

 

 

 

 

Investment and trust services fees

 

 

1,424 

 

 

1,353 

 

 

4,285 

 

 

3,991 

Loan service charges

 

 

191 

 

 

201 

 

 

640 

 

 

657 

Deposit service charges and fees

 

 

578 

 

 

611 

 

 

1,726 

 

 

1,789 

Other service charges and fees

 

 

357 

 

 

340 

 

 

1,043 

 

 

996 

Debit card income

 

 

422 

 

 

325 

 

 

1,224 

 

 

1,062 

Increase in cash surrender value of life insurance

 

 

129 

 

 

130 

 

 

386 

 

 

391 

Net loss on sale of other real estate owned

 

 

 —

 

 

(23)

 

 

 —

 

 

(23)

Debt securities gains, net

 

 

 

 

 

 

56 

 

 

Change in fair value of equity securities

 

 

(20)

 

 

 —

 

 

18 

 

 

 —

Other

 

 

34 

 

 

33 

 

 

111 

 

 

186 

Total noninterest income

 

 

3,120 

 

 

2,971 

 

 

9,489 

 

 

9,052 

Noninterest Expense

 

 

 

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

 

4,947 

 

 

4,694 

 

 

15,029 

 

 

14,190 

Occupancy, furniture and equipment, net

 

 

780 

 

 

809 

 

 

2,383 

 

 

2,386 

Advertising

 

 

345 

 

 

332 

 

 

1,113 

 

 

873 

Legal and professional

 

 

436 

 

 

502 

 

 

1,207 

 

 

1,173 

Data processing

 

 

591 

 

 

567 

 

 

1,791 

 

 

1,643 

Pennsylvania bank shares tax

 

 

239 

 

 

243 

 

 

712 

 

 

728 

FDIC Insurance

 

 

159 

 

 

82 

 

 

452 

 

 

281 

ATM/debit card processing

 

 

258 

 

 

190 

 

 

734 

 

 

630 

Foreclosed real estate

 

 

(8)

 

 

24 

 

 

46 

 

 

95 

Telecommunications

 

 

95 

 

 

106 

 

 

327 

 

 

308 

Provision for credit losses on off-balance sheet exposures

 

 

 —

 

 

 —

 

 

2,361 

 

 

 —

Other

 

 

729 

 

 

756 

 

 

2,253 

 

 

2,116 

Total noninterest expense

 

 

8,571 

 

 

8,305 

 

 

28,408 

 

 

24,423 

Income before federal income taxes

 

 

4,654 

 

 

3,850 

 

 

1,650 

 

 

11,956 

Federal income tax expense (benefit)

 

 

654 

 

 

774 

 

 

(671)

 

 

2,517 

Net income

 

$

4,000 

 

$

3,076 

 

$

2,321 

 

$

9,439 

Per share

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.91 

 

$

0.71 

 

$

0.53 

 

$

2.18 

Diluted earnings per share

 

$

0.91 

 

$

0.70 

 

$

0.53 

 

$

2.17 

Cash dividends declared

 

$

0.27 

 

$

0.24 

 

$

0.78 

 

$

0.69 

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

2


 

Consolidated Statements of Comprehensive Income





 

 

 

 

 

 

 

 

 

 

 

 



 

For the Three Months Ended

 

For the Nine Months Ended



 

September 30,

 

September 30,

(Dollars in thousands) (unaudited)

 

2018

 

2017

 

2018

 

2017

Net Income

 

$

4,000 

 

$

3,076 

 

$

2,321 

 

$

9,439 



 

 

 

 

 

 

 

 

 

 

 

 

Debt Securities:

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized (losses) gains arising during the period

 

 

(638)

 

 

(97)

 

 

(1,974)

 

 

924 

Reclassification adjustment included in net income (1)

 

 

(5)

 

 

(1)

 

 

(56)

 

 

(3)

Net unrealized (losses) gains

 

 

(643)

 

 

(98)

 

 

(2,030)

 

 

921 

Tax effect

 

 

135 

 

 

33 

 

 

469 

 

 

(313)

Net of tax amount

 

 

(508)

 

 

(65)

 

 

(1,561)

 

 

608 



 

 

 

 

 

 

 

 

 

 

 

 

Total other comprehensive (loss) income

 

 

(508)

 

 

(65)

 

 

(1,561)

 

 

608 



 

 

 

 

 

 

 

 

 

 

 

 

Total Comprehensive Income

 

$

3,492 

 

$

3,011 

 

$

760 

 

$

10,047 



 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

Reclassification adjustment / Statement line item

 

Tax  expense (benefit)

(1) Debt securities gains, net

 

$

 

$

 —

 

$

12 

 

$

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

3


 

 

Consolidated Statements of Changes in Shareholders' Equity

For the three and nine months ended September 30, 2018 and 2017





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 



 

 

 

Additional

 

 

 

 

Other

 

 

 

 

 

 



Common

 

Paid-in

 

Retained

 

Comprehensive

 

Treasury

 

 

 

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

Stock

 

Capital

 

Earnings

 

Loss

 

Stock

 

Total

Balance at June 30, 2018

$

4,700 

 

$

41,079 

 

$

78,514 

 

$

(7,282)

 

$

(5,839)

 

$

111,172 

Net income

 

 —

 

 

 —

 

 

4,000 

 

 

 —

 

 

 —

 

 

4,000 

Other comprehensive loss

 

 —

 

 

 —

 

 

 —

 

 

(508)

 

 

 —

 

 

(508)

Cash dividends declared, $.27 per share

 

 —

 

 

 —

 

 

(1,184)

 

 

 —

 

 

 —

 

 

(1,184)

Treasury shares issued under employee stock purchase plan, 381 shares

 

 —

 

 

 

 

 —

 

 

 —

 

 

 

 

12 

Treasury shares issued under dividend reinvestment plan, 12,957 shares

 

 —

 

 

210 

 

 

 —

 

 

 —

 

 

239 

 

 

449 

Common stock issued under incentive stock option plan, 1,600 shares

 

 

 

24 

 

 

 —

 

 

 —

 

 

 —

 

 

25 

Stock option compensation expense

 

 —

 

 

62 

 

 

 —

 

 

 —

 

 

 —

 

 

62 

Balance at September 30, 2018

$

4,701 

 

$

41,380 

 

$

81,330 

 

$

(7,790)

 

$

(5,593)

 

$

114,028 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2017

$

4,689 

 

$

40,396 

 

$

82,218 

 

$

(6,028)

 

$

(6,131)

 

$

115,144 

Cumulative adjustment for fair value of equity securities

 

 —

 

 

 —

 

 

201 

 

 

(201)

 

 

 —

 

 

 —

Net income

 

 —

 

 

 —

 

 

2,321 

 

 

 —

 

 

 —

 

 

2,321 

Other comprehensive (loss)

 

 —

 

 

 —

 

 

 —

 

 

(1,561)

 

 

 —

 

 

(1,561)

Cash dividends declared, $.78 per share

 

 —

 

 

 —

 

 

(3,410)

 

 

 —

 

 

 —

 

 

(3,410)

Acquisition of 2,605 shares of treasury stock

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(88)

 

 

(88)

Treasury shares issued under employee stock purchase plan, 2,944 shares

 

 —

 

 

34 

 

 

 —

 

 

 —

 

 

54 

 

 

88 

Treasury shares issued under dividend reinvestment plan, 30,966 shares

 

 —

 

 

513 

 

 

 —

 

 

 —

 

 

572 

 

 

1,085 

Common stock issued under incentive stock option plan, 12,268 shares

 

12 

 

 

252 

 

 

 —

 

 

 —

 

 

 —

 

 

264 

Stock option compensation expense

 

 —

 

 

185 

 

 

 —

 

 

 —

 

 

 —

 

 

185 

Balance at September 30, 2018

$

4,701 

 

$

41,380 

 

$

81,330 

 

$

(7,790)

 

$

(5,593)

 

$

114,028 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2017

$

4,688 

 

$

40,096 

 

$

87,498 

 

$

(3,542)

 

$

(6,380)

 

$

122,360 

Net income

 

 —

 

 

 —

 

 

3,076 

 

 

 —

 

 

 —

 

 

3,076 

Other comprehensive (loss)

 

 —

 

 

 —

 

 

 —

 

 

(65)

 

 

 —

 

 

(65)

Cash dividends declared, $.24 per share

 

 —

 

 

 —

 

 

(1,042)

 

 

 —

 

 

 —

 

 

(1,042)

Treasury shares issued under employee stock purchase plan, 241 shares

 

 —

 

 

 

 

 —

 

 

 —

 

 

 

 

Treasury shares issued under dividend reinvestment plan, 5,723 shares

 

 —

 

 

85 

 

 

 —

 

 

 —

 

 

105 

 

 

190 

Stock option compensation expense

 

 —

 

 

54 

 

 

 —

 

 

 —

 

 

 —

 

 

54 

Balance at September 30, 2017

$

4,688 

 

$

40,238 

 

$

89,532 

 

$

(3,607)

 

$

(6,271)

 

$

124,580 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2016

$

4,688 

 

$

39,752 

 

$

83,081 

 

$

(4,215)

 

$

(6,813)

 

$

116,493 

Net income

 

 —

 

 

 —

 

 

9,439 

 

 

 —

 

 

 —

 

 

9,439 

Other comprehensive income

 

 —

 

 

 —

 

 

 —

 

 

608 

 

 

 —

 

 

608 

Cash dividends declared, $.69 per share

 

 —

 

 

 —

 

 

(2,988)

 

 

 —

 

 

 —

 

 

(2,988)

Treasury shares issued under employee stock purchase plan, 6,568 shares

 

 —

 

 

29 

 

 

 —

 

 

 —

 

 

120 

 

 

149 

Treasury shares issued under dividend reinvestment plan, 22,990 shares

 

 —

 

 

296 

 

 

 —

 

 

 —

 

 

422 

 

 

718 

Stock option compensation expense

 

 —

 

 

161 

 

 

 —

 

 

 —

 

 

 —

 

 

161 

Balance at September 30, 2017

$

4,688 

 

$

40,238 

 

$

89,532 

 

$

(3,607)

 

$

(6,271)

 

$

124,580 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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

4


 

Consolidated Statements of Cash Flows





 

 

 

 

 

 



 

 

 

 

 

 



 

Nine Months Ended
September 30,



 

2018

 

2017

(Dollars in thousands) (unaudited)

 

 

 

 

 

 

Cash flows from operating activities

 

 

 

 

 

 

Net income

 

$

2,321 

 

$

9,439 

Adjustments to reconcile net income to net cash (used in) provided by operating activities:

 

 

 

 

 

 

Depreciation and amortization

 

 

989 

 

 

973 

Net amortization of loans and investment securities

 

 

1,307 

 

 

1,269 

Amortization and net change in mortgage servicing rights valuation

 

 

 —

 

 

41 

Provision for loan losses

 

 

9,579 

 

 

420 

Change in fair value of equity securities

 

 

(18)

 

 

 —

Debt securities gains, net

 

 

(56)

 

 

(3)

Pay-out of legal settlement

 

 

(10,000)

 

 

 —

Provision for credit losses on off-balance sheet exposures

 

 

2,361 

 

 

 —

Loans originated for sale

 

 

(16,137)

 

 

(6,773)

Proceeds from sale of loans

 

 

15,507 

 

 

6,861 

Write-down of other real estate owned

 

 

 

 

60 

Acquisition of other real estate owned

 

 

105 

 

 

 —

Write-down on premises and equipment available for sale

 

 

 —

 

 

45 

Loss on sale of premises

 

 

17 

 

 

23 

Increase in cash surrender value of life insurance

 

 

(386)

 

 

(391)

Stock option compensation

 

 

185 

 

 

161 

Contribution to pension plan

 

 

(1,000)

 

 

 —

Increase in other assets

 

 

(4,441)

 

 

(1,242)

Increase in other liabilities

 

 

1,638 

 

 

2,753 

Net cash provided by operating activities

 

 

1,977 

 

 

13,636 

Cash flows from investing activities

 

 

 

 

 

 

Proceeds from sales and calls of investment securities available for sale

 

 

4,115 

 

 

875 

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

 

 

14,289 

 

 

16,875 

Purchase of investment securities available for sale

 

 

(20,276)

 

 

(6,533)

Net decrease in restricted stock

 

 

 

 

1,311 

Net increase in loans

 

 

(36,188)

 

 

(17,643)

Capital expenditures

 

 

(599)

 

 

(871)

Proceeds from sale of other assets

 

 

117 

 

 

154 

Net proceeds from the sale of other real estate

 

 

32 

 

 

2,255 

Net cash used in investing activities

 

 

(38,506)

 

 

(3,577)

Cash flows from financing activities

 

 

 

 

 

 

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

 

 

32,411 

 

 

50,325 

Net (decrease) increase in time deposits

 

 

(7,735)

 

 

703 

Net decrease in short-term borrowings

 

 

 —

 

 

(24,270)

Dividends paid

 

 

(3,410)

 

 

(2,988)

Treasury shares issued under employee stock purchase plan

 

 

88 

 

 

149 

Treasury shares issued under dividend reinvestment plan

 

 

1,085 

 

 

718 

Common stock issued under stock option plans

 

 

264 

 

 

 —

Net cash provided by financing activities

 

 

22,703 

 

 

24,637 

(Decrease) increase in cash and cash equivalents

 

 

(13,826)

 

 

34,696 

Cash and cash equivalents as of January 1

 

 

58,603 

 

 

36,665 

Cash and cash equivalents as of September 30

 

$

44,777 

 

$

71,361 

Supplemental Disclosures of Cash Flow Information

 

 

 

 

 

 

Cash paid during the year for:

 

 

 

 

 

 

Interest on deposits and other borrowed funds

 

$

2,818 

 

$

1,786 

Income taxes

 

$

250 

 

$

3,405 



 

 

 

 

 

 

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

5


 

FRANKLIN FINANCIAL SERVICES CORPORATION and SUBSIDIARIES

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 1 - Basis of Presentation

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

In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the consolidated financial position, results of operations, and cash flows as of September 30, 2018, and for all other periods presented have been made.

Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted.  It is suggested that these consolidated financial statements be read in conjunction with the audited consolidated financial statements and notes thereto included in the Corporation’s 2017 Annual Report on Form 10-K.  The consolidated results of operations for the nine month period ended September 30, 2018 are not necessarily indicative of the operating results for the full year.  Management has evaluated subsequent events for potential recognition and/or disclosure through the date these consolidated financial statements were issued.

The consolidated balance sheet at December 31, 2017 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete consolidated financial statements.

For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, interest-bearing deposits in other banks and federal funds sold.  Generally, federal funds are purchased and sold for one-day periods. 

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







 

 

 

 

 

 

 

 

 

 

 

 



 

For the Three Months Ended

 

For the Nine Months Ended



 

September 30,

 

September 30,

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

 

2018

 

2017

 

2018

 

2017

Weighted average shares outstanding (basic)

 

 

4,391 

 

 

4,343 

 

 

4,375 

 

 

4,332 

Impact of common stock equivalents

 

 

21 

 

 

21 

 

 

24 

 

 

21 

Weighted average shares outstanding (diluted)

 

 

4,412 

 

 

4,364 

 

 

4,399 

 

 

4,353 

Anti-dilutive options excluded from calculation

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Net income

 

$

4,000 

 

$

3,076 

 

$

2,321 

 

$

9,439 

Basic earnings per share

 

$

0.91 

 

$

0.71 

 

$

0.53 

 

$

2.18 

Diluted earnings per share

 

$

0.91 

 

$

0.70 

 

$

0.53 

 

$

2.17 

 

6


 

Note 2. Recent Accounting Pronouncements





 

 

 

 

 

 

Standard

 

Description

 

Effective Date

 

Effect on the financial statements or other significant matters



 

 

 

 

 

 

ASU 2018-02, Income Statement (Topic 220), Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income

 

Under ASU 2018-02, entities are allowed, but not required, to reclassify from Accumulated Other Comprehensive Income (AOCI) to retained earnings stranded tax effects resulting from the new federal corporate income tax rate of the Tax Cuts and Jobs Act (the Act).  The reclassification could include other stranded tax effects that related to the Act but do not directly related to the change in the federal rate.  Tax effects that are stranded in AOCI for other reasons may not be reclassified.  Entities also will have an option to adopt the standard retrospectively or in the period of adoption. 

 

January 1, 2018

 

The Corporation adopted the provisions of the ASU in the fourth quarter of 2017.  The Company reclassified the disproportionate tax effect resulting from the Act by increasing retained earnings by $992 thousand and reducing AOCI by $992 thousand.



 

 

 

 

 

 

ASU 2016-15, Statements of Cash Flow (Topic 320): Classification of Certain Cash Receipts and Cash Payments

 

The standard clarifies how certain cash receipts and cash payments are presented and classified in the statement of cash flows.  The amendments are intended to reduce diversity in practice.  The standard contains additional guidance clarifying when an entity should separate cash receipts and cash payments and classifies them into more than one class of cash flows (including when reasonable judgement is required to estimate and allocate cash flows) versus when an entity should classify the aggregate amount into one class of cash flows on the basis of predominance.

 

January 1, 2018

 

The Corporation adopted the provisions of the ASU on January 1, 2018 and it had no material effect on the consolidated financial statements.



 

 

 

 

 

 

ASU 2017-07, Employee Benefits Plan (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost

 

This standard requires an employer to report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period.  The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations.  The amendments in this update also allow only the service cost component to be eligible for capitalization when applicable.  

 

January 1, 2018

 

The Corporation adopted the provisions of the ASU on January 1, 2018 and it had no material effect on the consolidated financial statements.  The service cost is reported in Salaries and Benefits expense and the nonservice cost is included in Other Expense on the Consolidated Statement of Income, which totaled $107 thousand and was reclassified for the first nine months of 2017.



 

 

 

 

 

 

ASU 2014-09, Revenue from Contracts with Customers (Topic 606)

 

The amendments in this Update (ASU 2014-09) establish a comprehensive revenue recognition standard. The revenue standard’s core principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. To accomplish this objective, the standard requires five basic steps: (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. Three basic transition methods are available – full retrospective, retrospective with certain practical expedients, and a cumulative effect approach.

 

January 1, 2018

 

The Corporation adopted this ASU on January 1, 2018, on a modified retrospective approach, and it did not have a material effect on the Corporation's consolidated financial statements.  See Note 11. Revenue Recognition for more information.



 

 

 

 

 

 

7


 

ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities

 

The standard amends the guidance on the classification and measurement of financial instruments.  Some of the amendments include the following: 1) requires equity investments to be measured at fair value with changes in fair value recognized in net income; 2) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; 3) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; and 4) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value; among others.

 

January 1, 2018

 

The Corporation adopted the provisions of the ASU on January 1, 2018 and it had no material effect on the consolidated financial statements. The Corporation reclassified the fair value of equity securities by increasing retained earnings by $201 thousand and decreasing AOCI by $201 thousand.  In addition, according to the standard, the Corporation measured the fair value of the loan portfolio beginning March 31, 2018 using an exit price notion.  See Note 9. Fair Value Measurements and Fair Values of Financial Instruments for more information.



 

 

 

 

 

 

ASU 2016-02, Leases (Topic 842)

 

From the lessee’s perspective, the new standard established a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months.  Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for lessees.  From the lessor’s perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating.  A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee.  If risks and rewards are conveyed without the transfer of control, the lease is treated as financing.  If the lessor doesn’t convey risks and rewards or control, an operating lease results.

 

January 1, 2019

 

The Corporation currently has real estate and equipment leases that it classifies as operating leases that are not recognized on the balance sheet.  Under the new standard, these leases will move onto the balance sheet in the form of a lease liability (the present value of a lessee's obligation to make lease payments) and a right-of-use asset (an asset that represents the lessee's right to use a specified asset for the lease term).  The offsetting transactions will gross-up the Consolidated Balance Sheet.  The Corporation has identified all of its leases (approximately 63, primarily equipment and property leases), but has not determined the effect on the Consolidated Balance Sheet. The Corporation has acquired a lease accounting model to implement the standard to be used in a test mode during 2018.  The Corporation expects to adopt the standard using the modified retrospective approach and elect the transition options of ASU 2018-11. The Corporation currently expects that the new standard will not have a material effect on its consolidated results of operations.



 

 

 

 

 

 

ASU 2018-11, Leases - Targeted Improvements (Topic 842)

 

This guidance provides entities with relief from the costs of implementing certain aspects of the new leasing standard, ASU No. 2016-02.  Specifically, under the amendments in ASU 2018-11: (1) entities may elect not to recast the comparative periods presented when transitioning to the new leasing standard, and (2) lessors may elect not to separate lease and non-lease components when certain conditions are met.  The amendments have the same effective date as ASU 2016-02 (January 1, 2019 for the Corporation).

 

 

 

 



 

 

 

 

 

 

ASU 2018-15, Accounting for Implementation Costs in a Cloud Computing Arrangement (Topic 350)

 

This ASU required an entity in a cloud computing arrangement (i.e., hosting arrangement) that is a service contract to follow the internal-use software guidance in ASC 350-40 to determine which implementation costs to capitalize as assets or expense as incurred.  Capitalized implementation costs should be presented in the same line item on the balance sheet as amounts prepaid for the hosted service, if any (generally as an "other asset").  The capitalized costs will be amortized over the term of the hosting arrangement, with the amortization expense being presented in the same income statement line item as the fees paid for the hosted service. 

 

January 1, 2019

 

The Corporation is reviewing its internal accounting procedures for this implementation.  The Corporation does not expect the standard will have a material effect on its consolidated results of operations. 



 

 

 

 

 

 

8


 

ASU 2018-13, Disclosure Framework (Topic 820)

 

This guidance eliminates, adds and modifies certain disclosure requirements for fair value measurements.  Among the changes, entities will no longer be required to disclose the amount of and reason for transfers between Level 1 and Level 2 of the fair value hierarchy, but will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements.

 

January 1, 2019

 

The Corporation is reviewing its financial reporting procedures for this implementation.  The Corporation does not expect the standard will have a material effect on its consolidated results of operations. 



 

 

 

 

 

 

ASU 2017-04, Goodwill (Topic 350)

 

This guidance, among other things, removes step 2 of the goodwill impairment test thus eliminating the need to determine the fair value of individual assets and liabilities of the reporting unit.  Upon adoption of this standard, goodwill impairment will be the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of goodwill.  This may result in more or less impairment being recognized than under the current guidance. Early adoption is permitted for any impairment tests performed after January 1, 2017, applied prospectively.

 

January 1, 2020

 

The Corporation expects to early adopt the ASU in the fourth quarter of 2018 with the completion of the 2018 impairment analysis.  We do not expect this guidance to have a material effect on the Corporation's consolidated financial statements based upon the prior goodwill impairment analysis.



 

 

 

 

 

 

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

 

This standard requires credit losses on most financial assets measured at amortized cost and certain other instruments to be measured using an expected credit loss model (referred to as the current expected credit loss (CECL) model).  Under this model, entities will estimate credit losses over the entire contractual term of the instrument (considering estimated prepayments, but not expected extensions or modifications unless reasonable expectation of a troubled debt restructuring exists) from the date of initial recognition of that instrument.  The ASU replaces the current accounting model for purchased credit impaired loans and debt securities.  The allowance for credit losses for purchased financial assets with a more-than insignificant amount of credit deterioration since origination (“PCD assets”), should be determined in a similar manner to other financial assets measured on an amortized cost basis.  However, upon initial recognition, the allowance for credit losses is added to the purchase price (“gross up approach”) to determine the initial amortized cost basis.  The subsequent accounting for PCD financial assets is the same expected loss model described above.

 

January 1, 2020

 

We have formed an implementation team led by the Corporation's Risk Management function. The team is reviewing the requirements of the ASU and evaluating methods and models for implementation.  The new standard will result in earlier recognition of additions to the allowance for loan losses and possibly a larger allowance for loan loss balance with a corresponding increase in the provision for loan losses in results of operations; however, the Corporation is continuing to evaluate the impact of the pending adoption of the new standard on its consolidated financial statements.  A third-party vendor has been selected to assist with the CECL calculations and the implementation process has started.  The Corporation expects to be able to run the CECL model in test mode starting near the end of the first quarter of 2019.





Note 3. Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive losses included in shareholders' equity are as follows:







 

 

 

 

 

 



 

 

 

 

 

 



 

September 30,

 

December 31,



 

2018

 

2017

(Dollars in thousands)

 

 

 

 

 

 

Net unrealized (losses) gains on debt securities

 

$

(2,077)

 

$

154 

Tax effect

 

 

436 

 

 

(33)

Net of tax amount

 

 

(1,641)

 

 

121 



 

 

 

 

 

 

Accumulated pension adjustment

 

 

(7,784)

 

 

(7,784)

Tax effect

 

 

1,635 

 

 

1,635 

Net of tax amount

 

 

(6,149)

 

 

(6,149)



 

 

 

 

 

 

Total accumulated other comprehensive loss

 

$

(7,790)

 

$

(6,028)

 

9


 

Note 4. Investments

Available for Sale (AFS) Securities

The amortized cost and estimated fair value of AFS securities as of September 30, 2018 and December 31, 2017 are as follows:







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

September 30, 2018

 

cost

 

gains

 

losses

 

value

U.S. Government and Agency securities

 

$

9,405 

 

$

15 

 

$

(144)

 

$

9,276 

Municipal securities

 

 

63,221 

 

 

176 

 

 

(994)

 

 

62,403 

Trust preferred securities

 

 

4,069 

 

 

 —

 

 

(122)

 

 

3,947 

Agency mortgage-backed securities

 

 

46,394 

 

 

39 

 

 

(1,063)

 

 

45,370 

Private-label mortgage-backed securities

 

 

474 

 

 

43 

 

 

 —

 

 

517 

Asset-backed securities

 

 

3,917 

 

 

 —

 

 

(27)

 

 

3,890 



 

$

127,480 

 

$

273 

 

$

(2,350)

 

$

125,403 









 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

December 31, 2017

 

cost

 

gains

 

losses

 

value

Equity securities

 

$

164 

 

$

201 

 

$

 —

 

$

365 

U.S. Government and Agency securities

 

 

11,451 

 

 

64 

 

 

(43)

 

 

11,472 

Municipal securities

 

 

57,374 

 

 

650 

 

 

(252)

 

 

57,772 

Trust preferred securities

 

 

6,000 

 

 

 —

 

 

(183)

 

 

5,817 

Agency mortgage-backed securities

 

 

51,307 

 

 

197 

 

 

(567)

 

 

50,937 

Private-label mortgage-backed securities

 

 

858 

 

 

88 

 

 

 —

 

 

946 

Asset-backed securities

 

 

28 

 

 

 —

 

 

(1)

 

 

27 



 

$

127,182 

 

$

1,200 

 

$

(1,046)

 

$

127,336 



At September 30, 2018 and December 31, 2017, the fair value of AFS securities pledged to secure public funds and trust deposits totaled $86.9 million and  $84.1 million, respectively.

The amortized cost and estimated fair value of debt securities at September 30, 2018, by contractual maturity are shown below. Actual maturities may differ from contractual maturities because of prepayment or call options embedded in the securities.



 

 

 

 

 

 



 

 

 

 

 

 

(Dollars in thousands)

 

Amortized
cost

 

Fair
value

Due in one year or less

 

$

14,466 

 

$

14,508 

Due after one year through five years

 

 

33,277 

 

 

33,081 

Due after five years through ten years

 

 

31,927 

 

 

31,026 

Due after ten years

 

 

942 

 

 

901 



 

 

80,612 

 

 

79,516 

Mortgage-backed securities

 

 

46,868 

 

 

45,887 



 

$

127,480 

 

$

125,403 



The composition of the net realized gains on AFS securities for the three and nine months ended are as follows:





 

 

 

 

 

 

 

 

 

 

 

 



 

For the Three Months Ended

 

For the Nine Months Ended



 

September 30,

 

September 30,

(Dollars in thousands)

 

2018

 

2017

 

2018

 

2017

Gross gains realized

 

$

 

$

 

$

67 

 

$

Gross losses realized

 

 

 —

 

 

 —

 

 

(11)

 

 

 —

Net gains realized

 

$

 

$

 

$

56 

 

$



10


 

Impairment:

The AFS investment portfolio contained 192 securities with $100 million of temporarily impaired fair value and $2.4 million in unrealized losses at September 30, 2018. The total unrealized loss position has increased $1.3 million since year-end 2017. 

For securities with an unrealized loss, Management applies a systematic methodology in order to perform an assessment of the potential for other-than-temporary impairment.  In the case of debt securities, investments considered for other-than-temporary impairment: (1) had a specified maturity or repricing date; (2) were generally expected to be redeemed at par, and (3) were expected to achieve a recovery in market value within a reasonable period of time. In addition, the Bank considers whether it intends to sell these securities or whether it will be forced to sell these securities before the earlier of amortized cost recovery or maturity.  The impairment identified on debt securities and subject to assessment at September 30, 2018, was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted.

 The following table reflects temporary impairment in the AFS portfolio, aggregated by investment category, length of time that individual securities have been in a continuous unrealized loss position and the number of securities in each category as of September 30, 2018 and December 31, 2017:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



September 30, 2018



Less than 12 months

 

12 months or more

 

Total



Fair

 

Unrealized

 

 

 

Fair

 

Unrealized

 

 

 

Fair

 

Unrealized

 

 

(Dollars in thousands)

Value

 

Losses

 

Count

 

Value

 

Losses

 

Count

 

Value

 

Losses

 

Count



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government and Agency
  securities

$

4,011 

 

$

(54)

 

 

$

4,381 

 

$

(90)

 

12 

 

$

8,392 

 

$

(144)

 

17 

Municipal securities

 

28,938 

 

 

(520)

 

47 

 

 

13,014 

 

 

(474)

 

23 

 

 

41,952 

 

 

(994)

 

70 

Trust preferred securities

 

2,102 

 

 

(62)

 

 

 

1,845 

 

 

(60)

 

 

 

3,947 

 

 

(122)

 

Agency mortgage-backed securities

 

18,326 

 

 

(311)

 

40 

 

 

22,996 

 

 

(752)

 

53 

 

 

41,322 

 

 

(1,063)

 

93 

Asset-backed securities

 

3,886 

 

 

(26)

 

 

 

 

 

(1)

 

 

 

3,890 

 

 

(27)

 

Total temporarily impaired
  securities

$

57,263 

 

$

(973)

 

101 

 

$

42,240 

 

$

(1,377)

 

91 

 

$

99,503 

 

$

(2,350)

 

192 









 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



December 31, 2017



Less than 12 months

 

12 months or more

 

Total



Fair

 

Unrealized

 

 

 

Fair

 

Unrealized

 

 

 

Fair

 

Unrealized

 

 

(Dollars in thousands)

Value

 

Losses

 

Count

 

Value

 

Losses

 

Count

 

Value

 

Losses

 

Count



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government and Agency
  securities

$

2,315 

 

$

(11)

 

 

$

3,528 

 

$

(32)

 

10 

 

$

5,843 

 

$

(43)

 

15 

Municipal securities

 

13,767 

 

 

(89)

 

22 

 

 

7,507 

 

 

(163)

 

14 

 

 

21,274 

 

 

(252)

 

36 

Trust preferred securities

 

1,216 

 

 

(12)

 

 

 

4,601 

 

 

(171)

 

 

 

5,817 

 

 

(183)

 

Agency mortgage-backed securities

 

16,287 

 

 

(129)

 

29 

 

 

20,563 

 

 

(438)

 

39 

 

 

36,850 

 

 

(567)

 

68 

Asset-backed securities

 

 —

 

 

 —

 

 —

 

 

 

 

(1)

 

 

 

 

 

(1)

 

Total temporarily impaired
  securities

$

33,585 

 

$

(241)

 

58 

 

$

36,203 

 

$

(805)

 

69 

 

$

69,788 

 

$

(1,046)

 

127 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



11


 

The following table represents the cumulative credit losses on AFS securities recognized in earnings for:







 

 

 

 

 

 



 

 

 

 

 

 



 

Nine Months Ended

(Dollars in thousands)

 

September 30,



 

2018

 

2017

Balance of cumulative credit-related OTTI at January 1

 

$

595 

 

$

595 

Additions for credit-related OTTI not previously recognized

 

 

 —

 

 

 —

Additional increases for credit-related OTTI previously recognized when there is

 

 

 

 

 

 

   no intent to sell and no requirement to sell before recovery of amortized cost basis

 

 

 —

 

 

 —

Decreases for previously recognized credit-related OTTI because there was an intent to sell

 

 

(323)

 

 

 —

Reduction for increases in cash flows expected to be collected

 

 

 —

 

 

 —

Balance of credit-related OTTI at September 30

 

$

272 

 

$

595 



 

 

 

 

 

 

Equity Securities at fair value

The Corporation owns one equity investment.  At September 30, 2018, this investment was reported at fair value ($383 thousand) with changes in value reported through income.  At December 31, 2017, this investment was reported at fair value with changes in value recorded through other comprehensive income and was included in the Available for Sale Securities table of this note.

Restricted Stock at Cost

The Bank held $452 thousand of restricted stock at September 30, 2018.  Except for $30 thousand, this investment represents stock in FHLB Pittsburgh. The Bank is required to hold this stock to be a member of FHLB and it is carried at cost of $100 per share. The level of FHLB stock held is determined by FHLB and is comprised of a minimum membership amount plus a variable activity amount. FHLB stock is evaluated for impairment primarily based on an assessment of the ultimate recoverability of its cost. As a government sponsored entity, FHLB has the ability to raise funding through the U.S. Treasury that can be used to support its operations.  There is not a public market for FHLB stock and the benefits of FHLB membership (e.g., liquidity and low cost funding) add value to the stock beyond purely financial measures. Management intends to remain a member of the FHLB and believes that it will be able to fully recover the cost basis of this investment. 





Note 5. Loans

The Bank reports its loan portfolio based on the primary collateral of the loan. It further classifies these loans by the primary purpose, either consumer or commercial. The Bank’s residential real estate loans include long-term loans to individuals and businesses secured by mortgages on the borrower’s real property and include home equity loans.  Construction loans are made to finance the purchase of land and the construction of residential and commercial buildings thereon, and are secured by mortgages on real estate.  Commercial real estate loans include construction, owner and non-owner occupied properties and farm real estate.  Commercial loans are made to businesses of various sizes for a variety of purposes including property, plant and equipment, working capital and loans to government municipalities.  Commercial lending is concentrated in the Bank’s primary market, but also includes purchased loan participations. Consumer loans are comprised of installment loans and unsecured personal lines of credit. 

12


 

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



 

 

 

 

 

 



 

 

 

 

 

 



 

September 30,

 

December 31,

(Dollars in thousands)

 

2018

 

2017

Residential Real Estate 1-4 Family

 

 

 

 

 

 

Consumer first liens

 

$

90,029 

 

$

97,159 

Commercial first lien

 

 

60,142 

 

 

61,275 

Total first liens

 

 

150,171 

 

 

158,434 



 

 

 

 

 

 

Consumer junior liens and lines of credit

 

 

43,044 

 

 

45,043 

Commercial junior liens and lines of credit

 

 

5,040 

 

 

5,328 

Total junior liens and lines of credit

 

 

48,084 

 

 

50,371 

Total residential real estate 1-4 family

 

 

198,255 

 

 

208,805 



 

 

 

 

 

 

Residential real estate - construction

 

 

 

 

 

 

Consumer

 

 

2,779 

 

 

1,813 

Commercial

 

 

9,510 

 

 

8,088 

Total residential real estate construction

 

 

12,289 

 

 

9,901 



 

 

 

 

 

 

Commercial real estate

 

 

475,838 

 

 

428,428 

Commercial

 

 

279,835 

 

 

291,519 

        Total commercial

 

 

755,673 

 

 

719,947 



 

 

 

 

 

 

Consumer

 

 

4,766 

 

 

5,047 



 

 

970,983 

 

 

943,700 

Less: Allowance for loan losses

 

 

(12,526)

 

 

(11,792)

Net Loans

 

$

958,457 

 

$

931,908 



 

 

 

 

 

 

Included in the loan balances are the following:

 

 

 

 

 

 

Net unamortized deferred loan costs

 

$

73 

 

$

98 



 

 

 

 

 

 

Loans pledged as collateral for borrowings and commitments from:

 

 

 

 

 

 

FHLB

 

$

762,292 

 

$

737,313 

Federal Reserve Bank

 

 

34,685 

 

 

35,740 



 

$

796,977 

 

$

773,053 

 

13


 

Note 6. Loan Quality and Allowance for Loan Losses

The following table presents, by class, the activity in the Allowance for Loan Losses (ALL) for the periods shown:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 



 

First

 

Junior Liens &

 

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

Liens

 

Lines of Credit

 

Construction

 

Real Estate

 

Commercial

 

Consumer

 

Unallocated

 

Total



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at June 30, 2018

 

$

1,022 

 

$

318 

 

$

282 

 

$

7,028 

 

$

2,233 

 

$

107 

 

$

1,492 

 

$

12,482 

Charge-offs

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(208)

 

 

(23)

 

 

 —

 

 

(231)

Recoveries

 

 

 —

 

 

 —

 

 

 —

 

 

 

 

19 

 

 

 

 

 —

 

 

25 

Provision

 

 

(16)

 

 

(4)

 

 

(4)

 

 

242 

 

 

122 

 

 

12 

 

 

(102)

 

 

250 

ALL at September 30, 2018

 

$

1,006 

 

$

314 

 

$

278 

 

$

7,271 

 

$

2,166 

 

$

101 

 

$

1,390 

 

$

12,526 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at December 31, 2017

 

$

1,060 

 

$

330 

 

$

224 

 

$

6,526 

 

$

2,110 

 

$

105 

 

$

1,437 

 

$

11,792 

Charge-offs

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(8,944)

 

 

(78)

 

 

 —

 

 

(9,022)

Recoveries

 

 

 

 

 —

 

 

 —

 

 

17 

 

 

135 

 

 

24 

 

 

 —

 

 

177 

Provision

 

 

(55)

 

 

(16)

 

 

54 

 

 

728 

 

 

8,865 

 

 

50 

 

 

(47)

 

 

9,579 

ALL at September 30, 2018

 

$

1,006 

 

$

314 

 

$

278 

 

$

7,271 

 

$

2,166 

 

$

101 

 

$

1,390 

 

$

12,526 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at June 30, 2017

 

$

1,075 

 

$

322 

 

$

281 

 

$

6,052 

 

$

2,023 

 

$

100 

 

$

1,454 

 

$

11,307 

Charge-offs

 

 

 —

 

 

 —

 

 

 —

 

 

(9)

 

 

(6)

 

 

(31)

 

 

 —

 

 

(46)

Recoveries

 

 

 

 

 

 

 —

 

 

17 

 

 

 

 

 

 

 —

 

 

32 

Provision

 

 

(15)

 

 

(3)

 

 

(42)

 

 

198 

 

 

(19)

 

 

19 

 

 

112 

 

 

250 

ALL at September 30, 2017

 

$

1,061 

 

$

324 

 

$

239 

 

$

6,258 

 

$

2,003 

 

$

92 

 

$

1,566 

 

$

11,543 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at December 31, 2016

 

$

1,105 

 

$

323 

 

$

224 

 

$

6,109 

 

$

1,893 

 

$

100 

 

$

1,321 

 

$

11,075 

Charge-offs

 

 

(13)

 

 

 —

 

 

 —

 

 

(14)

 

 

(8)

 

 

(83)

 

 

 —

 

 

(118)

Recoveries

 

 

 

 

 

 

 —

 

 

17 

 

 

111 

 

 

30 

 

 

 —

 

 

166 

Provision

 

 

(33)

 

 

(5)

 

 

15 

 

 

146 

 

 

 

 

45 

 

 

245 

 

 

420 

ALL at September 30, 2017

 

$

1,061 

 

$

324 

 

$

239 

 

$

6,258 

 

$

2,003 

 

$

92 

 

$

1,566 

 

$

11,543 



14


 

The following table presents, by class, loans that were evaluated for the ALL under the specific reserve (individually) and those that were evaluated under the general reserve (collectively) and the amount of the ALL established in each class as of September 30, 2018 and December 31, 2017:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 



 

First

 

Junior Liens &

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

Liens

 

Lines of Credit

 

Construction

 

Real Estate

 

Commercial

 

Consumer

 

Unallocated

 

Total



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for ALL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

408 

 

$

 —

 

$

460 

 

$

10,574 

 

$

3,106 

 

$

 —

 

$

 —

 

$

14,548 

Collectively

 

 

149,763 

 

 

48,084 

 

 

11,829 

 

 

465,264 

 

 

276,729 

 

 

4,766 

 

 

 —

 

 

956,435 

Total

 

$

150,171 

 

$

48,084 

 

$

12,289 

 

$

475,838 

 

$

279,835 

 

$

4,766 

 

$

 —

 

$

970,983 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL established for
  loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

181 

 

$

 —

 

$

 —

 

$

181 

Collectively

 

 

1,006 

 

 

314 

 

 

278 

 

 

7,271 

 

 

1,985 

 

 

101 

 

 

1,390 

 

 

12,345 

ALL at September 30, 2018

 

$

1,006 

 

$

314 

 

$

278 

 

$

7,271 

 

$

2,166 

 

$

101 

 

$

1,390 

 

$

12,526 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for ALL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

459 

 

$

 —

 

$

466 

 

$

10,981 

 

$

 —

 

$

 —

 

$

 —

 

$

11,906 

Collectively

 

 

157,975 

 

 

50,371 

 

 

9,435 

 

 

417,447 

 

 

291,519 

 

 

5,047 

 

 

 —

 

 

931,794 

Total

 

$

158,434 

 

$

50,371 

 

$

9,901 

 

$

428,428 

 

$

291,519 

 

$

5,047 

 

$

 —

 

$

943,700 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL established for
  loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

Collectively

 

 

1,060 

 

 

330 

 

 

224 

 

 

6,526 

 

 

2,110 

 

 

105 

 

 

1,437 

 

 

11,792 

ALL at December 31, 2017

 

$

1,060 

 

$

330 

 

$

224 

 

$

6,526 

 

$

2,110 

 

$

105 

 

$

1,437 

 

$

11,792 

15


 

The following table shows additional information about those loans considered to be impaired at September 30, 2018 and December 31, 2017:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Impaired Loans



 

With No Allowance

 

With Allowance

(Dollars in thousands)

 

 

 

 

Unpaid

 

 

 

 

Unpaid

 

 

 



 

Recorded

 

Principal

 

Recorded

 

Principal

 

Related

September 30, 2018

 

Investment

 

Balance

 

Investment

 

Balance

 

Allowance

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

754 

 

$

870 

 

$

 —

 

$

 —

 

$

 —

Junior liens and lines of credit

 

 

66 

 

 

66 

 

 

 —

 

 

 —

 

 

 —

Total

 

 

820 

 

 

936 

 

 

 —

 

 

 —

 

 

 —

 Residential real estate - construction

 

 

460 

 

 

531 

 

 

 —

 

 

 —

 

 

 —

 Commercial real estate

 

 

10,715 

 

 

11,248 

 

 

 —

 

 

 —

 

 

 —

 Commercial

 

 

3,082 

 

 

10,653 

 

 

181 

 

 

181 

 

 

181 

Total

 

$

15,077 

 

$

23,368 

 

$

181 

 

$

181 

 

$

181 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

869 

 

$

950 

 

$

 —

 

$

 —

 

$

 —

Junior liens and lines of credit

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Total

 

 

869 

 

 

950 

 

 

 —

 

 

 —

 

 

 —

 Residential real estate - construction

 

 

466 

 

 

531 

 

 

 —

 

 

 —

 

 

 —

 Commercial real estate

 

 

11,061 

 

 

11,541 

 

 

 —

 

 

 —

 

 

 —

 Commercial

 

 

187 

 

 

201 

 

 

 —

 

 

 —

 

 

 —

Total

 

$

12,583 

 

$

13,223 

 

$

 —

 

$

 —

 

$

 —



The following table shows the average of impaired loans and related interest income for the three and nine months ended September 30, 2018 and 2017:





 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

Nine Months Ended



 

September 30, 2018

 

September 30, 2018



 

Average

 

Interest

 

Average

 

Interest

(Dollars in thousands)

 

Recorded

 

Income

 

Recorded

 

Income



 

Investment

 

Recognized

 

Investment

 

Recognized

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

1,091 

 

$

10 

 

$

899 

 

$

31 

Junior liens and lines of credit

 

 

268 

 

 

 

 

750 

 

 

Total

 

 

1,359 

 

 

12 

 

 

1,649 

 

 

33 

 Residential real estate - construction

 

 

461 

 

 

 —

 

 

463 

 

 

 —

 Commercial real estate

 

 

10,789 

 

 

107 

 

 

10,314 

 

 

316 

 Commercial

 

 

3,465 

 

 

 —

 

 

5,284 

 

 

 —

Total

 

$

16,074 

 

$

119 

 

$

17,710 

 

$

349 



 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

Nine Months Ended



 

September 30, 2017

 

September 30, 2017



 

Average

 

Interest

 

Average

 

Interest

(Dollars in thousands)

 

Recorded

 

Income

 

Recorded

 

Income



 

Investment

 

Recognized

 

Investment

 

Recognized

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

1,157 

 

$

10 

 

$

1,152 

 

$

32 

Junior liens and lines of credit

 

 

54 

 

 

 —

 

 

85 

 

 

 —

Total

 

 

1,211 

 

 

10 

 

 

1,237 

 

 

32 

 Residential real estate - construction

 

 

471 

 

 

 —

 

 

475 

 

 

 —

 Commercial real estate

 

 

11,218 

 

 

109 

 

 

12,216 

 

 

328 

 Commercial

 

 

292 

 

 

 —

 

 

263 

 

 

 —

Total

 

$

13,192 

 

$

119 

 

$

14,191 

 

$

360 

16


 

The following table presents the aging of payments of the loan portfolio:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Loans Past Due and Still Accruing

 

 

 

 

Total



 

Current

 

30-59 Days

 

60-89 Days

 

90 Days+

 

Total

 

Non-Accrual

 

Loans

September 30, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

149,366 

 

$

503 

 

$

231 

 

$

 —

 

$

734 

 

$

71 

 

$

150,171 

Junior liens and lines of credit

 

 

47,907 

 

 

40 

 

 

71 

 

 

43 

 

 

154 

 

 

23 

 

 

48,084 

Total

 

 

197,273 

 

 

543 

 

 

302 

 

 

43 

 

 

888 

 

 

94 

 

 

198,255 

Residential real estate - construction

 

 

11,359 

 

 

70 

 

 

400 

 

 

 —

 

 

470 

 

 

460 

 

 

12,289 

Commercial real estate

 

 

468,202 

 

 

2,224 

 

 

3,606 

 

 

 —

 

 

5,830 

 

 

1,806 

 

 

475,838 

Commercial

 

 

276,180 

 

 

328 

 

 

64 

 

 

 —

 

 

392 

 

 

3,263 

 

 

279,835 

Consumer

 

 

4,726 

 

 

39 

 

 

 

 

 —

 

 

40 

 

 

 —

 

 

4,766 

Total

 

$

957,740 

 

$

3,204 

 

$

4,373 

 

$

43 

 

$

7,620 

 

$

5,623 

 

$

970,983 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

157,247 

 

$

485 

 

$

534 

 

$

 —

 

$

1,019 

 

$

168 

 

$

158,434 

Junior liens and lines of credit

 

 

50,202 

 

 

139 

 

 

30 

 

 

 —

 

 

169 

 

 

 —

 

 

50,371 

Total

 

 

207,449 

 

 

624 

 

 

564 

 

 

 —

 

 

1,188 

 

 

168 

 

 

208,805 

Residential real estate - construction

 

 

9,435 

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

466 

 

 

9,901 

Commercial real estate

 

 

425,806 

 

 

421 

 

 

347 

 

 

 —

 

 

768 

 

 

1,854 

 

 

428,428 

Commercial

 

 

291,221 

 

 

111 

 

 

 —

 

 

 —

 

 

111 

 

 

187 

 

 

291,519 

Consumer

 

 

5,017 

 

 

23 

 

 

 

 

 —

 

 

30 

 

 

 —

 

 

5,047 

Total

 

$

938,928 

 

$

1,179 

 

$

918 

 

$

 —

 

$

2,097 

 

$

2,675 

 

$

943,700 



The following table reports the internal credit rating for the loan portfolio.  Consumer purpose loans are assigned a rating of either pass or substandard based on the performance status of the loans.  Substandard consumer loans are comprised of loans 90 days or more past due and still accruing, and nonaccrual loans.  Commercial purpose loans may be assigned any rating in accordance with the Bank’s internal risk rating system.



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



Pass

 

Special Mention

 

Substandard

 

Doubtful

 

 

 

(Dollars in thousands)

(1-5)

 

(6)

 

(7)

 

(8)

 

Total



 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

$

149,741 

 

$

 —

 

$

430 

 

$

 —

 

$

150,171 

Junior liens and lines of credit

 

48,018 

 

 

 —

 

 

66 

 

 

 —

 

 

48,084 

Total

 

197,759 

 

 

 —

 

 

496 

 

 

 —

 

 

198,255 

Residential real estate - construction

 

11,556 

 

 

 —

 

 

733 

 

 

 —

 

 

12,289 

Commercial real estate

 

466,800 

 

 

665 

 

 

8,373 

 

 

 —

 

 

475,838 

Commercial

 

275,249 

 

 

 —

 

 

4,586 

 

 

 —

 

 

279,835 

Consumer

 

4,766 

 

 

 —

 

 

 —

 

 

 —

 

 

4,766 

Total

$

956,130 

 

$

665 

 

$

14,188 

 

$

 —

 

$

970,983 









 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

$

157,395 

 

$

 —

 

$

1,039 

 

$

 —

 

$

158,434 

Junior liens and lines of credit

 

50,371 

 

 

 —

 

 

 —

 

 

 —

 

 

50,371 

Total

 

207,766 

 

 

 —

 

 

1,039 

 

 

 —

 

 

208,805 

Residential real estate - construction

 

8,893 

 

 

 —

 

 

1,008 

 

 

 —

 

 

9,901 

Commercial real estate

 

419,277 

 

 

680 

 

 

8,471 

 

 

 —

 

 

428,428 

Commercial

 

289,916 

 

 

 —

 

 

1,603 

 

 

 —

 

 

291,519 

Consumer

 

5,047 

 

 

 —

 

 

 —

 

 

 —

 

 

5,047 

Total

$

930,899 

 

$

680 

 

$

12,121 

 

$

 —

 

$

943,700 

17


 



The following table presents information on the Bank’s Troubled Debt Restructuring (TDR) loans:



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

Troubled Debt Restructurings



 

 

 

 

 

 

 

 

 

 

 

 

Within the Last 12 Months



 

 

 

 

 

 

 

 

 

That Have Defaulted

(Dollars in thousands)

 

Troubled Debt Restructurings

 

On Modified Terms



 

Number of

 

Recorded

 

 

 

 

 

 

 

Number of

 

Recorded



 

Contracts

 

Investment

 

Performing*

 

Nonperforming*

 

Contracts

 

Investment

September 30, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

$

460 

 

$

 —

 

$

460 

 

 —

 

$

 —

Residential real estate

 

 

 

683 

 

 

683 

 

 

 —

 

 —

 

 

 —

Commercial real estate

 

11 

 

 

10,574 

 

 

8,909 

 

 

1,665 

 

 —

 

 

 —

  Total

 

16 

 

$

11,717 

 

$

9,592 

 

$

2,125 

 

 —

 

$

 —



   

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

$

466 

 

$

466 

 

$

 —

 

 —

 

$

 —

Residential real estate

 

 

 

737 

 

 

701 

 

 

36 

 

 —

 

 

 —

Commercial real estate

 

11 

 

 

10,983 

 

 

10,388 

 

 

595 

 

 —

 

 

 —

  Total

 

17 

 

$

12,186 

 

$

11,555 

 

$

631 

 

 —

 

$

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

*The performing status is determined by the loan’s compliance with the modified terms.



There were no new TDR loans during 2018 and 2017.





Note 7. Other Real Estate Owned

Changes in other real estate owned during the nine months ended September 30, 2018 and 2017 were as follows:





 

 

 

 

 

 



 

September 30,

(Dollars in thousands)

 

2018

 

2017

Balance at beginning of the period

 

$

2,598 

 

$

4,915 

   Additions

 

 

105 

 

 

52 

   Proceeds from dispositions

 

 

(32)

 

 

(2,255)

   Loss on sales, net

 

 

 —

 

 

(23)

   Valuation adjustment

 

 

(6)

 

 

(60)

Balance at the end of the period

 

$

2,665 

 

$

2,629 

 

Note 8. Pension

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





 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

Nine Months Ended



 

September 30,

 

September 30,

(Dollars in thousands)

 

2018

 

2017

 

2018

 

2017

Components of net periodic cost:

 

 

 

 

 

 

 

 

 

 

 

 

Service cost

 

$

90 

 

$

80 

 

$

270 

 

$

237 

Interest cost

 

 

138 

 

 

167 

 

 

414 

 

 

500 

Expected return on plan assets

 

 

(279)

 

 

(268)

 

 

(837)

 

 

(804)

Recognized net actuarial loss

 

 

176 

 

 

137 

 

 

528 

 

 

411 

Net period cost

 

$

125 

 

$

116 

 

$

375 

 

$

344 



The Bank expects its pension expense to increase to approximately $500 thousand in 2018 compared to $459 thousand in 2017, due primarily to increases in interest costs and recognized net actuarial losses.  A pension contribution of $1.0 million was made in first quarter of 2018. The service cost component of pension expense is in the salaries and employee benefits line on the income statement.  All other cost components are in the other expense line on the income statement.

 

18


 



Note 9.  Fair Value Measurements and Fair Values of Financial Instruments

Management uses its best judgment in estimating the fair value of the Corporation’s financial instruments; however, there are inherent weaknesses in any estimation technique.  Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Corporation could have realized in a sales transaction on the dates indicated.  The estimated fair value amounts have been measured as of their respective period-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates.  As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates maybe different than the amounts reported at each year-end.

FASB ASC Topic 820, “Financial Instruments”, requires disclosure of the fair value of financial assets and liabilities, including those financial assets and liabilities that are not measured and reported at fair value on a recurring and nonrecurring basis. The Corporation does not report any nonfinancial assets at fair value. FASB ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value.  The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).  The three levels of the fair value hierarchy under FASB ASC Topic 820 are as follows:

Level 1: Valuation is based on unadjusted, quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2:  Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.  There may be substantial differences in the assumptions used for securities within the same level.  For example, prices for U.S. Agency securities have fewer assumptions and are closer to level 1 valuations than the private label mortgage backed securities that require more assumptions and are closer to level 3 valuations.

Level 3: Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Corporation’s assumptions regarding what market participants would assume when pricing a financial instrument. 

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

On January 1, 2018, the Corporation adopted ASU 2016-01, which requires the use of the exit price notion to measure the fair value of financial instruments.

The following information regarding the fair value of the Corporation’s financial instruments should not be interpreted as an estimate of the fair value of the entire Corporation since a fair value calculation is only provided for a limited portion of the Corporation’s assets and liabilities.  Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Corporation’s disclosures and those of other companies may not be meaningful. 

19


 

The fair value of the Corporation's financial instruments are as follows:







 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



September 30, 2018



Carrying

 

Fair

 

 

 

 

 

 

 

(Dollars in thousands)

Amount

 

Value

 

Level 1

 

Level 2

 

Level 3

Financial assets, carried at cost:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

$

44,777 

 

$

44,777 

 

$

44,777 

 

$

 —

 

$

 —

Restricted stock

 

452 

 

 

452 

 

 

 —

 

 

452 

 

 

 —

Loans held for sale

 

1,072 

 

 

1,072 

 

 

 

 

 

1,072 

 

 

 

Net loans

 

958,457 

 

 

933,824 

 

 

 —

 

 

 —

 

 

933,824 

Accrued interest receivable

 

3,733 

 

 

3,733 

 

 

 —

 

 

3,733 

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial assets, available for sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt securities

 

125,403 

 

 

125,403 

 

 

 —

 

 

125,403 

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial assets, fair value

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

383 

 

 

383 

 

 

383 

 

 

 —

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

$

1,071,857 

 

$

1,071,744 

 

$

 —

 

$

1,071,744 

 

$

 —

Accrued interest payable

 

202 

 

 

202 

 

 

 —

 

 

202 

 

 

 —

Off balance sheet financial instruments

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 



December 31, 2017



Carrying

 

Fair

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

Amount

 

Value

 

Level 1

 

Level 2

 

Level 3

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

$

58,603 

 

$

58,603 

 

$

58,603 

 

$

 —

 

$

 —

Investment securities available for sale

 

127,336 

 

 

127,336 

 

 

365 

 

 

126,971 

 

 

 —

Restricted stock

 

456 

 

 

456 

 

 

 —

 

 

45 

 

 

 —

Loans held for sale

 

442 

 

 

442 

 

 

 —

 

 

442 

 

 

 —

Net loans

 

931,908 

 

 

929,891 

 

 

 —

 

 

 —

 

 

929,891 

Accrued interest receivable

 

3,847 

 

 

3,847 

 

 

 —

 

 

3,847 

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

$

1,047,181 

 

$

1,046,476 

 

$

 —

 

$

1,046,476 

 

$

 —

Accrued interest payable

 

149 

 

 

149 

 

 

 —

 

 

149 

 

 

 —



 

 

 

 

 

 

 

 

 

 

 

 

 

 

20


 

Recurring Fair Value Measurements

For financial assets and liabilities measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2018 and December 31, 2017 are as follows:







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands

 

Fair Value at September 30, 2018

Asset  Description

 

Level 1

 

Level 2

 

Level 3

 

Total

Equity securities, at fair value

 

$

383 

 

$

 —

 

$

 —

 

$

383 



 

 

 

 

 

 

 

 

 

 

 

 

Available for sale:

 

 

 

 

 

 

 

 

 

 

 

 

 U.S. Government and Agency securities

 

 

 —

 

 

9,276 

 

 

 —

 

 

9,276 

 Municipal securities

 

 

 —

 

 

62,403 

 

 

 —

 

 

62,403 

 Trust Preferred Securities

 

 

 —

 

 

3,947 

 

 

 —

 

 

3,947 

 Agency mortgage-backed securities

 

 

 —

 

 

45,370 

 

 

 —

 

 

45,370 

  Private-label mortgage-backed securities

 

 

 —

 

 

517 

 

 

 —

 

 

517 

 Asset-backed securities

 

 

 —

 

 

3,890 

 

 

 —

 

 

3,890 

Total assets

 

$

383 

 

$

125,403 

 

$

 —

 

$

125,786 



 

 

 

 

 

 

 

 

 

 

 

 







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

 

Fair Value at December 31, 2017

Asset  Description

 

Level 1

 

Level 2

 

Level 3

 

Total

Equity securities

 

$

365 

 

$

 —

 

$

 —

 

$

365 

U.S. Government and Agency securities

 

 

 —

 

 

11,472 

 

 

 —

 

 

11,472 

Municipal securities

 

 

 —

 

 

57,772 

 

 

 —

 

 

57,772 

Trust Preferred Securities

 

 

 —

 

 

5,817 

 

 

 —

 

 

5,817 

Agency mortgage-backed securities

 

 

 —

 

 

50,937 

 

 

 —

 

 

50,937 

Private-label mortgage-backed securities

 

 

 —

 

 

946 

 

 

 —

 

 

946 

Asset-backed securities

 

 

 —

 

 

27 

 

 

 —

 

 

27 

Total assets

 

$

365 

 

$

126,971 

 

$

 —

 

$

127,336 



 

 

 

 

 

 

 

 

 

 

 

 

Investment securities:  Level 1 securities represent equity securities that are valued using quoted market prices form nationally recognized markets.  Level 2 securities represent debt securities that are valued using a mathematical model based upon the specific characteristics of a security in relationship to quoted prices for similar securities.

Nonrecurring Fair Value Measurements

For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2018 and December 31, 2017 are as follows:







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

 

 

 

 

 



 

Fair Value at September 30, 2018

Asset  Description

 

Level 1

 

Level 2

 

Level 3

 

Total

Impaired Loans (1)

 

$

 —

 

$

 —

 

$

2,925 

 

$

2,925 

Total assets

 

$

 —

 

$

 —

 

$

2,925 

 

$

2,925 







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

 

Fair Value at December 31, 2017

Asset  Description

 

Level 1

 

Level 2

 

Level 3

 

Total

Other real estate owned (1)

 

$

 —

 

$

 —

 

$

90 

 

$

90 

Total assets

 

$

 —

 

$

 —

 

$

90 

 

$

90 

(1)

Includes assets directly charged-down to fair value during the year-to-date period.



The Corporation used the following methods and significant assumptions to estimate the fair values for financial assets measured at fair value on a nonrecurring basis.

Other real estate: The fair value of other real estate, upon initial recognition, is estimated using Level 2 inputs within the fair value hierarchy based on observable market data and Level 3 inputs based on customized discounting criteria.  In connection with the measurement and initial recognition of the foregoing assets, the Corporation recognizes charge-offs through the allowance for loan losses.  Subsequent charge-offs are recognized as an expense.

21


 

The Corporation did not record any liabilities at fair value for which measurement of the fair value was made on a nonrecurring basis at September 30, 2018. For financial assets and liabilities measured at fair value on a recurring basis, there were no transfers of financial assets or liabilities between Level 1 and Level 2 during the period ending September 30, 2018.

The following table presents additional quantitative information about Level 3 assets measured at fair value on a nonrecurring basis:





 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

 

 

Quantitative Information about Level 3 Fair Value Measurements



 

 

 

 

 

 

 

 

Range

September 30, 2018

 

 

Fair Value

 

Valuation Technique

 

Unobservable Input

 

(Weighted Average)

Impaired loans (1)

 

$

2,925 

 

Appraisal

 

Appraisal Adjustments (2)

 

0%-50% (45%)



 

 

 

 

 

 

Cost to sell

 

 



 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

Fair Value

 

Valuation Technique

 

Unobservable Input

 

Weighted Average

Other real estate owned (1)

 

$

90 

 

Appraisal

 

Cost to sell

 

8%



 

 

 

 

 

 

 

 

 

(1) Includes assets directly charged-down to fair value during the year-to-date period.

 

 

(2) Qualitative adjustments are discounts specific to each asset and are made as needed.

 

 

 

Note 10. Capital Ratios

Capital adequacy is currently defined by regulatory agencies through the use of several minimum required ratios.  In July 2013, Federal banking regulators approved the final rules from the Basel Committee on Banking Supervision for the regulation of capital requirements for bank holding companies and U.S banks, generally referred to as “Basel III.” The Basel III standards were effective for the Corporation and the Bank, effective January 1, 2015 (subject to a phase-in period for certain provisions).  Basel III imposes significantly higher capital requirements and more restrictive leverage and liquidity ratios than those previously in place.  The capital ratios to be considered “well capitalized” under Basel III are: (1) Common Equity Tier 1 (CET1) of 6.5%, (2) Tier 1 Leverage of 5%, (3) Tier 1 Risk-Based Capital of 8%, and (4) Total Risk-Based Capital of 10%.  The CET1 ratio is a new capital ratio under Basel III and the Tier 1 risk-based capital ratio of 8% has been increased from 6%. The rules also include changes in the risk weights of certain assets to better reflect credit and other risk exposures. In addition, a capital conservation buffer will be phased-in beginning January 1, 2016 at 0.625%,  1.25% for 2017, 1.875% for 2018 and 2.50% for 2019 and thereafter.  The capital conservation buffer will be applicable to all of the capital ratios except for the Tier1 Leverage ratio. The capital conservation buffer is equal to the lowest value of the three applicable capital ratios less the regulatory minimum for each respective capital measurement.  The Bank’s capital conservation buffer at September 30, 2018 was 6.89% (total risk-based capital 14.89% less 8.00%) compared to the 2018 regulatory buffer of 1.875%.  Compliance with the capital conservation buffer is required in order to avoid limitations to certain capital distributions.  As of September 30, 2018, the Bank was “well capitalized’ under the Basel III requirements and believes it would be “well capitalized” on a fully phased-in basis had such a requirement been in effect.

22


 

The following table summarizes regulatory capital information as of September 30, 2018 and December 31, 2017 for the Corporation and the Bank:    





 

 

 

 

 

 

 

 



 

 

 

 

 

Regulatory Ratios



 

 

 

 

 

Adequately

 

Well



 

September 30,

 

December 31,

 

Capitalized

 

Capitalized

(Dollars in thousands)

 

2018

 

2017

 

Minimum

 

Minimum



 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

13.64% 

 

14.06% 

 

4.500% 

 

N/A

Farmers & Merchants Trust Company

 

13.42% 

 

13.93% 

 

4.500% 

 

6.50% 



 

 

 

 

 

 

 

 

Tier 1 Risk-based Capital Ratio (2)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

13.64% 

 

14.06% 

 

6.000% 

 

N/A

Farmers & Merchants Trust Company

 

13.42% 

 

13.93% 

 

6.000% 

 

8.00% 



 

 

 

 

 

 

 

 

Total Risk-based Capital Ratio (3)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

14.89% 

 

15.31% 

 

8.000% 

 

N/A

Farmers & Merchants Trust Company

 

14.68% 

 

15.19% 

 

8.000% 

 

10.00% 



 

 

 

 

 

 

 

 

Tier 1 Leverage Ratio (4)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

9.59% 

 

9.73% 

 

4.000% 

 

N/A

Farmers & Merchants Trust Company

 

9.48% 

 

9.64% 

 

4.000% 

 

5.00% 



 

 

 

 

 

 

 

 

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

(3) Total risk-based capital / total risk-weighted assets, (4) Tier 1 capital / average quarterly assets

 

Note 11. Revenue Recognition

The Corporation adopted ASC 606 on January 1, 2018 using the modified retrospective approach applied to all contracts initiated on or after the effective date, and for contracts which have remaining obligations as of the effective date. Results for the reporting period beginning January 1, 2018 are presented under ASC 606 while the prior period results continue to be reported under legacy GAAP. Adoption of the standard did not have a material effect on any of the reported periods. The Corporation did not record a cumulative effect adjustment to the beginning retained earnings balance as of January 1, 2018 from the adoption of ASC 606 as it was determined the transition adjustment was immaterial to Corporation’s consolidated financial statements.

All of the Corporation’s revenue from contracts with customers within the scope of ASC 606 is recognized in non-interest income as presented in our consolidated statements of income. Revenue generating activities that fall within the scope of ASC 606 are described as follows:

Investment and Trust Service Fees - these represent fees from wealth management (assets under management), fees from the management and settlement of estates and commissions from the sale of investment and insurance products.

·

Asset management fees are generally assessed based on a tiered fee schedule, based on the value of assets under management, and are recognized monthly when the service obligation is completed. Fees recognized were $3.8 million for the first nine months of 2018 and $1.3 million for the third quarter of 2018.

·

Fees for estate management services are based on the estimated fair value of the estate. These fees are generally recognized monthly over an 18 month period that Management has determined to represent the average time to fulfill the performance obligations of the contract. Management has the discretion to adjust this time period as needed based upon the nature and complexity of an individual estate. Fees recognized were $228 thousand for the first nine months of 2018 and $86 thousand for the third quarter of 2018.

·

Commissions from the sale of investment and insurance products are recognized upon the completion of the transaction.  Fees recognized were $218 thousand for the first nine months of 2018 and $75 thousand for the third quarter of 2018.

Loan Service Charges – these represent fees on loans for services or charges that occur after the loan has been booked, for example, late payment fees. These also include fees for mortgages settled for a third party mortgage company. All of these fees are transactional in nature and are recognized upon completion of the transaction which represents the performance obligation.

23


 

Deposit Service Charges and Fees – these represent fees from deposit customers for transaction based, account maintenance, and overdraft services. Transaction based fees include, but are not limited to stop payment fees and overdraft fees. These fees are recognized at the time of the transaction when the performance obligation has been fulfilled. Account maintenance fees and account analysis fee are earned over the course of a month, representing the period of the performance obligation, and are recognized monthly.

Debit Card Income – this represents interchange fees from cardholder transactions conducted through the card payment network. Cardholders use the debit card to conduct point-of-sale transactions that produce interchange fees. The fees are transaction based and the fee is recognized with the processing of the transaction.  These fees are reported net of cardholder rewards.

Other Service Charges and Fees – these are comprised primarily of merchant card fees, credit card fees, ATM surcharges and interchange fees and wire transfer fees. Merchant card fees represent fees the Bank earns from a third party for enrolling a customer in the processor’s program. Credit card fees represent a fee earned by the Bank for a successful referral to a card-issuing company. ATM surcharges and interchange fees are the result of Bank customers conducting ATM transactions that generate fee income and are processed through multiple card networks. All of these fees are transaction based and are recognized at the time of the transaction.

Gains/Losses on the Sale of Other Real Estate – these are recognized when control of the property transfers to the buyer.

Increases in the cash surrender value of life insurance and security transactions are not within the scope of ASC 606.

Contract Balances

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

Contract Acquisition Costs

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



1Note 12. Commitments and Contingencies

In the normal course of business, the Bank is a party to financial instruments that are not reflected in the accompanying financial statements and are commonly referred to as off-balance-sheet instruments.  These financial instruments are entered into primarily to meet the financing needs of the Bank’s customers and include commitments to extend credit and standby letters of credit.  Those instruments involve, to varying degrees, elements of credit and interest rate risk not recognized in the consolidated balance sheet.

The Corporation’s exposure to credit loss in the event of nonperformance by other parties to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contract or notional amount of those instruments.  The Bank uses the same credit policies in making commitments and conditional obligations as they do for on-balance-sheet instruments.

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





 

 

 

 

 

 



 

September 30,

 

December 31,

(Dollars in thousands)

 

2018

 

2017

Financial instruments whose contract amounts represent credit risk

 

 

 

 

 

 

Commercial commitments to extend credit

 

$

226,069 

 

$

249,526 

Consumer commitments to extend credit (secured)

 

 

46,166 

 

 

44,866 

Consumer commitments to extend credit (unsecured)

 

 

5,663 

 

 

5,668 



 

$

277,898 

 

$

300,060 

Standby letters of credit

 

$

25,692 

 

$

28,630 



Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses with the exception of home equity lines and personal lines of credit and may require payment of a fee.  Since many of the

24


 

commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The Bank evaluates each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by the Bank, is based on Management’s credit evaluation of the counterparty.  Collateral for most commercial commitments varies but may include accounts receivable, inventory, property, plant, and equipment, and income-producing commercial properties.  Collateral for secured consumer commitments consists of liens on residential real estate.

Standby letters of credit are instruments issued by the Bank, which guarantee the beneficiary payment by the Bank in the event of default by the Bank’s customer in the nonperformance of an obligation or service.  Most standby letters of credit are extended for one-year periods.  Generally, the credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.  The Bank holds collateral supporting those commitments for which collateral is deemed necessary primarily in the form of certificates of deposit and liens on real estate. Management believes that the proceeds obtained through a liquidation of such collateral would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees.  As of June 30, 2018, the Bank established a $2.4 million allowance against letters of credit issued in connection with a commercial borrower that declared bankruptcy in the second quarter as a result of apparent fraudulent activities within the business.  Except for the liability recorded for standby letters of credit, liabilities for credit loss associated with off-balance sheet commitments were not material at September 30, 2018 and December 31, 2017.

Most of the Bank’s business activity is with customers located within its primary market and does not involve any significant concentrations of credit to any one entity or industry.

Legal Proceedings

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

We establish accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probably and the amount of the loss can be reasonably estimated.  When we are able to do so, we also determine estimates of possible losses, whether in excess of any accrued liability or where there is no accrued liability.

These assessments are based on our analysis of currently available information and are subject to significant judgment and a variety of assumptions and uncertainties.  As new information is obtained, we may change our assessments and, as a result, take or adjust the amounts of our accruals and change our estimates of possible losses or ranges of possible losses.  Due to the inherent subjectivity of the assessments and the unpredictability of outcomes of legal proceedings, any amounts that may be accrued or included in estimates of possible losses or ranges of possible losses may not represent the actual loss to the Corporation from any legal proceeding.  Our exposure and ultimate losses may be higher, possibly significantly higher, than amounts we may accrue or amounts we may estimate.

In management’s opinion, we do not anticipate, at the present time, that the ultimate aggregate liability, if any, arising out of all litigation to which the Corporation is a party will have a material adverse effect on our financial position.  We cannot now determine, however, whether or not any claim asserted against us, other than the Kalan case described below, will have a material adverse effect on our results of operations in any future reporting period, which will depend on, amount other things, the amount of loss resulting from the claim and the amount of income otherwise reported for the reporting period.  Thus, at June 30, 2018, we are unable to provide an evaluation of the likelihood of an unfavorable outcome or an estimate of the amount or range of potential loss with respect to such other matters and, accordingly, have not yet established any specific accrual for such other matters, except in connection with the Kalan case described below.

No material proceedings are pending or are known to be threatened or contemplated against us by governmental authorities.

On July 31, 2018, the court entered an order granting final approval of the settlement agreements in the Kalan et al. v. Farmers and Merchants Trust Company of Chambersburg et al. (Case No. 2:15-CV-01435-WB) case filed against F&M Trust in the United States District Court for the Eastern District of Pennsylvania in March, 2015. Among other things, the order also dismissed the case against F&M Trust with prejudice; certified the settlement class; and, permanently enjoined the named plaintiffs and the members of the settlement class from asserting any further claims arising out of or related to the claims alleged or that could have been alleged in the case against F&M Trust. The settlement agreements provide for the Bank to make a settlement payment of $10 million in full and final settlement of all such claims.  The settlement agreements further provide for general releases by all parties.  F&M Trust made the settlement payment in May, 2018, in accordance with the court’s earlier order preliminarily approving the settlement agreements.  The settlement payment was funded out of available assets.  The Corporation previously accrued the $10 million settlement payment in the Kalan case as an expense for the year ended December 31, 2017.

25


 

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

For the Three and Nine Months Ended September  30, 2018 and 2017



Forward Looking Statements



Certain statements appearing herein which are not historical in nature are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  Such forward-looking statements refer to a future period or periods, reflecting management’s current views as to likely future developments, and use words such as “may,” “will,” “expect,” “believe,” “estimate,” “anticipate,” or similar terms.  Because forward-looking statements involve certain risks, uncertainties and other factors over which the Corporation has no direct control, actual results could differ materially from those contemplated in such statements.  These factors include (but are not limited to) the following: general economic conditions, changes in interest rates, changes in the Corporation’s cost of funds, changes in government monetary policy, changes in government regulation and taxation of financial institutions, changes in the rate of inflation, changes in technology, the intensification of competition within the Corporation’s market area, and other similar factors.  We caution readers not to place undue reliance on these forward-looking statements.  They only reflect management’s analysis as of this date.  The Corporation does not revise or update these forward-looking statements to reflect events or changed circumstances.



Critical Accounting Policies



Management has identified critical accounting policies for the Corporation.  These policies are particularly sensitive, requiring significant judgements, estimates and assumptions to be made by Management. There were no changes to the critical accounting policies disclosed in the 2017 Annual Report on Form 10-K in regards to application or related judgments and estimates used.  Please refer to Item 7 of the Corporation’s 2017 Annual Report on Form 10-K for a more detailed disclosure of the critical accounting policies.



Results of Operations



Results for the nine months ended September 30, 2018 were affected by impairment charges on a loan participation (the Participation) that was initially reported in our current report on Form 8-K filed May 31, 2018.  The Participation represented the Bank’s portion of loans and off-balance sheet items to a single, large commercial lending relationship with the lead bank.  The impairment is believed to be the result of fraudulent activities believed to be perpetrated by one or more of the executives and personnel employed by the borrower.

During the second quarter, $8.7 million of the Participation was charged-off resulting in an increase in the provision for loan loss expense to replenish the allowance for loan losses.  In addition, a $2.4 million noninterest expense was recorded to establish a reserve for existing off-balance sheet commitments related to the Participation.  The impairment charges had a significant effect on various performance measurements for the year-to-date period.  For additional information on the Participation, please refer to the Loan Quality discussion.

Year-to-Date Summary

Reported net income of $4.0 million for the third quarter and $2.3 million year-to-date

·

Net interest income increased $921 thousand quarter over quarter and $2.4 million year-to-date due to the growth in interest income from the loan portfolio that outpaced higher interest expense.  

·

The provision for loan losses was unchanged quarter over quarter and increased $9.2 million year-to-date due to the previously mentioned charge-off.

·

Noninterest income increased $149 thousand quarter over quarter and $437 thousand year-to-date primarily from asset management fees in the Bank’s Investment and Trust Services department and debit card income

·

Noninterest expense increased $266 thousand quarter over quarter and $4.0 million year-to-date primarily from increases in salaries and benefits and the off-balance sheet reserve expense for the Participation.

Total assets were $1.195 billion at September 30, 2018, an increase of $15.0 million from the 2017 year-end balance of $1.180 billion

·

The loan portfolio increased approximately $27 million net of the Participation charge-off. 

·

Deposits increased $24.7 million (2.4%) year-to-date, primarily in municipal non-maturity deposits.

·

Shareholders’ equity decreased $1.1 million, mainly the result of the Corporation’s year-to-date cash dividend of $3.4 million exceeding year-to-date income of $2.3 million.

26


 

Key performance ratios as of, or for the nine months ended September 30, 2018 and 2017 and the year ended December 31, 2017 are listed below:







 

 

 

 

 

 

 

 

 



 

September 30,

 

December 31,

 

September 30,



 

2018

 

2017

 

2017

(Dollars in thousands, except per share)

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

Balance Sheet Highlights

 

 

 

 

 

 

 

 

 

Total assets

 

$

1,194,624 

 

$

1,179,813 

 

$

1,165,549 

Investment and equity securities

 

 

125,786 

 

 

127,336 

 

 

132,322 

Loans, net

 

 

958,457 

 

 

931,908 

 

 

899,960 

Deposits

 

 

1,071,857 

 

 

1,047,181 

 

 

1,033,148 

Shareholders' equity

 

 

114,028 

 

 

115,144 

 

 

124,580 



 

 

 

 

 

 

 

 

 

Summary of Operations

 

 

 

 

 

 

 

 

 

Interest income

 

$

33,019 

 

$

39,885 

 

$

29,547 

Interest expense

 

 

2,871 

 

 

2,491 

 

 

1,800 

Net interest income

 

 

30,148 

 

 

37,394 

 

 

27,747 

Provision for loan losses

 

 

9,579 

 

 

670 

 

 

420 

Net interest income after provision for loan losses

 

 

20,569 

 

 

36,724 

 

 

27,327 

Noninterest income

 

 

9,489 

 

 

12,189 

 

 

9,052 

Noninterest expense

 

 

28,408 

 

 

43,172 

 

 

24,423 

Income before income taxes

 

 

1,650 

 

 

5,741 

 

 

11,956 

Federal income tax (benefit) expense

 

 

(671)

 

 

3,565 

 

 

2,517 

Net income

 

$

2,321 

 

$

2,176 

 

$

9,439 



 

 

 

 

 

 

 

 

 

Performance Measurements

 

 

 

 

 

 

 

 

 

Return on average assets*

 

 

0.26% 

 

 

0.19% 

 

 

1.11% 

Return on average equity*

 

 

2.70% 

 

 

1.80% 

 

 

10.50% 

Return on average tangible equity (1)*

 

 

2.93% 

 

 

1.94% 

 

 

11.35% 

Efficiency ratio (1)

 

 

69.79% 

 

 

82.59% 

 

 

63.00% 

Net interest margin*

 

 

3.77% 

 

 

3.72% 

 

 

3.71% 



 

 

 

 

 

 

 

 

 

Shareholders' Value (per common share)

 

 

 

 

 

 

 

 

 

Diluted earnings per share

 

$

0.53 

 

$

0.50 

 

$

2.17 

Basic earnings per share

 

 

0.53 

 

 

0.50 

 

 

2.18 

Regular cash dividends declared

 

 

0.78 

 

 

0.93 

 

 

$0.69 

Book value

 

 

25.93 

 

 

26.44 

 

 

28.66 

Tangible book value (1)

 

 

23.88 

 

 

24.37 

 

 

26.59 

Market value

 

 

34.77 

 

 

37.36 

 

 

35.05 

Market value/book value ratio

 

 

134.09% 

 

 

141.30% 

 

 

122.30% 

Price/earnings multiple*

 

 

48.97 

 

 

74.72 

 

 

12.13 

Current quarter dividend yield

 

 

3.11% 

 

 

2.49% 

 

 

2.74% 

Dividend payout ratio year-to-date

 

 

146.92% 

 

 

185.25% 

 

 

31.66% 



 

 

 

 

 

 

 

 

 

Safety and Soundness

 

 

 

 

 

 

 

 

 

Risk-based capital ratio (Total)

 

 

14.85% 

 

 

15.31% 

 

 

16.25% 

Leverage ratio (Tier 1)

 

 

9.57% 

 

 

9.73% 

 

 

10.31% 

Common equity ratio (Tier 1)

 

 

13.60% 

 

 

14.06% 

 

 

14.99% 

Nonperforming loans/gross loans

 

 

0.58% 

 

 

0.28% 

 

 

0.34% 

Nonperforming assets/total assets

 

 

0.70% 

 

 

0.45% 

 

 

0.49% 

Allowance for loan losses as a % of loans

 

 

1.29% 

 

 

1.25% 

 

 

1.27% 

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

 

 

1.23% 

 

 

-0.01%

 

 

-0.01%



 

 

 

 

 

 

 

 

 

Assets under Management

 

 

 

 

 

 

 

 

 

Trust assets under management (fair value)

 

$

737,102 

 

$

686,941 

 

$

662,733 

Held at third-party brokers (fair value)

 

 

134,267 

 

 

158,145 

 

 

153,200 

*Year-to-date annualized

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

27


 

GAAP versus non-GAAP PresentationsThe Corporation supplements its traditional GAAP measurements with certain non-GAAP measurements to evaluate its performance and to eliminate the effect of intangible assets.  By eliminating intangible assets (Goodwill), the Corporation believes it presents a measurement that is comparable to companies that have no intangible assets or to companies that have eliminated intangible assets in similar calculations. However, not all companies may use the same calculation method for each measurement. The non-GAAP measurements are not intended to be used as a substitute for the related GAAP measurements. The following table shows the calculation of the non-GAAP measurements.





 

 

 

 

 

 

 

 

 

(Dollars in thousands, except per share)

 

Nine Months Ended

 

Twelve Months Ended

 

Nine Months Ended



 

September 30, 2018

 

December 31, 2017

 

September 30, 2017

Return on Tangible Equity (non-GAAP)

 

 

 

 

 

 

 

 

 

Net income

 

$

2,321 

 

$

2,176 

 

$

9,439 



 

 

 

 

 

 

 

 

 

Average shareholders' equity

 

 

114,704 

 

 

120,993 

 

 

119,886 

Less average intangible assets

 

 

(9,016)

 

 

(9,016)

 

 

(9,016)

Average shareholders' equity (non-GAAP)

 

 

105,688 

 

 

111,977 

 

 

110,870 



 

 

 

 

 

 

 

 

 

 Return on average tangible equity (non-GAAP)*

 

 

2.93% 

 

 

1.94% 

 

 

11.35% 



 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Shareholders' equity

 

$

114,028 

 

$

115,144 

 

$

124,580 

Less intangible assets

 

 

(9,016)

 

 

(9,016)

 

 

(9,016)

Shareholders' equity (non-GAAP)

 

 

105,012 

 

 

106,128 

 

 

115,564 



 

 

 

 

 

 

 

 

 

Shares outstanding (in thousands)

 

 

4,398 

 

 

4,355 

 

 

4,346 



 

 

 

 

 

 

 

 

 

 Tangible book value (non-GAAP)

 

 

23.88 

 

 

24.37 

 

 

26.59 



 

 

 

 

 

 

 

 

 

Efficiency Ratio

 

 

 

 

 

 

 

 

 

Noninterest expense

 

$

28,408 

 

$

43,172 

 

$

24,423 



 

 

 

 

 

 

 

 

 

Net interest income  

 

 

30,148 

 

 

37,394 

 

 

27,747 

Plus tax equivalent adjustment to net interest income

 

 

1,141 

 

 

2,690 

 

 

1,970 

Plus noninterest income, net of securities transactions

 

 

9,415 

 

 

12,186 

 

 

9,049 

Total revenue

 

 

40,704 

 

 

52,270 

 

 

38,766 



 

 

 

 

 

 

 

 

 

 Efficiency ratio

 

 

69.79% 

 

 

82.59% 

 

 

63.00% 



 

 

 

 

 

 

 

 

 

* Year-to-date annualized

 

 

 

 

 

 

 

 

 



Net Interest Income

The largest source of the Corporation’s earnings is net interest income, which is defined as the difference between income on interest-earning assets and the expense of interest-bearing liabilities supporting those assets.  Principal categories of interest-earning assets are loans and securities, while deposits, short-term borrowings and long-term debt are the principal categories of interest-bearing liabilities.  Demand deposits enhance net interest income because they are noninterest-bearing deposits. For the purpose of this discussion, balance sheet items refer to the average balance for the year and net interest income is adjusted to a fully taxable-equivalent basis.  This tax-equivalent adjustment facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Corporation’s 21% Federal statutory rate. 



28


 

Comparison of the three months ended September 30, 2018 to the three months ended September 30, 2017:

Tax equivalent net interest income increased $623 thousand to $10.7 million in the third quarter of 2018 compared to $10.1 million in the same period in 2017.  Balance sheet volume contributed $525 thousand to this increase and $98 thousand was the result of changes in rates.  Due to the lower corporate tax rate, the benefit of tax-exempt income was less in 2018 as compared to 2017.

The following table presents average balances, tax-equivalent (T/E) interest income, and yields earned or rates paid on the assets or liabilities.  All nontaxable interest income has been adjusted to a tax-equivalent basis using a tax rate of 21% for 2018 and 34% for 2017. 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



For the Three Months Ended September 30,



2018

 

2017



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



Average

 

Income or

 

Average

 

Average

 

Income or

 

Average

(Dollars in thousands)

balance

 

expense

 

yield/rate

 

balance

 

expense

 

yield/rate



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing obligations of other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

banks and federal funds sold

$

21,216 

 

$

108 

 

2.02% 

 

$

43,692 

 

$

147 

 

1.33% 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

81,881 

 

 

511 

 

2.48% 

 

 

92,074 

 

 

511 

 

2.20% 

Tax Exempt

 

46,447 

 

 

368 

 

3.17% 

 

 

43,032 

 

 

412 

 

3.83% 

               Investments

 

128,328 

 

 

879 

 

2.72% 

 

 

135,106 

 

 

923 

 

2.71% 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, industrial and agricultural

 

829,586 

 

 

9,254 

 

4.40% 

 

 

757,619 

 

 

8,029 

 

4.15% 

Residential mortgage

 

69,422 

 

 

723 

 

4.17% 

 

 

74,095 

 

 

742 

 

4.01% 

Home equity loans and lines

 

67,241 

 

 

825 

 

4.87% 

 

 

72,162 

 

 

843 

 

4.63% 

Consumer

 

4,994 

 

 

75 

 

5.96% 

 

 

4,644 

 

 

64 

 

5.47% 

Loans

 

971,243 

 

 

10,877 

 

4.42% 

 

 

908,520 

 

 

9,678 

 

4.18% 

Total interest-earning assets

 

1,120,787 

 

$

11,864 

 

4.20% 

 

 

1,087,318 

 

$

10,748 

 

3.92% 

Other assets

 

63,914 

 

 

 

 

 

 

 

64,536 

 

 

 

 

 

Total assets

$

1,184,701 

 

 

 

 

 

 

$

1,151,854 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking

$

304,480 

 

$

236 

 

0.31% 

 

$

280,727 

 

$

91 

 

0.13% 

Money Management

 

408,131 

 

 

637 

 

0.62% 

 

 

412,209 

 

 

391 

 

0.38% 

Savings

 

81,968 

 

 

86 

 

0.42% 

 

 

78,683 

 

 

36 

 

0.18% 

Time

 

68,385 

 

 

142 

 

0.82% 

 

 

72,154 

 

 

111 

 

0.61% 

Total interest-bearing deposits

 

862,964 

 

 

1,101 

 

0.51% 

 

 

843,773 

 

 

629 

 

0.30% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other borrowings

 

3,830 

 

 

21 

 

2.27% 

 

 

 —

 

 

 —

 

0.00% 

Total interest-bearing liabilities

 

866,794 

 

 

1,122 

 

0.51% 

 

 

843,773 

 

 

629 

 

0.30% 

Noninterest-bearing deposits

 

200,865 

 

 

 

 

 

 

 

180,034 

 

 

 

 

 

Other liabilities

 

5,269 

 

 

 

 

 

 

 

5,185 

 

 

 

 

 

Shareholders' equity

 

111,773 

 

 

 

 

 

 

 

122,862 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,184,701 

 

 

 

 

 

 

$

1,151,854 

 

 

 

 

 

T/E net interest income/Net interest margin

 

 

 

 

10,742 

 

3.80% 

 

 

 

 

 

10,119 

 

3.69% 

Tax equivalent adjustment

 

 

 

 

(387)

 

 

 

 

 

 

 

(685)

 

 

Net interest income

 

 

 

$

10,355 

 

 

 

 

 

 

$

9,434 

 

 



29


 

Provision for Loan Losses

Provision for loan loss expense for the third quarter was $250 thousand,  the same as in 2017For more information refer to the Loan Quality and Allowance for Loan Losses discussion in the Financial Condition section.



Noninterest Income

For the third quarter of 2018, noninterest income increased $149 thousand from the same period in 2017.  Investment and trust service fees increased due to growth in assets under management and a higher number of estates under management compared to the same period in 2017.  Debit card income was higher due to an increase in transaction volume.  The change in the fair value of equity investments recorded through income was a loss of $20 thousand.  In 2017 the change in fair value of equity investments was recorded through other comprehensive income.

The following table presents a comparison of noninterest income for the three months ended September 30, 2018 and 2017





 

 

 

 

 

 

 

 

 

 

 



 

For the Three Months Ended

 

 

 

 

 



 

September 30,

 

Change

(Dollars in thousands)

 

2018

 

2017

 

Amount

 

%

Noninterest Income

 

 

 

 

 

 

 

 

 

 

 

Investment and trust services fees

 

$

1,424 

 

$

1,353 

 

$

71 

 

5.2 

Loan service charges

 

 

191 

 

 

201 

 

 

(10)

 

(5.0)

Deposit service charges and fees

 

 

578 

 

 

611 

 

 

(33)

 

(5.4)

Other service charges and fees

 

 

357 

 

 

340 

 

 

17 

 

5.0 

Debit card income

 

 

422 

 

 

325 

 

 

97 

 

29.8 

Increase in cash surrender value of life insurance

 

 

129 

 

 

130 

 

 

(1)

 

(0.8)

Net loss on sale of other real estate owned

 

 

 —

 

 

(23)

 

 

23 

 

(100.0)

Debt securities gains, net

 

 

 

 

 

 

 

400.0 

Change in fair value of equity securities

 

 

(20)

 

 

 —

 

 

(20)

 

N/A

Other

 

 

34 

 

 

33 

 

 

 

3.0 

Total noninterest income

 

$

3,120 

 

$

2,971 

 

$

149 

 

5.0 



Noninterest Expense

Noninterest expense for the third  quarter of 2018 increased $266 thousand compared to the same period in 2017.  The increase in salaries and benefits was primarily due to an increase in salary expense ($338 thousand) from merit increases and increased staffing levels,  partially offset by a decrease in health insurance expense ($145 thousand) compared to the same period in 2017.  Legal and professional decreased due to the resolution of the Kalan lawsuit more thoroughly described in Part II, Item 1. Legal ProceedingsFDIC insurance increased due to an increase in the Bank’s base assessment rateATM/debit card processing expense increased due to purchasing EMV card inventory and increased fees from Mastercard.

The following table presents a comparison of noninterest expense for the three months ended September 30, 2018 and 2017



 

 

 

 

 

 

 

 

 

 

 



 

For the Three Months Ended

 

 

 

 

 

(Dollars in thousands)

 

September 30,

 

Change

Noninterest Expense

 

2018

 

2017

 

Amount

 

%

Salaries and benefits

 

$

4,947 

 

$

4,694 

 

$

253 

 

5.4 

Occupancy, furniture and equipment, net

 

 

780 

 

 

809 

 

 

(29)

 

(3.6)

Advertising

 

 

345 

 

 

332 

 

 

13 

 

3.9 

Legal and professional

 

 

436 

 

 

502 

 

 

(66)

 

(13.1)

Data processing

 

 

591 

 

 

567 

 

 

24 

 

4.2 

Pennsylvania bank shares tax

 

 

239 

 

 

243 

 

 

(4)

 

(1.6)

FDIC insurance

 

 

159 

 

 

82 

 

 

77 

 

93.9 

ATM/debit card processing

 

 

258 

 

 

190 

 

 

68 

 

35.8 

Foreclosed real estate

 

 

(8)

 

 

24 

 

 

(32)

 

(133.3)

Telecommunications

 

 

95 

 

 

106 

 

 

(11)

 

(10.4)

Other

 

 

729 

 

 

756 

 

 

(27)

 

(3.6)

Total noninterest expense

 

$

8,571 

 

$

8,305 

 

$

266 

 

3.2 



30


 

Provision for Income Taxes

For the third quarter, the Corporation recorded a Federal income tax expense of $654 thousand compared to a  $774 thousand tax expense for the same quarter in 2017.   The effective tax rate for the third quarter of 2018 was 14.1% compared to 20.1% for the same period in 2017. The federal statutory tax rate is 21% for 2018 and was 34% in 2017.



Comparison of the nine months ended September 30, 2018 to the nine months ended September 30, 2017:

Tax equivalent net interest income increased $1.6 million to $31.3 million in the first nine months of 2018 compared to $29.7 million in the same period in 2017.  Balance sheet volume contributed $1.5 million to this increase and  $44 thousand was the result of changes in rates.  Due to the lower corporate tax rate, the benefit of tax-exempt income was less in 2018 as compared to 2017.

The following table presents average balances, tax-equivalent (T/E) interest income, and yields earned or rates paid on the assets or liabilities.  All nontaxable interest income has been adjusted to a tax-equivalent basis using a tax rate of 21% for 2018 and 34% for 2017. 









 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



For the Nine Months Ended September 30,



2018

 

2017



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



Average

 

Income or

 

Average

 

Average

 

Income or

 

Average

(Dollars in thousands)

balance

 

expense

 

yield/rate

 

balance

 

expense

 

yield/rate



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing obligations of other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

banks and federal funds sold

$

24,108 

 

$

326 

 

1.81% 

 

$

31,431 

 

$

297 

 

1.26% 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

84,518 

 

 

1,563 

 

2.47% 

 

 

92,660 

 

 

1,581 

 

2.28% 

Tax Exempt

 

46,054 

 

 

1,084 

 

3.14% 

 

 

44,617 

 

 

1,291 

 

3.86% 

               Investments

 

130,572 

 

 

2,647 

 

2.71% 

 

 

137,277 

 

 

2,872 

 

2.80% 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, industrial and agricultural

 

810,622 

 

 

26,332 

 

4.30% 

 

 

749,693 

 

 

23,462 

 

4.13% 

Residential mortgage

 

70,576 

 

 

2,176 

 

4.11% 

 

 

75,243 

 

 

2,241 

 

3.97% 

Home equity loans and lines

 

69,194 

 

 

2,453 

 

4.74% 

 

 

71,945 

 

 

2,457 

 

4.57% 

Consumer

 

5,044 

 

 

226 

 

5.99% 

 

 

4,672 

 

 

188 

 

5.38% 

Loans

 

955,436 

 

 

31,187 

 

4.33% 

 

 

901,553 

 

 

28,348 

 

4.16% 

Total interest-earning assets

 

1,110,116 

 

$

34,160 

 

4.11% 

 

 

1,070,261 

 

$

31,517 

 

3.94% 

Other assets

 

63,550 

 

 

 

 

 

 

 

63,530 

 

 

 

 

 

Total assets

$

1,173,666 

 

 

 

 

 

 

$

1,133,791 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking

$

295,046 

 

$

633 

 

0.29% 

 

$

271,454 

 

$

257 

 

0.13% 

Money Management

 

409,920 

 

 

1,609 

 

0.52% 

 

 

414,988 

 

 

1,119 

 

0.36% 

Savings

 

81,804 

 

 

218 

 

0.36% 

 

 

78,269 

 

 

87 

 

0.15% 

Time

 

69,303 

 

 

387 

 

0.75% 

 

 

73,106 

 

 

322 

 

0.59% 

Total interest-bearing deposits

 

856,073 

 

 

2,847 

 

0.44% 

 

 

837,817 

 

 

1,785 

 

0.28% 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other borrowings

 

1,429 

 

 

24 

 

2.25% 

 

 

2,466 

 

 

15 

 

0.82% 

Total interest-bearing liabilities

 

857,502 

 

 

2,871 

 

0.45% 

 

 

840,283 

 

 

1,800 

 

0.29% 

Noninterest-bearing deposits

 

190,210 

 

 

 

 

 

 

 

168,453 

 

 

 

 

 

Other liabilities

 

11,250 

 

 

 

 

 

 

 

5,169 

 

 

 

 

 

Shareholders' equity

 

114,704 

 

 

 

 

 

 

 

119,886 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,173,666 

 

 

 

 

 

 

$

1,133,791 

 

 

 

 

 

T/E net interest income/Net interest margin

 

 

 

 

31,289 

 

3.77% 

 

 

 

 

 

29,717 

 

3.71% 

Tax equivalent adjustment

 

 

 

 

(1,141)

 

 

 

 

 

 

 

(1,970)

 

 

Net interest income

 

 

 

$

30,148 

 

 

 

 

 

 

$

27,747 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



31


 

Provision for Loan Losses

Provision for loan loss expense for the first nine months of 2018 was $9.6 million, compared to $420 thousand in 2017.  The increase in the provision expense was due to a large loan charge-off related to the Participation. For more information refer to the Loan Quality and Allowance for Loan Losses discussion in the Financial Condition section.



Noninterest Income

For the first nine months of 2018, noninterest income increased $437 thousand from the same period in 2017.  Investment and trust service fees increased due to growth in assets under management and a higher number of estates under management.  Debit card income increased due to higher transaction volume.  Gains on the sale of debit securities were $56 thousand compared to $3 thousand in the same period in 2017.  The change in the fair value of equity investments recorded through income was $18 thousand.  In 2017, the change in fair value of equity investments was recorded through other comprehensive income. Other income in 2017 included $50 thousand of nonrecurring income.

The following table presents a comparison of noninterest income for the nine months ended September 30, 2018 and 2017:







 

 

 

 

 

 

 

 

 

 

 



 

For the Nine Months Ended

 

 

 

 

 



 

September 30,

 

Change

(Dollars in thousands)

 

2018

 

2017

 

Amount

 

%

Noninterest Income

 

 

 

 

 

 

 

 

 

 

 

Investment and trust services fees

 

$

4,285 

 

$

3,991 

 

$

294 

 

7.4 

Loan service charges

 

 

640 

 

 

657 

 

 

(17)

 

(2.6)

Deposit service charges and fees

 

 

1,726 

 

 

1,789 

 

 

(63)

 

(3.5)

Other service charges and fees

 

 

1,043 

 

 

996 

 

 

47 

 

4.7 

Debit card income

 

 

1,224 

 

 

1,062 

 

 

162 

 

15.3 

Increase in cash surrender value of life insurance

 

 

386 

 

 

391 

 

 

(5)

 

(1.3)

Net loss on sale of other real estate owned

 

 

 —

 

 

(23)

 

 

23 

 

(100.0)

Debt securities gains, net

 

 

56 

 

 

 

 

53 

 

1,766.7 

Change in fair value of equity securities

 

 

18 

 

 

 —

 

 

18 

 

N/A

Other

 

 

111 

 

 

186 

 

 

(75)

 

(40.3)

Total noninterest income

 

$

9,489 

 

$

9,052 

 

$

437 

 

4.8 



Noninterest Expense

Noninterest expense for the first nine months of 2018 increased $4.0 million compared to the same period in 2017.  The largest component of noninterest expense is salaries and benefits. Increases in salaries and benefits were primarily due to an increase in salary expense ($904 thousand) from merit increases and increased staffing levels.  These increases were partially offset by a decrease in health insurance expense ($155 thousand).  Advertising increased due to digital marketing initiatives and projects.  Data processing fees increased due to the implementation of new software. FDIC insurance increased due to an increase in the Bank’s base assessment rate. The off-balance sheet reserve of $2.4 million is discussed in the Loan Quality section of Management’s Discussion and Analysis. Other expense increased due to search fees for new and open positions.

32


 

The following table presents a comparison of noninterest expense for the nine months ended September 30, 2018 and 2017:





 

 

 

 

 

 

 

 

 

 

 



 

For the Nine Months Ended

 

 

 

 

 

(Dollars in thousands)

 

September 30,

 

Change

Noninterest Expense

 

2018

 

2017

 

Amount

 

%

Salaries and employee benefits

 

$

15,029 

 

$

14,190 

 

$

839 

 

5.9 

Occupancy, furniture and equipment, net

 

 

2,383 

 

 

2,386 

 

 

(3)

 

(0.1)

Advertising

 

 

1,113 

 

 

873 

 

 

240 

 

27.5 

Legal and professional

 

 

1,207 

 

 

1,173 

 

 

34 

 

2.9 

Data processing

 

 

1,791 

 

 

1,643 

 

 

148 

 

9.0 

Pennsylvania bank shares tax

 

 

712 

 

 

728 

 

 

(16)

 

(2.2)

FDIC insurance

 

 

452 

 

 

281 

 

 

171 

 

60.9 

ATM/debit card processing

 

 

734 

 

 

630 

 

 

104 

 

16.5 

Foreclosed real estate

 

 

46 

 

 

95 

 

 

(49)

 

(51.6)

Telecommunications

 

 

327 

 

 

308 

 

 

19 

 

6.2 

Provision for credit losses on off-balance sheet exposures

 

 

2,361 

 

 

 —

 

 

2,361 

 

N/A

Other

 

 

2,253 

 

 

2,116 

 

 

137 

 

6.5 

Total noninterest expense

 

$

28,408 

 

$

24,423 

 

$

3,985 

 

16.3 



Provision for Income Taxes

For the first nine months of 2018, the Corporation recorded a Federal income tax benefit of $671 thousand compared to a  $2.5 million tax expense for the same period in 2017. The tax benefit was primarily the result of a pre-tax loss due to the significant increase in the provision for loan loss expense.  The effective tax rate for the first nine months of 2017 was 21.1%. The federal statutory tax rate is 21% for 2018 and was 34% in 2017.



Financial Condition

Cash and Cash Equivalents:

Cash and cash equivalents totaled $44.8 million at September 30, 2018, a decrease of $13.8 million from the prior year-end balance of $58.6 million. The decrease was mainly due to the pay-out of the $10 million Kalan settlement (see Part II, Item 1. Legal Proceedings), a $1 million contribution to the Bank’s pension plan and interest-bearing deposits being reinvested in the loan portfolio. Interest-bearing deposits are held primarily at the Federal Reserve ($22.4 million) and in short-term bank owned certificates of deposit ($5.7 million).



Investment Securities:    

AFS Securities

The AFS securities portfolio has increased $298 thousand on a cost basis, since year-end 2017. The composition of the portfolio has remained consistent with municipal securities and U.S. Agency mortgage-backed securities comprising the greatest portion of the portfolio at approximately 50% and 36% of the portfolio fair value, respectively.  The average life of the portfolio was 3.78 years. 

The AFS securities portfolio had a net unrealized loss of $2.1 million at September 30, 2018 compared to a net unrealized loss of $47 thousand (excluding equity securities) at the prior year-end. The increase in the unrealized loss is due primarily to the change in interest rates.  The portfolio averaged $130.6 million with a yield of 2.71% for the first nine months of 2018. This compares to an average of $137.3 million and a yield of 2.80% for the same period in 2017. 

The municipal bond portfolio is well diversified geographically (issuers from within 28 states) and is comprised primarily of general obligation bonds (70%).  Many municipal bonds have credit enhancements in the form of private bond insurance or other credit support. The largest geographic municipal bond exposure is in the states of Texas (14.1%), Washington (10.4%), and Ohio (8.2%).  The average rating of the municipal portfolio from Moody’s is AA.  No municipal bonds are rated below investment grade.

The holdings of trust preferred investments have declined $1.9 million in book value since prior year-end due to the payoff of two bonds.  The holdings of private-label mortgage-backed securities (PLMBS) have declined $384 thousand in book value since year-end due to the sale of one bond. 

 

33


 

The amortized cost and estimated fair value of AFS securities available for sale as of September 30, 2018 and December 31, 2017 is as follows:





 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

September 30, 2018

 

cost

 

gains

 

losses

 

value

U.S. Government and Agency securities

 

$

9,405 

 

$

15 

 

$

(144)

 

$

9,276 

Municipal securities

 

 

63,221 

 

 

176 

 

 

(994)

 

 

62,403 

Trust preferred securities

 

 

4,069 

 

 

 —

 

 

(122)

 

 

3,947 

Agency mortgage-backed securities

 

 

46,394 

 

 

39 

 

 

(1,063)

 

 

45,370 

Private-label mortgage-backed securities

 

 

474 

 

 

43 

 

 

 —

 

 

517 

Asset-backed securities

 

 

3,917 

 

 

 —

 

 

(27)

 

 

3,890 



 

$

127,480 

 

$

273 

 

$

(2,350)

 

$

125,403 







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

December 31, 2017

 

cost

 

gains

 

losses

 

value

Equity securities

 

$

164 

 

$

201 

 

$

 —

 

$

365 

U.S. Government and Agency securities

 

 

11,451 

 

 

64 

 

 

(43)

 

 

11,472 

Municipal securities

 

 

57,374 

 

 

650 

 

 

(252)

 

 

57,772 

Trust preferred securities

 

 

6,000 

 

 

 —

 

 

(183)

 

 

5,817 

Agency mortgage-backed securities

 

 

51,307 

 

 

197 

 

 

(567)

 

 

50,937 

Private-label mortgage-backed securities

 

 

858 

 

 

88 

 

 

 —

 

 

946 

Asset-backed securities

 

 

28 

 

 

 —

 

 

(1)

 

 

27 



 

$

127,182 

 

$

1,200 

 

$

(1,046)

 

$

127,336 



The AFS securities portfolio contained 192 securities with $100 million of temporarily impaired fair value and $2.4 million in unrealized losses at September 30, 2018. The total unrealized loss position has increased $1.3 million unrealized loss at year-end 2017. 

For securities with an unrealized loss, Management applies a systematic methodology in order to perform an assessment of the potential for other-than-temporary impairment.  In the case of debt securities, investments considered for other-than-temporary impairment: (1) had a specified maturity or repricing date; (2) were generally expected to be redeemed at par, and (3) were expected to achieve a recovery in market value within a reasonable period of time. In addition, the Bank considers whether it intends to sell these securities or whether it will be forced to sell these securities before the earlier of amortized cost recovery or maturity. The impairment identified on debt securities and subject to assessment at September 30, 2018, was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted.

 The following table reflects temporary impairment in the AFS securities portfolio, aggregated by investment category, length of time that individual securities have been in a continuous unrealized loss position and the number of securities in each category as of September 30, 2018 and December 31, 2017:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



September 30, 2018



Less than 12 months

 

12 months or more

 

Total



Fair

 

Unrealized

 

 

 

Fair

 

Unrealized

 

 

 

Fair

 

Unrealized

 

 

(Dollars in thousands)

Value

 

Losses

 

Count

 

Value

 

Losses

 

Count

 

Value

 

Losses

 

Count



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government and Agency
  securities

$

4,011 

 

$

(54)

 

 

$

4,381 

 

$

(90)

 

12 

 

$

8,392 

 

$

(144)

 

17 

Municipal securities

 

28,938 

 

 

(520)

 

47 

 

 

13,014 

 

 

(474)

 

23 

 

 

41,952 

 

 

(994)

 

70 

Trust preferred securities

 

2,102 

 

 

(62)

 

 

 

1,845 

 

 

(60)

 

 

 

3,947 

 

 

(122)

 

Agency mortgage-backed securities

 

18,326 

 

 

(311)

 

40 

 

 

22,996 

 

 

(752)

 

53 

 

 

41,322 

 

 

(1,063)

 

93 

Asset-backed securities

 

3,886 

 

 

(26)

 

 

 

 

 

(1)

 

 

 

3,890 

 

 

(27)

 

Total temporarily impaired
  securities

$

57,263 

 

$

(973)

 

101 

 

$

42,240 

 

$

(1,377)

 

91 

 

$

99,503 

 

$

(2,350)

 

192 





34


 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



December 31, 2017



Less than 12 months

 

12 months or more

 

Total



Fair

 

Unrealized

 

 

 

Fair

 

Unrealized

 

 

 

Fair

 

Unrealized

 

 

(Dollars in thousands)

Value

 

Losses

 

Count

 

Value

 

Losses

 

Count

 

Value

 

Losses

 

Count



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government and Agency
  securities

$

2,315 

 

$

(11)

 

 

$

3,528 

 

$

(32)

 

10 

 

$

5,843 

 

$

(43)

 

15 

Municipal securities

 

13,767 

 

 

(89)

 

22 

 

 

7,507 

 

 

(163)

 

14 

 

 

21,274 

 

 

(252)

 

36 

Trust preferred securities

 

1,216 

 

 

(12)

 

 

 

4,601 

 

 

(171)

 

 

 

5,817 

 

 

(183)

 

Agency mortgage-backed securities

 

16,287 

 

 

(129)

 

29 

 

 

20,563 

 

 

(438)

 

39 

 

 

36,850 

 

 

(567)

 

68 

Asset-backed securities

 

 —

 

 

 —

 

 —

 

 

 

 

(1)

 

 

 

 

 

(1)

 

Total temporarily impaired
  securities

$

33,585 

 

$

(241)

 

58 

 

$

36,203 

 

$

(805)

 

69 

 

$

69,788 

 

$

(1,046)

 

127 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



The unrealized loss in the municipal bond portfolio increased to $994 thousand from $252 thousand at December 31, 2017 as interest rates rose during the year.  There are seventy securities in this portfolio with an unrealized loss and the loss in this portfolio is deemed to be non-credit related and no other-than-temporary impairment charges have been recorded.

The trust preferred portfolio contains five securities with a fair value of $3.9 million and an unrealized loss of $122 thousand.  The trust-preferred securities held by the Bank are single entity issues, not pooled trust preferred securities.  Therefore, the impairment review of these securities is based only on the issuer and the security cannot be impaired by the performance of other issuers as if it was a pooled trust-preferred bond. All of the Bank’s trust preferred securities are single issue, variable rate notes with long maturities (2027 – 2028).  None of these bonds have suspended or missed a dividend payment. At September 30, 2018, the Bank believes it will be able to collect all interest and principal due on these bonds and no other-than-temporary-impairment charges were recorded.

Equity securities at Fair Value

The Corporation owns one equity investment. At September 30, 2018, this investment was reported at fair value ($383 thousand) with changes in value reported through income.  At December 31, 2017, this investment was reported at fair value with changes in value recorded through other comprehensive income.

Restricted Stock at Cost

The Bank held $452 thousand of restricted stock at September 30, 2018.  Except for $30 thousand, this investment represents stock in FHLB Pittsburgh. The Bank is required to hold this stock to be a member of FHLB and it is carried at cost of $100 per share. The level of FHLB stock held is determined by FHLB and is comprised of a minimum membership amount plus a variable activity amount. FHLB stock is evaluated for impairment primarily based on an assessment of the ultimate recoverability of its cost. As a government sponsored entity, FHLB has the ability to raise funding through the U.S. Treasury that can be used to support its operations.  There is not a public market for FHLB stock and the benefits of FHLB membership (e.g., liquidity and low cost funding) add value to the stock beyond purely financial measures. Management intends to remain a member of the FHLB and believes that it will be able to fully recover the cost basis of this investment.



Loans:    

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

Total residential real estate loans decreased $10.6 million over 2017,  as the Bank retained a lower percentage of its originations.  For the first nine months of 2018, the Bank originated and sold $16.1 million in mortgages for a fee through a third party brokerage agreement. The Bank does not originate or hold any loans that would be considered sub-prime or Alt-A, and does not generally originate mortgages outside of its primary market area.

Residential real estate construction:  The largest component of this category represents loans to residential real estate developers ($9.5 million), while loans for individuals to construct personal residences totaled $2.8 million at September 30, 2018.  The Bank’s exposure to residential construction loans is concentrated primarily in south central Pennsylvania. Real estate construction loans, including residential real estate and land development loans, occasionally provide an

35


 

interest reserve in order to assist the developer during the development stage when minimal cash flow is generated. All real estate construction loans are underwritten in the same manner, regardless of the use of an interest reserve.

At September  30, 2018, the Bank had $32.2 million in real estate construction loans funded with an interest reserve and capitalized $830 thousand of interest in 2018 from these reserves on active projects.  These loans were comprised of $2.5 million in residential construction and $29.7 million in commercial construction.   Real estate construction loans are monitored on a regular basis by either an independent third party inspector or the assigned loan officer depending on loan amount or complexity of the project. This monitoring process includes at a minimum, the submission of invoices and AIA documents (depending on the complexity of the project) detailing costs incurred by the borrower, on-site inspections, and a signature by the assigned loan officer for disbursement of funds.    

Commercial real estate (CRE): This category includes commercial, industrial, farm and agricultural loans, where real estate serves as the primary collateral for the loans. Total commercial real estate loans increased to $475.8 million from $428.4 million at the end of 2017, an increase of $47.4 million.  The increase was primarily in hotels and motels ($17.7 million) partially offset by pay-off of $3.5 million of a loan participation.    The largest sectors (by collateral) in the commercial real estate category are: hotels and motels ($71.0 million), office buildings ($59.8 million), land development ($47.2 million), manufacturing facilities ($42.0 million) and auto dealerships ($34.2 million).

Commercial (C&I):  This category includes commercial, industrial, farm, agricultural, and municipal loans.  C&I loans decreased $11.7 million to $279.8 million at September 30, 2018, compared to $291.5 million at the end of 2017, primarily due to an $8.7 million loan charge-off discussed in more detail in the Loan Quality section below. At September 30, 2018, the Bank had approximately $174 million in tax-free loans in the C&I portfolio. The largest sectors (by industry) in the commercial C&I category are: public administration ($85.7 million), utilities ($35.2 million), educational services ($27.1 million) and health care ($15.4 million).  The Bank expects that commercial lending will continue to be the primary area of loan growth in the future via in-market lending.  

The Bank may supplement its own commercial loan production by purchasing loan participations.  These participations are primarily located in south-central Pennsylvania.  At September 30, 2018, the outstanding commercial participations accounted for 10.9%, or $105.7 million, of total gross loans compared to 12.2% and $115.3 million at December 31, 2017The Bank’s total exposure (including unfunded commitments) to purchased participations is 14.6%, compared to 16.9% at December 31, 2017. The commercial loan participations are comprised of $35.8 million of C&I loans and $69.9 million of CRE loans, reported in the respective loan class.

Consumer loans: This category remained unchanged over year-end and is mainly comprised of unsecured personal lines of credit. 

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





 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



 

September 30,

 

December 31,

 

 

Change

(Dollars in thousands)

 

2018

 

2017

 

 

Amount

 

%

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

Consumer first liens

 

$

90,029 

 

$

97,159 

 

$

(7,130)

 

(7.3)

Commercial first lien

 

 

60,142 

 

 

61,275 

 

 

(1,133)

 

(1.8)

Total first liens

 

 

150,171 

 

 

158,434 

 

 

(8,263)

 

(5.2)



 

 

 

 

 

 

 

 

 

 

 

Consumer junior liens and lines of credit

 

 

43,044 

 

 

45,043 

 

 

(1,999)

 

(4.4)

Commercial junior liens and lines of credit

 

 

5,040 

 

 

5,328 

 

 

(288)

 

(5.4)

Total junior liens and lines of credit

 

 

48,084 

 

 

50,371 

 

 

(2,287)

 

(4.5)

Total residential real estate 1-4 family

 

 

198,255 

 

 

208,805 

 

 

(10,550)

 

(5.1)



 

 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

 

2,779 

 

 

1,813 

 

 

966 

 

53.3 

Commercial

 

 

9,510 

 

 

8,088 

 

 

1,422 

 

17.6 

Total residential real estate construction

 

 

12,289 

 

 

9,901 

 

 

2,388 

 

24.1 



 

 

 

 

 

 

 

 

 

 

 

Commercial real estate

 

 

475,838 

 

 

428,428 

 

 

47,410 

 

11.1 

Commercial

 

 

279,835 

 

 

291,519 

 

 

(11,684)

 

(4.0)

        Total commercial

 

 

755,673 

 

 

719,947 

 

 

35,726 

 

5.0 



 

 

 

 

 

 

 

 

 

 

 

Consumer

 

 

4,766 

 

 

5,047 

 

 

(281)

 

(5.6)



 

 

970,983 

 

 

943,700 

 

 

27,283 

 

2.9 

Less: Allowance for loan losses

 

 

(12,526)

 

 

(11,792)

 

 

(734)

 

6.2 

Net Loans

 

$

958,457 

 

$

931,908 

 

$

26,549 

 

2.8 



 

 

 

 

 

 

 

 

 

 

 

36


 

Loan Quality: 

Management utilizes a risk rating scale ranging from 1-Prime to 9-Loss to evaluate loan quality. This risk rating scale is used primarily for commercial purpose loans. Consumer purpose loans are identified as either a pass or substandard rating based on the performance status of the loans. Substandard consumer loans are loans that are 90 days or more past due and still accruing.  Loans rated 1 – 4 are considered pass credits. Loans that are rated 5 are pass credits, but have been identified as credits that are likely to warrant additional attention and monitoring. Loans rated 6-Special Mention or worse begin to receive enhanced monitoring and reporting by the Bank. Loans rated 7-Substandard or 8-Doubtful exhibit the greatest financial weakness and present the greatest possible risk of loss to the Bank. Nonaccrual loans are rated no better than 7-Substandard.   The following factors represent some of the factors used in determining the risk rating of a borrower: cash flow, debt coverage, liquidity, management, and collateral. Risk ratings, for pass credits, are generally reviewed annually for term debt and at renewal for revolving or renewing debt. The Bank monitors loan quality by reviewing four primary measurements: (1) loans rated 6-Special Mention or worse (collectively “watch list”), (2) delinquent loans, (3) net-charge-offs, and (4) other real estate owned (OREO).

Significant Impairment. During the second quarter the Bank recorded a material impairment charge on a $14.4 million commercial loan participation (the Participation). The impairment charge was initially reported on the Corporation’s current report on Form 8-K filed on May 31, 2018.  The Participation represented the Bank’s portion of loans and off-balance sheet commitments (letters-of-credit) to a single, large commercial lending relationship with the lead bank.  During the second quarter, the Bank was notified by the lead lender, another Pennsylvania bank, that the loan relationship had become impaired due to fraudulent activities believed to be perpetrated by one of more of the executives and personnel employed by the borrower.  The Bank is one of four Pennsylvania banks affected by the loan impairment. The impairment resulted in the Bank charging-off loans totaling $8.7 million. This total included a complete charge-off on a $1.3 million loan and a partial charge-off of $7.4 million on another loan. At September 30, 2018, the remaining balance on three loans in the Participation was $2.9 million.  The credit is now in bankruptcy and is being administered by a bankruptcy court appointed trustee and by the court. In September 2018, the Bankruptcy Court notified the Bank it would receive proceeds of $1.3 million in October 2018 to be applied to two term loans with a balance of $1.5 million. The Bank charged-off the short-fall ($208 thousand) in September and removed the specific reserve of $225 thousand that was established as of June 30, 2018. After receiving the October proceeds, the outstanding balance on the Participation is $1.6 million. The Bank expects to receive additional proceeds from the Bankruptcy Court to apply against the outstanding balance, but as of this time it is uncertain of when this may occur and in what amount.  

The Bank also has $2.4 million in off-balance sheet exposure through three letters-of-credit it issued for the benefit of the borrower. A $2.4 million reserve (reported in other liabilities and other expense) was established for these commitments. As of September 30, 2018, proof of claim for one letter-of-credit has been submitted to the Bankruptcy Court for payment. 

The impairment charges had a significant effect on various loan quality measures including: impaired loans, nonaccrual loans, provision for loan loss expense, and net-charge offs.  

Watch list loans exhibit financial weaknesses that increase the potential risk of default or loss to the Bank. However, inclusion on the watch list, does not by itself, mean a loss is certain. The watch list totaled $14.9 million at quarter end, compared to $16.0 million at June 30, 2018 and $12.8 million at December 31, 2017. The watch list includes both performing and nonperforming loans.  It is comprised entirely of loans rate 6-Special Mention and 7- Substandard. The increase in the watch list from year-end 2017 is the result of an increase in substandard commercial loans from the Participation (rated 7-Substandard). The Bank has no loans rated 8-Doubtful or 9-Loss. Included in the substandard total are $5.6 million of nonaccrual loans.  The Participation accounted for the increase in nonaccrual loans. The previously mentioned payment from the Bankruptcy Court will be applied against loans that are in nonaccrual at the end of the quarter. The credit composition of the portfolio, by primary collateral is shown in Note 6 of the accompanying financial statements.

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

Nonaccruing loans generally represent Management’s determination that the borrower will be unable to repay the loan in accordance with its contractual terms and that collateral liquidation may or may not fully repay both interest and principal. It is the Bank’s policy to evaluate the probable collectability of principal and interest due under terms of loan contracts for all loans 90-days or more, nonaccrual loans, or impaired loans. Further, it is the Bank’s policy to discontinue accruing interest on loans that are not adequately secured and in the process of collection.  Upon determination of nonaccrual status, the Bank subtracts any current year accrued and unpaid interest from its income, and any prior year

37


 

accrued and unpaid interest from the allowance for loan losses.  Management continually monitors the status of nonperforming loans, the value of any collateral and potential of risk of loss.  Nonaccrual loans are rated no better than 7-Substandard.

The Bank’s Loan Management Committee reviews these loans and risk ratings on a quarterly basis in order to proactively identify and manage problem loans. In addition, a committee meets monthly to discuss possible workout strategies for OREO and all credits rated 7-Substandard or worse. Management also tracks other commercial loan risk measurements including high loan to value loans, concentrations, participations and policy exceptions and reports these to the Credit Risk Oversight Committee of the Board of Directors. The Bank also uses a third-party consultant to assist with internal loan review with a goal of reviewing 60% of commercial loans each year. The FDIC defines certain supervisory loan-to-value lending limits.  The Bank’s internal loan–to-value limits are all equal to, or have a lower loan-to-value limit, than the supervisory limits. However, in certain instances, the Bank may make a loan that exceeds the supervisory loan-to-value limit.  At September 30, 2018 the Bank had loans of $18.7 million (1.9% of gross loans) that exceeded the supervisory limit, compared to 3.2% at year-end 2017.

Loan quality has declined since year-end 2017, as the balance of nonperforming loans has increased, primarily the result of moving the Participation loans to nonaccrual.   Potential problem loans, defined as watch list loans less loans on nonaccrual or past due more than 90 days at September 30, 2018 totaled $9.2 million compared to $10.3 million at June 30, 2018 and $10.1 million at year-end 2017.  See Note 7 in the accompanying financial statements for additional information about OREO.



The following table presents a summary of nonperforming assets as of:



 

 

 

 

 

 



 

September 30,

 

December 31,

(Dollars in thousands)

 

2018

 

2017



 

 

 

 

 

 

Nonaccrual loans

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

First liens

 

$

71 

 

$

168 

Junior liens and lines of credit

 

 

23 

 

 

 —

Total

 

 

94 

 

 

168 

Residential real estate - construction

 

 

460 

 

 

466 

Commercial real estate

 

 

1,806 

 

 

1,854 

Commercial

 

 

3,263 

 

 

187 

Total nonaccrual loans

 

 

5,623 

 

 

2,675 



 

 

 

 

 

 

Loans past due 90 days or more and still accruing

 

 

 

 

 

 

Junior liens and lines of credit

 

 

43 

 

 

 —

Total loans past due 90 days or more and still accruing

 

 

43 

 

 

 —



 

 

 

 

 

 

Total nonperforming loans

 

 

5,666 

 

 

2,675 



 

 

 

 

 

 

Other real estate owned

 

 

2,665 

 

 

2,598 

Total nonperforming assets

 

$

8,331 

 

$

5,273 



 

 

 

 

 

 

Nonperforming loans to total gross loans

 

 

0.58% 

 

 

0.28% 

Nonperforming assets to total assets

 

 

0.70% 

 

 

0.45% 

Allowance for loan losses to nonperforming loans

 

 

221.07% 

 

 

440.82% 

38


 

The following table identifies the most significant loans in nonaccrual status. These two nonaccrual loans account for 84% of the total nonaccrual balance.



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

ALL

 

Nonaccrual

 

TDR

 

 

 

 

 

Collateral



 

Balance

 

 

Reserve

 

Date

 

Status

 

Collateral

 

Location

 

Value



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit 1

$

1,592 

 

$

 —

 

Mar-12

 

Y

 

1st and 2nd liens on commercial real estate, residential real estate and business assets

 

PA

 

$

3,105 

Credit 2

 

2,925 

 

 

 —

 

May-18

 

N

 

1st lien commercial real estate and business assets

 

PA

 

$

3,175 



$

4,517 

 

$

 —

 

 

 

 

 

 

 

 

 

 

 



Credit 1 is a TDR that is delinquent under the modified terms. Credit 2 is the Participation and does not reflect the pay-down off $1.3 million received in October 2018, but does include the partial charge-off previously discussed.

In addition to monitoring nonaccrual loans, the Bank also closely monitors impaired loans and troubled debt restructurings (TDR).  A loan is considered to be impaired when, based on current information and events, it is probable that the Bank will be unable to collect all interest and principal payments due according to the originally contracted terms of the loan agreement.  Nonaccrual loans (excluding consumer purpose loans) and TDR loans are considered impaired.

A loan is considered a troubled debt restructuring if the creditor (the Bank), for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. These concessions may include lowering the rate, extending the maturity, re-amortization of the payment, or a combination of multiple concessions. The Bank reviews all loans rated 6-Special Mention or worse when it is providing a loan restructure, modification or new credit facility to determine if the action is a TDR.  If a TDR loan is placed on nonaccrual status, it remains on nonaccrual status for at least six months to ensure performance.

In accordance with financial accounting standards, TDR loans are always considered impaired until they are paid off or in certain circumstances, refinanced.  However, an impaired TDR loan can be a performing loan.  Impaired loans totaled $15.3 million at quarter-end compared to $12.6 million at year-end 2017. The increase is in the commercial loan portfolio was a result of the Participation.

The following table shows the composition of impaired loans as of:







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

September 30, 2018

(Dollars in thousands)

 

Nonaccrual

 

Accruing

 

 

Accruing

 

Total



 

Non-TDR

 

TDR

 

TDR

 

 

Other (1)

 

Impaired

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

71 

 

$

 —

 

$

683 

 

$

 —

 

$

754 

Junior liens and lines of credit

 

 

23 

 

 

 —

 

 

 —

 

 

43 

 

 

66 

Total

 

 

94 

 

 

 —

 

 

683 

 

 

43 

 

 

820 

Residential real estate - construction

 

 

 —

 

 

460 

 

 

 —

 

 

 —

 

 

460 

Commercial real estate

 

 

141 

 

 

1,665 

 

 

8,909 

 

 

 —

 

 

10,715 

Commercial

 

 

3,263 

 

 

 —

 

 

 —

 

 

 —

 

 

3,263 

Total

 

$

3,498 

 

$

2,125 

 

$

9,592 

 

$

43 

 

$

15,258 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1) impaired consumer purpose loans not on nonaccrual

 

 

 

 

 

 



Allowance for Loan Losses: 

Management monitors loan performance on a monthly basis and performs a quarterly evaluation of the adequacy of the allowance for loan losses (ALL). The ALL is determined by segmenting the loan portfolio based on the loan’s collateral. When calculating the ALL, consideration is given to a variety of factors in establishing this estimate including, but not limited to, current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, historical charge-offs, the adequacy of the underlying collateral (if collateral dependent) and other relevant factors. The Bank begins enhanced monitoring of all loans rated 6-Special Mention or worse, and obtains a new appraisal or asset valuation for any loan rated 7-Substandard or worse. Management, at its discretion, may determine that additional adjustments to the appraisal or valuation are required.  Valuation adjustments will be made as necessary based on factors, including, but not limited to: the economy, deferred maintenance, industry, type of property/equipment, age of the appraisal, etc. and the knowledge Management has about a particular situation. In addition, the cost to sell or liquidate the collateral is also estimated and deducted from the valuation in order to determine the net realizable value to the Bank. When determining the allowance for loan losses, certain factors involved in the evaluation are inherently subjective and require material estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans. Management monitors the adequacy of the allowance for loan losses on

39


 

an ongoing basis and reports its adequacy quarterly to the Credit Risk Oversight Committee of the Board of Directors.  Management believes that the allowance for loan losses at September 30, 2018 is adequate.

The analysis for determining the ALL is consistent with guidance set forth in generally accepted accounting principles (GAAP) and the Interagency Policy Statement on the Allowance for Loan and Lease Losses. The analysis has three components: specific allocations, general allocations, and an unallocated component. The specific component addresses specific reserves established for impaired loans. A loan is considered to be impaired when, based on current information and events, it is probable that the Bank will be unable to collect all interest and principal payments due according to the originally contracted terms of the loan agreement.  Collateral values discounted for market conditions and selling costs are used to establish specific allocations for impaired loans. It is possible that as a result of the credit analysis, a specific reserve is not required for an impaired loan. For impaired commercial loans with balances less than $250 thousand and all consumer purpose loans, a specific reserve analysis is not performed and these loans are added to the general allocation pool. These loans totaled $710 thousand at September 30, 2018 and Management does not believe that excluding these loans from the specific reserve analysis presents any additional risk.  The Bank currently has a $181 thousand specific reserve established against one commercial loan. Note 6 in the accompanying financial statements provides additional information about the ALL established for impaired loans.

The general allocation component addresses the reserves established for pools of homogenous loans. The general component includes a quantitative and qualitative analysis. When calculating the general allocation, the Bank segregates its loan portfolio into the following sectors based primarily on the type of supporting collateral:  residential real estate, commercial, industrial or agricultural real estate; commercial and industrial (C&I non-real estate), and consumer. Each sector may be further segregated by type of collateral, lien position, or owner/nonowner occupancy. The quantitative analysis uses the Bank’s twenty quarter rolling historical loan loss experience adjusted for factors derived from current economic and market conditions that have been determined to have an effect on the probability and magnitude of a loss.  For the third quarter of 2018, the historical loss experience was adjusted pursuant to the above process to in effect exclude the charge-off on the Participation.  This loss resulted from fraudulent activity believed to have been perpetrated by one or more employees of the borrower.  As such, the Bank believes this incident is an isolated occurrence and not indicative of a broader increase in exposure to fraud-related losses in its loan portfolio. The qualitative analysis utilizes a risk matrix that incorporates qualitative and environmental factors such as: loan volume, management, loan review process, credit concentrations, competition, and legal and regulatory issues. These factors are each risk rated from minimal to high risk and in total can add up to a maximum qualitative factor of 37.5 basis points.

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



The following table shows the composition of the allowance for loan losses:





 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

September 30, 2018

 

December 31, 2017

Allowance Component

 

 

Balance

 

% of Loans

 

 

Balance

 

% of Loans

General - Quantitative

 

$

8,327 

 

0.86 

 

$

7,808 

 

0.83 

General - Qualitative

 

 

2,628 

 

0.27 

 

 

2,547 

 

0.27 

Specific

 

 

181 

 

0.02 

 

 

 —

 

 —

Unallocated

 

 

1,390 

 

0.14 

 

 

1,437 

 

0.15 



 

$

12,526 

 

1.29 

 

$

11,792 

 

1.25 



Real estate appraisals and collateral valuations are an important part of the Bank’s process for determining potential loss on collateral dependent loans and thereby have a direct effect on the determination of loan reserves, charge-offs and the calculation of the allowance for loan losses.  As long as the loan remains a performing loan, no further updates to appraisals are required. If a loan or relationship migrates to risk rating of 7-Substandard or worse, an evaluation for impairment status is made based on the current information available at the time of downgrade and a new appraisal or collateral valuation is obtained.

In determining the allowance for loan losses, Management, at its discretion, may determine that additional adjustments to the fair value obtained from an appraisal or collateral valuation are required. Adjustments will be made as necessary based on factors, including, but not limited to the economy, deferred maintenance, industry, type of property or equipment etc., and the knowledge Management has about a particular situation. In addition, the cost to sell or liquidate the collateral is also estimated and deducted from the valuation in order to determine the net realizable value to the Bank. If an appraisal is not available, Management may make its best estimate of the real value of the collateral or use last known market value and apply appropriate discounts.  If an adjustment is made to the collateral valuation, this will be documented with appropriate support and reported to the Loan Management Committee.

40


 

The following table shows the loans that were evaluated for the allowance for loan losses under a specific reserve (individually) and those that were evaluated under a general reserve (collectively), and the amount of the allowance established in each loan class as of September 30, 2018 and December 31, 2017:



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 



 

First

 

Junior Liens &

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

Liens

 

Lines of Credit

 

Construction

 

Real Estate

 

Commercial

 

Consumer

 

Unallocated

 

Total



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for ALL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

408 

 

$

 —

 

$

460 

 

$

10,574 

 

$

3,106 

 

$

 —

 

$

 —

 

$

14,548 

Collectively

 

 

149,763 

 

 

48,084 

 

 

11,829 

 

 

465,264 

 

 

276,729 

 

 

4,766 

 

 

 —

 

 

956,435 

Total

 

$

150,171 

 

$

48,084 

 

$

12,289 

 

$

475,838 

 

$

279,835 

 

$

4,766 

 

$

 —

 

$

970,983 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL established for
  loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

181 

 

$

 —

 

$

 —

 

$

181 

Collectively

 

 

1,006 

 

 

314 

 

 

278 

 

 

7,271 

 

 

1,985 

 

 

101 

 

 

1,390 

 

 

12,345 

ALL at September 30, 2018

 

$

1,006 

 

$

314 

 

$

278 

 

$

7,271 

 

$

2,166 

 

$

101 

 

$

1,390 

 

$

12,526 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for ALL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

459 

 

$

 —

 

$

466 

 

$

10,981 

 

$

 —

 

$

 —

 

$

 —

 

$

11,906 

Collectively

 

 

157,975 

 

 

50,371 

 

 

9,435 

 

 

417,447 

 

 

291,519 

 

 

5,047 

 

 

 —

 

 

931,794 

Total

 

$

158,434 

 

$

50,371 

 

$

9,901 

 

$

428,428 

 

$

291,519 

 

$

5,047 

 

$

 —

 

$

943,700 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL established for
  loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

Collectively

 

 

1,060 

 

 

330 

 

 

224 

 

 

6,526 

 

 

2,110 

 

 

105 

 

 

1,437 

 

 

11,792 

ALL at December 31, 2017

 

$

1,060 

 

$

330 

 

$

224 

 

$

6,526 

 

$

2,110 

 

$

105 

 

$

1,437 

 

$

11,792 



Charged-off loans usually result from: (1) a borrower being legally relieved of loan repayment responsibility through bankruptcy, (2) insufficient collateral sale proceeds to repay a loan; or (3) the borrower and/or guarantor does not own other assets that, if sold, would generate sufficient sale proceeds to repay a loan. Charged-off loans decrease the Bank’s allowance for loan losses (ALL), while the recovery of previously charge-off loans and the provision for loan loss expense increase the ALL.

Year-to-date, the Bank recorded a net loan charge-offs of $8.8 million compared to net recoveries of $48 thousand for the same period in 2017. The Bank recorded $9.6 million in the provision for loan loss expense for the first nine months of 2018 compared to $420 thousand for the same period of 2017.  The Participation was primarily responsible for the increase in net loan charge-offs and the increase in the provision for loan loss expense. See Note 6 in the accompanying financial statements for additional information about the allowance for loan losses.

The following table presents an analysis of the allowance for loan losses for the periods ended:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 



 

First

 

Junior Liens &

 

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

Liens

 

Lines of Credit

 

Construction

 

Real Estate

 

Commercial

 

Consumer

 

Unallocated

 

Total



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at June 30, 2018

 

$

1,022 

 

$

318 

 

$

282 

 

$

7,028 

 

$

2,233 

 

$

107 

 

$

1,492 

 

$

12,482 

Charge-offs

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(208)

 

 

(23)

 

 

 —

 

 

(231)

Recoveries

 

 

 —

 

 

 —

 

 

 —

 

 

 

 

19 

 

 

 

 

 —

 

 

25 

Provision

 

 

(16)

 

 

(4)

 

 

(4)

 

 

242 

 

 

122 

 

 

12 

 

 

(102)

 

 

250 

ALL at September 30, 2018

 

$

1,006 

 

$

314 

 

$

278 

 

$

7,271 

 

$

2,166 

 

$

101 

 

$

1,390 

 

$

12,526 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL at December 31, 2017

 

$

1,060 

 

$

330 

 

$

224 

 

$

6,526 

 

$

2,110 

 

$

105 

 

$

1,437 

 

$

11,792 

Charge-offs

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(8,944)

 

 

(78)

 

 

 —

 

 

(9,022)

Recoveries

 

 

 

 

 —

 

 

 —

 

 

17 

 

 

135 

 

 

24 

 

 

 —

 

 

177 

Provision

 

 

(55)

 

 

(16)

 

 

54 

 

 

728 

 

 

8,865 

 

 

50 

 

 

(47)

 

 

9,579 

ALL at September 30, 2018

 

$

1,006 

 

$

314 

 

$

278 

 

$

7,271 

 

$

2,166 

 

$

101 

 

$

1,390 

 

$

12,526 

41


 

The allocation of the allowance for loan losses is based on estimates and is not intended to imply limitations on the usage of the allowance.  The entire allowance is available to absorb any losses without regard to the category in which the loan is classified. The following table shows the ALL and charge-off ratios for the periods ended:





 

 

 

 

 

 

 

 



Nine Months Ended

Year ended

 

Nine Months Ended



September 30, 2018

 

December 31, 2017

 

September 30, 2017

Net charge-offs (recoveries)/average loans*

 

1.23% 

 

 

-0.01%

 

 

-0.01%

Net loan charge-offs (recoveries) as a percentage of the provision for loan losses

 

92.34% 

 

 

-7.01%

 

 

-11.43%

Allowance for loan losses as a % of loans

 

1.29% 

 

 

1.25% 

 

 

1.27% 

Net charge-offs (recoveries)

$

8,845 

 

$

(47)

 

$

(48)

* Annualized

 

 

 

 

 

 

 

 





Other Real Estate Owned: 

The Bank holds $2.7 million of other real estate owned (OREO), comprised of two properties. The most significant OREO holding is one property carried at $2.6 million (98% of total OREO) that is secured by 196 acres of land intended for residential real estate development. This property was part of a participated loan with the workout being handled by the lead bank. During the second quarter the Bank purchased the remaining portion of this property that it did not own for $105 thousand. The Bank believes it can more aggressively market the property as the sole owner as compared to the effort put forth by the minority owner/lead bank. The Bank has a contract on the property subject to the buyers due diligence period that expires in May 2019.  During the due diligence period the buyer is responsible for covering the Bank’s carrying costs of the property.   During 2018, the Bank recorded write downs of $6 thousand and incurred expense of $46 thousand to hold and maintain OREO. Note 7 of the accompanying financial statements provides additional information on activity in OREO.



Other Assets:

The $4l.7  million increase in other assets is primarily due to the Bank’s current tax position changing to a receivable due to the reversal of the deferred tax asset from the payout of the $10.0 million legal settlement.



Deposits: 

Total deposits increased $24.7 million during the first nine months of 2018 to $1.072 billion. Non-interest bearing deposits remained unchanged, while total interest-bearing checking and savings increased $32.8 million and time deposits decreased $7.7 million. Interest bearing checking increased by $14.1 million, primarily in commercial and municipal deposits while the Bank’s Money Management product increased $16.2 million, primarily in retail and commercial accountsTime deposits decreased since year-end from maturities of short-term municipal deposits

As of September 30, 2018, the Bank had $155.0 million placed in the ICS program ($115.3 million in interesting-bearing checking and $39.7 million in money management) and $3.3 million in reciprocal time deposits in the CDARS program included in time deposits.  These programs allow the Bank to offer full FDIC coverage to large depositors, but with the convenience to the customer of only having to deal with one bank.  The Bank solicits these deposits from within its market and it believes they present no greater risk than any other local deposit.  The Bank had no wholesale brokered CDs at September 30, 2018.



 

 

 

 

 

 

 

 

 

 

 



 

September 30,

 

December 31,

 

 

Change

(Dollars in thousands)

 

2018

 

2017

 

 

Amount

 

%

Noninterest-bearing checking

 

$

196,478 

 

$

196,853 

 

$

(375)

 

(0.2)



 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking

 

 

295,049 

 

 

280,944 

 

 

14,105 

 

5.0 

Money management

 

 

431,200 

 

 

415,045 

 

 

16,155 

 

3.9 

Savings

 

 

81,394 

 

 

78,868 

 

 

2,526 

 

3.2 

Total interest-bearing checking and savings

 

 

807,643 

 

 

774,857 

 

 

32,786 

 

4.2 



 

 

 

 

 

 

 

 

 

 

 

Time deposits

 

 

67,736 

 

 

75,471 

 

 

(7,735)

 

(10.2)

Total deposits

 

$

1,071,857 

 

$

1,047,181 

 

$

24,676 

 

2.4 



 

 

 

 

 

 

 

 

 

 

 

Overdrawn deposit accounts reclassified as loans

 

$

105 

 

$

154 

 

 

 

 

 



Borrowings:

The Corporation had no short-term borrowings at September 30, 2018 and December 31, 2017. 

42


 

Other Liabilities:

The $8.7 million decrease in other liabilities is primarily due to the payout of the $10.0 million legal settlement.



Shareholders’ Equity:

Total shareholders’ equity decreased $1.1 million to $114.0 million at September 30, 2018, from $115.1 million at the end of 2017.  The Corporation’s net earnings of $2.3 million were offset by the cash dividend of $3.4 million. The Corporation’s Dividend Reinvestment Plan (DRIP) added $529 thousand in new capital from optional cash contributions and $556 thousand from the reinvestment of quarterly dividends. The Corporation’s dividend payout ratio was 146.9% for the first nine months of 2018 compared to 31.7% in 2017. The payout ratio for 2018 was negatively affected by the net loss recorded in the second quarter.

As part of its quarterly dividend decision, the Corporation considers current and future income projections, dividend yield, payout ratio, and current and future capital ratios. For the third quarter of 2018, the Corporation paid a $0.27 per share dividend, compared to $0.24 paid in the third quarter of 2017. On October  11, 2018 the Board of Directors declared a $0.27 per share regular quarterly dividend for the fourth quarter of 2018, which will be paid on November  28, 2018.

In addition, the Corporation considers how dividend decisions may affect the DRIP. On October 12, 2017, the Board of Directors authorized the repurchase of up to 100,000 shares of the Corporation’s $1.00 par value common stock at market prices in open market or privately negotiated transactions beginning October 16, 2017 and continuing through September 30, 2018.  During the first nine months of 2018, 2,605 shares were repurchased, compared to no shares repurchased in the first nine months of 2017.  The 2017 Repurchase Plan expired on September 30, 2018 and a new plan has not been authorized.

In July 2013, Federal banking regulators approved the final rules from the Basel Committee on Banking Supervision for the regulation of capital requirements for bank holding companies and U.S banks, generally referred to as “Basel III.” The Basel III standards were effective for the Corporation and the Bank, effective January 1, 2015 (subject to a phase-in period for certain provisions).  Basel III imposes significantly higher capital requirements and more restrictive leverage and liquidity ratios than those previously in place.  The capital ratios to be considered “well capitalized” under Basel III are: (1) Common Equity Tier 1 (CET1) of 6.5%, (2) Tier 1 Leverage of 5%, (3) Tier 1 Risk-Based Capital of 8%, and (4) Total Risk-Based Capital of 10%.  The CET1 ratio is a new capital ratio under Basel III and the Tier 1 risk-based capital ratio of 8% has been increased from 6%. The rules also include changes in the risk weights of certain assets to better reflect credit and other risk exposures. In addition, a capital conservation buffer will be phased-in beginning January 1, 2016 at 0.625%, 1.25% for 2017, 1.875% for 2018 and 2.50% for 2019 and thereafter.  The capital conservation buffer will be applicable to all of the capital ratios except for the Tier1 Leverage ratio. The capital conservation buffer is equal to the lowest value of the three applicable capital ratios less the regulatory minimum for each respective capital measurement.  The Bank’s capital conservation buffer at September 30, 2018 was 6.89% (total risk-based capital 14.89% less 8.00%) compared to the 2018 regulatory buffer of 1.875%.  Compliance with the capital conservation buffer is required in order to avoid limitations to certain capital distributions.  As of September 30, 2018, the Bank was “well capitalized” under the Basel III requirements and believes it would be “well capitalized” on a fully-phased in basis had such a requirement been in effect.

43


 

The following table summarizes regulatory capital information as of September 30, 2018 and December 31, 2017 for the Corporation and the Bank.  The ratios have decreased since December 31, 2017 due to the net loss caused by the impairment charges for the Participation, more fully discussed in the Loan Quality section of Management’s Discussion and Analysis.





 

 

 

 

 

 

 

 



 

 

 

 

 

Regulatory Ratios



 

 

 

 

 

Adequately

 

Well



 

September 30,

 

December 31,

 

Capitalized

 

Capitalized

(Dollars in thousands)

 

2018

 

2017

 

Minimum

 

Minimum



 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

13.64% 

 

14.06% 

 

4.500% 

 

N/A

Farmers & Merchants Trust Company

 

13.42% 

 

13.93% 

 

4.500% 

 

6.50% 



 

 

 

 

 

 

 

 

Tier 1 Risk-based Capital Ratio (2)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

13.64% 

 

14.06% 

 

6.000% 

 

N/A

Farmers & Merchants Trust Company

 

13.42% 

 

13.93% 

 

6.000% 

 

8.00% 



 

 

 

 

 

 

 

 

Total Risk-based Capital Ratio (3)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

14.89% 

 

15.31% 

 

8.000% 

 

N/A

Farmers & Merchants Trust Company

 

14.68% 

 

15.19% 

 

8.000% 

 

10.00% 



 

 

 

 

 

 

 

 

Tier 1 Leverage Ratio (4)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

9.59% 

 

9.73% 

 

4.000% 

 

N/A

Farmers & Merchants Trust Company

 

9.48% 

 

9.64% 

 

4.000% 

 

5.00% 



 

 

 

 

 

 

 

 

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

(3) Total risk-based capital / total risk-weighted assets, (4) Tier 1 capital / average quarterly assets



Economy 

The Corporation’s primary market area includes Franklin, Fulton, Cumberland and Huntingdon Counties, Pennsylvania.  This area is diverse in demographic and economic makeup.  County populations range from a low of approximately 15,000 in Fulton County to over 249,000 in Cumberland County. Unemployment in the Bank’s market area has remained virtually unchanged over the past year and ranges from a low of 3.5% in Cumberland County to 4.9% in Huntingdon County.  The market area has a diverse economic base and local industries include warehousing, truck & rail shipping centers, light and heavy manufacturers, health-care, higher education institutions, farming and agriculture, and a varied service sector.  The Corporation’s primary market area is located in South Central PA and provides easy access to the major metropolitan markets on the east coast via trucking and rail transportation. Because of this, warehousing and distribution companies continue to find the area attractive. The local economy is not overly dependent on any one industry or business and Management believes that the Bank’s primary market area continues to be well suited for growth.

44


 

The following provides selected economic data for the Bank’s primary market:

Economic Data





 

 

 

 



 

 

 

 



 

September 30,

 

December 31,



 

2018

 

2017

Unemployment Rate (seasonally adjusted)

 

 

 

 

Market area range (1)

 

3.5% - 4.9%

 

3.4 - 4.5%

Pennsylvania

 

4.2% 

 

4.6% 

United States

 

3.9% 

 

4.1% 



 

 

 

 

Housing Price Index - year over year change

 

 

 

 

PA, nonmetropolitan statistical area

 

4.4% 

 

2.3% 

United States

 

6.6% 

 

6.3% 



 

 

 

 

Building Permits - year over year change -12 moths

 

 

 

 

Harrisburg-Carlisle, PA MSA & Chambersburg-Waynesboro, PA MSA

 

 

 

 

Residential, estimated

 

10.0% 

 

5.2% 

Multifamily, estimated

 

97.1% 

 

-27.8%



 

 

 

 

(1) Franklin, Cumberland, Fulton and Huntingdon Counties

 

 

 



Unlike many companies, the assets and liabilities of the Corporation are financial in nature. As such, interest rates and changes in interest rates may have a more significant effect on the Corporation’s financial results than on other types of industries. Because of this, the Corporation watches the actions of the Federal Reserve Open Market Committee (FOMC) as it makes decisions about interest rate changes. In September 2018, the FOMC increased the federal funds rate target range by .25%, its seventh such increase since December 31, 2016.    Despite these actions, the yield curve has flattened during the year.  Looking through the remainder of 2018, the FOMC continues to state that the timing and magnitude of rate increases will be data dependent. Market forecasts predict another FOMC rate change in December 2018 and possibly three more increases in 2019.  However, the actions of the FOMC with regard to the direction and magnitude of rate changes is never certain.    

Liquidity

The Corporation must meet the financial needs of the customers that it serves, while providing a satisfactory return on the shareholders’ investment.  In order to accomplish this, the Corporation must maintain sufficient liquidity in order to respond quickly to the changing level of funds required for both loan and deposit activity.  The goal of liquidity management is to meet the ongoing cash flow requirements of depositors who want to withdraw funds and of borrowers who request loan disbursements. The Bank regularly reviews it liquidity position by measuring its projected net cash flows (in and out) at a 30 and 90-day interval.  The Bank stresses the measurements by assuming a level of deposit out-flows that have not historically been realized. In addition to this forecast, other funding sources are reviewed as a method to provide emergency funding if necessary.  The objective of this measurement is to identify the amount of cash that could be raised quickly without the need to liquidate assets.  The Bank also stresses its liquidity position utilizing different longer-term scenarios.  The varying degrees of stress create pressure on deposit flows in its local market, reduce access to wholesale funding and limit access of funds available through brokered deposit channels. In addition to stressing cash flow, specific liquidity risk indicators are monitored to help identify risk areas.  This analysis helps identify and quantify the potential cash surplus/deficit over a variety of time horizons to ensure the Bank has adequate funding resources.  Assumptions used for liquidity stress testing are subjective.  Should an evolving liquidity situation or business cycle present new data, potential assumption changes will be considered.  The Bank believes it can meet all anticipated liquidity demands.

Historically, the Corporation has satisfied its liquidity needs from earnings, repayment of loans and amortizing investment securities, maturing investment securities, loan` sales, deposit growth and its ability to access existing lines of credit.  All investment securities are classified as available for sale; therefore, securities that are not pledged as collateral for borrowings are an additional source of readily available liquidity, either by selling the security or, more preferably, to provide collateral for additional borrowing. At September 30, 2018, the Bank had $86.9 million (fair value) in its investment portfolio pledged as collateral for deposits.  The Bank also has access to other wholesale funding via the brokered CD market.

The FHLB system has always been a major funding source for community banks.  The Bank’s maximum borrowing capacity with the FHLB at September 30, 2018 was $337.7 million with $337.7 million available to borrow.  There are no indicators that lead the Bank to believe the FHLB would discontinue its lending function or restrict the Bank’s ability to

45


 

borrow. If either of these events would occur, it would have a negative effect on the Bank and it is unlikely that the Bank could replace the level of FHLB funding in a short time. 

The Bank has established credit at the Federal Reserve Discount Window and as of quarter-end had the ability to borrow approximately $19 million. 



Off Balance Sheet Commitments

The Corporation’s financial statements do not reflect various commitments that are made in the normal course of business, which may involve some liquidity risk.  These commitments consist mainly of unfunded loans and letters of credit made under the same standards as on-balance sheet instruments.  Because these instruments have fixed maturity dates, and because many of them will expire without being drawn upon, they do not generally present any significant liquidity risk to the Corporation.  Unused commitments and standby letters of credit totaled $303.6 million and $300.1 million, respectively, at September 30, 2018 and December 31, 2017.  As of June 30, 2018, the Bank established a $2.4 million allowance against letters of credit issued as part of the Participation discussed in the Loan Quality section.

The Corporation has entered into various contractual obligations to make future payments.  These obligations include time deposits, long-term debt, operating leases, deferred compensation and pension payments.  These amounts have not changed materially from those reported in the Corporation’s 2017 Annual Report on Form 10-K.

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk



There were no material changes in the Corporation’s exposure to market risk during the nine months ended September 30, 2018. For more information on market risk refer to the Corporation’s 2017 Annual Report on Form 10-K.



Item 4.  Controls and Procedures

Evaluation of Controls and Procedures

The Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon the evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer concluded that as of September 30, 2018, the Corporation’s disclosure controls and procedures are effective. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in the Corporation’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. There were no changes in the Corporation’s internal control over financial reporting during the quarterly period ended September 30, 2018, that have materially affected, or are reasonably likely to materially affect, the internal control over financial reporting.

The management of the Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. The Corporation’s internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. 

Part II – OTHER INFORMATION

Item 1.    Legal Proceedings

The nature of the Corporation’s business generates a certain amount of litigation. In management’s opinion, there are no proceedings pending to which the Corporation is a party or to which its property is subject which, if determined adversely to the Corporation, would be material.  No material proceedings are pending or are known to be threatened or contemplated against us by any governmental authorities.

As described in our current report on Form 8-K filed on August 3, 2018, the court entered an order on July 31, 2018 granting final approval of the settlement agreements in the Kalan et al. v. Farmers and Merchants Trust Company of Chambersburg, et al. (Case No. 2:15-CV-01435-WB) case filed against F&M Trust in the United States District Court for the Eastern District of Pennsylvania in March, 2015 and described in our current reports on Form 8-K filed July 29, 2016, July 28, 2017, November 3, 2017, January 2, 2018, April 13, 2018, May 7, 2018 and August 3, 2018. Among other things, the order also dismissed the case against F&M Trust with prejudice; certified the settlement class; and, permanently

46


 

enjoined the named plaintiffs and the members of the settlement class from asserting any further claims arising out of or related to the claims alleged or that could have been alleged in the case against F&M Trust. The settlement agreements provide for the Bank to make a settlement payment of $10 million in full and final settlement of all such claims.  The settlement agreements further provide for general releases by all parties.  F&M Trust made the settlement payment in May, 2018, in accordance with the court’s earlier order preliminarily approving the settlement agreements. The Corporation previously accrued the $10 million settlement payment as an expense for the year ended December 31, 2017.



Item 1A. Risk Factors 

Except as set forth below, there were no material changes in the Corporation’s risk factors during the nine months ended September 30, 2018. For more information, refer to the Corporation’s 2017 Annual Report on Form 10-K.



Our business and financial results could be impacted materially by adverse results in legal proceedings.

The nature of the Corporation’s business generates a certain amount of litigation involving matters arising in the ordinary course of business (and, in some cases, from the activities of companies we have acquired).  These legal proceedings, whether founded or unfounded, could result in reputation damage and have an adverse effect on our financial condition and results of operation if they are not resolved in a manner favorable to the Corporation.  Although we establish accruals for legal proceedings when information related to the loss contingencies represented by these matters indicates that both a loss is probable and that the amount of the loss can be reasonably estimated, we do not have accruals for all legal proceedings where we face a risk of loss.  In addition, due to the inherent subjectivity of the assessments and unpredictability of outcomes of legal proceedings, any amounts that may be accrued or included in estimates of possible losses or ranges of possible losses may not represent the actual loss to the Corporation.  We discuss these matters further in Part II, Item 1 Legal Proceedings and in Note 12 Contingencies in the Notes to Consolidated Financial Statements in Part I, Item 1 of this Report.



47


 

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







 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands, except per share)

 

 

 

 

 

 

Period

 

Number of
Shares Purchased

 

 

Weighted
Average
Price Paid
per Share

 

 

Dollar Amount of
Shares Purchased
as Part of Publically
Announced Program

 

 


Shares Yet
To Be Purchased
Under Program



 

 

 

 

 

 

 

 

 

 

 

March 2018

 

2,605 

 

$

33.80 

 

$

88 

 

 

97,395 



 

2,605 

 

$

33.80 

 

 

 

 

 

 





These shares were acquired through stock swap transactions by the exercise of incentive stock options. No shares were repurchased in the second or third quarters of 2018.  The 2017 Repurchase Plan expired on September 30, 2018 and a new plan has not been authorized.





Item 3.   Defaults by the Company on its Senior Securities

None

Item 4.   Mine Safety Disclosures

Not Applicable

48


 

Item 5.   Other Information

None

Item 6.   Exhibits 

Exhibits



 

49


 

FRANKLIN FINANCIAL SERVICES CORPORATION

and SUBSIDIARIES



SIGNATURES



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



Franklin Financial Services Corporation





 

 



 

 

November 5, 2018

 

/s/ Timothy G. Henry



 

Timothy G. Henry



 

Chief Executive Office and President



 

(Principal Executive Officer)



 

 

November 5, 2018

 

/s/ Mark R. Hollar



 

Mark R. Hollar



 

Treasurer and Chief Financial Officer



 

(Principal Financial and Accounting Officer)



50