20150630 Q2

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 June  30, 2015

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

PA17201-0819

(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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  No

 

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

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

 

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

 

There were 4,252,508 outstanding shares of the Registrant’s common stock as of July 31, 2015.

 


 

INDEX

 

               

 

 

 

Part I - FINANCIAL INFORMATION

 

 

 

 

Item 1 

Financial Statements

 

 

Consolidated Balance Sheets as of June  30, 2015 and December 31, 2014 (unaudited)

1

 

Consolidated Statements of Income for the Three and Six Months ended June  30, 2015 

2

 

and 2014 (unaudited)

 

 

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

3

 

June  30, 2015 and 2014 (unaudited)

 

 

Consolidated Statements of Changes in Shareholders’ Equity for the Six Months

4

 

ended June  30, 2015 and 2014 (unaudited)

 

 

Consolidated Statements of Cash Flows for the Six Months ended June  30, 2015 

5

 

and 2014 (unaudited)

 

 

Notes to Consolidated Financial Statements (unaudited)

6

 

 

 

Item 2 

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

28

Item 3 

Quantitative and Qualitative Disclosures about Market Risk

52

Item 4 

Controls and Procedures

52

 

 

 

Part II - OTHER INFORMATION 

 

 

 

 

Item 1 

Legal Proceedings

53

Item 1A 

Risk Factors

53

Item 2 

Unregistered Sales of Equity Securities and Use of Proceeds

53

Item 3 

Defaults Upon Senior Securities

53

Item 4 

Mine Safety Disclosures

53

Item 5 

Other Information

53

Item 6 

Exhibits

53

SIGNATURE PAGE 

54

EXHIBITS

 

 

 

 

 

 


 

Part I FINANCIAL INFORMATION

Item 1 Financial Statements

 

Consolidated Balance Sheets

 

 

 

 

 

 

 

 

 

(unaudited)

 

 

 

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

June 30

 

December 31

 

2015

 

2014

Assets

 

 

 

 

 

Cash and due from banks

$

17,649 

 

$

14,258 

Interest-bearing deposits in other banks

 

46,754 

 

 

34,335 

Total cash and cash equivalents

 

64,403 

 

 

48,593 

Investment securities available for sale, at fair value

 

176,424 

 

 

171,751 

Restricted stock

 

439 

 

 

438 

Loans held for sale

 

1,755 

 

 

389 

Loans

 

733,212 

 

 

726,531 

Allowance for loan losses

 

(9,450)

 

 

(9,111)

Net Loans

 

723,762 

 

 

717,420 

Premises and equipment, net

 

14,531 

 

 

15,046 

Bank owned life insurance

 

22,377 

 

 

22,098 

Goodwill

 

9,016 

 

 

9,016 

Other intangible assets

 

 -

 

 

181 

Other real estate owned

 

4,018 

 

 

3,666 

Deferred tax asset, net

 

4,690 

 

 

4,328 

Other assets

 

7,124 

 

 

8,522 

Total assets

$

1,028,539 

 

$

1,001,448 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Deposits

 

 

 

 

 

Noninterest-bearing checking

$

143,564 

 

$

136,910 

Money management, savings and interest checking

 

680,424 

 

 

645,672 

Time

 

92,071 

 

 

98,599 

Total Deposits

 

916,059 

 

 

881,181 

Repurchase Agreements

 

 -

 

 

9,079 

Other liabilities

 

5,302 

 

 

7,667 

Total liabilities

 

921,361 

 

 

897,927 

 

 

 

 

 

 

Shareholders' equity

 

 

 

 

 

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

 

 

 

 

 

4,625,071 shares issued and 4,241,355 shares outstanding at June 30, 2015 and

 

 

 

 

 

4,606,564 shares issued and 4,218,330 shares outstanding at December 31, 2014

 

4,625 

 

 

4,607 

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

 

 

 

 

 

shares issued and outstanding

 

 -

 

 

 -

Additional paid-in capital

 

37,926 

 

 

37,504 

Retained earnings

 

75,288 

 

 

71,452 

Accumulated other comprehensive loss

 

(3,800)

 

 

(3,100)

Treasury stock, 383,716 shares at June 30, 2015 and 388,234 shares at

 

 

 

 

 

December 31, 2014, at cost

 

(6,861)

 

 

(6,942)

Total shareholders' equity

 

107,178 

 

 

103,521 

Total liabilities and shareholders' equity

$

1,028,539 

 

$

1,001,448 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

1

 


 

Consolidated Statements of Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended

 

For the Six Months Ended

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

June 30

 

June 30

 

2015

 

2014

 

2015

 

2014

Interest income

 

 

 

 

 

 

 

 

 

 

 

   Loans, including fees

$

7,477 

 

$

7,648 

 

$

14,853 

 

$

15,159 

Interest and dividends on investments:

 

 

 

 

 

 

 

 

 

 

 

Taxable interest

 

613 

 

 

661 

 

 

1,248 

 

 

1,302 

Tax exempt interest

 

408 

 

 

376 

 

 

817 

 

 

734 

Dividend income

 

 

 

31 

 

 

60 

 

 

56 

Deposits and obligations of other banks

 

72 

 

 

45 

 

 

127 

 

 

84 

Total interest income

 

8,578 

 

 

8,761 

 

 

17,105 

 

 

17,335 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

619 

 

 

694 

 

 

1,260 

 

 

1,396 

Securities sold under agreements to repurchase

 

 -

 

 

 

 

 -

 

 

Long-term debt

 

 -

 

 

121 

 

 

 -

 

 

242 

Total interest expense

 

619 

 

 

817 

 

 

1,260 

 

 

1,647 

Net interest income

 

7,959 

 

 

7,944 

 

 

15,845 

 

 

15,688 

Provision for loan losses

 

310 

 

 

266 

 

 

635 

 

 

464 

Net interest income after provision for loan losses

 

7,649 

 

 

7,678 

 

 

15,210 

 

 

15,224 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest income

 

 

 

 

 

 

 

 

 

 

 

Investment and trust services fees

 

1,388 

 

 

1,101 

 

 

2,651 

 

 

2,192 

Loan service charges

 

297 

 

 

250 

 

 

471 

 

 

418 

Mortgage banking activities

 

17 

 

 

19 

 

 

25 

 

 

32 

Deposit service charges and fees

 

586 

 

 

525 

 

 

1,077 

 

 

990 

Other service charges and fees

 

311 

 

 

317 

 

 

607 

 

 

584 

Debit card income

 

356 

 

 

337 

 

 

675 

 

 

643 

Increase in cash surrender value of life insurance

 

140 

 

 

144 

 

 

279 

 

 

286 

Other real estate owned (losses) gains, net

 

 -

 

 

(62)

 

 

32 

 

 

(185)

Other

 

13 

 

 

10 

 

 

237 

 

 

62 

OTTI losses recognized in earnings

 

 -

 

 

 -

 

 

(20)

 

 

 -

Gain on conversion

 

 -

 

 

 -

 

 

728 

 

 

 -

Securities gains, net

 

 

 

221 

 

 

 

 

221 

Total noninterest income

 

3,116 

 

 

2,862 

 

 

6,770 

 

 

5,243 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest expense

 

 

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

4,203 

 

 

4,107 

 

 

8,286 

 

 

8,357 

Net occupancy expense

 

556 

 

 

586 

 

 

1,172 

 

 

1,262 

Furniture and equipment expense

 

239 

 

 

237 

 

 

470 

 

 

491 

Advertising

 

283 

 

 

270 

 

 

471 

 

 

586 

Legal and professional fees

 

203 

 

 

353 

 

 

499 

 

 

618 

Data processing

 

556 

 

 

493 

 

 

1,023 

 

 

884 

Pennsylvania bank shares tax

 

206 

 

 

173 

 

 

402 

 

 

347 

Intangible amortization

 

90 

 

 

104 

 

 

181 

 

 

207 

FDIC insurance

 

160 

 

 

222 

 

 

308 

 

 

454 

ATM/debit card processing

 

186 

 

 

178 

 

 

373 

 

 

357 

Other

 

977 

 

 

892 

 

 

1,965 

 

 

1,741 

Total noninterest expense

 

7,659 

 

 

7,615 

 

 

15,150 

 

 

15,304 

Income before federal income taxes

 

3,106 

 

 

2,925 

 

 

6,830 

 

 

5,163 

Federal income tax expense

 

632 

 

 

606 

 

 

1,472 

 

 

1,018 

Net income

$

2,474 

 

$

2,319 

 

$

5,358 

 

$

4,145 

 

 

 

 

 

 

 

 

 

 

 

 

Per share

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

$

0.58 

 

$

0.55 

 

$

1.27 

 

$

0.99 

Diluted earnings per share

$

0.58 

 

$

0.55 

 

$

1.26 

 

$

0.99 

Cash dividends declared

$

0.19 

 

$

0.17 

 

$

0.36 

 

$

0.34 

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 Six Months Ended

 

 

June 30

 

June 30

(Dollars in thousands) (unaudited)

 

2015

 

2014

 

2015

 

2014

Net Income

 

$

2,474 

 

$

2,319 

 

$

5,358 

 

$

4,145 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities:

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized (losses) gains arising during the period

 

 

(1,239)

 

 

774 

 

 

(536)

 

 

2,194 

Reclassification adjustment for gains included in net income (1)

 

 

(8)

 

 

(221)

 

 

(716)

 

 

(221)

Net unrealized (losses) gains

 

 

(1,247)

 

 

553 

 

 

(1,252)

 

 

1,973 

Tax effect

 

 

424 

 

 

(188)

 

 

426 

 

 

(671)

Net of tax amount

 

 

(823)

 

 

365 

 

 

(826)

 

 

1,302 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives:

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gains (losses) arising during the period

 

 

32 

 

 

(4)

 

 

31 

 

 

(12)

Reclassification adjustment for losses included in net income (2)

 

 

64 

 

 

94 

 

 

160 

 

 

189 

Net unrealized gains

 

 

96 

 

 

90 

 

 

191 

 

 

177 

Tax effect

 

 

(32)

 

 

(30)

 

 

(65)

 

 

(60)

Net of tax amount

 

 

64 

 

 

60 

 

 

126 

 

 

117 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total other comprehensive (loss) income

 

 

(759)

 

 

425 

 

 

(700)

 

 

1,419 

Total Comprehensive Income

 

$

1,715 

 

$

2,744 

 

$

4,658 

 

$

5,564 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reclassification adjustment / Statement line item

 

Tax  expense (benefit)

 

Tax  expense (benefit)

(1) Securities / gain on conversion & securities (gains) losses, net

 

$

 

$

75 

 

$

243 

 

$

75 

(2) Derivatives / interest expense on deposits

 

 

(22)

 

 

(32)

 

 

(54)

 

 

(64)

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

3

 


 

 

 

 

 

Consolidated Statements of Changes in Shareholders' Equity

For the Six months June 30, 2015 and 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 December 31, 2013

$

4,561 

 

$

36,636 

 

$

65,897 

 

$

(4,696)

 

$

(7,010)

 

$

95,388 

Net income

 

-

 

 

-

 

 

4,145 

 

 

 -

 

 

 -

 

 

4,145 

Other comprehensive income

 

 -

 

 

 -

 

 

 -

 

 

1,419 

 

 

 -

 

 

1,419 

Cash dividends declared, $.34 per share

 

-

 

 

-

 

 

(1,419)

 

 

 -

 

 

 -

 

 

(1,419)

Treasury shares issued under stock option plans, 3,476 shares

 

-

 

 

(10)

 

 

 -

 

 

 -

 

 

62 

 

 

52 

Common stock issued under dividend reinvestment plan, 20,642 shares

 

20 

 

 

354 

 

 

-

 

 

 -

 

 

 -

 

 

374 

Balance at June 30, 2014

$

4,581 

 

$

36,980 

 

$

68,623 

 

$

(3,277)

 

$

(6,948)

 

$

99,959 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2014

$

4,607 

 

$

37,504 

 

$

71,452 

 

$

(3,100)

 

$

(6,942)

 

$

103,521 

Net income

 

-

 

 

-

 

 

5,358 

 

 

-

 

 

-

 

 

5,358 

Other comprehensive loss

 

 -

 

 

 -

 

 

 -

 

 

(700)

 

 

 -

 

 

(700)

Cash dividends declared, $.36 per share

 

-

 

 

-

 

 

(1,522)

 

 

-

 

 

-

 

 

(1,522)

Treasury shares issued under stock option plans, 4,518 shares

 

-

 

 

 

 

 -

 

 

 -

 

 

81 

 

 

86 

Common stock issued under dividend reinvestment plan, 18,507 shares

 

18 

 

 

417 

 

 

-

 

 

-

 

 

-

 

 

435 

Balance at June 30, 2015

$

4,625 

 

$

37,926 

 

$

75,288 

 

$

(3,800)

 

$

(6,861)

 

$

107,178 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

4

 


 

 

 

Consolidated Statements of Cash Flows

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Six Months Ended June 30

 

2015

 

2014

(Dollars in thousands) (unaudited)

 

 

 

 

 

Cash flows from operating activities

 

 

 

 

 

Net income

$

5,358 

 

$

4,145 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

675 

 

 

732 

Net amortization of loans and investment securities

 

796 

 

 

893 

Amortization and net change in mortgage servicing rights valuation

 

 

 

Amortization of intangibles

 

181 

 

 

207 

Provision for loan losses

 

635 

 

 

464 

Net realized gains on sales of securities

 

(8)

 

 

(221)

Impairment writedown on securities recognized in earnings

 

20 

 

 

 -

Gain on conversion

 

(728)

 

 

 -

Loans originated for sale

 

(3,812)

 

 

(3,554)

Proceeds from sale of loans

 

2,446 

 

 

3,303 

Writedown on premises and equipment

 

60 

 

 

 -

Writedown of other real estate owned

 

 -

 

 

200 

Net gain on sale or disposal of other real estate/other repossessed assets

 

(32)

 

 

(15)

Increase in cash surrender value of life insurance

 

(279)

 

 

(286)

Decrease (increase) in other assets

 

1,380 

 

 

(118)

(Decrease) increase in other liabilities

 

(2,195)

 

 

613 

Net cash provided by operating activities

 

4,506 

 

 

6,371 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

Proceeds from sales and calls of investment securities available for sale

 

1,381 

 

 

1,582 

Proceeds from maturities and paydowns of securities available for sale

 

14,132 

 

 

12,313 

Purchase of investment securities available for sale

 

(21,689)

 

 

(28,362)

Net increase in restricted stock

 

(1)

 

 

(32)

Net increase in loans

 

(7,256)

 

 

(10,012)

Capital expenditures

 

(190)

 

 

(321)

Proceeds from sale of other real estate/other repossessed assets

 

129 

 

 

493 

Net cash used in investing activities

 

(13,494)

 

 

(24,339)

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

Net increase in demand deposits, NOW, and savings accounts

 

41,406 

 

 

63,087 

Net decrease in time deposits

 

(6,528)

 

 

(8,107)

Net decrease in repurchase agreements

 

(9,079)

 

 

(21,570)

Long-term debt payments

 

 -

 

 

(403)

Dividends paid

 

(1,522)

 

 

(1,419)

Treasury stock issued under stock option plans

 

86 

 

 

52 

Common stock issued under dividend reinvestment plan

 

435 

 

 

374 

Net cash provided by financing activities

 

24,798 

 

 

32,014 

 

 

 

 

 

 

Increase in cash and cash equivalents

 

15,810 

 

 

14,046 

Cash and cash equivalents as of January 1

 

48,593 

 

 

40,745 

Cash and cash equivalents as of June 30

$

64,403 

 

$

54,791 

 

 

 

 

 

 

Supplemental Disclosures of Cash Flow Information

 

 

 

 

 

Cash paid during the year for:

 

 

 

 

 

Interest on deposits and other borrowed funds

$

1,304 

 

$

1,670 

Income taxes

$

1,513 

 

$

236 

 

 

 

 

 

 

Noncash Activities

 

 

 

 

 

Loans transferred to Other Real Estate

$

449 

 

$

82 

 

 

 

 

 

 

The accompanying notes are an integral part of these 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 June  30, 2015, 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 2014 Annual Report on Form 10-K.  The consolidated results of operations for the period ended June 30, 2015 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, 2014 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 Six Months Ended

 

June 30

 

June 30

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

2015

 

2014

 

2015

 

2014

Weighted average shares outstanding (basic)

 

4,234 

 

 

4,184 

 

 

4,228 

 

 

4,178 

Impact of common stock equivalents

 

11 

 

 

 

 

 

 

Weighted average shares outstanding (diluted)

 

4,245 

 

 

4,191 

 

 

4,236 

 

 

4,184 

Anti-dilutive options excluded from calculation

 

13 

 

 

34 

 

 

28 

 

 

37 

Net income

$

2,474 

 

$

2,319 

 

$

5,358 

 

$

4,145 

Basic earnings per share

$

0.58 

 

$

0.55 

 

$

1.27 

 

$

0.99 

Diluted earnings per share

$

0.58 

 

$

0.55 

 

$

1.26 

 

$

0.99 

 

 

 

 

 

 

Note 2. Recent Accounting Pronouncements

Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement . ASU 2015-05 “Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, revises the scope of Subtopic 350-40 to include internal-use software accessed through a hosting arrangement (e.g., cloud computing, software as a service, etc.) only if both of the following criteria are met: (1) the customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty (there is no significant penalty if the customer has the ability to take delivery of the software without incurring significant cost and the ability to use the software separately without significant loss of utility or value); and (2) it is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software.  If both of the criteria are present in a hosting arrangement, then the arrangement contains a software license and the customer should account for that element in accordance with Subtopic 350-40 (i.e., expense fees as incurred).  The ASU is effective for public business entities for fiscal years beginning after

6

 


 

December 15, 2015, and interim periods within those fiscal years.  For all other entities, the ASU is effective for fiscal years beginning after December 15, 2015, and interim periods within fiscal year beginning after December 15, 2016.  Early adoption is permitted.  An entity can elect to adopt the amendments either (1) prospectively to all arrangements entered into or materially modified after the effective date, or (2) retrospectively.  The Corporation does not believe ASU 350-40 will have a material effect on its financial statements.

Receivables (Topic 310): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans Upon Foreclosure. ASU 2014-04 “Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans Upon Foreclosure” clarifies that a creditor is considered to have physical possession of residential real estate that is collateral for a residential mortgage loan when it obtains legal title to the collateral or a deed in lieu of foreclosure or similar legal agreement is completed.  Consequently, it should reclassify the loan to other real estate owned at that time.  ASU 2014-04 applies to all creditors who obtain physical possession resulting from an in substance repossession or foreclosure of residential real estate property collateralizing a consumer mortgage loan in satisfaction of a receivable.  The ASU does not apply to commercial real estate loans, as the foreclosure process and applicable laws for those assets are significantly different from residential real estate.  The ASU is effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014.  ASU 2014-04 did not have a material effect on the Corporation’s financial statements.

Revenue from Contracts with Customers (Topic 606). The amendments in this Update (ASU 2014-09) establish a comprehensive revenue recognition standard for virtually all industries under U.S. GAAP, including those that previously followed industry-specific guidance such as the real estate, construction and software industries. 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. The ASU is effective for public entities for annual periods beginning after December 15, 2016, including interim periods therein. Three basic transition methods are available – full retrospective, retrospective with certain practical expedients, and a cumulative effect approach. Under the third alternative, an entity would apply the new revenue standard only to contracts that are incomplete under legacy U.S. GAAP at the date of initial application (e.g. January 1, 2017) and recognize the cumulative effect of the new standard as an adjustment to the opening balance of retained earnings. That is, prior years would not be restated and additional disclosures would be required to enable users of the financial statements to understand the impact of adopting the new standard in the current year compared to prior years that are presented under legacy U.S. GAAP. Early adoption is prohibited under U.S. GAAP. The Corporation does not believe ASU 2014-09 will have a material effect on its financial statements. 

 

Note 3. Accumulated Other Comprehensive Loss

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30

 

December 31

 

2015

 

2014

(Dollars in thousands)

 

 

 

 

 

Net unrealized gains on securities

$

1,100 

 

$

2,352 

Tax effect

 

(374)

 

 

(800)

Net of tax amount

 

726 

 

 

1,552 

 

 

 

 

 

 

Net unrealized losses on derivatives

 

 -

 

 

(191)

Tax effect

 

 -

 

 

65 

Net of tax amount

 

 -

 

 

(126)

 

 

 

 

 

 

Accumulated pension adjustment

 

(6,858)

 

 

(6,858)

Tax effect

 

2,332 

 

 

2,332 

Net of tax amount

 

(4,526)

 

 

(4,526)

 

 

 

 

 

 

Total accumulated other comprehensive loss

$

(3,800)

 

$

(3,100)

 

 

 

7

 


 

Note 4. Guarantees

The Corporation does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit.  Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party.  Generally, all letters of credit, when issued, have expiration dates within one year.  The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers. The Bank generally holds collateral and/or personal guarantees supporting these commitments.  The Bank had $26.0 million and $22.7 million of standby letters of credit as of June  30, 2015 and December 31, 2014, respectively. Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payments required under the corresponding guarantees.  The amount of the liability as of June  30, 2015 and December 31, 2014 for guarantees under standby letters of credit issued was not material.

 

Note 5. Investments

The amortized cost and estimated fair value of investment securities available for sale as of June  30, 2015 and December 31, 2014 are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 

 

 

Amortized

 

unrealized

 

unrealized

 

Fair

June 30, 2015

 

cost

 

gains

 

losses

 

value

Equity securities

 

$

164 

 

$

78 

 

$

 -

 

$

242 

U.S. Government agency securities

 

 

16,245 

 

 

168 

 

 

(29)

 

 

16,384 

Municipal securities

 

 

71,277 

 

 

1,459 

 

 

(604)

 

 

72,132 

Trust preferred securities

 

 

5,949 

 

 

 -

 

 

(621)

 

 

5,328 

Agency mortgage-backed securities

 

 

80,145 

 

 

917 

 

 

(323)

 

 

80,739 

Private-label mortgage-backed securities

 

 

1,502 

 

 

58 

 

 

 -

 

 

1,560 

Asset-backed securities

 

 

42 

 

 

 -

 

 

(3)

 

 

39 

 

 

$

175,324 

 

$

2,680 

 

$

(1,580)

 

$

176,424 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 

 

 

Amortized

 

unrealized

 

unrealized

 

Fair

December 31, 2014

 

cost

 

gains

 

losses

 

value

Equity securities

 

$

274 

 

$

779 

 

$

 -

 

$

1,053 

U.S. Government and Agency securities

 

 

15,854 

 

 

173 

 

 

(64)

 

 

15,963 

Municipal securities

 

 

66,832 

 

 

1,826 

 

 

(292)

 

 

68,366 

Trust preferred securities

 

 

5,940 

 

 

 -

 

 

(803)

 

 

5,137 

Agency mortgage-backed securities

 

 

78,779 

 

 

932 

 

 

(217)

 

 

79,494 

Private-label mortgage-backed securities

 

 

1,675 

 

 

35 

 

 

(15)

 

 

1,695 

Asset-backed securities

 

 

45 

 

 

 -

 

 

(2)

 

 

43 

 

 

$

169,399 

 

$

3,745 

 

$

(1,393)

 

$

171,751 

 

At June  30, 2015 and December 31, 2014, the fair value of investment securities pledged to secure public funds, trust balances, repurchase agreements, deposit and other obligations totaled $69.3 million and $91.6 million, respectively.

8

 


 

The amortized cost and estimated fair value of debt securities at June  30, 2015, 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

$

4,570 

 

$

4,609 

Due after one year through five years

 

10,483 

 

 

10,680 

Due after five years through ten years

 

32,927 

 

 

33,512 

Due after ten years

 

45,533 

 

 

45,082 

 

 

93,513 

 

 

93,883 

Mortgage-backed securities

 

81,647 

 

 

82,299 

 

$

175,160 

 

$

176,182 

 

The following table provides additional detail about trust preferred securities as of June  30, 2015:

Trust Preferred Securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deal Name

 

Maturity

 

Single Issuer or Pooled

 

Class

 

Amortized Cost

 

Fair Value

 

Gross Unrealized Gain (Loss)

 

Lowest Credit Rating Assigned

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BankAmerica Cap III

 

1/15/2027

 

Single

 

Preferred Stock

 

$

964 

 

$

906 

 

$

(58)

 

BB

Wachovia Cap Trust II

 

1/15/2027

 

Single

 

Preferred Stock

 

 

277 

 

 

261 

 

 

(16)

 

BBB

Huntington Cap Trust

 

2/1/2027

 

Single

 

Preferred Stock

 

 

941 

 

 

816 

 

 

(125)

 

BB

Corestates Captl Tr II

 

2/15/2027

 

Single

 

Preferred Stock

 

 

937 

 

 

871 

 

 

(66)

 

BBB+

Huntington Cap Trust II

 

6/15/2028

 

Single

 

Preferred Stock

 

 

892 

 

 

790 

 

 

(102)

 

BB

Chase Cap VI JPM

 

8/1/2028

 

Single

 

Preferred Stock

 

 

963 

 

 

850 

 

 

(113)

 

BBB-

Fleet Cap Tr V

 

12/18/2028

 

Single

 

Preferred Stock

 

 

975 

 

 

834 

 

 

(141)

 

BB

 

 

 

 

 

 

 

 

$

5,949 

 

$

5,328 

 

$

(621)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The following table provides additional detail about private label mortgage-backed securities as of June  30, 2015:

Private Label Mortgage Backed Securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

Gross 

 

 

 

 

 

 

 

Cumulative

 

 

Origination

 

Amortized

 

Fair

 

Unrealized

 

Collateral

 

Lowest Credit

 

Credit

 

OTTI

Description

 

Date

 

Cost

 

Value

 

Gain (Loss)

 

Type

 

Rating Assigned

 

Support %

 

Charges

RALI 2004-QS4 A7

 

3/1/2004

 

$

43 

 

$

43 

 

$

 -

 

ALT A

 

BBB+

 

11.84 

 

$

 -

MALT 2004-6 7A1

 

6/1/2004

 

 

385 

 

 

393 

 

 

 

ALT A

 

CCC

 

14.11 

 

 

 -

RALI 2005-QS2 A1

 

2/1/2005

 

 

236 

 

 

251 

 

 

15 

 

ALT A

 

CC

 

5.20 

 

 

10 

RALI 2006-QS4 A2

 

4/1/2006

 

 

502 

 

 

523 

 

 

21 

 

ALT A

 

D

 

 -

 

 

313 

GSR 2006-5F 2A1

 

5/1/2006

 

 

72 

 

 

80 

 

 

 

Prime

 

D

 

 -

 

 

15 

RALI 2006-QS8 A1

 

7/28/2006

 

 

264 

 

 

270 

 

 

 

ALT A

 

D

 

 -

 

 

217 

 

 

 

 

$

1,502 

 

$

1,560 

 

$

58 

 

 

 

 

 

 

 

$

555 

 

 

Impairment:

The investment portfolio contained 91 securities with $59.9 million of temporarily impaired fair value and $1.6 million in unrealized losses at June 30, 2015. The total unrealized loss position has increased slightly from $1.4 million at year-end 2014. 

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

9

 


 

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. Equity securities are assessed for other-than-temporary impairment based on the length of time of impairment, dollar amount of the impairment and general market and financial conditions relating to specific issues.  The impairment identified on debt and equity securities and subject to assessment at June 30, 2015, 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 investment portfolio (excluding restricted stock), 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 June  30, 2015 and December 31, 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2015

 

 

 

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

$

1,498 

 

$

(7)

 

 

$

4,617 

 

$

(22)

 

10 

 

$

6,115 

 

$

(29)

 

13 

Municipal securities

 

20,359 

 

 

(386)

 

33 

 

 

4,775 

 

 

(218)

 

 

 

25,134 

 

 

(604)

 

40 

Trust preferred securities

 

 -

 

 

 -

 

 -

 

 

5,328 

 

 

(621)

 

 

 

5,328 

 

 

(621)

 

Agency mortgage-backed securities

 

18,002 

 

 

(179)

 

22 

 

 

5,346 

 

 

(144)

 

 

 

23,348 

 

 

(323)

 

30 

Asset-backed securities

 

 -

 

 

 -

 

 -

 

 

 

 

(3)

 

 

 

 

 

(3)

 

Total temporarily impaired securities

$

39,859 

 

$

(572)

 

58 

 

$

20,070 

 

$

(1,008)

 

33 

 

$

59,929 

 

$

(1,580)

 

91 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2014

 

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

 

 

 

 -

 

 

 

7,207 

 

 

(64)

 

14 

 

 

7,211 

 

 

(64)

 

15 

Municipal securities

 

5,651 

 

 

(33)

 

 

 

9,441 

 

 

(259)

 

14 

 

 

15,092 

 

 

(292)

 

23 

Trust preferred securities

 

 -

 

 

 -

 

 -

 

 

5,137 

 

 

(803)

 

 

 

5,137 

 

 

(803)

 

Agency mortgage-backed securities

 

9,304 

 

 

(60)

 

13 

 

 

8,199 

 

 

(157)

 

10 

 

 

17,503 

 

 

(217)

 

23 

Private-label mortgage-backed securities

 

 -

 

 

 -

 

 -

 

 

540 

 

 

(15)

 

 

 

540 

 

 

(15)

 

Asset-backed securities

 

 -

 

 

 -

 

 -

 

 

 

 

(2)

 

 

 

 

 

(2)

 

Total temporarily impaired securities

$

14,959 

 

$

(93)

 

23 

 

$

30,529 

 

$

(1,300)

 

47 

 

$

45,488 

 

$

(1,393)

 

70 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The municipal bond portfolio has an unrealized loss of $604 thousand at June 30, 2015 compared to $292 thousand at year-end 2014.  This number of securities in this portfolio with an unrealized loss increased from 23 to 40 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 7 securities with a fair value of $5.3 million and an unrealized loss of $621 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 June 30, 2015, 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. 

The PLMBS sector shows a net unrealized gain $58 thousand with all bonds showing an unrealized gain.  Even though there is no unrealized loss, due to the nature of these bonds, they are evaluated closely. These bonds were all rated AAA at time of purchase, but have since experienced rating declines. Some have experienced increased delinquencies and defaults, while others have seen the credit support increase as the bonds paid-down. The Bank monitors the performance of the PLMBS investments on a regular basis and reviews delinquencies, default rates, credit support levels and various cash flow stress test scenarios. In determining the credit related loss, Management considers all principal past due 60 days or more as a loss. If additional principal moves beyond 60 days past due, it will also be considered a loss. As a result of the analysis on PLMBS it was determined that a $20 thousand impairment charge was required at the end of the first

10

 


 

quarter; however, no additional impairment charge was required at June 30, 2015.   It is primarily a result of the cumulative OTTI charges that these bonds are showing an unrealized gain at quarter end.  The Bank has recorded $555 thousand of cumulative impairment charges on this portfolio. Management continues to monitor these securities and it is possible that additional write-downs may occur if current loss trends continue. The Bank is currently participating in a class-action lawsuit against one PLMBS servicer that centers on defective warranties and representations made as part of the underwriting process. The following table represents the cumulative credit losses on securities recognized in earnings as of June 30, 2015 and 2014.

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

Six Months Ended

 

2015

 

2014

Balance of cumulative credit-related OTTI at January 1

$

535 

 

$

515 

Additions for credit-related OTTI not previously recognized

 

20 

 

 

 -

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

 

 -

 

 

 -

Reduction for increases in cash flows expected to be collected

 

 -

 

 

 -

Balance of credit-related OTTI at June 30

$

555 

 

$

515 

 

 

 

 

 

 

 

The Bank held $439 thousand of restricted stock at June 30, 2015.  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. 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.   

 

 

11

 


 

Note 6. 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. 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change

(Dollars in thousands)

June 30, 2015

 

December 31, 2014

 

 

Amount

 

%

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

Consumer first liens

$

103,852 

 

$

105,014 

 

$

(1,162)

 

(1.1)

Consumer junior liens and lines of credit

 

39,915 

 

 

38,132 

 

 

1,783 

 

4.7 

Total consumer

 

143,767 

 

 

143,146 

 

 

621 

 

0.4 

 

 

 

 

 

 

 

 

 

 

 

Commercial first lien

 

60,438 

 

 

56,300 

 

 

4,138 

 

7.3 

Commercial junior liens and lines of credit

 

5,637 

 

 

5,663 

 

 

(26)

 

(0.5)

Total commercial

 

66,075 

 

 

61,963 

 

 

4,112 

 

6.6 

Total residential real estate 1-4 family

 

209,842 

 

 

205,109 

 

 

4,733 

 

2.3 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

 

 

 

 

 

 

 

 

Consumer

 

1,736 

 

 

1,627 

 

 

109 

 

6.7 

Commercial

 

6,676 

 

 

8,088 

 

 

(1,412)

 

(17.5)

Total residential real estate construction

 

8,412 

 

 

9,715 

 

 

(1,303)

 

(13.4)

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate

 

317,329 

 

 

326,482 

 

 

(9,153)

 

(2.8)

Commercial

 

192,224 

 

 

179,071 

 

 

13,153 

 

7.3 

        Total commercial

 

509,553 

 

 

505,553 

 

 

4,000 

 

0.8 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

5,405 

 

 

6,154 

 

 

(749)

 

(12.2)

 

 

733,212 

 

 

726,531 

 

 

6,681 

 

0.9 

Less: Allowance for loan losses

 

(9,450)

 

 

(9,111)

 

 

(339)

 

(3.7)

Net Loans

$

723,762 

 

$

717,420 

 

$

6,342 

 

0.9 

 

 

 

 

 

 

 

 

 

 

 

Included in the loan balances are the following:

 

 

 

 

 

 

 

 

 

 

Net unamortized deferred loan costs

$

169 

 

$

(76)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans pledged as collateral for borrowings and commitments from:

 

 

 

 

 

 

 

 

 

 

FHLB

$

612,011 

 

$

602,633 

 

 

 

 

 

Federal Reserve Bank

 

54,844 

 

 

56,367 

 

 

 

 

 

 

$

666,855 

 

$

659,000 

 

 

 

 

 

 

 

 

 

 

 

12

 


 

Note 7. Loan Quality

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Junior Liens &

 

 

 

 

Commercial

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

First Liens

 

Lines of Credit

 

Construction

 

Real Estate

 

Commercial

 

Consumer

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance at March 31, 2015

 

$

1,260 

 

$

334 

 

$

263 

 

$

5,600 

 

$

1,628 

 

$

125 

 

$

9,210 

Charge-offs

 

 

(43)

 

 

 -

 

 

(21)

 

 

 -

 

 

(17)

 

 

(26)

 

 

(107)

Recoveries

 

 

 

 

 -

 

 

 -

 

 

14 

 

 

 

 

14 

 

 

37 

Provision

 

 

75 

 

 

25 

 

 

(22)

 

 

72 

 

 

152 

 

 

 

 

310 

Allowance at June 30, 2015

 

$

1,293 

 

$

359 

 

$

220 

 

$

5,686 

 

$

1,771 

 

$

121 

 

$

9,450 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance at December 31, 2014

 

$

1,225 

 

$

334 

 

$

226 

 

$

5,417 

 

$

1,773 

 

$

136 

 

$

9,111 

Charge-offs

 

 

(43)

 

 

 -

 

 

(21)

 

 

 -

 

 

(218)

 

 

(78)

 

 

(360)

Recoveries

 

 

 

 

 -

 

 

 -

 

 

14 

 

 

14 

 

 

33 

 

 

64 

Provision

 

 

108 

 

 

25 

 

 

15 

 

 

255 

 

 

202 

 

 

30 

 

 

635 

Allowance at June 30, 2015

 

$

1,293 

 

$

359 

 

$

220 

 

$

5,686 

 

$

1,771 

 

$

121 

 

$

9,450 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance at March 31, 2014

 

$

1,133 

 

$

276 

 

$

374 

 

$

5,509 

 

$

2,309 

 

$

144 

 

$

9,745 

Charge-offs

 

 

(241)

 

 

 -

 

 

 -

 

 

(234)

 

 

(11)

 

 

(37)

 

 

(523)

Recoveries

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

13 

 

 

18 

 

 

31 

Provision

 

 

187 

 

 

(10)

 

 

(113)

 

 

137 

 

 

55 

 

 

10 

 

 

266 

Allowance at June 30, 2014

 

$

1,079 

 

$

266 

 

$

261 

 

$

5,412 

 

$

2,366 

 

$

135 

 

$

9,519 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance at December 31, 2013

 

$

1,108 

 

$

278 

 

$

291 

 

$

5,571 

 

$

2,306 

 

$

148 

 

$

9,702 

Charge-offs

 

 

(257)

 

 

 -

 

 

(27)

 

 

(348)

 

 

(12)

 

 

(80)

 

 

(724)

Recoveries

 

 

 

 

 -

 

 

 -

 

 

 -

 

 

33 

 

 

41 

 

 

77 

Provision

 

 

225 

 

 

(12)

 

 

(3)

 

 

189 

 

 

39 

 

 

26 

 

 

464 

Allowance at June 30, 2014

 

$

1,079 

 

$

266 

 

$

261 

 

$

5,412 

 

$

2,366 

 

$

135 

 

$

9,519 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

13

 


 

 

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 June  30, 2015 and December 31, 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Junior Liens &

 

 

 

 

Commercial

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

First Liens

 

Lines of Credit

 

Construction

 

Real Estate

 

Commercial

 

Consumer

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for allowance:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

1,083 

 

$

51 

 

$

513 

 

$

21,512 

 

$

237 

 

$

 -

 

$

23,396 

Collectively

 

 

163,207 

 

 

45,501 

 

 

7,899 

 

 

295,817 

 

 

191,987 

 

 

5,405 

 

 

709,816 

Total

 

$

164,290 

 

$

45,552 

 

$

8,412 

 

$

317,329 

 

$

192,224 

 

$

5,405 

 

$

733,212 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance established for loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 -

 

$

 -

 

$

 -

 

$

 

$

 

$

 -

 

$

10 

Collectively

 

 

1,293 

 

 

359 

 

 

220 

 

 

5,684 

 

 

1,763 

 

 

121 

 

 

9,440 

Allowance at June 30, 2015

 

$

1,293 

 

$

359 

 

$

220 

 

$

5,686 

 

$

1,771 

 

$

121 

 

$

9,450 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for allowance:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

1,171 

 

$

51 

 

$

931 

 

$

22,307 

 

$

1,298 

 

$

 -

 

$

25,758 

Collectively

 

 

160,143 

 

 

43,744 

 

 

8,784 

 

 

304,175 

 

 

177,773 

 

 

6,154 

 

 

700,773 

Total

 

$

161,314 

 

$

43,795 

 

$

9,715 

 

$

326,482 

 

$

179,071 

 

$

6,154 

 

$

726,531 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance established for loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 -

 

$

 -

 

$

 -

 

$

60 

 

$

171 

 

$

 -

 

$

231 

Collectively

 

 

1,225 

 

 

334 

 

 

226 

 

 

5,357 

 

 

1,602 

 

 

136 

 

 

8,880 

Allowance at December 31, 2014

 

$

1,225 

 

$

334 

 

$

226 

 

$

5,417 

 

$

1,773 

 

$

136 

 

$

9,111 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

14

 


 

The following table shows additional information about those loans considered to be impaired at June  30, 2015 and December 31, 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Impaired Loans

 

 

With No Allowance

 

With Allowance

(Dollars in thousands)

 

 

 

 

Unpaid

 

 

 

 

 

Unpaid

 

 

 

 

 

Recorded

 

Principal

 

Recorded

 

Principal

 

Related

June 30, 2015

 

Investment

 

Balance

 

Investment

 

Balance

 

Allowance

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

1,601 

 

$

1,778 

 

$

 -

 

$

 -

 

$

 -

Junior liens and lines of credit

 

 

117 

 

 

144 

 

 

 -

 

 

 -

 

 

 -

Total

 

 

1,718 

 

 

1,922 

 

 

 -

 

 

 -

 

 

 -

 Residential real estate - construction

 

 

513 

 

 

551 

 

 

 -

 

 

 -

 

 

 -

 Commercial real estate

 

 

21,317 

 

 

25,297 

 

 

195 

 

 

278 

 

 

 Commercial

 

 

337 

 

 

397 

 

 

 

 

10 

 

 

Total

 

$

23,885 

 

$

28,167 

 

$

204 

 

$

288 

 

$

10 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

1,804 

 

$

2,002 

 

$

 -

 

$

 -

 

$

 -

Junior liens and lines of credit

 

 

169 

 

 

195 

 

 

 -

 

 

 -

 

 

 -

Total

 

 

1,973 

 

 

2,197 

 

 

 -

 

 

 -

 

 

 -

 Residential real estate - construction

 

 

931 

 

 

977 

 

 

 -

 

 

 -

 

 

 -

 Commercial real estate

 

 

21,487 

 

 

25,744 

 

 

862 

 

 

1,001 

 

 

60 

 Commercial

 

 

78 

 

 

80 

 

 

1,274 

 

 

1,990 

 

 

171 

Total

 

$

24,469 

 

$

28,998 

 

$

2,136 

 

$

2,991 

 

$

231 

 

 

15

 


 

The following table shows the average of impaired loans and related interest income for the three and six months ended June  30, 2015 and 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

June 30, 2015

 

June 30, 2015

 

Average

 

Interest

 

Average

 

Interest

(Dollars in thousands)

Recorded

 

Income

 

Recorded

 

Income

 

Investment

 

Recognized

 

Investment

 

Recognized

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

First liens

$

1,618 

 

$

 

$

1,723 

 

$

16 

Junior liens and lines of credit

 

117 

 

 

 -

 

 

131 

 

 

 -

Total

 

1,735 

 

 

 

 

1,854 

 

 

16 

 Residential real estate - construction

 

516 

 

 

 -

 

 

723 

 

 

 -

 Commercial real estate

 

21,756 

 

 

174 

 

 

21,971 

 

 

327 

 Commercial

 

361 

 

 

 -

 

 

1,012 

 

 

 -

Total

$

24,368 

 

$

183 

 

$

25,560 

 

$

343 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

June 30, 2014

 

June 30, 2014

 

Average

 

Interest

 

Average

 

Interest

(Dollars in thousands)

Recorded

 

Income

 

Recorded

 

Income

 

Investment

 

Recognized

 

Investment

 

Recognized

 Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

First liens

$

2,289 

 

$

15 

 

$

2,753 

 

$

25 

Junior liens and lines of credit

 

120 

 

 

 -

 

 

123 

 

 

 -

Total

 

2,409 

 

 

15 

 

 

2,876 

 

 

25 

 Residential real estate - construction

 

527 

 

 

 -

 

 

530 

 

 

 -

 Commercial real estate

 

22,399 

 

 

81 

 

 

24,032 

 

 

174 

 Commercial

 

2,056 

 

 

 -

 

 

2,074 

 

 

Total

$

27,391 

 

$

96 

 

$

29,512 

 

$

200 

 

 

 

 

 

 

 

 

 

 

 

 

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

June 30, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

162,515 

 

$

58 

 

$

625 

 

$

153 

 

$

836 

 

$

939 

 

$

164,290 

Junior liens and lines of credit

 

 

45,171 

 

 

167 

 

 

97 

 

 

 -

 

 

264 

 

 

117 

 

 

45,552 

Total

 

 

207,686 

 

 

225 

 

 

722 

 

 

153 

 

 

1,100 

 

 

1,056 

 

 

209,842 

Residential real estate - construction

 

 

7,106 

 

 

793 

 

 

 -

 

 

 -

 

 

793 

 

 

513 

 

 

8,412 

Commercial real estate

 

 

309,525 

 

 

367 

 

 

 -

 

 

 -

 

 

367 

 

 

7,437 

 

 

317,329 

Commercial

 

 

191,849 

 

 

29 

 

 

 -

 

 

 -

 

 

29 

 

 

346 

 

 

192,224 

Consumer

 

 

5,369 

 

 

15 

 

 

11 

 

 

10 

 

 

36 

 

 

 -

 

 

5,405 

Total

 

$

721,535 

 

$

1,429 

 

$

733 

 

$

163 

 

$

2,325 

 

$

9,352 

 

$

733,212 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

 

$

158,197 

 

$

1,531 

 

$

297 

 

$

165 

 

$

1,993 

 

$

1,124 

 

$

161,314 

Junior liens and lines of credit

 

 

43,424 

 

 

174 

 

 

28 

 

 

 -

 

 

202 

 

 

169 

 

 

43,795 

Total

 

 

201,621 

 

 

1,705 

 

 

325 

 

 

165 

 

 

2,195 

 

 

1,293 

 

 

205,109 

Residential real estate - construction

 

 

8,784 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

931 

 

 

9,715 

Commercial real estate

 

 

317,576 

 

 

336 

 

 

 -

 

 

140 

 

 

476 

 

 

8,430 

 

 

326,482 

Commercial

 

 

177,407 

 

 

12 

 

 

15 

 

 

 -

 

 

27 

 

 

1,637 

 

 

179,071 

Consumer

 

 

6,056 

 

 

59 

 

 

22 

 

 

17 

 

 

98 

 

 

 -

 

 

6,154 

Total

 

$

711,444 

 

$

2,112 

 

$

362 

 

$

322 

 

$

2,796 

 

$

12,291 

 

$

726,531 

17

 


 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

Pass

 

Special Mention

 

Substandard

 

Doubtful

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

$

158,575 

 

$

2,240 

 

$

3,475 

 

$

 -

 

$

164,290 

Junior liens and lines of credit

 

45,273 

 

 

29 

 

 

250 

 

 

 -

 

 

45,552 

Total

 

203,848 

 

 

2,269 

 

 

3,725 

 

 

 -

 

 

209,842 

Residential real estate - construction

 

7,899 

 

 

 -

 

 

513 

 

 

 -

 

 

8,412 

Commercial real estate

 

294,338 

 

 

10,732 

 

 

12,259 

 

 

 -

 

 

317,329 

Commercial

 

183,559 

 

 

7,256 

 

 

1,409 

 

 

 -

 

 

192,224 

Consumer

 

5,395 

 

 

 -

 

 

10 

 

 

 -

 

 

5,405 

Total

$

695,039 

 

$

20,257 

 

$

17,916 

 

$

 -

 

$

733,212 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First liens

$

155,676 

 

$

1,919 

 

$

3,719 

 

$

 -

 

$

161,314 

Junior liens and lines of credit

 

43,559 

 

 

29 

 

 

207 

 

 

 -

 

 

43,795 

Total

 

199,235 

 

 

1,948 

 

 

3,926 

 

 

 -

 

 

205,109 

Residential real estate - construction

 

8,784 

 

 

 -

 

 

931 

 

 

 -

 

 

9,715 

Commercial real estate

 

301,149 

 

 

10,578 

 

 

14,755 

 

 

 -

 

 

326,482 

Commercial

 

170,774 

 

 

5,413 

 

 

2,884 

 

 

 -

 

 

179,071 

Consumer

 

6,137 

 

 

 -

 

 

17 

 

 

 -

 

 

6,154 

Total

$

686,079 

 

$

17,939 

 

$

22,513 

 

$

 -

 

$

726,531 

 

18

 


 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Troubled Debt Restructurings

 

 

 

 

 

 

 

 

 

 

That Have Defaulted on

(Dollars in thousands)

 

Troubled Debt Restructurings

 

Modified Terms YTD

 

 

Number of

 

Recorded

 

 

 

 

 

 

 

Number of

 

Recorded

 

 

Contracts

 

Investment

 

Performing*

 

Nonperforming*

 

Contracts

 

Investment

June 30, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

$

513 

 

$

513 

 

$

 -

 

 -

 

$

 -

Residential real estate

 

 

 

661 

 

 

661 

 

 

 -

 

 -

 

 

 -

Commercial real estate

 

12 

 

 

15,493 

 

 

1,493 

 

 

 -

 

 -

 

 

 -

  Total

 

17 

 

$

16,667 

 

$

2,667 

 

$

 

 -

 

$

 -

 

   

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

$

521 

 

$

 -

 

$

521 

 

 -

 

$

 -

Residential real estate

 

 

 

699 

 

 

673 

 

 

26 

 

 -

 

 

 -

Commercial real estate

 

12 

 

 

15,748 

 

 

14,283 

 

 

1,465 

 

 -

 

 

 -

  Total

 

18 

 

$

16,968 

 

$

14,956 

 

$

2,012 

 

 -

 

$

 -

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

There were no new TDR loans made in the first six months of 2015 or 2014.

 

Note 8. Pension

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30

 

Six Months Ended June 30

(Dollars in thousands)

2015

 

2014

 

2015

 

2014

Components of net periodic cost:

 

 

 

 

 

 

 

 

 

 

 

Service cost

$

92 

 

$

83 

 

$

192 

 

$

169 

Interest cost

 

172 

 

 

194 

 

 

350 

 

 

391 

Expected return on plan assets

 

(296)

 

 

(291)

 

 

(592)

 

 

(581)

Recognized net actuarial loss

 

123 

 

 

81 

 

 

254 

 

 

163 

Net period cost

$

91 

 

$

67 

 

$

204 

 

$

142 

 

The Bank expects its pension expense to increase to approximately $387 thousand in 2015 compared to $276 thousand in 2014

In October, 2014, the Society of Actuaries released new mortality tables for pension plans. The new tables are expected to raise the assumed life of plan participants due to refinements in age and gender distribution of participants. This change is expected to result in higher pension contribution requirements, lower balance sheet funded status, pricier lump-sum payouts, and higher PBGC variable rate premiums. The Bank has not adopted the new mortality tables. If the tables had been adopted at year-end 2014, it is estimated that the new tables would reduce the funded status by $1.6 million and increase the 2015 pension expense by $272 thousand over the current 2015 estimate.  The Bank is still in the process of reviewing the effect of the new tables and is also watching the IRS for its decision on adoption of the new table. Therefore an adoption date for the new tables has not been determined.   

 

 

 

 

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-

19

 


 

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.

 

The following methods and assumptions were used to estimate the fair values of the Corporation’s financial instruments at June 30, 2015 and December 31, 2014.

Cash and Cash Equivalents:  For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

Investment securities:  The fair value of investment securities is determined in accordance with the methods described under FASB ASC Topic 820 as discussed below.

Restricted stock:  The carrying value of restricted stock approximates its fair value based on redemption provisions for the restricted stock.

Loans held for sale: The fair value of loans held for sale is determined by the price set between the Bank and the purchaser prior to origination. These loans are usually sold at par.

Net loans:  The fair value of fixed-rate loans is estimated for each major type of loan (e.g. real estate, commercial, industrial and agricultural and consumer) by discounting the future cash flows associated with such loans using rates currently offered for loans with similar terms to borrowers of comparable credit quality.  The model considers scheduled principal maturities, repricing characteristics, prepayment assumptions and interest cash flows.  The discount rates used are estimated based upon consideration of a number of factors including the treasury yield curve, expense and service charge factors. For variable rate loans that reprice frequently and have no significant change in credit quality, carrying values approximate the fair value.

Accrued Interest Receivable:  The carrying amount is a reasonable estimate of fair value.

Mortgage servicing rights:  The fair value of mortgage servicing rights is based on observable market prices when available or the present value of expected future cash flows when not available.  Assumptions such as loan default rates, costs to service, and prepayment speeds significantly affect the estimate of future cash flows. Mortgage servicing rights are carried at the lower of cost or fair value.

Deposits, Securities sold under agreements to repurchase and Long-term debt:  The fair value of demand deposits, savings accounts, and money market deposits is the amount payable on demand at the reporting date.  The fair value of fixed-rate certificates of deposit and long-term debt is estimated by discounting the future cash flows using rates approximating those currently offered for certificates of deposit and borrowings with similar remaining maturities.  For securities sold under agreements to repurchase, the carrying value approximates a reasonable estimate of the fair value.

20

 


 

Accrued interest payable:  The carrying amount is a reasonable estimate of fair value.

Derivatives:  The fair value of the interest rate swaps is based on other similar financial instruments and is classified as Level 2.

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. 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2015

 

Carrying

 

Fair

 

 

 

 

 

 

 

(Dollars in thousands)

Amount

 

Value

 

Level 1

 

Level 2

 

Level 3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

$

64,403 

 

$

64,403 

 

$

64,403 

 

$

 -

 

$

 -

Investment securities available for sale

 

176,424 

 

 

176,424 

 

 

242 

 

 

176,182 

 

 

 -

Restricted stock

 

439 

 

 

439 

 

 

 -

 

 

439 

 

 

 -

Loans held for sale

 

1,755 

 

 

1,755 

 

 

 -

 

 

1,755 

 

 

 -

Net loans

 

723,762 

 

 

730,507 

 

 

 -

 

 

 -

 

 

730,507 

Accrued interest receivable

 

3,068 

 

 

3,068 

 

 

 -

 

 

3,068 

 

 

 -

Mortgage servicing rights

 

133 

 

 

133 

 

 

 -

 

 

 -

 

 

133 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

$

916,059 

 

$

916,110 

 

$

 -

 

$

916,110 

 

$

 -

Accrued interest payable

 

125 

 

 

125 

 

 

 -

 

 

125 

 

 

 -

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2014

 

Carrying

 

Fair

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

Amount

 

Value

 

Level 1

 

Level 2

 

Level 3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

$

48,593 

 

$

48,593 

 

$

48,593 

 

$

 -

 

$

 -

Investment securities available for sale

 

171,751 

 

 

171,751 

 

 

1,053 

 

 

170,698 

 

 

 -

Restricted stock

 

438 

 

 

438 

 

 

 -

 

 

438 

 

 

 -

Loans held for sale

 

389 

 

 

389 

 

 

 -

 

 

389 

 

 

 -

Net loans

 

717,420 

 

 

721,680 

 

 

 -

 

 

 -

 

 

721,680 

Accrued interest receivable

 

3,038 

 

 

3,038 

 

 

 -

 

 

3,038 

 

 

 -

Mortgage servicing rights

 

143 

 

 

143 

 

 

 -

 

 

 -

 

 

143 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

$

881,181 

 

$

881,289 

 

$

 -

 

$

881,289 

 

$

 -

Securities sold under agreements to repurchase

 

9,079 

 

 

9,079 

 

 

 -

 

 

9,079 

 

 

 -

Accrued interest payable

 

169 

 

 

169 

 

 

 -

 

 

169 

 

 

 -

Interest rate swaps

 

191 

 

 

191 

 

 

 -

 

 

191 

 

 

 -

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

21

 


 

Recurring Fair Value Measurements

For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at June  30, 2015 and December 31, 2014 are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands

Fair Value at June 30, 2015

Asset  Description

Level 1

 

Level 2

 

Level 3

 

Total

Equity securities

$

242 

 

$

 -

 

$

 -

 

$

242 

U.S. Government and Agency securities

 

 -

 

 

16,384 

 

 

 -

 

 

16,384 

Municipal securities

 

 -

 

 

72,132 

 

 

 -

 

 

72,132 

Trust Preferred Securities

 

 -

 

 

5,328 

 

 

 -

 

 

5,328 

Agency mortgage-backed securities

 

 -

 

 

80,739 

 

 

 -

 

 

80,739 

Private-label mortgage-backed securities

 

 -

 

 

1,560 

 

 

 -

 

 

1,560 

Asset-backed securities

 

 -

 

 

39 

 

 

 -

 

 

39 

Total assets

$

242 

 

$

176,182 

 

$

 -

 

$

176,424 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

Fair Value at December 31, 2014

Asset  Description

Level 1

 

Level 2

 

Level 3

 

Total

Equity securities

$

1,053 

 

$

 -

 

$

 -

 

$

1,053 

U.S. Government and Agency securities

 

 -

 

 

15,963 

 

 

 -

 

 

15,963 

Municipal securities

 

 -

 

 

68,366 

 

 

 -

 

 

68,366 

Trust Preferred Securities

 

 -

 

 

5,137 

 

 

 -

 

 

5,137 

Agency mortgage-backed securities

 

 -

 

 

79,494 

 

 

 -

 

 

79,494 

Private-label mortgage-backed securities

 

 -

 

 

1,695 

 

 

 -

 

 

1,695 

Asset-backed securities

 

 -

 

 

43 

 

 

 -

 

 

43 

Total assets

$

1,053 

 

$

170,698 

 

$

 -

 

$

171,751 

 

 

 

 

 

 

 

 

 

 

 

 

Liability Description

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

$

 -

 

$

191 

 

$

 -

 

$

191 

Total liabilities

$

 -

 

$

191 

 

$

 -

 

$

191 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

Investment securities:  Level 1 securities represent equity securities that are valued using quoted market prices from 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.    

Interest rate swaps: The interest rate swaps are valued using a discounted cash flow model that uses verifiable market environment inputs to calculate the fair value. This method is not dependent on the input of any significant judgments or assumptions by Management.  

22

 


 

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 June  30, 2015 and December 31, 2014 are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value at June 30, 2015

Asset  Description

Level 1

 

Level 2

 

Level 3

 

Total

Impaired loans (1)

$

 -

 

$

 -

 

$

636 

 

$

636 

Premises held-for-sale (1)

 

 -

 

 

 -

 

 

358 

 

 

358 

Other real estate owned (1)

 

 -

 

 

 -

 

 

449 

 

 

449 

Mortgage servicing rights

 

 -

 

 

 -

 

 

133 

 

 

133 

Total assets

$

 -

 

$

 -

 

$

1,576 

 

$

1,576 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in Thousands)

Fair Value at December 31, 2014

Asset  Description

Level 1

 

Level 2

 

Level 3

 

Total

Impaired loans (1)

$

 -

 

$

 -

 

$

3,469 

 

$

3,469 

Other real estate owned (1)

 

 -

 

 

 -

 

 

760 

 

 

760 

Mortgage servicing rights

 

 -

 

 

 -

 

 

143 

 

 

143 

Total assets

$

 -

 

$

 -

 

$

4,372 

 

$

4,372 

 

(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.

Impaired loans: Impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral.  Collateral values are estimated using Level 3 inputs based on customized discounting criteria. 

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.

Mortgage servicing rights: The fair value of mortgage servicing rights, upon initial recognition, is estimated using a valuation model that calculates the present value of estimated future net servicing income.  The model incorporates Level 3 assumptions such as cost to service, discount rate, prepayment speeds, default rates and losses. 

The Corporation did not record any liabilities at fair value for which measurement of the fair value was made on a nonrecurring basis at June  30, 2015. 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 June  30, 2015.

23

 


 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Quantitative Information about Level 3 Fair Value Measurements

(Dollars in Thousands)

 

 

at June 30, 2015

 

 

 

 

 

 

 

 

 

Range

Asset  Description

 

 

Fair Value

 

Valuation Technique

 

Unobservable Input

 

(Weighted Average)

Impaired loans (1)

 

$

636 

 

Appraisal

 

Appraisal Adjustments (2)

 

0% - 10% (4.39%)

 

 

 

 

 

 

 

Cost to sell

 

0% - 8%    (4.49%)

Premises held-for-sale (1)

 

 

358 

 

Appraisal

 

Appraisal Adjustments (2)

 

 

 

 

 

 

 

 

 

 

 

 

Other real estate owned (1)

 

 

449 

 

Appraisal

 

Appraisal Adjustments (2)

 

 

 

 

 

 

 

 

 

Cost to sell

 

8% (8%)

Mortgage servicing rights

 

 

133 

 

Discounted Cash Flow (3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

at December 31, 2014

Impaired loans (1)

 

$

3,469 

 

Appraisal

 

Appraisal Adjustments (2)

 

0% - 100% (26%)

 

 

 

 

 

 

 

Cost to sell

 

0% - 10%    (5%)

Other real estate owned (1)

 

 

760 

 

Appraisal

 

Appraisal Adjustments (2)

 

 

 

 

 

 

 

 

 

Cost to sell

 

8% (8%)

Mortgage servicing rights

 

 

143 

 

Discounted Cash Flow (3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(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.

 

 

(3) Valuation and inputs are determined by a third-party pricing service without adjustment.

 

 

 

 

 

Note 10.  Financial Derivatives

The Board of Directors has given Management authorization to enter into additional derivative activity including interest rate swaps, caps and floors, forward-rate agreements, options and futures contracts in order to hedge interest rate risk.  The Bank is exposed to credit risk equal to the positive fair value of a derivative instrument, if any, as a positive fair value indicates that the counterparty to the agreement is financially liable to the Bank.  To limit this risk, counterparties must have an investment grade long-term debt rating and individual counterparty credit exposure is limited by Board approved parameters.  Management anticipates continuing to use derivatives, as permitted by its Board-approved policy, to manage interest rate risk.

Fair Value of Derivative Instruments in the Consolidated Balance Sheets were as follows as of June  30, 2015 and December 31, 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value of Derivative Instruments

(Dollars in thousands)

 

 

 

Balance Sheet

 

 

 

Date

 

Type

 

Location

 

Fair Value

June 30, 2015

 

Interest rate contracts

 

Other liabilities

 

$

 -

December 31, 2014

 

Interest rate contracts

 

Other liabilities

 

$

191 

 

 

24

 


 

The Effect of Derivative Instruments on the Statement of Income for the Three and Six Months Ended June  30, 2015 and 2014 follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives in ASC Topic 815 Cash Flow Hedging Relationships

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

Amount of Gain

 

 

 

 

 

 

 

 

 

Location of

 

or (Loss)

 

 

 

 

 

 

 

 

 

Gain or (Loss)

 

Recognized in

 

 

 

 

 

 

 

 

 

Recognized in

 

Income on

 

 

 

 

Location of

 

Amount of Gain

 

Income on

 

Derivatives

 

Amount of Gain

 

Gain or (Loss)

 

or (Loss)

 

Derivative (Ineffective

 

(Ineffective Portion

 

or (Loss)

 

Reclassified from

 

Reclassified from

 

Portion and Amount

 

and Amount

 

Recognized in OCI

 

Accumulated OCI

 

Accumulated OCI

 

Excluded from

 

Excluded from

 

net of tax on Derivative

 

into Income

 

into Income

 

Effectiveness

 

Effectiveness

Date / Type

(Effective Portion)

 

(Effective Portion)

 

(Effective Portion)

 

Testing)

 

Testing)

Interest rate contracts

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended:

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2015

$

64 

 

Interest Expense

 

$

(64)

 

Other income (expense)

 

$

 -

June 30, 2014

$

60 

 

Interest Expense

 

$

(94)

 

Other income (expense)

 

$

 -

 

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended:

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2015

$

126 

 

Interest Expense

 

$

(160)

 

Other income (expense)

 

$

 -

June 30, 2014

$

117 

 

Interest Expense

 

$

(189)

 

Other income (expense)

 

$

 -

 

Interest Rate Swap Agreements (“Swap Agreements”)

As of June 30, 2015, the Bank had no swap agreements outstanding. The Bank had entered into interest rate swap agreements as part of its asset/liability management program.  The swap agreements were free-standing derivatives and were recorded at fair value in the Corporation’s consolidated statements of condition.  The Bank was party to master netting arrangements with its financial institution counterparties; however, the Bank did not offset assets and liabilities under these arrangements for financial statement presentation purposes.  The master netting arrangements provided for a single net settlement of all swap agreements, as well as collateral, in the event of default on, or termination of, any one contract.  Collateral, in the form of marketable securities, was posted by the counterparty with net liability positions in accordance with contract thresholds. 

 

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

As of June 30, 2015, the Bank had no repurchase agreements outstanding.  The Bank entered into agreements under which it sold securities subject to an obligation to repurchase the same or similar securities.  Under these arrangements, the Bank may have transferred legal control over the assets but still retained effective control through an agreement that both entitled and obligated the Bank to repurchase the agreements.  As a result, these repurchase agreements were accounted for as collateralized financing arrangements (i.e., secured borrowings) and not as a sale and subsequent repurchase of securities.  The obligation to repurchase the securities was reflected as a liability in the Corporation’s consolidated statements of condition, while the securities underlying the repurchase agreements remained in the respective investment securities asset accounts.  In other words, there was no offsetting or netting of the investment securities assets with the repurchase agreement liabilities.  In addition, as the Bank did not enter into reverse repurchase agreements, there was no such offsetting to be done with repurchase agreements.

 

25

 


 

The following table presents the liabilities subject to an enforceable master netting arrangement or repurchase agreements as of June  30, 2015 and December 31, 2014.  As of these dates, all of the Bank’s swap agreement with an institutional counterparty  was in a liability position.  Therefore, there were no assets to be recognized in the consolidated statements of condition.  The Bank has no swap agreements with our commercial banking customers. 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Amounts

 

 

Gross Amounts Not Offset in the

 

 

Gross

 

 

Gross Amounts

 

 

of Liabilities

 

 

Statements of Condition

 

 

Amounts of

 

 

Offset in the

 

 

Presented in the

 

 

 

 

 

 

 

 

 

 

 

Recognized

 

 

Statements of

 

 

Statements of

 

 

Financial

 

 

Cash Collateral

 

 

Net 

(Dollars in thousands)

 

Liabilities

 

 

Condition

 

 

Condition

 

 

Instruments

 

 

Pledged

 

 

Amount

Interest Rate Swap Agreements

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2015

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

 -

December 31, 2014

 

191 

 

 

 -

 

 

191 

 

 

191 

 

 

 -

 

 

 -

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Note 11. 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 U.S. Banks, generally referred to as “Basel III.”  Basel III imposes significantly higher capital requirements and more restrictive leverage and liquidity ratios than those in place at the end of 2014.  The capital ratios to be considered “well capitalized” under Basel III are: common equity tier 1 of 6.5%, Tier 1 leverage of 5%, Tier 1 risk-based capital of 8%, and Total Risk-Based capital of 10%.  The common equity tier 1 ratio is a new capital ratio under Basel III.  Common equity consists of common stock, additional paid-in capital and retained earnings.  The Tier 1 risk-based capital ratio of 8% has been increased from 6%.  The new rule also includes a provision for banks to make a one-time irrevocable choice to exclude accumulated other comprehensive income (AOCI) from its common equity Tier 1 capital.  The Bank elected to exclude AOCI from the capital calculation with its March 31, 2015 regulatory filing.  In addition, a capital conservation buffer will be required to be maintained above the minimum capital ratios to avoid any capital distribution restrictions.  The capital conservation buffer will be phased in from 0% in 2015 to 2.5% in 2019.  The Basel III capital rules took effect for the Corporation and the Bank on January 1, 2015.  At June 30, 2015, the Corporation and the Bank were both well capitalized as defined by the banking regulatory agencies. 

26

 


 

The following table summarizes regulatory capital information as of June  30, 2015 and December 31, 2014 on a consolidated basis and for the Bank, as defined.  Regulatory capital ratios for June  30, 2015 were calculated in accordance with the Basel III rules, whereas the December 31, 2015 regulatory ratios were calculated in accordance with Basel I rules.  The minimum regulatory ratios shown below define capital levels under Basel III rules.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Regulatory Ratios

 

 

 

 

 

 

Adequately

 

Well

 

 

 

 

 

 

Capitalized

 

Capitalized

(Dollars in thousands)

 

June 30, 2015

 

December 31, 2014

 

Minimum

 

Minimum

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

14.48% 

 

N/A

 

4.50% 

 

N/A

Farmers & Merchants Trust Company

 

14.39% 

 

N/A

 

4.50% 

 

6.50% 

 

 

 

 

 

 

 

 

 

Tier 1 Risk-based Capital Ratio (2)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

14.48% 

 

14.19% 

 

6.00% 

 

N/A

Farmers & Merchants Trust Company

 

14.39% 

 

13.96% 

 

6.00% 

 

8.00% 

 

 

 

 

 

 

 

 

 

Total Risk-based Capital Ratio (3)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

15.73% 

 

15.49% 

 

8.00% 

 

N/A

Farmers & Merchants Trust Company

 

15.64% 

 

15.26% 

 

8.00% 

 

10.00% 

 

 

 

 

 

 

 

 

 

Tier 1 Leverage Ratio (4)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

10.17% 

 

9.69% 

 

4.00% 

 

N/A

Farmers & Merchants Trust Company

 

9.96% 

 

9.55% 

 

4.00% 

 

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

 

 

 

 

 

1Note 12. Reclassification

Certain prior period amounts may have been reclassified to conform to the current year presentation.  Such reclassifications did not affect the Corporation’s financial position or results of operations.

 

 

 

27

 


 

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

For the Three and Six Months Ended June  30, 2015 and 2014

 

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.

 

Critical Accounting Policies

 

Management has identified critical accounting policies for the Corporation to include Allowance for Loan Losses, Mortgage Servicing Rights, Financial Derivatives, Temporary Investment Impairment and Stock-based Compensation.  There were no changes to the critical accounting policies disclosed in the 2014 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 2014 Annual Report on Form 10-K for a more detailed disclosure of the critical accounting policies.

 

Results of Operations

 

Year-to-Date Summary

At June  30, 2015, total assets were $1.029 billion, an increase of $27.1 million from December 31, 2014. Net loans increased to $723.8 million and total deposits increased to $916.1 million.  The Corporation reported net income for the first six months of 2015 of $5.4 million.  This is a 29.3% increase versus net income of $4.1 million for the same period in 2014.  Net income for 2015 was enhanced by two nonrecurring events that increased noninterest income by $899 thousand. These events included a gain of $171 thousand from the liquidation of an off-shore insurance company in which the Bank held an ownership interest and a $728 thousand gain on the conversion of equity securities held by the Bank as the result of an acquisition. Without these events, net income for the first six months would have been $4.8 million, a 15% increase over the prior year.  Total revenue (interest income and noninterest income) increased $1.3 million year-over-year boosted by these nonrecurring items. Interest income decreased $230 thousand,  while interest expense decreased by  $387 thousand, resulting in a $157 thousand increase in net interest income. The provision for loan losses was $635 thousand for the period, $171 thousand more than in 2014. Noninterest income increased $1.5 million, while noninterest expense decreased $154 thousand. Income tax expense increased from $1.0 million in 2014 to $1.5 million in 2015. The effective tax rate increased from 19.7% in 2014 to 21.6% in 2015 due to a lower ratio of tax exempt income to income before federal income taxes. Diluted earnings per share increased to $1.26 in 2015 from $0.99 in 2014.  

28

 


 

Key performance ratios as of, or for the six months ended June 30, 2015 and 2014 and twelve months ended December 31, 2014 are listed below:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30,

 

December 31,

 

June 30,

 

 

2015

 

2014

 

2014

 

 

 

 

 

 

 

 

 

 

 

Performance measurements

 

 

 

 

 

 

 

 

 

Return on average assets*

 

1.07% 

 

 

0.83% 

 

 

0.82% 

 

Return on average equity*

 

10.28% 

 

 

8.44% 

 

 

8.60% 

 

Return on average tangible assets (1)*

 

1.09% 

 

 

0.87% 

 

 

0.85% 

 

Return on average tangible equity (1)*

 

11.40% 

 

 

9.72% 

 

 

9.77% 

 

Efficiency ratio (1)

 

66.11% 

 

 

70.83% 

 

 

70.63% 

 

Net interest margin*

 

3.60% 

 

 

3.56% 

 

 

3.56% 

 

Current dividend yield*

 

3.10% 

 

 

3.09% 

 

 

3.42% 

 

Dividend payout ratio

 

28.41% 

 

 

33.88% 

 

 

34.23% 

 

 

 

 

 

 

 

 

 

 

 

Shareholders' Value (per common share)

 

 

 

 

 

 

 

 

 

Diluted earnings per share

$

1.26 

 

$

2.00 

 

$

0.99 

 

Basic earnings per share

 

1.27 

 

 

2.01 

 

 

0.99 

 

Regular cash dividends paid

 

0.36 

 

 

0.68 

 

 

0.34 

 

Book value

 

25.27 

 

 

24.54 

 

 

23.85 

 

Tangible book value (1)

 

23.14 

 

 

22.36 

 

 

21.57 

 

Market value

 

24.55 

 

 

22.00 

 

 

19.90 

 

Market value/book value ratio

 

97.15% 

 

 

89.65% 

 

 

83.44% 

 

Price/earnings multiple*

 

9.74 

 

 

11.00 

 

 

10.05 

 

 

 

 

 

 

 

 

 

 

 

Safety and Soundness

 

 

 

 

 

 

 

 

 

Risk-based capital ratio (Total)

 

15.73% 

 

 

15.49% 

 

 

14.53% 

 

Leverage ratio (Tier 1)

 

10.17% 

 

 

9.69% 

 

 

9.26% 

 

Common equity ratio (Tier 1)

 

14.48% 

 

 

 -

 

 

 -

 

Tangible common equity ratio (1)

 

9.63% 

 

 

9.51% 

 

 

8.93% 

 

Nonperforming loans/gross loans

 

1.30% 

 

 

1.74% 

 

 

2.87% 

 

Nonperforming assets/total assets

 

1.32% 

 

 

1.63% 

 

 

2.46% 

 

Allowance for loan losses as a % of loans

 

1.29% 

 

 

1.25% 

 

 

1.30% 

 

Net charge-offs/average loans*

 

0.08% 

 

 

0.19% 

 

 

0.18% 

 

 

 

 

 

 

 

 

 

 

 

Trust assets under management (fair value)

$

598,085 

 

$

605,796 

 

$

582,647 

 

 

 

 

 

 

 

 

 

 

 

* Annualized

 

 

 

 

 

 

 

 

 

(1) See GAAP versus Non-GAAP disclosures that follow

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

29

 


 

GAAP versus Non-GAAP DisclosureThe Corporation supplements its traditional GAAP measurements with Non-GAAP measurements. The Non-GAAP measurements include Return on Average Tangible Assets, Return on Average Tangible Equity, Tangible Book Value and Tangible Common Equity ratio. As a result of merger transactions, intangible assets (primarily goodwill, core deposit intangibles and customer list) were created. The Non-GAAP disclosures are intended to eliminate the effects of the intangible assets and allow for better comparisons to periods when such assets did not exist.  However, not all companies use the same calculation methods for the same non-GAAP measurements and therefore may not be comparable. The following table shows the adjustments made between the GAAP and NON-GAAP measurements:

 

 

GAAP Measurement

Calculation

Return on Average Assets

Net Income / Average Assets

Return on Average Equity

Net Income / Average Equity

Book Value

Total Shareholders’ Equity / Shares Outstanding

 

 

Non- GAAP Measurement

Calculation

Return on Average Tangible Assets

Net Income plus Intangible Amortization (net of tax) / Average Assets less Average Intangible Assets

Return on Average Tangible Equity

Net Income plus Intangible Amortization (net of tax) / Average Equity less Average Intangible Assets

Tangible Book Value

Total Shareholders’ Equity less Intangible Assets / Shares outstanding

Tangible Common Equity Ratio

 

Efficiency Ratio

Total Shareholders’ Equity less Intangible Assets / Total Assets less Intangible Assets

Noninterest expense  / tax equivalent net interest income plus noninterest income less net securities gains or losses

Comparison of the three months ended June 30, 2015 to the three months ended June 30, 2014:

Net Interest Income

The most important 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, securities sold under agreements to repurchase (Repos), 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 34% Federal statutory rate. 

Tax equivalent net interest income for the second quarter of 2015 increased $32 thousand quarter over quarter.  Average interest-earning assets increased $5.8 million from 2014,  but the yield on these assets decreased to 3.80% from 3.90% in 2014.  The average balance of investment securities increased $5.4 million while average loans decreased $2.8 million quarter over quarter.  Average commercial loans decreased $3.9 million and average mortgage loans decreased $2.5 million.  These decreases were partially offset with an increase in the average balance of consumer loans, including home equity loans, which increased by  $3.6 million.

Interest expense was $619 thousand for the second quarter, a decrease of $198 thousand from the 2014 total of $817 thousand.  Average interest-bearing liabilities decreased $18.7 million to $770.1 million for 2015 from an average balance of $788.8 million in 2014.  The average cost of these liabilities decreased from 0.42% in 2014 to  0.32% in 2015.  Average interest-bearing deposits increased $404 thousand and the cost of these deposits decreased from 0.36% to 0.32%.   The securities sold under agreements to repurchase (Repo) accounts were closed out in 2014 and transferred to other products.  All long-term debt was paid off in 2014.

The changes in the balance sheet and interest rates resulted in an increase in tax equivalent net interest income of $32 thousand to $8.5 million in 2015 compared to $8.4 million in 2014.  The increase in net interest income was due to a $100 thousand increase from higher volume offset by a $68 thousand decrease due to changes in rates.

 

30

 


 

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 34%. 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended June 30,

 

2015

 

2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

$

52,114 

 

$

72 

 

0.55% 

 

$

48,903 

 

$

45 

 

0.37% 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

121,383 

 

 

621 

 

2.05% 

 

 

125,219 

 

 

692 

 

2.22% 

Tax Exempt

 

55,611 

 

 

613 

 

4.41% 

 

 

46,397 

 

 

563 

 

4.86% 

               Investments

 

176,994 

 

 

1,234 

 

2.80% 

 

 

171,616 

 

 

1,255 

 

2.93% 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, industrial and agricultural

 

578,985 

 

 

6,134 

 

4.22% 

 

 

582,877 

 

 

6,184 

 

4.20% 

Residential mortgage

 

80,474 

 

 

829 

 

4.14% 

 

 

82,954 

 

 

854 

 

4.13% 

Home equity loans and lines

 

63,650 

 

 

745 

 

4.69% 

 

 

58,750 

 

 

772 

 

5.27% 

Consumer

 

6,490 

 

 

79 

 

4.88% 

 

 

7,786 

 

 

149 

 

7.68% 

Loans

 

729,599 

 

 

7,787 

 

4.25% 

 

 

732,367 

 

 

7,959 

 

4.31% 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest-earning assets

 

958,707 

 

 

9,093 

 

3.80% 

 

 

952,886 

 

 

9,259 

 

3.90% 

Other assets

 

66,770 

 

 

 

 

 

 

 

71,627 

 

 

 

 

 

Total assets

$

1,025,477 

 

 

 

 

 

 

$

1,024,513 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking

$

227,943 

 

 

67 

 

0.12% 

 

$

206,850 

 

 

60 

 

0.12% 

Money Management

 

382,738 

 

 

387 

 

0.41% 

 

 

391,283 

 

 

424 

 

0.43% 

Savings

 

65,738 

 

 

12 

 

0.07% 

 

 

63,704 

 

 

12 

 

0.08% 

Time

 

93,687 

 

 

153 

 

0.66% 

 

 

107,865 

 

 

198 

 

0.74% 

Total interest-bearing deposits

 

770,106 

 

 

619 

 

0.32% 

 

 

769,702 

 

 

694 

 

0.36% 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities sold under agreements to repurchase

 

 -

 

 

 -

 

 -

 

 

6,855 

 

 

 

0.15% 

Other borrowings

 

 -

 

 

 -

 

 -

 

 

12,286 

 

 

121 

 

3.93% 

Total interest-bearing liabilities

 

770,106 

 

 

619 

 

0.32% 

 

 

788,843 

 

 

817 

 

0.42% 

Noninterest-bearing deposits

 

142,621 

 

 

 

 

 

 

 

129,464 

 

 

 

 

 

Other liabilities

 

6,751 

 

 

 

 

 

 

 

7,871 

 

 

 

 

 

Shareholders' equity

 

105,999 

 

 

 

 

 

 

 

98,335 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,025,477 

 

 

 

 

 

 

$

1,024,513 

 

 

 

 

 

T/E net interest income/Net interest margin

 

 

 

 

8,474 

 

3.55% 

 

 

 

 

 

8,442 

 

3.55% 

Tax equivalent adjustment

 

 

 

 

(515)

 

 

 

 

 

 

 

(498)

 

 

Net interest income

 

 

 

$

7,959 

 

 

 

 

 

 

$

7,944 

 

 

 

31

 


 

Provision for Loan Losses

For the second quarter of 2015, the Bank recorded net charge-offs of $70 thousand compared to $492 thousand in 2014.  Provision expense for the second quarter was $310 thousand and as a result, the allowance for loan losses (ALL) increased $240 thousand during the quarter.  For more information refer to the Loan Quality and Allowance for Loan Losses discussion in the Financial Condition section.

 

Noninterest Income

For the second quarter of 2015, noninterest income increased $254 thousand from the same period in 2014.  Investment and trust service fees increased due to higher recurring trust fees and an increase in estate fees. Loan service charges increased primarily due to a large commercial loan prepayment penalty.  Deposit service charges increased due to higher fees from the Bank’s overdraft programThe other real estate owned expense in 2014 was a writedown compared to none in 2015.    The securities gains in both years were in the equity portfolio.

The following table presents a comparison of noninterest income for the three months ended June 30, 2015 and 2014.

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended

 

 

 

 

 

 

June 30

 

Change

(Dollars in thousands)

2015

 

2014

 

Amount

 

%

Noninterest Income

 

 

 

 

 

 

 

 

 

 

Investment and trust services fees

$

1,388 

 

$

1,101 

 

$

287 

 

26.1 

Loan service charges

 

297 

 

 

250 

 

 

47 

 

18.8 

Mortgage banking activities

 

17 

 

 

19 

 

 

(2)

 

(10.5)

Deposit service charges and fees

 

586 

 

 

525 

 

 

61 

 

11.6 

Other service charges and fees

 

311 

 

 

317 

 

 

(6)

 

(1.9)

Debit card income

 

356 

 

 

337 

 

 

19 

 

5.6 

Increase in cash surrender value of life insurance

 

140 

 

 

144 

 

 

(4)

 

(2.8)

Other real estate owned

 

 -

 

 

(62)

 

 

62 

 

N/A

Other

 

13 

 

 

10 

 

 

 

30.0 

Securities gain (losses), net

 

 

 

221 

 

 

(213)

 

(96.4)

Total noninterest income

$

3,116 

 

$

2,862 

 

$

254 

 

8.9 

 

 

Noninterest Expense

Noninterest expense for the second quarter of 2015 increased $44 thousand compared to the same period in 2014.  The increase in salaries and benefits was primarily due to a $47 thousand increase in salaries, primarily for merit increases, as well as a $24 thousand increase in pension expense and a $23 increase in health insurance expenseNet occupancy expenses decreased compared to prior year due to less utility and snow removal expense in 2015.  Legal and professional fees decreased as 2014 had higher consulting expenses for the implementation of strategic initiatives.  The increase in data processing was due to higher charges for mobile banking, remote deposit capture, and Franklin Businesslink due to growth in volume, as well as the migration to a new mortgage origination system. The shares tax increase was due to the growth in the Bank’s balance sheet and shareholders’ equity.  FDIC insurance expense decreased over prior year due to a reduction in the assessment rate used to calculate the premium.    Other expenses increased due to several one-time expenses the Bank took related to branch assets taken out of service.

32

 


 

 

The following table presents a comparison of noninterest expense for the three months ended June  30, 2015 and 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended

 

 

 

 

 

(Dollars in thousands)

June 30

 

Change

Noninterest Expense

2015

 

2014

 

Amount

 

%

Salaries and benefits

$

4,203 

 

$

4,107 

 

$

96 

 

2.3 

Net occupancy expense

 

556 

 

 

586 

 

 

(30)

 

(5.1)

Furniture and equipment expense

 

239 

 

 

237 

 

 

 

0.8 

Advertising

 

283 

 

 

270 

 

 

13 

 

4.8 

Legal and professional fees

 

203 

 

 

353 

 

 

(150)

 

(42.5)

Data processing

 

556 

 

 

493 

 

 

63 

 

12.8 

Pennsylvania bank shares tax

 

206 

 

 

173 

 

 

33 

 

19.1 

Intangible amortization

 

90 

 

 

104 

 

 

(14)

 

(13.5)

FDIC insurance

 

160 

 

 

222 

 

 

(62)

 

(27.9)

ATM/debit card processing

 

186 

 

 

178 

 

 

 

4.5 

Other

 

977 

 

 

892 

 

 

85 

 

9.5 

Total noninterest expense

$

7,659 

 

$

7,615 

 

$

44 

 

0.6 

 

Provision for Income Taxes

For the second quarter of 2015, the Corporation recorded a Federal income tax expense of $632 thousand compared to $606 thousand for the same quarter in 2014. The effective tax rate was 20.3% for the second quarter of 2015 compared to 20.7% for the same period in 2014.  All taxable income for the Corporation is taxed at a rate of 34%.

 

Comparison of the six months ended June  30, 2015 to the six months ended June  30, 2014:

Net Interest Income

Tax equivalent net interest income for the first half of 2015 increased $214 thousand from the prior year.  Average interest-earning assets increased $2.5 million from 2014 and the yield on these assets decreased from 3.92% in 2014 to 3.87% in 2015.  The average balance of investment securities increased $9.4 million while average loans decreased $2.0 million year over year.  Average commercial loans decreased $3.2 million and average mortgage loans decreased $1.9 million.  These decreases were partially offset by an increase of $3.1 million in the average balance of consumer loans, including home equity loans.

Interest expense was $1.3 million for the first six months, a decrease of $387 thousand from the 2014 total of $1.6 million.  Average interest-bearing liabilities decreased $26.7 million to $759.5 million for 2015 from an average balance of $786.1 million in 2014.  The average cost of these liabilities decreased from 0.42% in 2014 to 0.33% in 2015.  Average interest-bearing deposits decreased $1.8 million and the cost of these deposits decreased from 0.37% to 0.33%.   The securities sold under agreements to repurchase (Repo) accounts were being closed out in 2014 and transferred to other products.  The final Repo account closed in January 2015.  Other borrowings reflect a short-term borrowing in 2015, as all long-term debt was paid off in 2014.

The changes in the balance sheet and interest rates resulted in an increase in tax equivalent net interest income of $214 thousand to $16.9 million in 2015 compared to $16.6 million in 2014.  The increase in tax equivalent net interest income was due to a $268 thousand increase from higher volume offset by a $54 thousand decrease due to changes in rates.

 

33

 


 

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 34%. 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Six Months Ended June 30,

 

2015

 

2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

$

42,577 

 

$

127 

 

0.60% 

 

$

47,550 

 

$

84 

 

0.36% 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

120,988 

 

 

1,308 

 

2.18% 

 

 

122,885 

 

 

1,358 

 

2.23% 

Tax Exempt

 

55,083 

 

 

1,225 

 

4.45% 

 

 

43,755 

 

 

1,101 

 

5.32% 

               Investments

 

176,071 

 

 

2,533 

 

2.90% 

 

 

166,640 

 

 

2,459 

 

2.98% 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, industrial and agricultural

 

574,924 

 

 

12,147 

 

4.22% 

 

 

578,084 

 

 

12,179 

 

4.19% 

Residential mortgage

 

80,902 

 

 

1,653 

 

4.10% 

 

 

82,841 

 

 

1,713 

 

4.17% 

Home equity loans and lines

 

63,778 

 

 

1,496 

 

4.73% 

 

 

59,061 

 

 

1,558 

 

5.32% 

Consumer

 

6,478 

 

 

165 

 

5.14% 

 

 

8,077 

 

 

301 

 

7.52% 

Loans

 

726,082 

 

 

15,461 

 

4.25% 

 

 

728,063 

 

 

15,751 

 

4.31% 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest-earning assets

 

944,730 

 

 

18,121 

 

3.87% 

 

 

942,253 

 

 

18,294 

 

3.92% 

Other assets

 

66,786 

 

 

 

 

 

 

 

71,420 

 

 

 

 

 

Total assets

$

1,011,516 

 

 

 

 

 

 

$

1,013,673 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking

$

216,313 

 

 

120 

 

0.11% 

 

$

197,481 

 

 

109 

 

0.11% 

Money Management

 

383,423 

 

 

803 

 

0.42% 

 

 

391,317 

 

 

845 

 

0.44% 

Savings

 

64,487 

 

 

24 

 

0.08% 

 

 

62,325 

 

 

24 

 

0.08% 

Time

 

95,180 

 

 

313 

 

0.66% 

 

 

110,112 

 

 

418 

 

0.77% 

Total interest-bearing deposits

 

759,403 

 

 

1,260 

 

0.33% 

 

 

761,235 

 

 

1,396 

 

0.37% 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities sold under agreements to repurchase

 

50 

 

 

 -

 

0.15% 

 

 

12,548 

 

 

 

0.15% 

Other borrowings

 

12 

 

 

 -

 

0.30% 

 

 

12,343 

 

 

242 

 

3.92% 

Total interest-bearing liabilities

 

759,465 

 

 

1,260 

 

0.33% 

 

 

786,126 

 

 

1,647 

 

0.42% 

Noninterest-bearing deposits

 

139,399 

 

 

 

 

 

 

 

122,807 

 

 

 

 

 

Other liabilities

 

7,481 

 

 

 

 

 

 

 

7,573 

 

 

 

 

 

Shareholders' equity

 

105,171 

 

 

 

 

 

 

 

97,167 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,011,516 

 

 

 

 

 

 

$

1,013,673 

 

 

 

 

 

T/E net interest income/Net interest margin

 

 

 

 

16,861 

 

3.60% 

 

 

 

 

 

16,647 

 

3.56% 

Tax equivalent adjustment

 

 

 

 

(1,016)

 

 

 

 

 

 

 

(959)

 

 

Net interest income

 

 

 

$

15,845 

 

 

 

 

 

 

$

15,688 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

All nontaxable interest income has been adjusted to a tax-equivalent basis, using a tax rate of 34%.

 

 

34

 


 

Provision for Loan Losses

For the first half of 2015, the Bank recorded net charge-offs of $296 thousand compared to $674 thousand in 2014.  Provision expense for the first six months was $635 thousand and as a result, the allowance for loan losses (ALL) increased $339 thousand.  For more information refer to the Loan Quality and Allowance for Loan Losses discussion in the Financial Condition section.

 

Noninterest Income

For the first six months of 2015, noninterest income increased $1.5 million from the same period in 2014.  Investment and trust service fees increased due to higher recurring trust fees, estate fees and insurance commissions. Loan service charges increased primarily from a large commercial loan prepayment penalty.    Mortgage banking fees remained flat, while deposit service charges increased due to the Bank’s overdraft program.  Other service charges and fees increased primarily due to ATM and merchant card fees.   The net gain in other real estate owned was from the gain on a sale, compared to write downs in 2014.  Other income increased from an investment the Corporation owned in an offshore insurance company that liquidated and paid out the investors. Other than temporary impairment charges were recorded on one bond in 2015. The gain on conversion occurred in the equity portfolio and was the result of the Bank receiving shares of S&T Bancorp following its acquisition of Integrity Bancshares.

The following table presents a comparison of noninterest income for the six months ended June 30, 2015 and 2014.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Six Months Ended

 

 

 

 

 

 

June 30

 

Change

(Dollars in thousands)

2015

 

2014

 

Amount

 

%

Noninterest Income

 

 

 

 

 

 

 

 

 

 

Investment and trust services fees

$

2,651 

 

$

2,192 

 

$

459 

 

20.9 

Loan service charges

 

471 

 

 

418 

 

 

53 

 

12.7 

Mortgage banking activities

 

25 

 

 

32 

 

 

(7)

 

(21.9)

Deposit service charges and fees

 

1,077 

 

 

990 

 

 

87 

 

8.8 

Other service charges and fees

 

607 

 

 

584 

 

 

23 

 

3.9 

Debit card income

 

675 

 

 

643 

 

 

32 

 

5.0 

Increase in cash surrender value of life insurance

 

279 

 

 

286 

 

 

(7)

 

(2.4)

Other real estate owned

 

32 

 

 

(185)

 

 

217 

 

(117.3)

Other

 

237 

 

 

62 

 

 

175 

 

282.3 

OTTI losses recognized in income

 

(20)

 

 

 -

 

 

(20)

 

N/A

Gain on conversion

 

728 

 

 

 -

 

 

728 

 

N/A

Securities gain (losses), net

 

 

 

221 

 

 

(213)

 

(96.4)

Total noninterest income

$

6,770 

 

$

5,243 

 

$

1,527 

 

29.1 

 

 

Noninterest Expense

Noninterest expense for the first six months of 2015 decreased $154 thousand compared to the same period in 2014.  The decrease in salaries and benefits was primarily due to a decrease in incentive pay expense, as the 2014 expense included a final adjustment for the 2013 payout, and lower commissions expense, but these decreases were partially offset by increases in pension expense and health insurance expensesNet occupancy expenses decreased compared to prior year due to less utility and snow removal expense in 2015.  Advertising expenses decreased over prior year, due to the timing of various marketing campaigns.   Legal and professional fees decreased due to a change in internal audit firms.  The increase in data processing expenses was from higher volumes in mobile banking, remote deposit capture, and Franklin Businesslink volumes, as well as the migration to a new mortgage origination system. FDIC insurance expense decreased over prior year due to a reduction in the assessment rate used to calculate the premium.    Other expenses increased due to one-time expenses the Bank took to fulfill the funding requirement of a deferred director’s benefit plan established thirty years ago, as well as expenses related to branch assets taken out of service.

35

 


 

 

The following table presents a comparison of noninterest expense for the six months ended June  30, 2015 and 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Six Months Ended

 

 

 

 

 

(Dollars in thousands)

June 30

 

Change

Noninterest Expense

2015

 

2014

 

Amount

 

%

Salaries and benefits

$

8,286 

 

$

8,357 

 

$

(71)

 

(0.8)

Net occupancy expense

 

1,172 

 

 

1,262 

 

 

(90)

 

(7.1)

Furniture and equipment expense

 

470 

 

 

491 

 

 

(21)

 

(4.3)

Advertising

 

471 

 

 

586 

 

 

(115)

 

(19.6)

Legal and professional fees

 

499 

 

 

618 

 

 

(119)

 

(19.3)

Data processing

 

1,023 

 

 

884 

 

 

139 

 

15.7 

Pennsylvania bank shares tax

 

402 

 

 

347 

 

 

55 

 

15.9 

Intangible amortization

 

181 

 

 

207 

 

 

(26)

 

(12.6)

FDIC insurance

 

308 

 

 

454 

 

 

(146)

 

(32.2)

ATM/debit card processing

 

373 

 

 

357 

 

 

16 

 

4.5 

Other

 

1,965 

 

 

1,741 

 

 

224 

 

12.9 

Total noninterest expense

$

15,150 

 

$

15,304 

 

$

(154)

 

(1.0)

 

Provision for Income Taxes

For the first half of 2015, the Corporation recorded a Federal income tax expense of $1.5 million compared to $1.0 million for the same period in 2014.  The increase was due to a lower ratio of tax exempt income to income before federal income taxes.  As a result, the effective tax rate increased to 21.5% for the first six months of 2015 compared to 19.7% for 2014.  All taxable income for the Corporation is taxed at a rate of 34%.

 

Financial Condition

Summary:

At June 30, 2015, assets totaled $1.029 billion, an increase of $27.1 million from the 2014 year-end balance of $1.001 billion. Investment securities increased $4.7 million, while net loans increased $6.3 million. Deposits were up $34.9 million for the first six months of 2015 due to increases in every deposit category except time deposits and money management accounts. Shareholders’ equity increased $3.7 million during the first six months as retained earnings increased approximately $3.8 million, other comprehensive loss decreased  $700 thousand and the Corporation’s Dividend Reinvestment Plan (DRIP) added an additional $435 thousand in new capital.

 

Cash and Cash Equivalents:

Cash and cash equivalents totaled $64.4 million at June 30, 2015, an increase of $15.8 million from the prior year-end balance of $48.6 million.  Interest-bearing deposits are held primarily at the Federal Reserve and in short-term bank owned certificates of deposit.

 

Investment Securities:    

The investment portfolio has grown approximately $6 million on a cost basis, since year-end 2014. The composition of the portfolio is essentially unchanged with municipal securities and U.S. Agency mortgage-backed securities comprising the greatest portion of the portfolio at approximately 41% and 45% of the portfolio fair value, respectively. The Bank invested $21.7 million during the first six months of 2015 with the purchases spread between, U.S. Agency mortgage-backed securities and municipal securities.  

The investment portfolio had a net unrealized gain of $1.1 million at June 30, 2015 compared to $2.4 million at the prior year-end. The decline in the unrealized gain is primarily the result of a $700 thousand reduction in the unrealized gain in equity securities as Bank should equity securities and recorded the gain from this portfolio. The municipal portfolio also saw its unrealized gains decline during the year, primarily the result of changes in the yield curve.  The portfolio averaged $176.1 million with a yield of 2.90% for the first half of 2015. This compares to an average of $166.6 million and a yield of 2.98% for the same period in 2014. 

The Bank holds only one equity security, a Pennsylvania community bank. The municipal bond portfolio is well diversified geographically (issuers from within 29 states) and is comprised primarily of general obligation bonds (70%).  Most municipal bonds have credit enhancements in the form of private bond insurance or other credit support. The largest

36

 


 

geographic municipal bond exposure is to 20 issuers in the state of Texas with a fair value of $10.9 million and 15 issuers in the state of Pennsylvania with a fair value of $9.0 million. The average rating of the municipal portfolio from Moody’s is Aa2. It contains $70.2 million of bonds rated A3 or higher and $1.9 million that are not rated by Moody’s rating agency.  No municipal bonds are rated below investment grade.

The holdings of trust preferred investments and private-label mortgage-backed securities are unchanged since year-end and are detailed in separate tables.

The amortized cost and estimated fair value of investment securities available for sale as of June 30, 2015 and December 31, 2014 is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 

 

 

Amortized

 

unrealized

 

unrealized

 

Fair

June 30, 2015

 

cost

 

gains

 

losses

 

value

Equity securities

 

$

164 

 

$

78 

 

$

 -

 

$

242 

U.S. Government agency securities

 

 

16,245 

 

 

168 

 

 

(29)

 

 

16,384 

Municipal securities

 

 

71,277 

 

 

1,459 

 

 

(604)

 

 

72,132 

Trust preferred securities

 

 

5,949 

 

 

 -

 

 

(621)

 

 

5,328 

Agency mortgage-backed securities

 

 

80,145 

 

 

917 

 

 

(323)

 

 

80,739 

Private-label mortgage-backed securities

 

 

1,502 

 

 

58 

 

 

 -

 

 

1,560 

Asset-backed securities

 

 

42 

 

 

 -

 

 

(3)

 

 

39 

 

 

$

175,324 

 

$

2,680 

 

$

(1,580)

 

$

176,424 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

Gross

 

Gross

 

 

 

 

 

Amortized

 

unrealized

 

unrealized

 

Fair

December 31, 2014

 

cost

 

gains

 

losses

 

value

Equity securities

 

$

274 

 

$

779 

 

$

 -

 

$

1,053 

U.S. Government and Agency securities

 

 

15,854 

 

 

173 

 

 

(64)

 

 

15,963 

Municipal securities

 

 

66,832 

 

 

1,826 

 

 

(292)

 

 

68,366 

Trust preferred securities

 

 

5,940 

 

 

 -

 

 

(803)

 

 

5,137 

Agency mortgage-backed securities

 

 

78,779 

 

 

932 

 

 

(217)

 

 

79,494 

Private-label mortgage-backed securities

 

 

1,675 

 

 

35 

 

 

(15)

 

 

1,695 

Asset-backed securities

 

 

45 

 

 

 -

 

 

(2)

 

 

43 

 

 

$

169,399 

 

$

3,745 

 

$

(1,393)

 

$

171,751 

37

 


 

The following table provides additional detail about the Bank’s trust preferred securities as of June 30, 2015:  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deal Name

 

Maturity

 

Single Issuer or Pooled

 

Class

 

Amortized Cost

 

Fair Value

 

Gross Unrealized Gain (Loss)

 

Lowest Credit Rating Assigned

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BankAmerica Cap III

 

1/15/2027

 

Single

 

Preferred Stock

 

$

964 

 

$

906 

 

$

(58)

 

BB

Wachovia Cap Trust II

 

1/15/2027

 

Single

 

Preferred Stock

 

 

277 

 

 

261 

 

 

(16)

 

BBB

Huntington Cap Trust

 

2/1/2027

 

Single

 

Preferred Stock

 

 

941 

 

 

816 

 

 

(125)

 

BB

Corestates Captl Tr II

 

2/15/2027

 

Single

 

Preferred Stock

 

 

937 

 

 

871 

 

 

(66)

 

BBB+

Huntington Cap Trust II

 

6/15/2028

 

Single

 

Preferred Stock

 

 

892 

 

 

790 

 

 

(102)

 

BB

Chase Cap VI JPM

 

8/1/2028

 

Single

 

Preferred Stock

 

 

963 

 

 

850 

 

 

(113)

 

BBB-

Fleet Cap Tr V

 

12/18/2028

 

Single

 

Preferred Stock

 

 

975 

 

 

834 

 

 

(141)

 

BB

 

 

 

 

 

 

 

 

$

5,949 

 

$

5,328 

 

$

(621)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The following table provides additional detail about private label mortgage-backed securities as of June 30, 2015:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

Gross 

 

 

 

 

 

 

 

Cumulative

 

 

Origination

 

Amortized

 

Fair

 

Unrealized

 

Collateral

 

Lowest Credit

 

Credit

 

OTTI

Description

 

Date

 

Cost

 

Value

 

Gain (Loss)

 

Type

 

Rating Assigned

 

Support %

 

Charges

RALI 2004-QS4 A7

 

3/1/2004

 

$

43 

 

$

43 

 

$

 -

 

ALT A

 

BBB+

 

11.84 

 

$

 -

MALT 2004-6 7A1

 

6/1/2004

 

 

385 

 

 

393 

 

 

 

ALT A

 

CCC

 

14.11 

 

 

 -

RALI 2005-QS2 A1

 

2/1/2005

 

 

236 

 

 

251 

 

 

15 

 

ALT A

 

CC

 

5.20 

 

 

10 

RALI 2006-QS4 A2

 

4/1/2006

 

 

502 

 

 

523 

 

 

21 

 

ALT A

 

D

 

 -

 

 

313 

GSR 2006-5F 2A1

 

5/1/2006

 

 

72 

 

 

80 

 

 

 

Prime

 

D

 

 -

 

 

15 

RALI 2006-QS8 A1

 

7/28/2006

 

 

264 

 

 

270 

 

 

 

ALT A

 

D

 

 -

 

 

217 

 

 

 

 

$

1,502 

 

$

1,560 

 

$

58 

 

 

 

 

 

 

 

$

555 

 

The investment portfolio contained 91 securities with $59.9 million of temporarily impaired fair value and $1.6 million in unrealized losses at June 30, 2015. The total unrealized loss position has increased slightly from $1.4 million at year-end 2014. 

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. Equity securities are assessed for other-than-temporary impairment based on the length of time of impairment, dollar amount of the impairment and general market and financial conditions relating to specific issues.  The impairment identified on debt and equity securities and subject to assessment at June 30, 2015, was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted.

38

 


 

The following table reflects temporary impairment in the investment portfolio (excluding restricted stock), 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 June 30, 2015 and December 31, 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2015

 

 

 

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

$

1,498 

 

$

(7)

 

 

$

4,617 

 

$

(22)

 

10 

 

$

6,115 

 

$

(29)

 

13 

Municipal securities

 

20,359 

 

 

(386)

 

33 

 

 

4,775 

 

 

(218)

 

 

 

25,134 

 

 

(604)

 

40 

Trust preferred securities

 

 -

 

 

 -

 

 -

 

 

5,328 

 

 

(621)

 

 

 

5,328 

 

 

(621)

 

Agency mortgage-backed securities

 

18,002 

 

 

(179)

 

22 

 

 

5,346 

 

 

(144)

 

 

 

23,348 

 

 

(323)

 

30 

Asset-backed securities

 

 -

 

 

 -

 

 -

 

 

 

 

(3)

 

 

 

 

 

(3)

 

Total temporarily impaired securities

$

39,859 

 

$

(572)

 

58 

 

$

20,070 

 

$

(1,008)

 

33 

 

$

59,929 

 

$

(1,580)

 

91 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2014

 

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

 

 

 

 -

 

 

 

7,207 

 

 

(64)

 

14 

 

 

7,211 

 

 

(64)

 

15 

Municipal securities

 

5,651 

 

 

(33)

 

 

 

9,441 

 

 

(259)

 

14 

 

 

15,092 

 

 

(292)

 

23 

Trust preferred securities

 

 -

 

 

 -

 

 -

 

 

5,137 

 

 

(803)

 

 

 

5,137 

 

 

(803)

 

Agency mortgage-backed securities

 

9,304 

 

 

(60)

 

13 

 

 

8,199 

 

 

(157)

 

10 

 

 

17,503 

 

 

(217)

 

23 

Private-label mortgage-backed securities

 

 -

 

 

 -

 

 -

 

 

540 

 

 

(15)

 

 

 

540 

 

 

(15)

 

Asset-backed securities

 

 -

 

 

 -

 

 -

 

 

 

 

(2)

 

 

 

 

 

(2)

 

Total temporarily impaired securities

$

14,959 

 

$

(93)

 

23 

 

$

30,529 

 

$

(1,300)

 

47 

 

$

45,488 

 

$

(1,393)

 

70 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The municipal bond portfolio has an unrealized loss of $604 thousand at June 30, 2015 compared to $292 thousand at year-end 2014.  This number of securities in this portfolio with an unrealized loss increased from 23 to 40 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 7 securities with a fair value of $5.3 million and an unrealized loss of $621 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 June 30, 2015, 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. 

The PLMBS sector shows a net unrealized gain $58 thousand with all bonds showing an unrealized gain.  Even though there is no unrealized loss, due to the nature of these bonds, they are evaluated closely. These bonds were all rated AAA at time of purchase, but have since experienced rating declines. Some have experienced increased delinquencies and defaults, while others have seen the credit support increase as the bonds paid-down. The Bank monitors the performance of the PLMBS investments on a regular basis and reviews delinquencies, default rates, credit support levels and various cash flow stress test scenarios. In determining the credit related loss, Management considers all principal past due 60 days or more as a loss. If additional principal moves beyond 60 days past due, it will also be considered a loss. As a result of the analysis on PLMBS it was determined that a $20 thousand impairment charge was required at the end of the first quarter; however, no additional impairment charge was required at June 30, 2015.   It is primarily a result of the cumulative OTTI charges that these bonds are showing an unrealized gain at quarter end.  The Bank has recorded $555 thousand of cumulative impairment charges on this portfolio. Management continues to monitor these securities and it is possible that additional write-downs may occur if current loss trends continue. The Bank is currently participating in a class-action lawsuit against one PLMBS servicer that centers on defective warranties and representations made as part of the underwriting process.  

39

 


 

The Bank held $439 thousand of restricted stock at June 30, 2015.  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. 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 increased $4.7 million over 2014, primarily in the commercial first lien and consumer junior liens and lines of credit categories.  For the first six months of 2015, the Bank originated $8.4 million in mortgages, including approximately $3.8 million 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 ($6.7 million), while loans for individuals to construct personal residences totaled $1.7 million at June  30, 2015.  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 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. 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 of costs incurred by the borrower, on-site inspections, and a signature by the assigned loan officer for disbursement of funds.  The Bank does not currently have any residential real estate construction loans with an interest reserve.    

Commercial loans and commercial real estate: Loans in this category include commercial, industrial, farm, agricultural, land development and municipal government loans. Collateral for these loans may include commercial real estate, farm real estate, equipment or other business assets. Total commercial real estate loans decreased to $317.3 million from $326.5 million at the end of 2014. The largest sectors (by collateral) in the commercial real estate category are: office buildings ($45.9 million), land development ($45.7 million), hotels and motels ($35.5 million), farm land ($33.6 million), and auto dealerships ($17.4 million). Commercial loans increased $13.2 million compared to year end, with increases in commercial and industrial loans ($13.0 million) and municipal loans ($8.8 million), offset by a payoff of $8.5 million from one borrower.  The Bank booked $47.4 million of new commercial loans in the first six months of 2015, but had unexpected pay-offs of $25.7 million from three large commercial loans. Subsequent to quarter end, the Bank booked two large commercial loans totaling $17.4 million.  The largest sectors (by industry) in the commercial loan category are: retail trade ($56.7 million), construction ($54.9 million), manufacturing ($40.9 million), food services ($40.4 million) and agriculture ($39.1 million).  The Bank is very active in its market in pursuing commercial lending opportunities, but supplements in-market growth with purchased loan participations. The Bank purchases commercial loan participations in an effort to increase its commercial lending and diversify its loan mix, both geographically and by industry sector.  Purchased loans are originated primarily within the south central Pennsylvania market and are purchased from only a few select counter parties. These loans usually represent an opportunity to participate in larger credits that are not available in market, with the benefit of lower origination and servicing costsFor the first six months of 2015, the Bank purchased $765 thousand of loan participations and commitments.  At June 30, 2015, the Bank held $118.6 million in purchased loan participations in its portfolio. 

Consumer loans decreased $749 thousand due primarily to regular payments and maturities.  The Bank believes the consumer portfolio will continue to run-down, as consumers are unwilling to increase their debt and nearly all consumer auto financing has shifted to dealer financing.

40

 


 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change

(Dollars in thousands)

June 30, 2015

 

December 31, 2014

 

 

Amount

 

%

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

Consumer first liens

$

103,852 

 

$

105,014 

 

$

(1,162)

 

(1.1)

Consumer junior liens and lines of credit

 

39,915 

 

 

38,132 

 

 

1,783 

 

4.7 

Total consumer

 

143,767 

 

 

143,146 

 

 

621 

 

0.4 

 

 

 

 

 

 

 

 

 

 

 

Commercial first lien

 

60,438 

 

 

56,300 

 

 

4,138 

 

7.3 

Commercial junior liens and lines of credit

 

5,637 

 

 

5,663 

 

 

(26)

 

(0.5)

Total commercial

 

66,075 

 

 

61,963 

 

 

4,112 

 

6.6 

Total residential real estate 1-4 family

 

209,842 

 

 

205,109 

 

 

4,733 

 

2.3 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate - construction

 

 

 

 

 

 

 

 

 

 

Consumer

 

1,736 

 

 

1,627 

 

 

109 

 

6.7 

Commercial

 

6,676 

 

 

8,088 

 

 

(1,412)

 

(17.5)

Total residential real estate construction

 

8,412 

 

 

9,715 

 

 

(1,303)

 

(13.4)

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate

 

317,329 

 

 

326,482 

 

 

(9,153)

 

(2.8)

Commercial

 

192,224 

 

 

179,071 

 

 

13,153 

 

7.3 

        Total commercial

 

509,553 

 

 

505,553 

 

 

4,000 

 

0.8 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

5,405 

 

 

6,154 

 

 

(749)

 

(12.2)

 

 

733,212 

 

 

726,531 

 

 

6,681 

 

0.9 

Less: Allowance for loan losses

 

(9,450)

 

 

(9,111)

 

 

(339)

 

(3.7)

Net Loans

$

723,762 

 

$

717,420 

 

$

6,342 

 

0.9 

 

 

 

 

 

 

 

 

 

 

 

Included in the loan balances are the following:

 

 

 

 

 

 

 

 

 

 

Net unamortized deferred loan costs

$

169 

 

$

(76)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans pledged as collateral for borrowings and commitments from:

 

 

 

 

 

 

 

 

 

 

FHLB

$

612,011 

 

$

602,633 

 

 

 

 

 

Federal Reserve Bank

 

54,844 

 

 

56,367 

 

 

 

 

 

 

$

666,855 

 

$

659,000 

 

 

 

 

 

41

 


 

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. 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.   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 measurements: (1) loans rated 6 or worse (collectively “watch list”), (2) delinquent loans, (3) other real estate owned (OREO), and (4) net-charge-offs. Management compares trends in these measurements with the Bank’s internally established targets, as well as its national peer group.

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 includes both performing and nonperforming loans. Watch list loans totaled $38.2 million at quarter-end, a slight improvement from $40.5 million at the prior year-end. The watch list is comprised of $20.3 million rated 6 and $17.9 million rated 7. The Bank has no loans rated 8-doubtful or 9-loss.  The credit composition of the portfolio, by primary collateral is shown in Note 7 of the accompanying financial statement. Included in the substandard loan total is $9.4 million of nonaccrual loans. 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 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.  At June 30, 2015, the Bank had loans of $23.6 million that exceeded the supervisory limit.  

 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 7 in the accompanying financial statements for a note 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 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).

42

 


 

Loan quality, as measured by the balance of nonperforming loans, is improving from year-end and the performance ratios related to nonperforming loans have also improved. The following table presents a summary of nonperforming assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

June 30, 2015

 

December 31, 2014

 

 

 

 

 

 

Nonaccrual loans

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

First liens

$

939 

 

$

1,124 

Junior liens and lines of credit

 

117 

 

 

169 

Total

 

1,056 

 

 

1,293 

Residential real estate - construction

 

513 

 

 

931 

Commercial real estate

 

7,437 

 

 

8,430 

Commercial

 

346 

 

 

1,637 

Total nonaccrual loans

 

9,352 

 

 

12,291 

 

 

 

 

 

 

Loans past due 90 days or more and not included above

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

First liens

 

153 

 

 

165 

Junior liens and lines of credit

 

 -

 

 

 -

Total

 

153 

 

 

165 

Commercial real estate

 

 -

 

 

140 

Consumer

 

10 

 

 

17 

Total loans past due 90 days or more and still accruing

 

163 

 

 

322 

 

 

 

 

 

 

Total nonperforming loans

 

9,515 

 

 

12,613 

 

 

 

 

 

 

Other real estate owned

 

4,018 

 

 

3,666 

Total nonperforming assets

$

13,533 

 

$

16,279 

 

 

 

 

 

 

 

 

 

 

 

 

Nonperforming loans to total gross loans

 

1.30% 

 

 

1.74% 

Nonperforming assets to total assets

 

1.32% 

 

 

1.63% 

Allowance for loan losses to nonperforming loans

 

99.31% 

 

 

72.23% 

 

43

 


 

The following table identifies the most significant loans in nonaccrual status. These six nonaccrual loans account for 90% of the total nonaccrual balance. The table also indicates those significant nonaccrual loans that are classified as troubled debt restructurings (TDR). A TDR loan is maintained on nonaccrual status until a satisfactory repayment history is established.  All loans on the watch list that are not on nonaccrual or past due 90 days more are considered potential problem loans. Potential problem loans at June 30, 2015 totaled $28.6 million compared to $27.8 million at year-end 2014.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALL

 

Nonaccrual

 

TDR

 

 

 

 

 

Last

(Dollars in thousands)

 

Balance

 

 

Reserve

 

Date

 

Status

 

Collateral

 

Location

 

Appraisal(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit 1 - Commercial real estate

$

3,039 

 

$

 -

 

Dec-10

 

N

 

1st lien on 90 acres undeveloped commercial real estate

 

PA

 

Nov-14

$

5,855 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit 2 - Residential real estate and commercial real estate

 

719 

 

 

 -

 

Aug-11

 

N

 

1st lien on commercial and residential properties and 70 acres of farmland

 

PA

 

Nov-14

$

1,140 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit 3 - Residential real estate

 

1,932 

 

 

 -

 

Mar-12

 

Y

 

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

 

PA

 

Oct-14

$

3,895 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit 4 - Residential real estate

 

1,637 

 

 

 -

 

Dec-14

 

N

 

Hotel and entertainment complex

 

PA

 

Feb-15

$

4,000 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit 5 - Commercial real estate

 

442 

 

 

 -

 

Mar-13

 

N

 

Liens on land and residential real estate, and investment accounts

 

PA

 

Sep-14

$

1,055 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit 6 - Commercial / commercial real estate

 

664 

 

 

 -

 

Mar-14

 

N

 

1st lien on commercial real estate

 

PA

 

Jun-13

$

1,550 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

8,433 

 

$

 -

 

 

 

 

 

 

 

 

 

 

 

 

 

(1) Appraisal value, as reported, does not reflect the pay-off of any senior liens or the cost to liquidate the collateral, but does reflect only the Bank’s share of the collateral if it is a participated loan.

Credit 1 has been charged down by $3.5 million since being placed on nonaccrual due to declining appraisal values.  This credit is part of a purchased loan participation and the lead bank has reached a settlement agreement with the borrower.  The Bank expects that it will know if the borrower can satisfy the terms of this agreement in the third quarter of 2015 or if this loan will be moved to other real estate owned.  Credit 2 has sold another piece of real estate and the Bank received a pay down of $158 thousand after June 30, 2015.  The remaining balance is expected to be restructured into a new loan.  Credit 3 is a TDR that is performing in accordance with the modified terms. Credit 4 is a hotel and entertainment complex being operated as part of an estate liquidation. Credit 5 borrower and guarantor have filed bankruptcy and are in the process of selling assets that will result in debt reduction. Subsequent to quarter end, the loan was fully paid off. This credit was written down by $749 thousand, including a $200 thousand write down in the first quarter of 2015.  Credit 6 did not comply with a forbearance agreement and a demand letter was issued in July 2015.

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 and TDR loans are always considered impaired. 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. In accordance with financial accounting standards, TDR loans are always considered impaired until they are paid off.  However, an impaired TDR loan can be a performing loan. Impaired loans totaled $24.1 million at quarter-end compared to $26.6 million at year-end 2014. Included in the impaired loan total is $14.6 million of accruing TDR loans and $2.1 million of nonaccrual TDR loans. Note 7 of the accompanying financial statements provides additional information on the composition of the impaired loans, including the allowance for loan loss that has been established for impaired loans.

A loan is considered a troubled debt restructuring (TDR) 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, reamortization of the payment, or a combination of multiple concessions.   The Bank reviews all loans rated 6 or worse when it is providing a loan restructure, modification

44

 


 

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. All TDR loans are in compliance with their modified terms. See Note 7 in the accompanying financial statements for a note that identifies TDR loans in the portfolio.

The Bank holds $4.0 million of other real estate owned (OREO), comprised of six properties compared to $3.7 million and five properties at December 31, 2014.  The most significant OREO holdings are listed in the table below. The appraised value for Property 2 reflects the commercial and industrial development potential of the property, which is the most likely use for the property. At December 31, 2014, the Bank reported this property with an “as is” valuation. During 2015, the Bank has incurred a net gain of $32 thousand on the sale of OREO and an expense of $19 thousand to hold and maintain OREO.

The following table provides additional information on significant other real estate owned properties:

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

Date

 

 

 

 

 

 

 

 

 

 

Acquired

 

Balance

 

Collateral

Location

 

Last Appraisal

 

 

 

 

 

 

 

 

 

 

 

Property 1

2011

$

488 

 

unimproved real estate for residential development

PA

 

Jan-15

$

585 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property 2

2012

 

2,758 

 

1st, 2nd, and 3rd liens residential development land - four tracts with 196 acres

PA

 

Apr-14

$

6,586 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

3,246 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At June 30, 2015, the Bank had $10 thousand of residential properties in the process of foreclosure compared to $763 thousand at the end of 2014.

Allowance for Loan Losses: 

Management 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. The Bank further classifies the portfolio based on the primary purpose of the loan, either consumer or commercial.  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 (OAEM) 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 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 June 30, 2015 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 two components, specific and general allocations. 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. At June 30, 2015, impaired loans totaled $24.1 million compared to $26.6 million at year-end 2014. Included in the June impaired loan total are loans of $204 thousand with a specific reserve of $10 thousand.  The specific reserve has decreased $221 thousand since year-

45

 


 

end, primarily as the result of a charge-off of $200 thousand on Credit 5 on the significant nonaccrual table that eliminated the $162 thousand specific reserve on this credit at December 31, 2014. Note 7 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.  The residential real estate sector is further segregated by first lien loans, junior liens and home equity products, and residential real estate construction. 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. Prior to March 31, 2015, the Bank was using an eight quarter rolling history for the quantitative analysis. The change to a longer historical period is based upon improving charge-offs and a more stable and slowly improving economy.   The historical loss experience resulted in a general allocation of $9.4 million (1.08% of gross loans) compared to $8.9 million (1.00% of gross loans) at December 31, 2014.  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. At quarter-end, this factor was 21.5 basis points unchanged from year-end 2014.  These factors are determined on the basis of Management’s observation, judgment and experience. 

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 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.

46

 


 

 

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 June  30, 2015 and December 31, 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Junior Liens &

 

 

 

 

Commercial

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

First Liens

 

Lines of Credit

 

Construction

 

Real Estate

 

Commercial

 

Consumer

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for allowance:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

1,083 

 

$

51 

 

$

513 

 

$

21,512 

 

$

237 

 

$

 -

 

$

23,396 

Collectively

 

 

163,207 

 

 

45,501 

 

 

7,899 

 

 

295,817 

 

 

191,987 

 

 

5,405 

 

 

709,816 

Total

 

$

164,290 

 

$

45,552 

 

$

8,412 

 

$

317,329 

 

$

192,224 

 

$

5,405 

 

$

733,212 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance established for loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 -

 

$

 -

 

$

 -

 

$

 

$

 

$

 -

 

$

10 

Collectively

 

 

1,293 

 

 

359 

 

 

220 

 

 

5,684 

 

 

1,763 

 

 

121 

 

 

9,440 

Allowance at June 30, 2015

 

$

1,293 

 

$

359 

 

$

220 

 

$

5,686 

 

$

1,771 

 

$

121 

 

$

9,450 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans evaluated for allowance:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

1,171 

 

$

51 

 

$

931 

 

$

22,307 

 

$

1,298 

 

$

 -

 

$

25,758 

Collectively

 

 

160,143 

 

 

43,744 

 

 

8,784 

 

 

304,175 

 

 

177,773 

 

 

6,154 

 

 

700,773 

Total

 

$

161,314 

 

$

43,795 

 

$

9,715 

 

$

326,482 

 

$

179,071 

 

$

6,154 

 

$

726,531 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance established for loans evaluated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually

 

$

 -

 

$

 -

 

$

 -

 

$

60 

 

$

171 

 

$

 -

 

$

231 

Collectively

 

 

1,225 

 

 

334 

 

 

226 

 

 

5,357 

 

 

1,602 

 

 

136 

 

 

8,880 

Allowance at December 31, 2014

 

$

1,225 

 

$

334 

 

$

226 

 

$

5,417 

 

$

1,773 

 

$

136 

 

$

9,111 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

During the first half of 2015, the Bank recorded $635 thousand for the loan loss provision expense, $171 thousand more than the same period in 2014.  For the second quarter of 2015, the provision expense was $310 thousand compared to $266 thousand for the same quarter of 2014.

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. The Bank recorded net loan charge-offs of $296 thousand for the six months of 2015. The largest charge-off during the period was $200 thousand related to Credit 5 on the significant nonaccrual table.

 

47

 


 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Real Estate 1-4 Family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Junior Liens &

 

 

 

 

Commercial

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

First Liens

 

Lines of Credit

 

Construction

 

Real Estate

 

Commercial

 

Consumer

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance at March 31, 2015

 

$

1,260 

 

$

334 

 

$

263 

 

$

5,600 

 

$

1,628 

 

$

125 

 

$

9,210 

Charge-offs

 

 

(43)

 

 

 -

 

 

(21)

 

 

 -

 

 

(17)

 

 

(26)

 

 

(107)

Recoveries

 

 

 

 

 -

 

 

 -

 

 

14 

 

 

 

 

14 

 

 

37 

Provision

 

 

75 

 

 

25 

 

 

(22)

 

 

72 

 

 

152 

 

 

 

 

310 

Allowance at June 30, 2015

 

$

1,293 

 

$

359 

 

$

220 

 

$

5,686 

 

$

1,771 

 

$

121 

 

$

9,450 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance at December 31, 2014

 

$

1,225 

 

$

334 

 

$

226 

 

$

5,417 

 

$

1,773 

 

$

136 

 

$

9,111 

Charge-offs

 

 

(43)

 

 

 -

 

 

(21)

 

 

 -

 

 

(218)

 

 

(78)

 

 

(360)

Recoveries

 

 

 

 

 -

 

 

 -

 

 

14 

 

 

14 

 

 

33 

 

 

64 

Provision

 

 

108 

 

 

25 

 

 

15 

 

 

255 

 

 

202 

 

 

30 

 

 

635 

Allowance at June 30, 2015

 

$

1,293 

 

$

359 

 

$

220 

 

$

5,686 

 

$

1,771 

 

$

121 

 

$

9,450 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2015

 

December 31, 2014

 

June 30, 2014

Net loans charged-off as a percentage of average gross loans

 

0.08% 

 

 

0.19% 

 

 

0.18% 

Net loans charged-off as a percentage of the provision for loan losses

 

46.61% 

 

 

177.36% 

 

 

139.44% 

Allowance as a percentage of loans

 

1.29% 

 

 

1.25% 

 

 

1.30% 

Net charge-offs

$

296 

 

$

1,355 

 

$

647 

48

 


 

Deposits: 

Total deposits increased $34.9 million during the first six months of 2015 to $916.1 million. Non-interest bearing deposits increased $6.7 million, while savings and interest-bearing checking increased $34.8 million and time deposits decreased $6.5 million. The increase in non-interest bearing checking accounts occurred primarily in retail checking accounts ($3.1 million) and commercial checking accounts ($2.5 million). Interest bearing checking increased by $34.4 million, primarily from commercial deposits.  The Bank’s Money Management product decreased to $383.2 million from $388.0 million.  Retail money management accounts increased $2.6 million, but were offset by a decrease of $6.3 million in commercial money management accounts.  Retail time deposits decreased since year-end, as customers moved funds to more liquid accounts.  As of June  30, 2015, the Bank had $3.4 million in CDARS reciprocal time deposits included in brokered time deposits.  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change

(Dollars in thousands)

June 30, 2015

 

December 31, 2014

 

 

Amount

 

%

Noninterest-bearing checking

$

143,564 

 

$

136,910 

 

$

6,654 

 

4.9 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking

 

229,438 

 

 

194,992 

 

 

34,446 

 

17.7 

Money management

 

383,204 

 

 

388,043 

 

 

(4,839)

 

(1.2)

Savings

 

67,782 

 

 

62,637 

 

 

5,145 

 

8.2 

Total interest-bearing checking and savings

 

680,424 

 

 

645,672 

 

 

34,752 

 

5.4 

 

 

 

 

 

 

 

 

 

 

 

Retail time deposits

 

88,708 

 

 

92,973 

 

 

(4,265)

 

(4.6)

Brokered time deposits

 

3,363 

 

 

5,626 

 

 

(2,263)

 

(40.2)

Total time deposits

 

92,071 

 

 

98,599 

 

 

(6,528)

 

(6.6)

Total deposits

$

916,059 

 

$

881,181 

 

$

34,878 

 

4.0 

 

 

 

 

 

 

 

 

 

 

 

Overdrawn deposit accounts reclassified as loans

$

180 

 

$

138 

 

 

 

 

 

 

Borrowings:

The Corporation had no short-term or long-term borrowings at June 30, 2015

Shareholders’ Equity:

Total shareholders’ equity increased $3.7 million to $107.2 million at June  30, 2015, compared to $103.5 million at the end of 2014.  The increase in retained earnings from the Corporation’s net income of $5.4 million was partially offset by the cash dividend of $1.5 million. The Corporation’s dividend payout ratio is 28.4% for the first six months of 2015 compared to 34.2% in 2014.  

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. Year-to-date, the Corporation paid dividends of $0.36 per share, compared to $.034 for the same period in 2014, 5.9% increase.  For the second quarter of 2015, the Corporation paid a $.19 per share dividend for the second quarter of 2015, compared to $.17 paid in the second quarter of 2014.  On July 23, 2015 the Board of Directors declared a $0.19 per share regular quarterly dividend for the third quarter of 2015, which will be paid on August 26, 2015.

In addition, the Corporation considers how dividend decisions may affect the Dividend Reinvestment Plan (DRIP), which has raised $435 thousand in new capital this year with 18,507 new shares purchased.  The Corporation continually explores other sources of capital as part of its capital management plan for the Corporation and the Bank.  The Corporation did not repurchase any shares of the Corporation’s common stock during the first six months of 2015.  

49

 


 

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 U.S. Banks, generally referred to as “Basel III.”  Basel III imposes significantly higher capital requirements and more restrictive leverage and liquidity ratios than those in place at the end of 2014.  The capital ratios to be considered “well capitalized” under Basel III are: common equity tier 1 of 6.5%, Tier 1 leverage of 5%, Tier 1 risk-based capital of 8%, and Total Risk-Based capital of 10%.  The common equity tier 1 ratio is a new capital ratio under Basel III.  Common equity consists of common stock, additional paid-in capital and retained earnings.  The Tier 1 risk-based capital ratio of 8% has been increased from 6%.  The new rule also includes a provision for banks to make a one-time irrevocable choice to exclude accumulated other comprehensive income (AOCI) from its common equity Tier 1 capital.  The Bank elected to exclude AOCI from the capital calculation with its March 31, 2015 regulatory filing.  In addition, a capital conservation buffer will be required to be maintained above the minimum capital ratios to avoid any capital distribution restrictions.  The capital conservation buffer will be phased in from 0% in 2015 to 2.5% in 2019.  The Basel III capital rules took effect for the Corporation and the Bank on January 1, 2015.  At June  30, 2015, the Corporation and the Bank were both well capitalized as defined by the banking regulatory agencies. 

The following table summarizes regulatory capital information as of June 30, 2015 and December 31, 2014 on a consolidated basis and for the Bank, as defined.  Regulatory capital ratios for June 30, 2015 were calculated in accordance with the Basel III rules, whereas the December 31, 2015 regulatory ratios were calculated in accordance with Basel I rules.  The minimum regulatory ratios shown below define capital levels under Basel III rules.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Regulatory Ratios

 

 

 

 

 

 

Adequately

 

Well

 

 

 

 

 

 

Capitalized

 

Capitalized

(Dollars in thousands)

 

June 30, 2015

 

December 31, 2014

 

Minimum

 

Minimum

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

14.48% 

 

N/A

 

4.50% 

 

N/A

Farmers & Merchants Trust Company

 

14.39% 

 

N/A

 

4.50% 

 

6.50% 

 

 

 

 

 

 

 

 

 

Tier 1 Risk-based Capital Ratio (2)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

14.48% 

 

14.19% 

 

6.00% 

 

N/A

Farmers & Merchants Trust Company

 

14.39% 

 

13.96% 

 

6.00% 

 

8.00% 

 

 

 

 

 

 

 

 

 

Total Risk-based Capital Ratio (3)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

15.73% 

 

15.49% 

 

8.00% 

 

N/A

Farmers & Merchants Trust Company

 

15.64% 

 

15.26% 

 

8.00% 

 

10.00% 

 

 

 

 

 

 

 

 

 

Tier 1 Leverage Ratio (4)

 

 

 

 

 

 

 

 

Franklin Financial Services Corporation

 

10.17% 

 

9.69% 

 

4.00% 

 

N/A

Farmers & Merchants Trust Company

 

9.96% 

 

9.55% 

 

4.00% 

 

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 County, PA.  This area is diverse in demographic and economic makeup.  County populations range from a low of approximately 14,000 in Fulton County to over 220,000 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 high of 5.9% 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 Pennsylvania 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

50

 


 

or business and Management believes that the Bank’s primary market area continues to be well suited for growth as the recession eases.

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

Economic Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2015

 

December 31, 2014

Unemployment Rate (seasonally adjusted)

 

 

 

 

Market area range (1)

 

3.5% - 5.9%

 

3.6% - 5.8%

Pennsylvania

 

5.4% 

 

5.1% 

United States

 

5.5% 

 

5.8% 

 

 

 

 

 

Housing Price Index - year over year change

 

 

 

 

PA, nonmetropolitan statistical area

 

3.2% 

 

0.5% 

United States

 

5.5% 

 

5.7% 

 

 

 

 

 

Franklin County Building Permits - year over year change

 

 

 

 

Residential, estimated

 

25.9% 

 

32.7% 

Multifamily, estimated

 

-57.9%

 

157.8% 

 

 

 

 

 

(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. The FOMC continues to hold short-term rates at historic lows.  It continues to monitor employment and inflation data as it considers the timing of an increase in the Fed Funds rate.  Many analysts believe that the FOMC will begin to increase rates in the second half 2015.

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 this measurement 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 will help 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 June 30, 2015, the Bank had approximately $69.3 million (fair value) in its investment portfolio pledged as collateral for deposits.  Another source of available liquidity for the Bank is a line of credit with the FHLB.  At June  30, 2015, the Bank had approximately $35 million available on this line of credit and $16.0 million of unsecured lines of credit at correspondent banks. At  June  30, 2015, the Bank had an excess borrowing

51

 


 

capacity of $240.8 million, which includes the amount available on the line of credit.  The Bank has established credit at the Federal Reserve Discount Window and as of quarter-end had the ability to borrow approximately $28 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 $274.1 million and $248.3 million, respectively, at June  30, 2015 and December 31, 2014.

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 2014 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 six months ended June  30, 2015. For more information on market risk refer to the Corporation’s 2014 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 June  30, 2015, 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.

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. 

52

 


 

 

Part II – OTHER INFORMATION

Item 1.     Legal Proceedings

The nature of the Corporation’s business generates a certain amount of litigation involving matters arising in the ordinary course of business.  However, in management’s opinion, there are no proceedings pending to which the Corporation is a party or to which our property is subject, which, if determined adversely to the Corporation, would be material in relation to our shareholders’ equity or financial condition.  In addition, no material proceedings are pending or are known to be threatened or contemplated against us by governmental authorities or other parties.

 

Item 1A. Risk Factors 

There were no material changes in the Corporation’s risk factors during the six months ended June  30, 2015. For more information, refer to the Corporation’s 2014 Annual Report on Form 10-K.

 

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

None

 

Item 3.   Defaults by the Company on its Senior Securities

None

 

Item 4.   Mine Safety Disclosures

Not Applicable  

 

Item 5.   Other Information

None

 

Item 6.  Exhibits

Exhibits

3.1   Articles of Incorporation of the Corporation.  (Filed as Exhibit 3.1 to Annual Report on Form 10-K for the year ended December 31, 2014 and incorporated herein by reference.)

 

3.2   Bylaws of the Corporation. (Filed as Exhibit 99 to Current Report on Form 8-K filed on December 20, 2014 and incorporated herein by reference.)

 

31.1 Rule 13a – 14(a)/15d-14(a) Certifications – Principal Executive Officer

 

31.2 Rule 13a – 14(a)/15d-14(a) Certifications – Principal Financial Officer

 

32.1 Section 1350 Certifications – Principal Executive Officer

 

32.2 Section 1350 Certifications – Principal Financial Officer

 

101 Interactive Data File (XBRL)

53

 


 

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

 

 

 

 

August 7, 2015

 

/s/ William E. Snell, Jr

 

 

William E. Snell, Jr.

 

 

President and Chief Executive Officer

 

 

(Principal Executive Officer)

 

 

 

 

 

August 7, 2015

 

/s/ Mark R. Hollar

 

 

Mark R. Hollar

 

 

Treasurer and Chief Financial Officer

 

 

(Principal Financial and Accounting Officer)

 

54