10-Q 1 fraf-20190331x10q.htm 10-Q

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 March 3 1, 201 9

☐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 01-38884

FRANKLIN FINANCIAL SERVICES CORPORATION

(Exact name of registrant as specified in its charter)

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PENNSYLVANIA | 25-1440803
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.)

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20 South Main Street, Chambersburg, PA | 17201-0819
(Address of principal executive offices) | (Zip Code)

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(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)

Securities registered pursuant to Section 12(b) of the Act:

Title of class Symbol Name of exchange on which registered

Common stock FRAF Nasdaq Stock Market, Inc.

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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 ☐

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

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

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

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

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

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There w ere 4,3 8 9,414 ou t st anding shares of the Registrant’s common stock as of April 3 0, 201 9.

INDEX

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Part I - FINANCIAL INFORMATION |
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﻿Item 1 | Financial Statements |
﻿ | Consolidated Balance Sheets as of March 3 1, 201 9 and December 31, 201 8 (unaudited) | 1
﻿ | Consolidated Statements of Income for the Three Months ended March 3 1, 201 9 | 2
﻿ | and 201 8 (unaudited) |
﻿ | Consolidated Statements of Comprehensive Income for the Three M onths ended | 3
﻿ | March 3 1, 201 9 and 201 8 (unaudited) |
﻿ | Consolidated Statements of Changes in Shareholders’ Equity for the Three Months | 3
﻿ | ended March 31, 201 9 and 201 8 (unaudited) |
﻿ | Consolidated Statements of Cash Flows for the Three Months ended March 3 1, 201 9 | 4
﻿ | and 201 8 (unaudited) |
﻿ | Notes to Consolidated Financial Statements (unaudited) | 5
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﻿Item 2 | Management’s Discussion and Analysis of Results of Operations and Financial Condition | 24
﻿Item 3 | Quantitative and Qualitative Disclosures about Market Risk | 40
﻿Item 4 | Controls and Procedures | 40
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Part II - OTHER INFORMATION |
﻿ |  |
﻿Item 1 | Legal Proceedings | 41
﻿Item 1A | Risk Factors | 41
﻿Item 2 | Unregistered Sales of Equity Securities and Use of Proceeds | 42
﻿Item 3 | Defaults Upon Senior Securities | 42
﻿Item 4 | Mine Safety Disclosures | 42
﻿Item 5 | Other Information | 43
﻿Item 6 | Exhibits | 43
﻿SIGNATURE PAGE | 44
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Part I FINANCIAL INFORMATION

Item 1 Financial Statements

C onsolidated Balance Sheet s

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﻿ |  |  |  |  |
(Dollars in thousands, except share and per share data)(unaudited) | March 31, |  | December 31,
﻿ | 2019 |  | 2018
Assets |  |  |  |  |
Cash and due from banks | $ | 11,771 |  | $ | 16,957
Interest-bearing deposits in other banks |  | 35,262 |  |  | 36,000
Total cash and cash equivalents |  | 47,033 |  |  | 52,957
Debt securities available for sale, at fair value |  | 127,881 |  |  | 131,472
Equity securities |  | 377 |  |  | 374
Restricted stock |  | 452 |  |  | 452
Loans held for sale |  | 195 |  |  | 118
Loans |  | 980,466 |  |  | 973,375
Allowance for loan losses |  | (12,681) |  |  | (12,415)
Net Loans |  | 967,785 |  |  | 960,960
Premises and equipment, net |  | 13,347 |  |  | 13,521
Right of use asset |  | 6,099 |  |  | —
Bank owned life insurance |  | 23,623 |  |  | 23,496
Goodwill |  | 9,016 |  |  | 9,016
Other real estate owned |  | 2,684 |  |  | 2,684
Deferred tax asset, net |  | 5,700 |  |  | 5,992
Other assets |  | 8,768 |  |  | 8,545
Total assets | $ | 1,212,960 |  | $ | 1,209,587
﻿ |  |  |  |  |
Liabilities |  |  |  |  |
Deposits |  |  |  |  |
Non-interest bearing checking | $ | 192,004 |  | $ | 197,417
Money management, savings and interest checking |  | 795,411 |  |  | 823,619
Time |  | 89,076 |  |  | 61,593
Total deposits |  | 1,076,491 |  |  | 1,082,629
Lease liability |  | 6,113 |  |  | —
Other liabilities |  | 8,865 |  |  | 8,562
Total liabilities |  | 1,091,469 |  |  | 1,091,191
﻿ |  |  |  |  |
Shareholders' equity |  |  |  |  |
Common stock, $1 par value per share,15,000,000 shares authorized with |  |  |  |  |
4,708,349 shares issued and 4,410,880 shares outstanding at March 31, 2019 and |  |  |  |  |
4,701,367 shares issued and 4,408,761 shares outstanding at December 31, 2018 |  | 4,708 |  |  | 4,701
Capital stock without par value, 5,000,000 shares authorized with no |  |  |  |  |
shares issued and outstanding |  | — |  |  | —
Additional paid-in capital |  | 41,841 |  |  | 41,530
Retained earnings |  | 85,991 |  |  | 83,946
Accumulated other comprehensive loss |  | (5,281) |  |  | (6,380)
Treasury stock, 297,469 shares at March 31, 2019 and 292,606 shares at |  |  |  |  |
December 31, 2018, at cost |  | (5,768) |  |  | (5,401)
Total shareholders' equity |  | 121,491 |  |  | 118,396
Total liabilities and shareholders' equity | $ | 1,212,960 |  | $ | 1,209,587

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

1

Consolidated Statements of Income

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﻿ |  |  |  |  |  |
﻿ |  | For the Three Months Ended
(Dollars in thousands, except per share data) (unaudited) |  | March 31,
﻿ |  | 2019 |  | 2018
Interest income |  |  |  |  |  |
Loans, including fees |  | $ | 11,009 |  | $ | 9,577
Interest and dividends on investments: |  |  |  |  |  |
Taxable interest |  |  | 540 |  |  | 513
Tax exempt interest |  |  | 338 |  |  | 274
Dividend income |  |  | 5 |  |  | 6
Deposits and obligations of other banks |  |  | 97 |  |  | 118
Total interest income |  |  | 11,989 |  |  | 10,488
Interest expense |  |  |  |  |  |
Deposits |  |  | 1,624 |  |  | 795
Short-term borrowings |  |  | 36 |  |  | —
Total interest expense |  |  | 1,660 |  |  | 795
Net interest income |  |  | 10,329 |  |  | 9,693
Provision for loan losses |  |  | 399 |  |  | 200
Net interest income after provision for loan losses |  |  | 9,930 |  |  | 9,493
Noninterest income |  |  |  |  |  |
Investment and trust services fees |  |  | 1,452 |  |  | 1,397
Loan service charges |  |  | 203 |  |  | 231
Deposit service charges and fees |  |  | 545 |  |  | 574
Other service charges and fees |  |  | 353 |  |  | 333
Debit card income |  |  | 402 |  |  | 385
Increase in cash surrender value of life insurance |  |  | 127 |  |  | 128
Debt securities gains, net |  |  | 24 |  |  | —
Change in fair value of equity securities |  |  | 3 |  |  | 45
Other |  |  | 56 |  |  | 55
Total noninterest income |  |  | 3,165 |  |  | 3,148
Noninterest Expense |  |  |  |  |  |
Salaries and employee benefits |  |  | 5,442 |  |  | 4,986
Net occupancy |  |  | 856 |  |  | 815
Advertising |  |  | 402 |  |  | 427
Legal and professional |  |  | 430 |  |  | 329
Data processing |  |  | 705 |  |  | 596
Pennsylvania bank shares tax |  |  | 243 |  |  | 239
FDIC Insurance |  |  | 65 |  |  | 129
ATM/debit card processing |  |  | 258 |  |  | 238
Foreclosed real estate |  |  | 17 |  |  | 14
Telecommunications |  |  | 105 |  |  | 109
Other |  |  | 889 |  |  | 766
Total noninterest expense |  |  | 9,412 |  |  | 8,648
Income before federal income taxes |  |  | 3,683 |  |  | 3,993
Federal income tax expense |  |  | 446 |  |  | 491
Net income |  | $ | 3,237 |  | $ | 3,502
Per share |  |  |  |  |  |
Basic earnings per share |  | $ | 0.73 |  | $ | 0.80
Diluted earnings per share |  | $ | 0.73 |  | $ | 0.80
Cash dividends declared |  | $ | 0.27 |  | $ | 0.24

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

2

Consolidated Statements of Comprehensive Income

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﻿ |  |  |  |  |  |
﻿ |  | For the Three Months Ended
﻿ |  | March 31,
(Dollars in thousands) (unaudited) |  | 2019 |  | 2018
Net Income |  | $ | 3,237 |  | $ | 3,502
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Debt Securities: |  |  |  |  |  |
Unrealized gains (losses) arising during the period |  |  | 1,414 |  |  | (1,043)
Reclassification adjustment included in net income (1) |  |  | (24) |  |  | —
Net unrealized gains (losses) |  |  | 1,390 |  |  | (1,043)
Tax effect |  |  | (291) |  |  | 262
Net of tax amount |  |  | 1,099 |  |  | (781)
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Total other comprehensive income (loss) |  |  | 1,099 |  |  | (781)
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Total Comprehensive Income |  | $ | 4,336 |  | $ | 2,721
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﻿ |  |  |  |  |  |
Reclassification adjustment / Statement line item |  | Tax expense (benefit)
(1) Debt securities gains, net |  | $ | 5 |  | $ | —

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

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Consolidated State ments of Changes in Shareholders' Equity

For the three months ended March 31, 2019 and 2018

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﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  | 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, 2018 | $ | 4,701 |  | $ | 41,530 |  | $ | 83,946 |  | $ | (6,380) |  | $ | (5,401) |  | $ | 118,396
Net income |  | — |  |  | — |  |  | 3,237 |  |  | — |  |  | — |  |  | 3,237
Other comprehensive income |  | — |  |  | — |  |  | — |  |  | 1,099 |  |  | — |  |  | 1,099
Cash dividends declared, $.27 per share |  | — |  |  | — |  |  | (1,192) |  |  | — |  |  | — |  |  | (1,192)
Acquisition of 15,163 shares of treasury stock |  | — |  |  | — |  |  | — |  |  | — |  |  | (560) |  |  | (560)
Treasury shares issued under employee stock purchase plan, 150 shares |  | — |  |  | 2 |  |  | — |  |  | — |  |  | 3 |  |  | 5
Treasury shares issued under dividend reinvestment plan, 10,150 shares |  | — |  |  | 161 |  |  | — |  |  | — |  |  | 190 |  |  | 351
Common stock issued under incentive stock option plan, 6,982 shares |  | 7 |  |  | 148 |  |  | — |  |  | — |  |  | — |  |  | 155
Balance at March 31, 2019 | $ | 4,708 |  | $ | 41,841 |  | $ | 85,991 |  | $ | (5,281) |  | $ | (5,768) |  | $ | 121,491

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﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Balance at December 31, 2017 | $ | 4,689 |  | $ | 40,396 |  | $ | 82,218 |  | $ | (6,028) |  | $ | (6,131) |  | $ | 115,144
Cumulative adjustment for fair value of equity securities |  | — |  |  | — |  |  | 201 |  |  | (201) |  |  | — |  |  | —
Net income |  | — |  |  | — |  |  | 3,502 |  |  | — |  |  | — |  |  | 3,502
Other comprehensive (loss) |  | — |  |  | — |  |  | — |  |  | (781) |  |  | — |  |  | (781)
Cash dividends declared, $.24 per share |  | — |  |  | — |  |  | (1,045) |  |  | — |  |  | — |  |  | (1,045)
Acquisition of 2,605 shares of treasury stock |  | — |  |  | — |  |  | — |  |  | — |  |  | (88) |  |  | (88)
Treasury shares issued under employee stock purchase plan, 200 shares |  | — |  |  | 2 |  |  | — |  |  | — |  |  | 4 |  |  | 6
Treasury shares issued under dividend reinvestment plan, 5,911 shares |  | — |  |  | 97 |  |  | — |  |  | — |  |  | 109 |  |  | 206
Common stock issued under incentive stock option plan, 6,518 shares |  | 7 |  |  | 142 |  |  | — |  |  | — |  |  | — |  |  | 149
Stock option compensation expense |  | — |  |  | 31 |  |  | — |  |  | — |  |  | — |  |  | 31
Balance at March 31, 2018 | $ | 4,696 |  | $ | 40,668 |  | $ | 84,876 |  | $ | (7,010) |  | $ | (6,106) |  | $ | 117,124

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

3

Consolidated Statements of Cash Flows

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﻿ |  |  |  |  |  |
﻿ |  | Three Months Ended March 31,
﻿ |  | 2019 |  | 2018
(Dollars in thousands) (unaudited) |  |  |  |  |  |
Cash flows from operating activities |  |  |  |  |  |
Net income |  | $ | 3,237 |  | $ | 3,502
Adjustments to reconcile net income to net cash provided by operating activities: |  |  |  |  |  |
Depreciation and amortization |  |  | 338 |  |  | 333
Net amortization of loans and investment securities |  |  | 409 |  |  | 438
Provision for loan losses |  |  | 399 |  |  | 200
Change in fair value of equity securities |  |  | (3) |  |  | (45)
Debt securities gains, net |  |  | (24) |  |  | —
Loans originated for sale |  |  | (6,467) |  |  | (2,527)
Proceeds from sale of loans |  |  | 6,390 |  |  | 2,969
Write-down of other real estate owned |  |  | — |  |  | 6
Loss on sale of premises |  |  | — |  |  | 17
Increase in cash surrender value of life insurance |  |  | (127) |  |  | (128)
Stock option compensation |  |  | — |  |  | 31
Contribution to pension plan |  |  | — |  |  | (1,000)
Increase in other assets |  |  | (50) |  |  | (448)
Increase in other liabilities |  |  | 118 |  |  | 148
Net cash provided by operating activities |  |  | 4,220 |  |  | 3,496
Cash flows from investing activities |  |  |  |  |  |
Proceeds from sales and calls of investment securities available for sale |  |  | 3,876 |  |  | —
Proceeds from maturities and pay-downs of securities available for sale |  |  | 6,084 |  |  | 5,726
Purchase of investment securities available for sale |  |  | (5,344) |  |  | (13,380)
Net (increase) decrease in loans |  |  | (7,245) |  |  | 1,031
Capital expenditures |  |  | (136) |  |  | (107)
Proceeds from sale of other assets |  |  | — |  |  | 117
Net cash used in investing activities |  |  | (2,765) |  |  | (6,613)
Cash flows from financing activities |  |  |  |  |  |
Net decrease in demand deposits, interest-bearing checking, and savings accounts |  |  | (33,621) |  |  | (3,636)
Net increase (decrease) in time deposits |  |  | 27,483 |  |  | (9,084)
Dividends paid |  |  | (1,192) |  |  | (1,045)
Purchase of Treasury shares |  |  | (560) |  |  | —
Cash received from option exercises |  |  | 160 |  |  | 206
Treasury shares under dividend reinvestment plan |  |  | 351 |  |  | 155
Net cash used in financing activities |  |  | (7,379) |  |  | (13,404)
Decrease in cash and cash equivalents |  |  | (5,924) |  |  | (16,521)
Cash and cash equivalents as of January 1 |  |  | 52,957 |  |  | 58,603
Cash and cash equivalents as of March 31 |  | $ | 47,033 |  | $ | 42,082
Supplemental Disclosures of Cash Flow Information |  |  |  |  |  |
Cash paid during the year for: |  |  |  |  |  |
Interest on deposits and other borrowed funds |  | $ | 1,562 |  | $ | 792
Noncash Activities |  |  |  |  |  |
Recognition of Operating Lease Right-of-Use Asset |  | $ | 6,236 |  | $ | —
Recognition of Operating Lease Liability |  | $ | 6,236 |  | $ | —

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

4

FRANKLIN FINANCIAL SERVICES CORPORATION and SUBSIDIARIES

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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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 Propert ies 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 March 31, 2019, 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 2018 Annual Report on Form 10-K. The consolidated results of operations for the three month period ended March 31, 2019 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, 2018 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:

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﻿ |  |  |  |  |  |
﻿ |  | For the Three Months Ended
﻿ |  | March 31,
(Dollars and shares in thousands, except per share data) |  | 2019 |  | 2018
Weighted average shares outstanding (basic) |  |  | 4,412 |  |  | 4,359
Impact of common stock equivalents |  |  | 21 |  |  | 28
Weighted average shares outstanding (diluted) |  |  | 4,433 |  |  | 4,387
Anti-dilutive options excluded from calculation |  |  | — |  |  | —
Net income |  | $ | 3,237 |  | $ | 3,502
Basic earnings per share |  | $ | 0.73 |  | $ | 0.80
Diluted earnings per share |  | $ | 0.73 |  | $ | 0.80

5

Note 2. Recent Accounting Pronouncements

The following accounting pronouncements have recently been adopted or will be adopted in future periods. For information on accounting pronouncements previously adopted, please refer to the Corporation’s report on Form 10-K for the year-ended December 31, 2018.

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﻿ |  |  |  |  |  |
Standard |  | Description |  | Effective Date |  | Effect on the financial statements or other significant matters
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ASU 2016-02, Leases (Topic 842) and all subsequently issued amendments |  | In February 2016, the FASB issued ASU 2016-02, "Leases (Subtopic 842)." This ASU requires all lessees to recognize a lease liability and a right-of-use asset, measured at the present value of the future minimum lease payments, at the lease commencement date. Lessor accounting remains largely unchanged under the new guidance. FASB subsequently issued various amendments that provided implementation guidance designed to provide entities with relief from the costs of implementing certain aspects of the new standard. From the lessee's perspective, the new standard requires a lessee to record a right-of-use asset and a lease liability on the balance sheet for all leases. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for lessees. ASU 2016-02 and all subsequent amendments are effective for fiscal years, including interim periods, beginning after December 15, 2018. Early adoption of ASU 2016-02 is permitted. |  | January 1, 2019 |  | The Corporation adopted ASU 2016-02, "Leases (Topic 842)" and all subsequent amendments on January 1, 2019 using the modified retrospective approach, and it did not have a material effect on its consolidated results of operations. Adoption of the new standard resulted in the recognition of a lease liability and a right-of-use asset of $6.2 million without a cumulative effect adjustment to retained earnings. The Corporation did not restate any prior period results. The Corporation adopted the package of practical expedients offered in ASU 2016-02 and therefore, existing lease classifications were not reassessed, expired or existing contracts were not reassessed for a lease, and the initial direct costs for any existing leases were not reassessed. In addition to the package of practical expedients, the Corporation also utilized other practical expedients offered: (1) the hindsight expedient which allows entities to use hindsight to determine the lease term was not adopted, (2) leases, for all underlying asset classes, with a term less than 12 months and no purchase option were excluded, (3) the option to not separate lease and non-lease components and account for them as a single component was adopted for real estate leases, and (4) the option to not apply lease accounting to existing land easements was adopted. See Note 7 for additional information on the adoption of the new standard.
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ASU 2018-13, Disclosure Framework (Topic 820) |  | This guidance eliminates, adds and modifies certain disclosure requirements for fair value measurements. Among the changes, entities will no longer be required to disclose the amount of and reason for transfers between Level 1 and Level 2 of the fair value hierarchy, but will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. |  | January 1, 2019 |  | The Corporation adopted the standard on January 1, 2019 and it did not have a material effect on its consolidated results of operations.
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ASU 2018-15, Accounting for Implementation Costs in a Cloud Computing Arrangement (Topic 350) |  | This ASU required an entity in a cloud computing arrangement (i.e., hosting arrangement) that is a service contract to follow the internal-use software guidance in ASC 350-40 to determine which implementation costs to capitalize as assets or expense as incurred. Capitalized implementation costs should be presented in the same line item on the balance sheet as amounts prepaid for the hosted service, if any (generally as an "other asset"). The capitalized costs will be amortized over the term of the hosting arrangement, with the amortization expense being presented in the same income statement line item as the fees paid for the hosted service. The ASU is effective January 1, 2020 with early adoption permitted. |  | January 1, 2020 |  | The Corporation adopted the standard on January 1, 2019 and it did not have a material effect on its consolidated results of operations.
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6

ASU 2017-04, Goodwill (Topic 350) |  | This guidance, among other things, removes step 2 of the goodwill impairment test thus eliminating the need to determine the fair value of individual assets and liabilities of the reporting unit. Upon adoption of this standard, goodwill impairment will be the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. This may result in more or less impairment being recognized than under the current guidance. Early adoption is permitted for any impairment tests performed after January 1, 2017, applied prospectively. |  | January 1, 2020 |  | The Corporation early adopted the ASU in the fourth quarter of 2018 with the completion of the 2018 impairment analysis. The Corporation is still evaluating the effect of the standard on its consolidated financial statements.
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ASU 2018-14, Disclosure Framework (Topic 715): Changes to the Disclosure Requirements for Defined Benefit Plans |  | This ASU makes minor changes to the disclosure requirements for employers that sponsor defined benefit pension and/or other postretirement benefit plans. ASU 2018-14 is effective for fiscal years ending after December 15, 2020; early adoption is permitted. |  | January 1, 2020 |  | The Corporation will adopt the provisions of the ASU on January 1, 2020. As the ASU only revises disclosure requirements, it is not expected to have a material effect on the consolidated financial statements.
﻿ |  |  |  |  |  |
ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments |  | This standard requires credit losses on most financial assets measured at amortized cost and certain other instruments to be measured using an expected credit loss model (referred to as the current expected credit loss (CECL) model). Under this model, entities will estimate credit losses over the entire contractual term of the instrument (considering estimated prepayments, but not expected extensions or modifications unless reasonable expectation of a troubled debt restructuring exists) from the date of initial recognition of that instrument. The ASU replaces the current accounting model for purchased credit impaired loans and debt securities. The allowance for credit losses for purchased financial assets with a more-than insignificant amount of credit deterioration since origination (“PCD assets”), should be determined in a similar manner to other financial assets measured on an amortized cost basis. However, upon initial recognition, the allowance for credit losses is added to the purchase price (“gross up approach”) to determine the initial amortized cost basis. The subsequent accounting for PCD financial assets is the same expected loss model described above. |  | January 1, 2020 |  | We have formed an implementation team led by the Corporation's Risk Management function. The team is reviewing the requirements of the ASU and evaluating methods and models for implementation. The new standard will result in earlier recognition of additions to the allowance for loan losses and possibly a larger allowance for loan loss balance with a corresponding increase in the provision for loan losses in results of operations; however, the Corporation is continuing to evaluate the impact of the pending adoption of the new standard on its consolidated financial statements. A third-party vendor has been selected to assist with the CECL calculations and the implementation process has started. The Corporation expects to be able to run the CECL model in test mode starting in the second quarter of 2019.
﻿ |  |  |  |  |  |

﻿

Note 3. Accumulated Other Comprehensive Loss

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

﻿

﻿

﻿ |  |  |  |  |  |
﻿ |  |  |  |  |  |
﻿ |  | March 31, |  | December 31,
﻿ |  | 2019 |  | 2018
(Dollars in thousands) |  |  |  |  |  |
Net unrealized (losses) gains on debt securities |  | $ | 290 |  | $ | (1,100)
Tax effect |  |  | (61) |  |  | 230
Net of tax amount |  |  | 229 |  |  | (870)
﻿ |  |  |  |  |  |
Accumulated pension adjustment |  |  | (6,975) |  |  | (6,975)
Tax effect |  |  | 1,465 |  |  | 1,465
Net of tax amount |  |  | (5,510) |  |  | (5,510)
﻿ |  |  |  |  |  |
Total accumulated other comprehensive loss |  | $ | (5,281) |  | $ | (6,380)

7

Note 4. Investments

Available for Sale (AFS) Securities

The amortized cost and estimated fair value of AFS securities as of March 31, 2019 and December 31, 2018 are as follows:

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |
(Dollars in thousands) |  |  |  |  | Gross |  | Gross |  |  |
﻿ |  | Amortized |  | unrealized |  | unrealized |  | Fair
March 31, 2019 |  | cost |  | gains |  | losses |  | value
U.S. Government and Agency securities |  | $ | 9,634 |  | $ | 24 |  | $ | (40) |  | $ | 9,618
Municipal securities |  |  | 63,820 |  |  | 845 |  |  | (108) |  |  | 64,557
Trust preferred securities |  |  | 4,080 |  |  | — |  |  | (180) |  |  | 3,900
Agency mortgage-backed securities |  |  | 42,818 |  |  | 135 |  |  | (364) |  |  | 42,589
Private-label mortgage-backed securities |  |  | 448 |  |  | 30 |  |  | — |  |  | 478
Asset-backed securities |  |  | 6,791 |  |  | — |  |  | (52) |  |  | 6,739
﻿ |  | $ | 127,591 |  | $ | 1,034 |  | $ | (744) |  | $ | 127,881

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |
(Dollars in thousands) |  |  |  |  | Gross |  | Gross |  |  |
﻿ |  | Amortized |  | unrealized |  | unrealized |  | Fair
December 31, 2018 |  | cost |  | gains |  | losses |  | value
U.S. Government and Agency securities |  | $ | 9,120 |  | $ | 21 |  | $ | (65) |  | $ | 9,076
Municipal securities |  |  | 67,811 |  |  | 320 |  |  | (484) |  |  | 67,647
Trust preferred securities |  |  | 4,074 |  |  | — |  |  | (316) |  |  | 3,758
Agency mortgage-backed securities |  |  | 45,241 |  |  | 65 |  |  | (648) |  |  | 44,658
Private-label mortgage-backed securities |  |  | 457 |  |  | 31 |  |  | — |  |  | 488
Asset-backed securities |  |  | 5,869 |  |  | — |  |  | (24) |  |  | 5,845
﻿ |  | $ | 132,572 |  | $ | 437 |  | $ | (1,537) |  | $ | 131,472

﻿

At March 31, 2019 and December 31, 2018, the fair value of AFS securities pledged to secure public funds and trust deposit s totaled $7 6.7 million and $84.6 million, respectively.

The amortized cost and estimated fair value of debt securities at March 31, 2019, 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 |  | $ | 21,030 |  | $ | 21,084
Due after one year through five years |  |  | 25,764 |  |  | 25,839
Due after five years through ten years |  |  | 35,173 |  |  | 35,467
Due after ten years |  |  | 2,358 |  |  | 2,424
﻿ |  |  | 84,325 |  |  | 84,814
Mortgage-backed securities |  |  | 43,266 |  |  | 43,067
﻿ |  | $ | 127,591 |  | $ | 127,881

﻿

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

﻿

﻿ |  |  |  |  |  |
﻿ |  | For the Three Months Ended
﻿ |  | March 31,
(Dollars in thousands) |  | 2019 |  | 2018
Gross gains realized |  | $ | 33 |  | $ | —
Gross losses realized |  |  | (9) |  |  | —
Net gains realized |  | $ | 24 |  | $ | —

﻿

Impairment:

The AFS securities portfolio contained 125 securities with $57.7 million of temporarily impaired fair value and $744 thousand in unrealized losses at March 31, 2019. The total unrealized loss position has decreased $793 thousand since year-end 2018.

8

For securities with an unrealized loss, Management applies a systematic methodology in order to perform an assessment of the potential for other-than-temporary impairment. In the case of debt securities, investments considered for other-than-temporary impairment: (1) had a specified maturity or repricing date; (2) were generally expected to be redeemed at par, and (3) were expected to achieve a recovery in market value within a reasonable period of time. In addition, the Bank considers whether it intends to sell these securities or whether it will be forced to sell these securities before the earlier of amortized cost recovery or maturity. The impairment identified on debt securities and subject to assessment at March 31, 2019, was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted.

The following table reflects temporary impairment in the AFS portfolio, aggregated by investment category, length of time that individual securities have been in a continuous unrealized loss position and the number of securities in each category as of March 31, 2019 and December 31, 2018:

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ | March 31, 2019
﻿ | Less than 12 months |  | 12 months or more |  | Total
﻿ | Fair |  | Unrealized |  |  |  | Fair |  | Unrealized |  |  |  | Fair |  | Unrealized |  |
(Dollars in thousands) | Value |  | Losses |  | Count |  | Value |  | Losses |  | Count |  | Value |  | Losses |  | Count
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
U.S. Government and Agency securities | $ | — |  | $ | — |  | — |  | $ | 4,777 |  | $ | (40) |  | 14 |  | $ | 4,777 |  | $ | (40) |  | 14
Municipal securities |  | 238 |  |  | — |  | 1 |  |  | 12,377 |  |  | (108) |  | 21 |  |  | 12,615 |  |  | (108) |  | 22
Trust preferred securities |  | 1,166 |  |  | (33) |  | 2 |  |  | 2,734 |  |  | (147) |  | 3 |  |  | 3,900 |  |  | (180) |  | 5
Agency mortgage-backed securities |  | 895 |  |  | (1) |  | 4 |  |  | 28,746 |  |  | (363) |  | 71 |  |  | 29,641 |  |  | (364) |  | 75
Asset-backed securities |  | 6,721 |  |  | (51) |  | 7 |  |  | 18 |  |  | (1) |  | 2 |  |  | 6,739 |  |  | (52) |  | 9
Total temporarily impaired securities | $ | 9,020 |  | $ | (85) |  | 14 |  | $ | 48,652 |  | $ | (659) |  | 111 |  | $ | 57,672 |  | $ | (744) |  | 125

﻿

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ | December 31, 2018
﻿ | Less than 12 months |  | 12 months or more |  | Total
﻿ | Fair |  | Unrealized |  |  |  | Fair |  | Unrealized |  |  |  | Fair |  | Unrealized |  |
(Dollars in thousands) | Value |  | Losses |  | Count |  | Value |  | Losses |  | Count |  | Value |  | Losses |  | Count
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
U.S. Government and Agency securities | $ | 2,071 |  | $ | (6) |  | 2 |  | $ | 5,175 |  | $ | (59) |  | 14 |  | $ | 7,246 |  | $ | (65) |  | 16
Municipal securities |  | 5,832 |  |  | (12) |  | 10 |  |  | 25,091 |  |  | (472) |  | 42 |  |  | 30,923 |  |  | (484) |  | 52
Trust preferred securities |  | 2,008 |  |  | (159) |  | 3 |  |  | 1,750 |  |  | (157) |  | 2 |  |  | 3,758 |  |  | (316) |  | 5
Agency mortgage-backed securities |  | 7,687 |  |  | (46) |  | 16 |  |  | 30,511 |  |  | (602) |  | 74 |  |  | 38,198 |  |  | (648) |  | 90
Asset-backed securities |  | 5,826 |  |  | (22) |  | 6 |  |  | 19 |  |  | (2) |  | 2 |  |  | 5,845 |  |  | (24) |  | 8
Total temporarily impaired securities | $ | 23,424 |  | $ | (245) |  | 37 |  | $ | 62,546 |  | $ | (1,292) |  | 134 |  | $ | 85,970 |  | $ | (1,537) |  | 171
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

﻿

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

﻿

﻿

﻿ |  |  |  |  |  |
﻿ |  |  |  |  |  |
﻿ |  | Three Months Ended
(Dollars in thousands) |  | March 31,
﻿ |  | 2019 |  | 2018
Balance of cumulative credit-related OTTI at January 1 |  | $ | 272 |  | $ | 595
Additions for credit-related OTTI not previously recognized |  |  | — |  |  | —
Additional increases for credit-related OTTI previously recognized when there is |  |  |  |  |  |
no intent to sell and no requirement to sell before recovery of amortized cost basis |  |  | — |  |  | —
Decreases for previously recognized credit-related OTTI because there was an intent to sell |  |  | — |  |  | —
Reduction for increases in cash flows expected to be collected |  |  | — |  |  | —
Balance of credit-related OTTI at March 31 |  | $ | 272 |  | $ | 595
﻿ |  |  |  |  |  |

Equity securities at Fair Value

The Corporation owns one equity investment. At March 31, 2019 and December 31, 2018, this investment was reported at fair value of $377 thousand and $374 thousand, respectively, with changes in value reported through income.

9

Restricted Stock at Cost

The Bank held $452 thousand of restricted stock at March 31, 2019. Except for $30 thousand, this investment represents stock in FHLB Pittsburgh. The Bank is required to hold this stock to be a member of FHLB and it is carried at cost of $100 per share. The level of FHLB stock held is determined by FHLB and is comprised of a minimum membership amount plus a variable activity amount. FHLB stock is evaluated for impairment primarily based on an assessment of the ultimate recoverability of its cost. As a government sponsored entity, FHLB has the ability to raise funding through the U.S. Treasury that can be used to support its operations. There is not a public market for FHLB stock and the benefits of FHLB membership (e.g., liquidity and low cost funding) add value to the stock beyond purely financial measures. Management intends to remain a member of the FHLB and believes that it will be able to fully recover the cost basis of this investment.

﻿

﻿

Note 5. Loans

The Bank reports i t s 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.

10

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

﻿ |  |  |  |  |  |
﻿ |  |  |  |  |  |
﻿ |  | March 31, |  | December 31,
(Dollars in thousands) |  | 2019 |  | 2018
Residential Real Estate 1-4 Family |  |  |  |  |  |
Consumer first liens |  | $ | 89,212 |  | $ | 89,673
Commercial first lien |  |  | 58,210 |  |  | 59,227
Total first liens |  |  | 147,422 |  |  | 148,900
﻿ |  |  |  |  |  |
Consumer junior liens and lines of credit |  |  | 41,831 |  |  | 42,504
Commercial junior liens and lines of credit |  |  | 4,859 |  |  | 4,716
Total junior liens and lines of credit |  |  | 46,690 |  |  | 47,220
Total residential real estate 1-4 family |  |  | 194,112 |  |  | 196,120
﻿ |  |  |  |  |  |
Residential real estate - construction |  |  |  |  |  |
Consumer |  |  | 2,750 |  |  | 1,667
Commercial |  |  | 11,231 |  |  | 8,558
Total residential real estate construction |  |  | 13,981 |  |  | 10,225
﻿ |  |  |  |  |  |
Commercial real estate |  |  | 497,974 |  |  | 487,980
Commercial |  |  | 269,243 |  |  | 274,054
Total commercial |  |  | 767,217 |  |  | 762,034
﻿ |  |  |  |  |  |
Consumer |  |  | 5,156 |  |  | 4,996
﻿ |  |  | 980,466 |  |  | 973,375
Less: Allowance for loan losses |  |  | (12,681) |  |  | (12,415)
Net Loans |  | $ | 967,785 |  | $ | 960,960
﻿ |  |  |  |  |  |
Included in the loan balances are the following: |  |  |  |  |  |
Net unamortized deferred loan costs |  | $ | 125 |  | $ | 123
﻿ |  |  |  |  |  |
Loans pledged as collateral for borrowings and commitments from: |  |  |  |  |  |
FHLB |  | $ | 787,055 |  | $ | 772,564
Federal Reserve Bank |  |  | 33,645 |  |  | 34,160
﻿ |  | $ | 820,700 |  | $ | 806,724

Note 6. Loan Quality and Allowance for Loan Losses

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

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  | Residential Real Estate 1-4 Family |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  | First |  | Junior Liens & |  |  |  |  | Commercial |  |  |  |  |  |  |  |  |  |  |
(Dollars in thousands) |  | Liens |  | Lines of Credit |  | Construction |  | Real Estate |  | Commercial |  | Consumer |  | Unallocated |  | Total
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
ALL at December 31, 2018 |  | $ | 491 |  | $ | 133 |  | $ | 108 |  | $ | 5,698 |  | $ | 4,511 |  | $ | 70 |  | $ | 1,404 |  | $ | 12,415
Charge-offs |  |  | (33) |  |  | (1) |  |  | (3) |  |  | (63) |  |  | (61) |  |  | (26) |  |  | — |  |  | (187)
Recoveries |  |  | 1 |  |  | — |  |  | — |  |  | 1 |  |  | 42 |  |  | 10 |  |  | — |  |  | 54
Provision |  |  | 28 |  |  | — |  |  | 47 |  |  | 270 |  |  | 70 |  |  | 18 |  |  | (34) |  |  | 399
ALL at March 31, 2019 |  | $ | 487 |  | $ | 132 |  | $ | 152 |  | $ | 5,906 |  | $ | 4,562 |  | $ | 72 |  | $ | 1,370 |  | $ | 12,681
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
ALL at December 31, 2017 |  | $ | 1,060 |  | $ | 330 |  | $ | 224 |  | $ | 6,526 |  | $ | 2,110 |  | $ | 105 |  | $ | 1,437 |  | $ | 11,792
Charge-offs |  |  | - |  |  | — |  |  | — |  |  | — |  |  | — |  |  | (26) |  |  | — |  |  | (26)
Recoveries |  |  | 1 |  |  | — |  |  | — |  |  | — |  |  | 8 |  |  | 14 |  |  | — |  |  | 23
Provision |  |  | (18) |  |  | (10) |  |  | 36 |  |  | 172 |  |  | (45) |  |  | 11 |  |  | 54 |  |  | 200
ALL at March 31, 2018 |  | $ | 1,043 |  | $ | 320 |  | $ | 260 |  | $ | 6,698 |  | $ | 2,073 |  | $ | 104 |  | $ | 1,491 |  | $ | 11,989
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

﻿

11

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 March 31, 2019 and December 31, 2018:

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  | Residential Real Estate 1-4 Family |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  | First |  | Junior Liens & |  |  |  | Commercial |  |  |  |  |  |  |  |  |  |  |
(Dollars in thousands) |  | Liens |  | Lines of Credit |  | Construction |  | Real Estate |  | Commercial |  | Consumer |  | Unallocated |  | Total
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
March 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans evaluated for ALL: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually |  | $ | 401 |  | $ | — |  | $ | 652 |  | $ | 13,247 |  | $ | — |  | $ | — |  | $ | — |  | $ | 14,300
Collectively |  |  | 147,021 |  |  | 46,690 |  |  | 13,329 |  |  | 484,727 |  |  | 269,243 |  |  | 5,156 |  |  | — |  |  | 966,166
Total |  | $ | 147,422 |  | $ | 46,690 |  | $ | 13,981 |  | $ | 497,974 |  | $ | 269,243 |  | $ | 5,156 |  | $ | — |  | $ | 980,466
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
ALL established for loans evaluated: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually |  | $ | — |  | $ | — |  | $ | — |  | $ | — |  | $ | — |  | $ | — |  | $ | — |  | $ | —
Collectively |  |  | 487 |  |  | 132 |  |  | 152 |  |  | 5,906 |  |  | 4,562 |  |  | 72 |  |  | 1,370 |  |  | 12,681
ALL at March 31, 2019 |  | $ | 487 |  | $ | 132 |  | $ | 152 |  | $ | 5,906 |  | $ | 4,562 |  | $ | 72 |  | $ | 1,370 |  | $ | 12,681
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
December 31, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans evaluated for ALL: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually |  | $ | 405 |  | $ | — |  | $ | 455 |  | $ | 10,099 |  | $ | 181 |  | $ | — |  | $ | — |  | $ | 11,140
Collectively |  |  | 148,495 |  |  | 47,220 |  |  | 9,770 |  |  | 477,881 |  |  | 273,873 |  |  | 4,996 |  |  | — |  |  | 962,235
Total |  | $ | 148,900 |  | $ | 47,220 |  | $ | 10,225 |  | $ | 487,980 |  | $ | 274,054 |  | $ | 4,996 |  | $ | — |  | $ | 973,375
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
ALL established for loans evaluated: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually |  | $ | — |  | $ | — |  | $ | — |  | $ | — |  | $ | — |  | $ | — |  | $ | — |  | $ | —
Collectively |  |  | 491 |  |  | 133 |  |  | 108 |  |  | 5,698 |  |  | 4,511 |  |  | 70 |  |  | 1,404 |  |  | 12,415
ALL at December 31, 2018 |  | $ | 491 |  | $ | 133 |  | $ | 108 |  | $ | 5,698 |  | $ | 4,511 |  | $ | 70 |  | $ | 1,404 |  | $ | 12,415

12

The following table shows additional information about those loans considered to be impaired at March 31, 2019 and December 31, 2018:

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  | Impaired Loans
﻿ |  | With No Allowance |  | With Allowance
(Dollars in thousands) |  |  |  |  | Unpaid |  |  |  |  | Unpaid |  |  |
﻿ |  | Recorded |  | Principal |  | Recorded |  | Principal |  | Related
March 31, 2019 |  | Investment |  | Balance |  | Investment |  | Balance |  | Allowance
Residential Real Estate 1-4 Family |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
First liens |  | $ | 889 |  | $ | 889 |  | $ | — |  | $ | — |  | $ | —
Junior liens and lines of credit |  |  | 44 |  |  | 44 |  |  | — |  |  | — |  |  | —
Total |  |  | 933 |  |  | 933 |  |  | — |  |  | — |  |  | —
Residential real estate - construction |  |  | 652 |  |  | 729 |  |  | — |  |  | — |  |  | —
Commercial real estate |  |  | 13,446 |  |  | 14,022 |  |  | — |  |  | — |  |  | —
Commercial |  |  | 129 |  |  | 146 |  |  | — |  |  | — |  |  | —
Total |  | $ | 15,160 |  | $ | 15,830 |  | $ | — |  | $ | — |  | $ | —

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
December 31, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential Real Estate 1-4 Family |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
First liens |  | $ | 871 |  | $ | 958 |  | $ | — |  | $ | — |  | $ | —
Junior liens and lines of credit |  |  | 49 |  |  | 49 |  |  | — |  |  | — |  |  | —
Total |  |  | 920 |  |  | 1,007 |  |  | — |  |  | — |  |  | —
Residential real estate - construction |  |  | 455 |  |  | 531 |  |  | — |  |  | — |  |  | —
Commercial real estate |  |  | 10,236 |  |  | 10,808 |  |  | — |  |  | — |  |  | —
Commercial |  |  | 315 |  |  | 9,763 |  |  | — |  |  | — |  |  | —
Total |  | $ | 11,926 |  | $ | 22,109 |  | $ | — |  | $ | — |  | $ | —

﻿

The following table shows the average of impaired loans and related interest income for the three months ended March 31, 2019 and 201 8:

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  | Three Months Ended |  | Three Months Ended
﻿ |  | March 31, 2019 |  | March 31, 2018
﻿ |  | Average |  | Interest |  | Average |  | Interest
(Dollars in thousands) |  | Recorded |  | Income |  | Recorded |  | Income
﻿ |  | Investment |  | Recognized |  | Investment |  | Recognized
Residential Real Estate 1-4 Family |  |  |  |  |  |  |  |  |  |  |  |
First liens |  | $ | 893 |  | $ | 11 |  | $ | 805 |  | $ | 11
Junior liens and lines of credit |  |  | 44 |  |  | — |  |  | — |  |  | —
Total |  |  | 937 |  |  | 11 |  |  | 805 |  |  | 11
Residential real estate - construction |  |  | 653 |  |  | — |  |  | 466 |  |  | —
Commercial real estate |  |  | 13,494 |  |  | 102 |  |  | 10,994 |  |  | 105
Commercial |  |  | 129 |  |  | — |  |  | 185 |  |  | —
Total |  | $ | 15,213 |  | $ | 113 |  | $ | 12,450 |  | $ | 116

13

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
March 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential Real Estate 1-4 Family |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
First liens |  | $ | 146,866 |  | $ | 309 |  | $ | 30 |  | $ | 137 |  | $ | 476 |  | $ | 80 |  | $ | 147,422
Junior liens and lines of credit |  |  | 46,588 |  |  | 29 |  |  | 29 |  |  | 18 |  |  | 76 |  |  | 26 |  |  | 46,690
Total |  |  | 193,454 |  |  | 338 |  |  | 59 |  |  | 155 |  |  | 552 |  |  | 106 |  |  | 194,112
Residential real estate - construction |  |  | 13,329 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 652 |  |  | 13,981
Commercial real estate |  |  | 491,462 |  |  | 438 |  |  | 1,331 |  |  | — |  |  | 1,769 |  |  | 4,743 |  |  | 497,974
Commercial |  |  | 268,527 |  |  | 273 |  |  | 262 |  |  | 52 |  |  | 587 |  |  | 129 |  |  | 269,243
Consumer |  |  | 5,135 |  |  | 21 |  |  | — |  |  | — |  |  | 21 |  |  | — |  |  | 5,156
Total |  | $ | 971,907 |  | $ | 1,070 |  | $ | 1,652 |  | $ | 207 |  | $ | 2,929 |  | $ | 5,630 |  | $ | 980,466

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
December 31, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential Real Estate 1-4 Family |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
First liens |  | $ | 148,183 |  | $ | 322 |  | $ | 202 |  | $ | 113 |  | $ | 637 |  | $ | 80 |  | $ | 148,900
Junior liens and lines of credit |  |  | 47,040 |  |  | 131 |  |  | — |  |  | 26 |  |  | 157 |  |  | 23 |  |  | 47,220
Total |  |  | 195,223 |  |  | 453 |  |  | 202 |  |  | 139 |  |  | 794 |  |  | 103 |  |  | 196,120
Residential real estate - construction |  |  | 9,572 |  |  | — |  |  | 198 |  |  | — |  |  | 198 |  |  | 455 |  |  | 10,225
Commercial real estate |  |  | 481,774 |  |  | 1,343 |  |  | 3,323 |  |  | 113 |  |  | 4,779 |  |  | 1,427 |  |  | 487,980
Commercial |  |  | 273,534 |  |  | 65 |  |  | 40 |  |  | 100 |  |  | 205 |  |  | 315 |  |  | 274,054
Consumer |  |  | 4,933 |  |  | 46 |  |  | 12 |  |  | 5 |  |  | 63 |  |  | — |  |  | 4,996
Total |  | $ | 965,036 |  | $ | 1,907 |  | $ | 3,775 |  | $ | 357 |  | $ | 6,039 |  | $ | 2,300 |  | $ | 973,375

﻿

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

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ | Pass |  | Special Mention |  | Substandard |  | Doubtful |  |  |
(Dollars in thousands) | (1-5) |  | (6) |  | (7) |  | (8) |  | Total
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
March 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential Real Estate 1-4 Family |  |  |  |  |  |  |  |  |  |  |  |  |  |
First liens | $ | 146,986 |  | $ | — |  | $ | 436 |  | $ | — |  | $ | 147,422
Junior liens and lines of credit |  | 46,646 |  |  | — |  |  | 44 |  |  | — |  |  | 46,690
Total |  | 193,632 |  |  | — |  |  | 480 |  |  | — |  |  | 194,112
Residential real estate - construction |  | 13,329 |  |  | — |  |  | 652 |  |  | — |  |  | 13,981
Commercial real estate |  | 490,057 |  |  | 655 |  |  | 7,262 |  |  | — |  |  | 497,974
Commercial |  | 268,345 |  |  | — |  |  | 898 |  |  | — |  |  | 269,243
Consumer |  | 5,156 |  |  | — |  |  | — |  |  | — |  |  | 5,156
Total | $ | 970,519 |  | $ | 655 |  | $ | 9,292 |  | $ | — |  | $ | 980,466

﻿

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
December 31, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential Real Estate 1-4 Family |  |  |  |  |  |  |  |  |  |  |  |  |  |
First liens | $ | 148,453 |  | $ | — |  | $ | 447 |  | $ | — |  | $ | 148,900
Junior liens and lines of credit |  | 47,171 |  |  | — |  |  | 49 |  |  | — |  |  | 47,220
Total |  | 195,624 |  |  | — |  |  | 496 |  |  | — |  |  | 196,120
Residential real estate - construction |  | 9,572 |  |  | — |  |  | 653 |  |  | — |  |  | 10,225
Commercial real estate |  | 479,969 |  |  | 660 |  |  | 7,351 |  |  | — |  |  | 487,980
Commercial |  | 272,959 |  |  | — |  |  | 1,095 |  |  | — |  |  | 274,054
Consumer |  | 4,991 |  |  | — |  |  | 5 |  |  | — |  |  | 4,996
Total | $ | 963,115 |  | $ | 660 |  | $ | 9,600 |  | $ | — |  | $ | 973,375

14

﻿

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

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  | Troubled Debt Restructurings
﻿ |  |  |  |  |  |  |  |  |  |  |  |  | Within the Last 12 Months
﻿ |  |  |  |  |  |  |  |  |  | That Have Defaulted
(Dollars in thousands) |  | Troubled Debt Restructurings |  | On Modified Terms
﻿ |  | Number of |  | Recorded |  |  |  |  |  |  |  | Number of |  | Recorded
﻿ |  | Contracts |  | Investment |  | Performing* |  | Nonperforming* |  | Contracts |  | Investment
March 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential real estate - construction |  | 1 |  | $ | 454 |  | $ | — |  | $ | 454 |  | — |  | $ | —
Residential real estate |  | 4 |  |  | 673 |  |  | 673 |  |  | — |  | — |  |  | —
Commercial real estate |  | 11 |  |  | 9,982 |  |  | 8,703 |  |  | 1,279 |  | — |  |  | —
Total |  | 16 |  | $ | 11,109 |  | $ | 9,376 |  | $ | 1,733 |  | — |  | $ | —
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
December 31, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential real estate - construction |  | 1 |  | $ | 455 |  | $ | — |  | $ | 455 |  | — |  | $ | —
Residential real estate |  | 4 |  |  | 678 |  |  | 678 |  |  | — |  | — |  |  | —
Commercial real estate |  | 11 |  |  | 10,099 |  |  | 8,809 |  |  | 1,290 |  | — |  |  | —
Total |  | 16 |  | $ | 11,232 |  | $ | 9,487 |  | $ | 1,745 |  | — |  | $ | —
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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

There were no new TDR loans during 201 9 and 201 8.

﻿

﻿

Note 7. Leases

The Corporation adopted ASU 2016-02 “Leases (Topic 842)” and all subsequent amendments on January 1, 2019 using the modified retrospective method. The Corporation has elected the option to apply the new standard as of January 1, 2019 without restatement of any prior period results. Adoption of the new standard resulted in the recognition of a lease liability and a right-of-use asset of $6.2 million without a cumulative effect adjustment to retained earnings.

The Corporation leases various assets in the course of its operations that are subject to recognition under the new standard. The Corporation considers all of i t s leases to be operating leases and it has no finance leases. The leased assets are comprised of equipment; and buildings and land (collectively real estate). The equipment leases are shorter-term than the real estate leases, and generally have a fixed payment over a defined term without renewal options. Certain equipment leases have purchase options and it was determined the option was not reasonably certain to be exercised. T he real estate leases are longer-term and may contain renewal options after the initial term, but none of the real estate leases contain a purchase option. The renewal options on real estate leases were reviewed and if it was determined the option was reasonably certain to be renewed, the option term was considered in the determination of the lease liability. There is only one real estate lease with a variable payment based on an index included in the lease liability. None of the leases contain any restrictive covenants and there are no significant leases that have not yet commenced. The discount rate used to determine the lease liability is based on the Bank’s fully secured borrowing rate from the Federal Home Loan Bank for a term similar to the lease term. Adoption of the new standard did not affect the Corporation’s status as a “well-capitalized” institution. The Corporation has one real estate lease to a related party with a liability value of $1.8 million. Operating lease expense is included in net occupancy expense in the consolidated statements of income. See Note 1 for additional information on the adoption of the new standard.

﻿

Lease costs for the three months ended March 31, 201 9 were as follows:

﻿

﻿ |  |  |
﻿ |  | Three Months Ended
(Dollars in thousands) |  | March 31, 2019
Operating lease cost |  | $ | 188
Short-term lease cost |  |  | 6
Variable lease cost |  |  | 11
Total lease cost |  | $ | 205

﻿

15

Cash paid for amounts included in the measurement of lease liabilities and the weighted-average remaining lease term and discount rate were as follows:

﻿

﻿ |  |  |
﻿ |  | Three Months Ended
(Dollars in thousands) |  | March 31, 2019
Cash paid for amounts included in the measurement of lease liabilities: |  |  |
Operating cash flows from operating leases |  | $ | 123
﻿ |  |  |
Weighted-average remaining lease term |  |  | 13.7 years
Weighted-average discount rate |  |  | 3.54%

﻿

As of March 31, 2019, t he future minimum payments for operating leases having initial or remaining lease terms in excess of one year were as follows:

﻿

﻿ |  |  |
(Dollars in thousands) |  |  |
﻿ |  |  |
2019 |  | $ | 706
2020 |  |  | 664
2021 |  |  | 651
2022 |  |  | 543
2023 |  |  | 539
2024 and beyond |  |  | 4,790
Total undiscounted cash flows |  |  | 7,893
Discounted cash flows |  |  | (1,780)
Total lease liability |  | $ | 6,113

﻿

﻿

Note 8. O ther R eal E state O wned

Changes in other real estate owned were as follows:

﻿

﻿ |  |  |  |  |  |
﻿ |  | Three Months Ended
﻿ |  | March 31,
(Dollars in thousands) |  | 2019 |  | 2018
Balance at beginning of the period |  | $ | 2,684 |  | $ | 2,598
Additions |  |  | — |  |  | —
Proceeds from dispositions |  |  | — |  |  | —
Loss on sales, net |  |  | — |  |  | —
Valuation adjustment |  |  | — |  |  | (6)
Balance at the end of the period |  | $ | 2,684 |  | $ | 2,592

Note 9. Pension

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

﻿

﻿ |  |  |  |  |  |
﻿ |  | Three Months Ended
﻿ |  | March 31,
(Dollars in thousands) |  | 2019 |  | 2018
Components of net periodic cost: |  |  |  |  |  |
Service cost |  | $ | 80 |  | $ | 90
Interest cost |  |  | 158 |  |  | 138
Expected return on plan assets |  |  | (270) |  |  | (279)
Recognized net actuarial loss |  |  | 152 |  |  | 176
Net period cost |  | $ | 120 |  | $ | 125

﻿

The Bank expects its pension expense to de crease to approximately $420 thousand in 201 9 compared to $500 thousand in 201 8, due primarily to de creases in service costs and recognized net actuarial losses. The service cost component of pension expense is in the salaries and employee benefits line on the income statement. All other cost components are in the other expense line on the income statement.

16

﻿

Note 10. Fair Value Measurements and Fair Values of Financial Instruments

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

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 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.

17

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

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ | March 31, 2019
﻿ | Carrying |  | Fair |  |  |  |  |  |  |
(Dollars in thousands) | Amount |  | Value |  | Level 1 |  | Level 2 |  | Level 3
Financial assets, carried at cost: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and cash equivalents | $ | 47,033 |  | $ | 47,033 |  | $ | 47,033 |  | $ | — |  | $ | —
Restricted stock |  | 452 |  |  | 452 |  |  | — |  |  | 452 |  |  | —
Loans held for sale |  | 195 |  |  | 195 |  |  |  |  |  | 195 |  |  |
Net loans |  | 967,785 |  |  | 952,024 |  |  | — |  |  | — |  |  | 952,024
Accrued interest receivable |  | 3,963 |  |  | 3,963 |  |  | — |  |  | 3,963 |  |  | —
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
Financial assets, available for sale |  |  |  |  |  |  |  |  |  |  |  |  |  |
Debt securities |  | 127,881 |  |  | 127,881 |  |  | — |  |  | 127,881 |  |  | —
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
Financial assets, fair value |  |  |  |  |  |  |  |  |  |  |  |  |  |
Equity securities |  | 377 |  |  | 377 |  |  | 377 |  |  | — |  |  | —
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
Financial liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Deposits | $ | 1,076,491 |  | $ | 1,076,572 |  | $ | — |  | $ | 1,076,572 |  | $ | —
Accrued interest payable |  | 291 |  |  | 291 |  |  | — |  |  | 291 |  |  | —
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ | December 31, 2018
﻿ | Carrying |  | Fair |  |  |  |  |  |  |  |  |
(Dollars in thousands) | Amount |  | Value |  | Level 1 |  | Level 2 |  | Level 3
Financial assets, carried at cost: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and cash equivalents | $ | 52,957 |  | $ | 52,957 |  | $ | 52,957 |  | $ | — |  | $ | —
Restricted stock |  | 452 |  |  | 452 |  |  | — |  |  | 452 |  |  | —
Loans held for sale |  | 118 |  |  | 118 |  |  | — |  |  | 118 |  |  | —
Net loans |  | 960,960 |  |  | 941,930 |  |  | — |  |  | — |  |  | 941,930
Accrued interest receivable |  | 4,103 |  |  | 4,103 |  |  | — |  |  | 4,103 |  |  | —
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
Financial assets, available for sale |  |  |  |  |  |  |  |  |  |  |  |  |  |
Debt securities |  | 131,472 |  |  | 131,472 |  |  | — |  |  | 131,472 |  |  | —
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
Financial assets, fair value |  |  |  |  |  |  |  |  |  |  |  |  |  |
Equity securities |  | 374 |  |  | 374 |  |  | 374 |  |  | — |  |  | —
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
Financial liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Deposits | $ | 1,082,629 |  | $ | 1,082,425 |  | $ | — |  | $ | 1,082,425 |  | $ | —
Accrued interest payable |  | 193 |  |  | 193 |  |  | — |  |  | 193 |  |  | —
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |

18

Recurring Fair Value Measurements

For financial assets and liabilities measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at March 31, 2019 and December 31, 2018 are as follows:

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |
(Dollars in Thousands |  | Fair Value at March 31, 2019
Asset Description |  | Level 1 |  | Level 2 |  | Level 3 |  | Total
Equity securities, at fair value |  | $ | 377 |  | $ | — |  | $ | — |  | $ | 377
﻿ |  |  |  |  |  |  |  |  |  |  |  |
Available for sale: |  |  |  |  |  |  |  |  |  |  |  |
U.S. Government and Agency securities |  |  | — |  |  | 9,618 |  |  | — |  |  | 9,618
Municipal securities |  |  | — |  |  | 64,557 |  |  | — |  |  | 64,557
Trust Preferred Securities |  |  | — |  |  | 3,900 |  |  | — |  |  | 3,900
Agency mortgage-backed securities |  |  | — |  |  | 42,589 |  |  | — |  |  | 42,589
Private-label mortgage-backed securities |  |  | — |  |  | 478 |  |  | — |  |  | 478
Asset-backed securities |  |  | — |  |  | 6,739 |  |  | — |  |  | 6,739
Total assets |  | $ | 377 |  | $ | 127,881 |  | $ | — |  | $ | 128,258
﻿ |  |  |  |  |  |  |  |  |  |  |  |

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |
(Dollars in Thousands) |  | Fair Value at December 31, 2018
Asset Description |  | Level 1 |  | Level 2 |  | Level 3 |  | Total
Equity securities, at fair value |  | $ | 374 |  | $ | — |  | $ | — |  | $ | 374
﻿ |  |  |  |  |  |  |  |  |  |  |  |
Available for sale: |  |  |  |  |  |  |  |  |  |  |  |
U.S. Government and Agency securities |  |  | — |  |  | 9,076 |  |  | — |  |  | 9,076
Municipal securities |  |  | — |  |  | 67,647 |  |  | — |  |  | 67,647
Trust Preferred Securities |  |  | — |  |  | 3,758 |  |  | — |  |  | 3,758
Agency mortgage-backed securities |  |  | — |  |  | 44,658 |  |  | — |  |  | 44,658
Private-label mortgage-backed securities |  |  | — |  |  | 488 |  |  | — |  |  | 488
Asset-backed securities |  |  | — |  |  | 5,845 |  |  | — |  |  | 5,845
Total assets |  | $ | 374 |  | $ | 131,472 |  | $ | — |  | $ | 131,846
﻿ |  |  |  |  |  |  |  |  |  |  |  |

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

Nonrecurring Fair Value Measurements

The Corporation did not record any assets at fair value for which measurement of the fair value was made on a nonrecurring basis at March 31, 2019. For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at December 31, 2018 was as follows:

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |
(Dollars in Thousands) |  | Fair Value at December 31, 2018
Asset Description |  | Level 1 |  | Level 2 |  | Level 3 |  | Total
Other real estate owned (1) |  | $ | — |  | $ | — |  | $ | 71 |  | $ | 71
Total assets |  | $ | — |  | $ | — |  | $ | 71 |  | $ | 71

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

﻿

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

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

The Corporation did not record any liabilities at fair value for which measurement of the fair value was made on a nonrecurring basis at March 31, 2019. 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 March 31, 2019.

19

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

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |
(Dollars in Thousands) |  |  |  |  |  |  |  |  |
December 31, 2018 |  |  | Fair Value |  | Valuation Technique |  | Unobservable Input |  | Weighted Average
Other real estate owned (1) |  | $ | 71 |  | Appraisal |  | Cost to sell |  | 8% (8%)
﻿ |  |  |  |  |  |  |  |  |
(1) Includes assets directly charged-down to fair value during the year-to-date period. |  |
(2) Qualitative adjustments are discounts specific to each asset and are made as needed. |  |

Note 1 1. Capital Ratios

Capital adequacy is currently defined by regulatory agencies through the use of several minimum required ratios. In July 2013, Federal banking regulators approved the final rules from the Basel Committee on Banking Supervision for the regulation of capital requirements for bank holding companies and U.S banks, generally referred to as “Basel III.” The Basel III standards were effective for the Corporation and the Bank, effective January 1, 2015 (subject to a phase-in period for certain provisions). Basel III imposes significantly higher capital requirements and more restrictive leverage and liquidity ratios than those previously in place. The capital ratios to be considered “well capitalized” under Basel III are: (1) Common Equity Tier 1 (CET1) of 6.5%, (2) Tier 1 Leverage of 5%, (3) Tier 1 Risk-Based Capital of 8%, and (4) Total Risk-Based Capital of 10%. The CET1 ratio is a new capital ratio under Basel III and the Tier 1 risk-based capital ratio of 8% has been increased from 6%. The rules also include changes in the risk weights of certain assets to better reflect credit and other risk exposures. In addition, a capital conservation buffer will be phased-in beginning January 1, 2016 at 0.6 25%, 1.25% for 2017, 1.875% for 2018 and 2.50% for 2019 and thereafter. The capital conservation buffer will be applicable to all of the capital ratios except for the Tier1 Leverage ratio. The capital conservation buffer is equal to the lowest value of the three applicable capital ratios less the regulatory minimum for each respective capital measurement. The Bank’s capital conservation buffer at March 31, 2019 was 6.95% (total risk-based capital 1 4.95% less 8.00%) compared to the 201 9 regulatory buffer of 2.50%. Complia nc e with the capital conservation buffer is required in order to avoid limitations to certain capital distributions. As of March 31, 2019, the Bank was “well capitalized’ under the Basel III requirements.

The following table summarizes regulatory capital information as of March 31, 2019 and December 31, 2018 for the Corporation and the Bank:

﻿

﻿ |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  | Regulatory Ratios
﻿ |  |  |  |  |  | Adequately |  | Well
﻿ |  | March 31, |  | December 31, |  | Capitalized |  | Capitalized
(Dollars in thousands) |  | 2019 |  | 2018 |  | Minimum |  | Minimum
﻿ |  |  |  |  |  |  |  |
Common Equity Tier 1 Risk-based Capital Ratio (1) |  |  |  |  |  |  |  |
Franklin Financial Services Corporation |  | 13.78% |  | 13.96% |  | 4.500% |  | N/A
Farmers & Merchants Trust Company |  | 13.69% |  | 13.80% |  | 4.500% |  | 6.50%
﻿ |  |  |  |  |  |  |  |
Tier 1 Risk-based Capital Ratio (2) |  |  |  |  |  |  |  |
Franklin Financial Services Corporation |  | 13.78% |  | 13.96% |  | 6.000% |  | N/A
Farmers & Merchants Trust Company |  | 13.69% |  | 13.80% |  | 6.000% |  | 8.00%
﻿ |  |  |  |  |  |  |  |
Total Risk-based Capital Ratio (3) |  |  |  |  |  |  |  |
Franklin Financial Services Corporation |  | 15.04% |  | 15.21% |  | 8.000% |  | N/A
Farmers & Merchants Trust Company |  | 14.95% |  | 15.06% |  | 8.000% |  | 10.00%
﻿ |  |  |  |  |  |  |  |
Tier 1 Leverage Ratio (4) |  |  |  |  |  |  |  |
Franklin Financial Services Corporation |  | 9.88% |  | 9.78% |  | 4.000% |  | N/A
Farmers & Merchants Trust Company |  | 9.82% |  | 9.68% |  | 4.000% |  | 5.00%
﻿ |  |  |  |  |  |  |  |
(1) Common equity Tier 1 capital/ total risk-weighted assets (2) Tier 1 capital / total risk-weighted assets
(3) Total risk-based capital / total risk-weighted assets, (4) Tier 1 capital / average quarterly assets

20

Note 1 2. Revenue Recognition

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

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

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

| · |  | Asset management fees are generally assessed based on a tiered fee schedule, based on the value of assets under management, and are recognized monthly when the service obligation is completed. Fees recognized were $1.3 million for the first quarter s of 201 9 and 2018.

| · |  | Fees for estate management services are based on the estimated fair value of the estate. These fees are generally recognized monthly over an 18 month period that Management has determined to represent the average time to fulfill the performance obligation s of the contract. Management has the discretion to adjust this time period as needed based upon the nature and complexity of an individual estate. Fees recognized were $70 thousand for the first quarter of 201 9, compared to $61 thousand for the first quarter of 2018.

| · |  | Commissions from the sale of investment and insurance products are recognized upon the completion of the transaction. Fees recognized were $68 thousand for the first quarter s of 201 9 and 2018.

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

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

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

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

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

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

Contract Balances

A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s noninterest revenue streams are largely based on transactional activity, or standard month-end revenue accruals such as asset management fees based on month-end market values. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and

21

revenue is recognized. The Company does not typically enter into longer-term revenue contracts with customers, and therefore, does not experience significant contract balances.

Contract Acquisition Costs

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

﻿

1 Note 1 3. Commitments and Contingencies

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

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

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

﻿

﻿ |  |  |  |  |  |
﻿ |  | March 31, |  | December 31,
(Dollars in thousands) |  | 2019 |  | 2018
Financial instruments whose contract amounts represent credit risk |  |  |  |  |  |
Commercial commitments to extend credit |  | $ | 231,555 |  | $ | 216,913
Consumer commitments to extend credit (secured) |  |  | 50,950 |  |  | 49,221
Consumer commitments to extend credit (unsecured) |  |  | 5,506 |  |  | 5,605
﻿ |  | $ | 288,011 |  | $ | 271,739
Standby letters of credit |  | $ | 25,306 |  | $ | 25,429

﻿

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses with the exception of home equity lines and personal lines of credit and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank, is based on Management’s credit evaluation of the counterparty. Collateral for most commercial commitments varies but may include accounts receivable, inventory, property, plant, and equipment, and income-producing commercial properties. Collateral for secured consumer commitments consists of liens on residential real estate.

Standby letters of credit are instruments issued by the Bank, which guarantee the beneficiary payment by the Bank in the event of default by the Bank’s customer in the nonperformance of an obligation or service. Most standby letters of credit are extended for one-year periods. Generally, t he credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds collateral supporting those commitments for which collateral is deemed necessary primarily in the form of certificates of deposit and liens on real estate. Management believes that the proceeds obtained through a liquidation of such collateral would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees. As of June 30, 2018, the Bank established a $2.4 million allowance against letters of credit issued in connection with a commercial borrower that declared bankruptcy in the second quarter of 2018 which remains at March 31, 2019. Except for the liability recorded for standby letters of credit, liabilities for credit loss associated with off-balance sheet commitments were not material at March 31, 201 9 and December 31, 201 8.

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

Legal Proceedings

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

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

22

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

In management’s opinion, we do not anticipate, at the present time, that the ultimate aggregate liability, if any, arising out of all litigation to which the Corporat ion is a party at this time will h ave a material adverse effect on our financial position. We cannot now determine, however, whether or not any claim asserted against us will have a material adverse effect on our results of operations in any future reporting period, which will depend on, amount other things, the amount of loss resulting from the claim and the amount of income otherwise reported for the reporting period. Thus, at March 31, 2019, we are unable to provide an evaluation of the likelihood of an unfavorable outcome or an estimate of the amount or range of potential loss with respect to such other matters and, accordingly, have not yet established any specific accrual for such other matters.

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

23

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

For the Three Months Ended March 3 1, 201 9 and 201 8

﻿

Forward Looking Statements

﻿

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

﻿

Critical Accounting Policies

﻿

Management has identified critical accounting policies for the Corporation. These policies are particularly sensitive, requiring significant judgements, estimates and assumptions to be made by Management. T here were no changes to the critical accounting policies disclosed in the 2018 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 2018 Annual Report on Form 10-K for a more detailed disclosure of the critical accounting policies.

﻿

Results of Operations

﻿

Year-to-Date Summary

Reported net income of $3.2 million for the first quarter

| · |  | Net interest income increased $636 thousand quarter over quarter due to the growth in interest income from the loan portfolio that outpaced higher interest expense.

| · |  | The provision for loan losses increased $199 thousand quarter over quarter due primarily to loan growth.

| · |  | Noninterest income increased $17 thousand quarter over quarter primarily from asset management fees in the Bank’s Investment and Trust Services department, foreign ATM fees and fees from the merchant card program.

| · |  | Noninterest expense increased $7 6 4 thousand quarter over quarter primarily from increases in salaries and benefits.

Total assets were $1.213 billion at March 3 1, 201 9, a n in crease of $3.4 million from the 201 8 year-end balance of $1.210 billion

| · |  | The loan portfolio increased approximately $7 million due to loan growth in commercial real estate loans for hotels and motels and land development.

| · |  | A lease liability and a right-of-use asset of $6.2 million were recognized during the quarter.

| · |  | Deposits de creased $6.1 million in the first quarter, primarily in municipal money management accounts.

| · |  | Shareholders’ equity in creased $3.1 million due to net income of $3.2 million and $1.1 million increase in other comprehensive income for the quarter, offset by the first quarter dividend of $1.2 million. 24

Key performance ratios as of, or for the three months ended March 31, 2019 and 2018 and the year ended December 31, 2018 are listed below:

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |
﻿ |  | March 31, |  | December 31, |  | March 31,
﻿ |  | 2019 |  | 2018 |  | 2018
(Dollars in thousands, except per share) |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |
Balance Sheet Highlights |  |  |  |  |  |  |  |  |
Total assets |  | $ | 1,212,960 |  | $ | 1,209,587 |  | $ | 1,168,542
Investment and equity securities |  |  | 128,258 |  |  | 131,846 |  |  | 133,732
Loans, net |  |  | 967,785 |  |  | 960,960 |  |  | 930,664
Deposits |  |  | 1,076,491 |  |  | 1,082,629 |  |  | 1,034,461
Shareholders' equity |  |  | 121,491 |  |  | 118,396 |  |  | 117,124
﻿ |  |  |  |  |  |  |  |  |
Summary of Operations |  |  |  |  |  |  |  |  |
Interest income |  | $ | 11,989 |  | $ | 44,868 |  | $ | 10,488
Interest expense |  |  | 1,660 |  |  | 4,214 |  |  | 795
Net interest income |  |  | 10,329 |  |  | 40,654 |  |  | 9,693
Provision for loan losses |  |  | 399 |  |  | 9,954 |  |  | 200
Net interest income after provision for loan losses |  |  | 9,930 |  |  | 30,700 |  |  | 9,493
Noninterest income |  |  | 3,165 |  |  | 12,629 |  |  | 3,148
Noninterest expense |  |  | 9,412 |  |  | 37,369 |  |  | 8,648
Income before income taxes |  |  | 3,683 |  |  | 5,960 |  |  | 3,993
Federal income tax (benefit) expense |  |  | 446 |  |  | (165) |  |  | 491
Net income |  | $ | 3,237 |  | $ | 6,125 |  | $ | 3,502
﻿ |  |  |  |  |  |  |  |  |
Performance Measurements |  |  |  |  |  |  |  |  |
Return on average assets* |  |  | 1.08% |  |  | 0.52% |  |  | 1.21%
Return on average equity* |  |  | 10.90% |  |  | 5.34% |  |  | 12.17%
Return on average tangible equity (1)* |  |  | 11.79% |  |  | 5.80% |  |  | 13.20%
Efficiency ratio (1) |  |  | 67.93% |  |  | 68.27% |  |  | 65.68%
Net interest margin* |  |  | 3.86% |  |  | 3.78% |  |  | 3.72%
﻿ |  |  |  |  |  |  |  |  |
Shareholders' Value (per common share) |  |  |  |  |  |  |  |  |
Diluted earnings per share |  | $ | 0.73 |  | $ | 1.39 |  | $ | 0.80
Basic earnings per share |  |  | 0.73 |  |  | 1.40 |  |  | 0.80
Regular cash dividends declared |  |  | 0.27 |  |  | 1.05 |  |  | 0.24
Book value |  |  | 27.54 |  |  | 26.85 |  |  | 26.83
Tangible book value (1) |  |  | 25.50 |  |  | 24.81 |  |  | 24.77
Market value |  |  | 36.00 |  |  | 31.50 |  |  | 36.54
Market value/book value ratio |  |  | 130.72% |  |  | 117.32% |  |  | 136.19%
Price/earnings multiple* |  |  | 12.33 |  |  | 22.66 |  |  | 11.42
Current quarter dividend yield |  |  | 3.00% |  |  | 3.43% |  |  | 2.63%
Dividend payout ratio year-to-date |  |  | 36.82% |  |  | 75.07% |  |  | 29.84%
﻿ |  |  |  |  |  |  |  |  |
Safety and Soundness |  |  |  |  |  |  |  |  |
Risk-based capital ratio (Total) |  |  | 15.04% |  |  | 15.21% |  |  | 15.55%
Leverage ratio (Tier 1) |  |  | 9.88% |  |  | 9.78% |  |  | 9.95%
Common equity ratio (Tier 1) |  |  | 13.78% |  |  | 13.96% |  |  | 14.30%
Nonperforming loans/gross loans |  |  | 0.60% |  |  | 0.27% |  |  | 0.29%
Nonperforming assets/total assets |  |  | 0.70% |  |  | 0.44% |  |  | 0.46%
Allowance for loan losses as a % of loans |  |  | 1.29% |  |  | 1.28% |  |  | 1.27%
Net loans charged-off/average loans* |  |  | 0.05% |  |  | 0.97% |  |  | 0.00%
﻿ |  |  |  |  |  |  |  |  |
Assets under Management |  |  |  |  |  |  |  |  |
Trust assets under management (fair value) |  | $ | 753,086 |  | $ | 684,825 |  | $ | 684,648
Held at third-party brokers (fair value) |  |  | 127,515 |  |  | 122,213 |  |  | 152,728

*Year-to-date a nnualized

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

25

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

﻿

﻿ |  |  |  |  |  |  |  |  |
(Dollars in thousands, except per share) |  | Three Months Ended |  | Twelve Months Ended |  | Three Months Ended
﻿ |  | March 31, 2019 |  | December 31, 2018 |  | March 31, 2018
Return on Tangible Equity (non-GAAP) |  |  |  |  |  |  |  |  |
Net income |  | $ | 3,237 |  | $ | 6,125 |  | $ | 3,502
﻿ |  |  |  |  |  |  |  |  |
Average shareholders' equity |  |  | 118,793 |  |  | 114,625 |  |  | 115,129
Less average intangible assets |  |  | (9,016) |  |  | (9,016) |  |  | (9,016)
Average shareholders' equity (non-GAAP) |  |  | 109,777 |  |  | 105,609 |  |  | 106,113
﻿ |  |  |  |  |  |  |  |  |
Return on average tangible equity (non-GAAP)* |  |  | 11.79% |  |  | 5.80% |  |  | 13.20%
﻿ |  |  |  |  |  |  |  |  |
Tangible Book Value (per share) (non-GAAP) |  |  |  |  |  |  |  |  |
Shareholders' equity |  | $ | 121,491 |  | $ | 118,396 |  | $ | 117,124
Less intangible assets |  |  | (9,016) |  |  | (9,016) |  |  | (9,016)
Shareholders' equity (non-GAAP) |  |  | 112,475 |  |  | 109,380 |  |  | 108,108
﻿ |  |  |  |  |  |  |  |  |
Shares outstanding (in thousands) |  |  | 4,411 |  |  | 4,409 |  |  | 4,365
﻿ |  |  |  |  |  |  |  |  |
Tangible book value (non-GAAP) |  |  | 25.50 |  |  | 24.81 |  |  | 24.77
﻿ |  |  |  |  |  |  |  |  |
Efficiency Ratio |  |  |  |  |  |  |  |  |
Noninterest expense |  | $ | 9,412 |  | $ | 37,369 |  | $ | 8,648
﻿ |  |  |  |  |  |  |  |  |
Net interest income |  |  | 10,329 |  |  | 40,654 |  |  | 9,693
Plus tax equivalent adjustment to net interest income |  |  | 388 |  |  | 1,522 |  |  | 370
Plus noninterest income, net of securities transactions |  |  | 3,138 |  |  | 12,564 |  |  | 3,103
Total revenue |  |  | 13,855 |  |  | 54,740 |  |  | 13,166
﻿ |  |  |  |  |  |  |  |  |
Efficiency ratio |  |  | 67.93% |  |  | 68.27% |  |  | 65.68%
﻿ |  |  |  |  |  |  |  |  |
* Year-to-date annualized |  |  |  |  |  |  |  |  |

﻿

Net Interest Income

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

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26

Compar ison of the three months ended March 31, 2019 to the three months ended March 31, 2018:

Tax equivalent net interest income increased $654 thousand to $10.7 million in the first quarter of 2019 compared to $10.1 million in the same period in 2018. Balance sheet volume contributed $348 thousand to this increase and $30 6 thousand was the result of changes in rates.

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

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﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ | For the Three Months Ended March 31,
﻿ | 2019 |  | 2018
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ | 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 | $ | 15,112 |  | $ | 97 |  | 2.60% |  | $ | 29,478 |  | $ | 118 |  | 1.62%
Investment securities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Taxable |  | 82,297 |  |  | 545 |  | 2.69% |  |  | 86,783 |  |  | 519 |  | 2.43%
Tax Exempt |  | 51,167 |  |  | 425 |  | 3.33% |  |  | 44,253 |  |  | 344 |  | 3.11%
Investments |  | 133,464 |  |  | 970 |  | 2.95% |  |  | 131,036 |  |  | 863 |  | 2.67%
Loans: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial, industrial and agricultural |  | 837,906 |  |  | 9,644 |  | 4.60% |  |  | 787,614 |  |  | 8,261 |  | 4.20%
Residential mortgage |  | 69,466 |  |  | 752 |  | 4.32% |  |  | 71,927 |  |  | 733 |  | 4.07%
Home equity loans and lines |  | 65,981 |  |  | 832 |  | 5.11% |  |  | 71,423 |  |  | 809 |  | 4.59%
Consumer |  | 5,124 |  |  | 82 |  | 6.49% |  |  | 5,075 |  |  | 74 |  | 5.91%
Loans |  | 978,477 |  |  | 11,310 |  | 4.63% |  |  | 936,039 |  |  | 9,877 |  | 4.23%
Total interest-earning assets |  | 1,127,053 |  | $ | 12,377 |  | 4.45% |  |  | 1,096,553 |  | $ | 10,858 |  | 4.02%
Other assets |  | 67,718 |  |  |  |  |  |  |  | 62,845 |  |  |  |  |
Total assets | $ | 1,194,771 |  |  |  |  |  |  | $ | 1,159,398 |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest-bearing liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Deposits: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest-bearing checking | $ | 295,786 |  | $ | 263 |  | 0.36% |  | $ | 281,421 |  | $ | 177 |  | 0.26%
Money Management |  | 424,969 |  |  | 1,046 |  | 1.00% |  |  | 416,555 |  |  | 442 |  | 0.43%
Savings |  | 81,156 |  |  | 107 |  | 0.54% |  |  | 80,253 |  |  | 56 |  | 0.28%
Time |  | 72,481 |  |  | 208 |  | 1.16% |  |  | 71,452 |  |  | 120 |  | 0.68%
Total interest-bearing deposits |  | 874,392 |  |  | 1,624 |  | 0.75% |  |  | 849,681 |  |  | 795 |  | 0.38%
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Other borrowings |  | 5,386 |  |  | 36 |  | 2.61% |  |  | 22 |  |  | — |  | 2.02%
Total interest-bearing liabilities |  | 879,778 |  |  | 1,660 |  | 0.77% |  |  | 849,703 |  |  | 795 |  | 0.38%
Noninterest-bearing deposits |  | 183,809 |  |  |  |  |  |  |  | 177,101 |  |  |  |  |
Other liabilities |  | 12,391 |  |  |  |  |  |  |  | 17,465 |  |  |  |  |
Shareholders' equity |  | 118,793 |  |  |  |  |  |  |  | 115,129 |  |  |  |  |
Total liabilities and shareholders' equity | $ | 1,194,771 |  |  |  |  |  |  | $ | 1,159,398 |  |  |  |  |
T/E net interest income/Net interest margin |  |  |  |  | 10,717 |  | 3.86% |  |  |  |  |  | 10,063 |  | 3.72%
Tax equivalent adjustment |  |  |  |  | (388) |  |  |  |  |  |  |  | (370) |  |
Net interest income |  |  |  | $ | 10,329 |  |  |  |  |  |  | $ | 9,693 |  |

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27

Provision for Loan Losses

Provision for loan loss expense for the first quarter was $399 thousand, $199 thousand higher than in 2018. For more information refer to the Loan Quality and Allowance for Loan Losses discussion in the Financial Condition section.

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Noninterest Income

For the first quarter of 2019, noninterest income increased $17 thousand from the same period in 2018. Investment and trust service fees increased due to growth in assets under management. Loan service charges were less than the same period in 2018 due to a lower volume of commercial loan originations. Deposit service charges were less than the same period in 2018 due to fewer fees from the Bank’s overdraft protection program, partially offset by increased fees from retail checking accounts. Other service charges and fees were higher from increased income from the Bank’s merchant card program. Debit card income was higher due to an increase in transaction volume. The change in the fair value of equity investments recorded through income was a gain of $3 thousand compared to a gain of $45 thousand in the same period in 2018.

The following table presents a comparison of noninterest incom e for the three months ended March 31, 2019 and 2018

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﻿ |  |  |  |  |  |  |  |  |  |  |
﻿ |  | For the Three Months Ended |  |  |  |  |
﻿ |  | March 31, |  | Change
(Dollars in thousands) |  | 2019 |  | 2018 |  | Amount |  | %
Noninterest Income |  |  |  |  |  |  |  |  |  |  |
Investment and trust services fees |  | $ | 1,452 |  | $ | 1,397 |  | $ | 55 |  | 3.9
Loan service charges |  |  | 203 |  |  | 231 |  |  | (28) |  | (12.1)
Deposit service charges and fees |  |  | 545 |  |  | 574 |  |  | (29) |  | (5.1)
Other service charges and fees |  |  | 353 |  |  | 333 |  |  | 20 |  | 6.0
Debit card income |  |  | 402 |  |  | 385 |  |  | 17 |  | 4.4
Increase in cash surrender value of life insurance |  |  | 127 |  |  | 128 |  |  | (1) |  | (0.8)
Debt securities gains, net |  |  | 24 |  |  | — |  |  | 24 |  | NA
Change in fair value of equity securities |  |  | 3 |  |  | 45 |  |  | (42) |  | (93.3)
Other |  |  | 56 |  |  | 55 |  |  | 1 |  | 1.8
Total noninterest income |  | $ | 3,165 |  | $ | 3,148 |  | $ | 17 |  | 0.5

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Noninterest Expense

Noninterest expense for the first quarter of 2018 increased $764 thousand compared to the same period in 201 8. The increase in salaries and benefits was primarily due to an increase in salary expense ($389 thousand) from merit increases and incentive plans ($90 thousand) compared to the same period in 201 8. Legal and profession al in creased due to fees for various consulting services. FDIC insurance expense decreased due to a reduction in the Bank’s base assessment rate. Other expenses increased related to the Nasdaq listing fee, increased director’s fees and recruiting fees.

The following table presents a comparison of noninterest expense for the three months ended March 31, 2019 and 2018

﻿ |  |  |  |  |  |  |  |  |  |  |
﻿ |  | For the Three Months Ended |  |  |  |  |
(Dollars in thousands) |  | March 31, |  | Change
Noninterest Expense |  | 2019 |  | 2018 |  | Amount |  | %
Salaries and benefits |  | $ | 5,442 |  | $ | 4,986 |  | $ | 456 |  | 9.1
Net occupancy |  |  | 856 |  |  | 815 |  |  | 41 |  | 5.0
Advertising |  |  | 402 |  |  | 427 |  |  | (25) |  | (5.9)
Legal and professional |  |  | 430 |  |  | 329 |  |  | 101 |  | 30.7
Data processing |  |  | 705 |  |  | 596 |  |  | 109 |  | 18.3
Pennsylvania bank shares tax |  |  | 243 |  |  | 239 |  |  | 4 |  | 1.7
FDIC insurance |  |  | 65 |  |  | 129 |  |  | (64) |  | (49.6)
ATM/debit card processing |  |  | 258 |  |  | 238 |  |  | 20 |  | 8.4
Foreclosed real estate |  |  | 17 |  |  | 14 |  |  | 3 |  | 21.4
Telecommunications |  |  | 105 |  |  | 109 |  |  | (4) |  | (3.7)
Other |  |  | 889 |  |  | 766 |  |  | 123 |  | 16.1
Total noninterest expense |  | $ | 9,412 |  | $ | 8,648 |  | $ | 764 |  | 8.8

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28

Provision for Income Taxes

For the first quarter, the Corporation recorded a Federal income tax expense of $446 thousand compared to $491 thousand for the same quarter i n 2018. The effective tax rate for the first quarter of 2019 was 12.1% compared to 12.3% for the same period in 2018. The federal statutory tax rate is 21% for 2019 and 2018.

Financial Condition

Cash and Cash Equivalents:

Cash and cash equivalents totaled $47.0 million at March 31, 2019, a decrease of $6.0 million from the prior year-end balance of $5 3.0 million. The decrease was mainly due to a reduction in non-interest bearing balances at the Federal Reserve. Interest-bearing deposits are held primarily at the Federal Reserve ($26.8 million) and in short-term bank owned certificates of deposit ($8.0 million).

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Investment Securities:

AFS Securities: The AFS securities portfolio has decreased $5.0 million on a cost basis, since year-end 2018. The composition of the portfolio has remained consistent with municipal securities and U.S. Agency mortgage-backed securities comprising the greatest portion of the portfolio at approximately 50% and 33% of the portfolio fair value, respectively. The average life of the portfolio was 3.98 years.

The AFS securities portfolio had a net unrealized gain of $290 thousand at March 31, 2019 compared to a net unrealized loss of $1.1 million at the prior year-end. The portfolio averaged $133.5 million with a yield of 2.95% for the first three months of 2019. This compares to an average of $131.0 million and a yield of 2.67% for the same period in 2018.

The municipal bond portfolio is well diversified geographically (issuers from within 27 states) and is comprised primarily of general obligation bonds (67.4%). Many municipal bonds have credit enhancements in the form of private bond insurance or other credit support. The largest geographic municipal bond exposure is in the states of Texas (13.5%), Washington (10.3%), and Ohio (9.1%). The average rating of the municipal portfolio from Moody’s is AA. No municipal bonds are rated below investment grade.

The amortized cost and estimated fair value of AFS securities available for sale as of March 31, 2019 and December 31, 2018 is as follows:

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |
(Dollars in thousands) |  |  |  |  | Gross |  | Gross |  |  |
﻿ |  | Amortized |  | unrealized |  | unrealized |  | Fair
March 31, 2019 |  | cost |  | gains |  | losses |  | value
U.S. Government and Agency securities |  | $ | 9,634 |  | $ | 24 |  | $ | (40) |  | $ | 9,618
Municipal securities |  |  | 63,820 |  |  | 845 |  |  | (108) |  |  | 64,557
Trust preferred securities |  |  | 4,080 |  |  | — |  |  | (180) |  |  | 3,900
Agency mortgage-backed securities |  |  | 42,818 |  |  | 135 |  |  | (364) |  |  | 42,589
Private-label mortgage-backed securities |  |  | 448 |  |  | 30 |  |  | — |  |  | 478
Asset-backed securities |  |  | 6,791 |  |  | — |  |  | (52) |  |  | 6,739
﻿ |  | $ | 127,591 |  | $ | 1,034 |  | $ | (744) |  | $ | 127,881

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |
(Dollars in thousands) |  |  |  |  | Gross |  | Gross |  |  |
﻿ |  | Amortized |  | unrealized |  | unrealized |  | Fair
December 31, 2018 |  | cost |  | gains |  | losses |  | value
U.S. Government and Agency securities |  | $ | 9,120 |  | $ | 21 |  | $ | (65) |  | $ | 9,076
Municipal securities |  |  | 67,811 |  |  | 320 |  |  | (484) |  |  | 67,647
Trust preferred securities |  |  | 4,074 |  |  | — |  |  | (316) |  |  | 3,758
Agency mortgage-backed securities |  |  | 45,241 |  |  | 65 |  |  | (648) |  |  | 44,658
Private-label mortgage-backed securities |  |  | 457 |  |  | 31 |  |  | — |  |  | 488
Asset-backed securities |  |  | 5,869 |  |  | — |  |  | (24) |  |  | 5,845
﻿ |  | $ | 132,572 |  | $ | 437 |  | $ | (1,537) |  | $ | 131,472

﻿

The AFS securities portfolio contained 125 securities with $57.7 million of temporarily impaired fair value and $744 thousand in unrealized losses at March 31, 2019. The total unrealized loss position has decreased $793 thousand since year-end 2018.

29

For securities with an unrealized loss, Management applies a systematic methodology in order to perform an assessment of the potential for other-than-temporary impairment. In the case of debt securities, investments considered for other-than-temporary impairment: (1) had a specified maturity or repricing date; (2) were generally expected to be redeemed at par, and (3) were expected to achieve a recovery in market value within a reasonable period of time. In addition, the Bank considers whether it intends to sell these securities or whether it will be forced to sell these securities before the earlier of amortized cost recovery or maturity. The impairment identified on debt securities and subject to assessment at March 31, 2019, was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted.

The following table reflects temporary impairment in the AFS securities portfolio, aggregated by investment category, length of time that individual securities have been in a continuous unrealized loss position and the number of securities in each category as of March 31, 2019 and December 31, 2018:

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﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ | March 31, 2019
﻿ | Less than 12 months |  | 12 months or more |  | Total
﻿ | Fair |  | Unrealized |  |  |  | Fair |  | Unrealized |  |  |  | Fair |  | Unrealized |  |
(Dollars in thousands) | Value |  | Losses |  | Count |  | Value |  | Losses |  | Count |  | Value |  | Losses |  | Count
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
U.S. Government and Agency securities | $ | — |  | $ | — |  | — |  | $ | 4,777 |  | $ | (40) |  | 14 |  | $ | 4,777 |  | $ | (40) |  | 14
Municipal securities |  | 238 |  |  | — |  | 1 |  |  | 12,377 |  |  | (108) |  | 21 |  |  | 12,615 |  |  | (108) |  | 22
Trust preferred securities |  | 1,166 |  |  | (33) |  | 2 |  |  | 2,734 |  |  | (147) |  | 3 |  |  | 3,900 |  |  | (180) |  | 5
Agency mortgage-backed securities |  | 895 |  |  | (1) |  | 4 |  |  | 28,746 |  |  | (363) |  | 71 |  |  | 29,641 |  |  | (364) |  | 75
Asset-backed securities |  | 6,721 |  |  | (51) |  | 7 |  |  | 18 |  |  | (1) |  | 2 |  |  | 6,739 |  |  | (52) |  | 9
Total temporarily impaired securities | $ | 9,020 |  | $ | (85) |  | 14 |  | $ | 48,652 |  | $ | (659) |  | 111 |  | $ | 57,672 |  | $ | (744) |  | 125

﻿

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﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ | December 31, 2018
﻿ | Less than 12 months |  | 12 months or more |  | Total
﻿ | Fair |  | Unrealized |  |  |  | Fair |  | Unrealized |  |  |  | Fair |  | Unrealized |  |
(Dollars in thousands) | Value |  | Losses |  | Count |  | Value |  | Losses |  | Count |  | Value |  | Losses |  | Count
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
U.S. Government and Agency securities | $ | 2,071 |  | $ | (6) |  | 2 |  | $ | 5,175 |  | $ | (59) |  | 14 |  | $ | 7,246 |  | $ | (65) |  | 16
Municipal securities |  | 5,832 |  |  | (12) |  | 10 |  |  | 25,091 |  |  | (472) |  | 42 |  |  | 30,923 |  |  | (484) |  | 52
Trust preferred securities |  | 2,008 |  |  | (159) |  | 3 |  |  | 1,750 |  |  | (157) |  | 2 |  |  | 3,758 |  |  | (316) |  | 5
Agency mortgage-backed securities |  | 7,687 |  |  | (46) |  | 16 |  |  | 30,511 |  |  | (602) |  | 74 |  |  | 38,198 |  |  | (648) |  | 90
Asset-backed securities |  | 5,826 |  |  | (22) |  | 6 |  |  | 19 |  |  | (2) |  | 2 |  |  | 5,845 |  |  | (24) |  | 8
Total temporarily impaired securities | $ | 23,424 |  | $ | (245) |  | 37 |  | $ | 62,546 |  | $ | (1,292) |  | 134 |  | $ | 85,970 |  | $ | (1,537) |  | 171
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

The unrealized loss in the municipal bond portfolio decreased to $108 thousand from $484 thousand at December 31, 2018 as interest rates remained flat during the year. There are twenty-two securities in this portfolio with an unrealized loss and the loss in this portfolio is deemed to be non-credit related and no other-than-temporary impairment charges have been recorded.

The trust preferred portfolio contains five securities with a fair value of $3.9 million and an unrealized loss of $180 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 March 31, 2019, the Bank believes it will be able to collect all interest and principal due on these bonds and no other-than-temporary-impairment charges were recorded.

Equity securities at Fair Value: The Corporation owns one equity investment. At March 31, 2019 and December 31, 2018, this investment was reported at fair value of $377 thousand and $374 thousand, respectively, with changes in value reported through income.

Restricted Stock at Cost: The Bank held $452 thousand of restricted stock at March 31, 2019. Except for $30 thousand, this investment represents stock in FHLB Pittsburgh. The Bank is required to hold this stock to be a member of FHLB and it is carried at cost of $100 per share. The level of FHLB stock held is determined by FHLB and is comprised of a minimum membership amount plus a variable activity amount. FHLB stock is evaluated for impairment primarily

30

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.

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Loans:

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

Total residential real estate loans decreased $2.0 million over year-end 201 8, as the Bank retained a lower percentage of its originations. For the first three months of 201 9, the Bank origi nated and sold $6.2 million i n mortgages for a fee through a third party brokerage agreement. The Bank does not originate or hold any loans that would be considered sub-prime or Alt-A, and does not generally originate mortgages outside of its primary market area.

Residential real estate construction: The largest component of this category represents loans to residential real estate developers ($11.2 million), while loans for individuals to construct personal residences totaled $2.8 million at March 31, 2019. 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.

At March 3 1, 201 9, the Bank had $8.7 million in real estate construction loans funded with an interest reserve and capitaliz ed $23 thousand of interest in 2019 from these reserves on active projects. These loans were comprised of $2.5 million in residential construction and $6.2 million in commercial construction. Real estate construction loans are monitored on a regular basis by either an independent third party inspector or the assigned loan officer depending on loan amount or complexity of the project. This monitoring process includes at a minimum, the submission of invoices and AIA documents (depending on the complexity of the project) detailing costs incurred by the borrower, on-site inspections, and a signature by the assigned loan officer for disbursement of funds.

Commercial real estate (CRE): This category includes commercial, industrial, farm and agricultural loans, where real estate serves as the primary collateral for the loans. Total commercial real estate loans increased to $498.0 million from $488.0 million at the end of 2018, an increase of $10.0 million. The increase was primarily in hotels and motels ($4.0 million) and land development ($5.1 million). The largest sectors (by collateral) in the commercial real estate category are: hotels and motels ($74.5 million), office buildings ($62.6 million), land development ($48.3 million), manufacturing facilities ($41.5 million) and auto dealerships ($32.8 million).

Commercial (C&I): This category includes commercial, industrial, farm, agricultural, and municipal loans. C&I loans decreased $4.8 million to $269.2 million at March 31, 2019, compared to $274.1 million at the end of 2018, primarily due to a $3.9 million tax free loan pay-off. At March 31, 2019, the Bank had approximately $162 million in tax-free loans in the C&I portfolio. The largest sectors (by industry) in the commercial C&I category are: public administration ($84.4 million), utilities ($34.8 million), educational services ($25.0 million) and real estate rental and leasing ($15.2 million). The Bank expects that commercial lending will continue to be the primary area of loan growth in the future via in-market lending.

Participations: The Bank may supplement its own commercial loan production by purchasing loan participations. These participations are primarily located in south-central Pennsylvania. At March 31, 2019, the outstanding commercial participations accounted for 9.3%, or $91.0 million, of total gross loans compared to 9.6% and $93.4 million at December 31, 2018. The Bank’s total exposure (including outstanding balances and unfunded commitments) to purchased participations is $115.2 million, compared to $120.4 million at December 31, 2018. The commercial loan participations are comprised of $21.6 million of C&I loans and $69.4 million of CRE loans, reported in the respective loan class. The above results indicate that Management has been executing its strategy to emphasize loan originations over purchasing participations.

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

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

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﻿ |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |
﻿ |  | March 31, |  | December 31, |  |  | Change
(Dollars in thousands) |  | 2019 |  | 2018 |  |  | Amount |  | %
Residential Real Estate 1-4 Family |  |  |  |  |  |  |  |  |  |  |
Consumer first liens |  | $ | 89,212 |  | $ | 89,673 |  | $ | (461) |  | (0.5)
Commercial first lien |  |  | 58,210 |  |  | 59,227 |  |  | (1,017) |  | (1.7)
Total first liens |  |  | 147,422 |  |  | 148,900 |  |  | (1,478) |  | (1.0)
﻿ |  |  |  |  |  |  |  |  |  |  |
Consumer junior liens and lines of credit |  |  | 41,831 |  |  | 42,504 |  |  | (673) |  | (1.6)
Commercial junior liens and lines of credit |  |  | 4,859 |  |  | 4,716 |  |  | 143 |  | 3.0
Total junior liens and lines of credit |  |  | 46,690 |  |  | 47,220 |  |  | (530) |  | (1.1)
Total residential real estate 1-4 family |  |  | 194,112 |  |  | 196,120 |  |  | (2,008) |  | (1.0)
﻿ |  |  |  |  |  |  |  |  |  |  |
Residential real estate - construction |  |  |  |  |  |  |  |  |  |  |
Consumer |  |  | 2,750 |  |  | 1,667 |  |  | 1,083 |  | 65.0
Commercial |  |  | 11,231 |  |  | 8,558 |  |  | 2,673 |  | 31.2
Total residential real estate construction |  |  | 13,981 |  |  | 10,225 |  |  | 3,756 |  | 36.7
﻿ |  |  |  |  |  |  |  |  |  |  |
Commercial real estate |  |  | 497,974 |  |  | 487,980 |  |  | 9,994 |  | 2.0
Commercial |  |  | 269,243 |  |  | 274,054 |  |  | (4,811) |  | (1.8)
Total commercial |  |  | 767,217 |  |  | 762,034 |  |  | 5,183 |  | 0.7
﻿ |  |  |  |  |  |  |  |  |  |  |
Consumer |  |  | 5,156 |  |  | 4,996 |  |  | 160 |  | 3.2
﻿ |  |  | 980,466 |  |  | 973,375 |  |  | 7,091 |  | 0.7
Less: Allowance for loan losses |  |  | (12,681) |  |  | (12,415) |  |  | (266) |  | 2.1
Net Loans |  | $ | 967,785 |  | $ | 960,960 |  | $ | 6,825 |  | 0.7
﻿ |  |  |  |  |  |  |  |  |  |  |

Loan Quality:

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

Watch list loans exhibit financial weaknesses that increase the potential risk of default or loss to the Bank. However, inclusion on the watch list, does not by itself, mean a loss is certain. T he watch list totaled $9.9 million at quarte r end, compared to $10.3 million at December 31, 2018. The watch list includes both performing and nonperforming loans. It is comprised entirely of loans rate 6-Special Mention and 7-Substandard. Included in the substandard total are $5.6 million of nonaccrual loans. The credit composition of the watch list (loans rate 6, 7, or 8), by primary collateral is shown in Note 6 of the accompanying financial statements.

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

Nonaccruing loans generally represent Management’s determination that the borrower will be unable to repay the loan in accordance with its contractual terms and that collateral liquidation may or may not fully repay both interest and principal. It is the Bank’s policy to evaluate the probable collectability of principal and interest due under terms of loan contracts for all loans 90-days or more, nonaccrual loans, or impaired loans. Further, it is the Bank’s policy to discontinue

32

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.

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 and all credits rated 7-Substandard or worse. Management also tracks other commercial loan risk measurements including high loan to value loans, concentrations, participations and policy exceptions and reports these to the Credit Risk Oversight Committee of the Board of Directors. The Bank also uses a third-party consultant to assist with internal loan review with a goal of reviewing 60% of commercial loans each year. The FDIC defines certain supervisory loan-to-value lending limits. The Bank’s internal loan–to-value limits are all equal to, or have a lower loan-to-value limit, than the supervisory limits. However, in certain instances, the Bank may make a loan that exceeds the supervisory loan-to-value limit. At March 31, 2019 the Bank had loans of $18.8 million (1.9% of gross loans) that exceeded the supervisory limit, compared to 1.9% at year-end 2018.

Loan quality has declined since year-end 2018, as measured by the balance of nonaccrual loans. Nonaccrual loans increased $3.3 million from year-end 2018 as one commercial real estate credit ($3.5 million) moved from 60-89 days past due to nonaccrual during the first quarter of 2019. Potential problem loans, defined as watch list loans less loans on nonaccrual or past due more than 90 days declined to $4.1 million at March 31, 2019 compared to $7.6 million at December 31, 2018 as a result of the commercial real estate loan moving to nonaccrual.

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

﻿ |  |  |  |  |  |
﻿ |  | March 31, |  | December 31,
(Dollars in thousands) |  | 2019 |  | 2018
﻿ |  |  |  |  |  |
Nonaccrual loans |  |  |  |  |  |
Residential Real Estate 1-4 Family |  |  |  |  |  |
First liens |  | $ | 80 |  | $ | 80
Junior liens and lines of credit |  |  | 26 |  |  | 23
Total |  |  | 106 |  |  | 103
Residential real estate - construction |  |  | 652 |  |  | 455
Commercial real estate |  |  | 4,743 |  |  | 1,427
Commercial |  |  | 129 |  |  | 315
Total nonaccrual loans |  |  | 5,630 |  |  | 2,300
﻿ |  |  |  |  |  |
Loans past due 90 days or more and still accruing |  |  |  |  |  |
Residential Real Estate 1-4 Family |  |  |  |  |  |
First liens |  |  | 137 |  |  | 113
Junior liens and lines of credit |  |  | 18 |  |  | 26
Total |  |  | 155 |  |  | 139
Commercial real estate |  |  | — |  |  | 113
Commercial |  |  | 52 |  |  | 100
Consumer |  |  | — |  |  | 5
Total loans past due 90 days or more and still accruing |  |  | 207 |  |  | 357
﻿ |  |  |  |  |  |
Total nonperforming loans |  |  | 5,837 |  |  | 2,657
﻿ |  |  |  |  |  |
Other real estate owned |  |  | 2,684 |  |  | 2,684
Total nonperforming assets |  | $ | 8,521 |  | $ | 5,341
﻿ |  |  |  |  |  |
Nonperforming loans to total gross loans |  |  | 0.60% |  |  | 0.27%
Nonperforming assets to total assets |  |  | 0.70% |  |  | 0.44%
Allowance for loan losses to nonperforming loans |  |  | 217.25% |  |  | 467.26%

33

The following table identifies the most significant loans in nonaccrual status. These tw o nonaccrual loans account for 87% of the total nonaccrual balance.

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  | ALL |  | Nonaccrual |  | TDR |  |  |  |  |  | Collateral
﻿ |  | Balance |  |  | Reserve |  | Date |  | Status |  | Collateral |  | Location |  | Value
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Credit 1 | $ | 1,408 |  | $ | — |  | Mar-12 |  | Y |  | 1st and 2nd liens on commercial real estate, residential real estate and business assets |  | PA |  | $ | 3,267
Credit 2 |  | 3,464 |  |  | — |  | Mar-19 |  | N |  | land for residential development, residential and commercial real estate |  | PA |  | $ | 5,203
﻿ | $ | 4,872 |  | $ | — |  |  |  |  |  |  |  |  |  |  |

﻿

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

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

In accordance with financial accounting standards, TDR loans are always considered impaired until they are paid off or in certain circumstances, refinanced. However, an impaired TDR loan can be a performing loan. Impaired loans increased to $15.2 million at quarter-end compared to $11.9 million at year-end 2018, primarily from the new nonaccrual loan previously discussed.

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

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  | March 31, 2019
(Dollars in thousands) |  | Nonaccrual |  | Accruing |  |  | Accruing |  | Total
﻿ |  | Non-TDR |  | TDR |  | TDR |  |  | Other (1) |  | Impaired
Residential Real Estate 1-4 Family |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
First liens |  | $ | 80 |  | $ | — |  | $ | 673 |  | $ | 136 |  | $ | 889
Junior liens and lines of credit |  |  | 26 |  |  | — |  |  | — |  |  | 18 |  |  | 44
Total |  |  | 106 |  |  | — |  |  | 673 |  |  | 154 |  |  | 933
Residential real estate - construction |  |  | 198 |  |  | 454 |  |  | — |  |  | — |  |  | 652
Commercial real estate |  |  | 3,464 |  |  | 1,279 |  |  | 8,703 |  |  | — |  |  | 13,446
Commercial |  |  | 129 |  |  | — |  |  | — |  |  | — |  |  | 129
Total |  | $ | 3,897 |  | $ | 1,733 |  | $ | 9,376 |  | $ | 154 |  | $ | 15,160
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
(1) impaired consumer purpose loans not on nonaccrual |  |  |  |  |  |

﻿

Allowance for Loan Losses:

Management monitors loan performance on a monthly basis and performs a quarterly evaluation of the adequacy of the allowance for loan losses (ALL). The ALL is determined by segmenting the loan portfolio based on the loan’s collateral. When calculating the ALL, consideration is given to a variety of factors in establishing this estimate including, but not limited to, current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, historical charge-offs, the adequacy of the underlying collateral (if collateral dependent) and other relevant factors. The Bank begins enhanced monitoring of all loans rated 6-Special Mention or worse, and obtains a new appraisal or asset valuation for any placed on nonaccrual and 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

34

Committee of the Board of Directors. Management believes that the allowance for loan losses at March 31, 2019 is adequate.

The analysis for determining the ALL is consistent with guidance set forth in generally accepted accounting principles (GAAP) and the Interagency Policy Statement on the Allowance for Loan and Lease Losses. The analysis has three components; specific, general and unallocated. 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. However, it is possible that as a result of the credit analysis, a specific reserve is not required for an impaired loan. For impaired loans with balances less than $250 thousand and all consumer purpose loans, a specific reserve analysis is not performed and these loans are added to the general allocation pool. These loans totaled $860 thousand at March 31, 2019 and are comprised primarily of loans secured by residential real estate. Management does not believe that excluding these loans from the specific reserve analysis presents any additional risk. T here was no specific reserve established for any of the impaired loans. Note 6 of 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 segments based primarily on the type of supporting collateral: residential real estate, commercial, industrial or agricultural real estate; commercial and industrial (C&I non-real estate), and consumer. Each segment may be further segregated by type of collateral, lien position, or owner/nonowner occupied properties. The quantitative analysis uses the Bank’s twenty quarter rolling historical loan loss experience as determined for each loan segment to determine a loss factor applicable to each loan segment. The qualitative analysis utilizes a risk matrix that incorporates four primary risk factors: economic conditions, delinquency, classified loans, and level of risk, and assigns a risk level (as measured in basis points) to each factor. In determining the risk level for these primary factors, consideration is given to operational factors such as: loan volume, management, loan review process, credit concentrations, competition, and legal and regulatory issues. The level of risk (as measured in basis points) for each primary factor is set for five risk levels ranging from minimal risk to very high risk and is determined independently for commercial loans, residential mortgage loans and consumer loans.

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

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 nonaccrual and a risk rating of 7-Substandard or worse, an evaluation for impairment status is made based on the current information available at the time of downgrade and a new appraisal or collateral valuation is obtained. We believe this practice complies with the regulatory guidance.

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.

35

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 March 31, 2019 and December 31, 2018:

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  | Residential Real Estate 1-4 Family |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  | First |  | Junior Liens & |  |  |  | Commercial |  |  |  |  |  |  |  |  |  |  |
(Dollars in thousands) |  | Liens |  | Lines of Credit |  | Construction |  | Real Estate |  | Commercial |  | Consumer |  | Unallocated |  | Total
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
March 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans evaluated for ALL: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually |  | $ | 401 |  | $ | — |  | $ | 652 |  | $ | 13,247 |  | $ | — |  | $ | — |  | $ | — |  | $ | 14,300
Collectively |  |  | 147,021 |  |  | 46,690 |  |  | 13,329 |  |  | 484,727 |  |  | 269,243 |  |  | 5,156 |  |  | — |  |  | 966,166
Total |  | $ | 147,422 |  | $ | 46,690 |  | $ | 13,981 |  | $ | 497,974 |  | $ | 269,243 |  | $ | 5,156 |  | $ | — |  | $ | 980,466
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
ALL established for loans evaluated: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually |  | $ | — |  | $ | — |  | $ | — |  | $ | — |  | $ | — |  | $ | — |  | $ | — |  | $ | —
Collectively |  |  | 487 |  |  | 132 |  |  | 152 |  |  | 5,906 |  |  | 4,562 |  |  | 72 |  |  | 1,370 |  |  | 12,681
ALL at March 31, 2019 |  | $ | 487 |  | $ | 132 |  | $ | 152 |  | $ | 5,906 |  | $ | 4,562 |  | $ | 72 |  | $ | 1,370 |  | $ | 12,681
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
December 31, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans evaluated for ALL: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually |  | $ | 405 |  | $ | — |  | $ | 455 |  | $ | 10,099 |  | $ | 181 |  | $ | — |  | $ | — |  | $ | 11,140
Collectively |  |  | 148,495 |  |  | 47,220 |  |  | 9,770 |  |  | 477,881 |  |  | 273,873 |  |  | 4,996 |  |  | — |  |  | 962,235
Total |  | $ | 148,900 |  | $ | 47,220 |  | $ | 10,225 |  | $ | 487,980 |  | $ | 274,054 |  | $ | 4,996 |  | $ | — |  | $ | 973,375
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
ALL established for loans evaluated: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Individually |  | $ | — |  | $ | — |  | $ | — |  | $ | — |  | $ | — |  | $ | — |  | $ | — |  | $ | —
Collectively |  |  | 491 |  |  | 133 |  |  | 108 |  |  | 5,698 |  |  | 4,511 |  |  | 70 |  |  | 1,404 |  |  | 12,415
ALL at December 31, 2018 |  | $ | 491 |  | $ | 133 |  | $ | 108 |  | $ | 5,698 |  | $ | 4,511 |  | $ | 70 |  | $ | 1,404 |  | $ | 12,415

﻿

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

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  | Residential Real Estate 1-4 Family |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  | First |  | Junior Liens & |  |  |  |  | Commercial |  |  |  |  |  |  |  |  |  |  |
(Dollars in thousands) |  | Liens |  | Lines of Credit |  | Construction |  | Real Estate |  | Commercial |  | Consumer |  | Unallocated |  | Total
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
ALL at December 31, 2018 |  | $ | 491 |  | $ | 133 |  | $ | 108 |  | $ | 5,698 |  | $ | 4,511 |  | $ | 70 |  | $ | 1,404 |  | $ | 12,415
Charge-offs |  |  | (33) |  |  | (1) |  |  | (3) |  |  | (63) |  |  | (61) |  |  | (26) |  |  | — |  |  | (187)
Recoveries |  |  | 1 |  |  | — |  |  | — |  |  | 1 |  |  | 42 |  |  | 10 |  |  | — |  |  | 54
Provision |  |  | 28 |  |  | — |  |  | 47 |  |  | 270 |  |  | 70 |  |  | 18 |  |  | (34) |  |  | 399
ALL at March 31, 2019 |  | $ | 487 |  | $ | 132 |  | $ | 152 |  | $ | 5,906 |  | $ | 4,562 |  | $ | 72 |  | $ | 1,370 |  | $ | 12,681

﻿

The allocation of the allowance for loan losses is based on estimates and is not intended to imply limitations on the usage of the allowance. The entire allowance is available to absorb any losses without regard to the category in which the loan is classified.

The following table shows the ALL and charge-off ratios for the periods ended:

﻿

﻿ |  |  |  |  |  |  |  |
﻿ | Three Months Ended | Year ended |  | Three Months Ended
﻿ | March 31, 2019 |  | December 31, 2018 |  | March 31, 2018
Net charge-offs (recoveries)/average loans* |  | 0.05% |  |  | 0.97% |  |  | 0.00%
Net loan charge-offs (recoveries) as a percentage of the provision for loan losses |  | 33.33% |  |  | 93.74% |  |  | 1.50%
Allowance for loan losses as a % of loans |  | 1.29% |  |  | 1.28% |  |  | 1.27%
Net charge-offs (recoveries) | $ | 133 |  | $ | 9,331 |  | $ | 3
* Annualized |  |  |  |  |  |  |  |

﻿

﻿

36

Other Real Estate Owned:

The Bank holds $2.7 million of other real estate owned (OREO), comprised of two properties. The most significant OREO holding is one property carried at $2.6 million (98% of total OREO) that is secured by 196 acres of land intended for residential real estate development. The Bank has a contract on the property that is expected to settle in 2019 with no loss to the Bank. During 2019, the expense to hold and maintain OREO was $17 thousand. Note 8 of the accompanying financial statements provides additional information on activity in OREO.

﻿

Deposits:

Total deposits decreased $6.1 million during the first three months of 2019 to $1.076 billion. Non-interest bearing deposits decreased $5.4 million (primarily in commercial checking deposits) and interest-bearing checking deposits decreased $28.2 million, while time deposits increased $27.5 million. Interest bearing checking de creased by $9.3 million, primarily in commercial and retail depo sits while t he Bank’s Money Management product de creased $19.8 million, primarily in retail accounts as customers moved funds to higher rate time deposits. T ime deposits in creased since year-end from CD promotions. The Bank acquired $10 million of short-term wholesale brokered CDs in the first quarter of 2019.

As of March 31, 2019, the Bank had $155.7 million placed in the ICS program ($108.7 million in interesting-bearing checking and $47.0 million in money management) and $3.3 million in reciprocal time deposits in the CDARS program included in time deposits. These programs allow the Bank to offer full FDIC coverage to large depositors, but with the convenience to the customer of only having to deal with one bank. The Bank solicits these deposits from within its market and it believes they present no greater risk than any other local deposit.

﻿ |  |  |  |  |  |  |  |  |  |  |
﻿ |  | March 31, |  | December 31, |  |  | Change
(Dollars in thousands) |  | 2019 |  | 2018 |  |  | Amount |  | %
Noninterest-bearing checking |  | $ | 192,004 |  | $ | 197,417 |  | $ | (5,413) |  | (2.7)
﻿ |  |  |  |  |  |  |  |  |  |  |
Interest-bearing checking |  |  | 296,346 |  |  | 305,661 |  |  | (9,315) |  | (3.0)
Money management |  |  | 416,976 |  |  | 436,752 |  |  | (19,776) |  | (4.5)
Savings |  |  | 82,089 |  |  | 81,206 |  |  | 883 |  | 1.1
Total interest-bearing checking and savings |  |  | 795,411 |  |  | 823,619 |  |  | (28,208) |  | (3.4)
﻿ |  |  |  |  |  |  |  |  |  |  |
Time deposits |  |  | 79,076 |  |  | 61,593 |  |  | 17,483 |  | 28.4
Brokered time deposits |  |  | 10,000 |  |  | — |  |  | 10,000 |  | N/A
Total time deposits |  |  | 89,076 |  |  | 61,593 |  |  | 27,483 |  | 44.6
﻿ |  |  |  |  |  |  |  |  |  |  |
Total deposits |  | $ | 1,076,491 |  | $ | 1,082,629 |  | $ | (6,138) |  | (0.6)
﻿ |  |  |  |  |  |  |  |  |  |  |
Overdrawn deposit accounts reclassified as loans |  | $ | 99 |  | $ | 120 |  |  |  |  |

﻿

Borrowings:

The Corporation had no short-term borrowings at March 31, 2019 and December 31, 2018.

Shareholders’ Equity:

Total shareholders’ equity increased $3.1 million to $121.5 million at March 31, 2019, from $118.4 million at the end of 2018. The Corporation’s net earnings of $3.2 million were partially offset by the cash dividend of $1.2 million. The Corporation’s Dividend Reinvestment Plan (DRIP) added $161 thousand in new capital from optional cash contributions and $190 thousand from the reinvestment of quarterly dividends. The Corporation’s dividend payout ratio was 36.8% for the first three months of 2019 compared to 29.8% in 2018.

As part of its quarterly dividend decision, the Corporation considers current and future income projections, dividend yield, payout ratio, and current and future capital ratios. For the first quarter of 2019, the Corporation paid a $0.27 per share dividend, compared to $0.27 paid in the fourth quarter of 2018. On April 18, 2019 the Board of Directors declared a $0.30 p er share regular quarterly dividend for the second quarter of 2019, which will be paid on May 22, 2019.

On December 20, 2018, the Board of Directors authorized the 2018 Repurchase Plan for the repurchase of up to 100,000 shares of the Corporation’s $1.00 par value common stock at market prices in open market or privately negotiated transactions beginning December 21, 2018 and continuing through December 21, 2019. During the first three months of 2019, 14,553 shares were repurchased. No shares were repurchased in the first three months of 2018. The 2017 Repurchase Plan expired on September 30, 2018.

In July 2013, Federal banking regulators approved the final rules from the Basel Committee on Banking Supervision for the regulation of capital requirements for bank holding companies and U.S banks, generally referred to as “Basel III.” The Basel III standards were effective for the Corporation and the Bank, effective January 1, 2015 (subject to a phase-in

37

period for certain provisions). Basel III imposes significantly higher capital requirements and more restrictive leverage and liquidity ratios than those previously in place. The capital ratios to be considered “well capitalized” under Basel III are: (1) Common Equity Tier 1 (CET1) of 6.5%, (2) Tier 1 Leverage of 5%, (3) Tier 1 Risk-Based Capital of 8%, and (4) Total Risk-Based Capital of 10%. The CET1 ratio is a new capital ratio under Basel III and the Tier 1 risk-based capital ratio of 8% has been increased from 6%. The rules also include changes in the risk weights of certain assets to better reflect credit and other risk exposures. In addition, a capital conservation buffer will be phased-in beginning January 1, 2016 at 0.625%, 1.25% for 2017, 1.875% for 2018 and 2.50% for 2019 and thereafter. The capital conservation buffer will be applicable to all of the capital ratios except for the Tier1 Leverage ratio. The capital conservation buffer is equal to the lowest value of the three applicable capital ratios less the regulatory minimum for each respective capital measurement. The Bank’s capital conservation buffer at March 31, 2019 was 6.95% (total risk-based capital 1 4.95% less 8.00%) compared to the 2018 regulatory buffer of 2.50%. Compliance with the capital conservation buffer is required in order to avoid limitations to certain capital distributions. As of March 31, 2019, the Bank was “well capitalized” under the Basel III requirements and believes it would be “well capitalized” on a fully-phased in basis had such a requirement been in effect.

The following table summarizes regulatory capital information as of March 31, 2019 and December 31, 2018 for the Corporation and the Bank.

﻿

﻿ |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  | Regulatory Ratios
﻿ |  |  |  |  |  | Adequately |  | Well
﻿ |  | March 31, |  | December 31, |  | Capitalized |  | Capitalized
(Dollars in thousands) |  | 2019 |  | 2018 |  | Minimum |  | Minimum
﻿ |  |  |  |  |  |  |  |
Common Equity Tier 1 Risk-based Capital Ratio (1) |  |  |  |  |  |  |  |
Franklin Financial Services Corporation |  | 13.78% |  | 13.96% |  | 4.500% |  | N/A
Farmers & Merchants Trust Company |  | 13.69% |  | 13.80% |  | 4.500% |  | 6.50%
﻿ |  |  |  |  |  |  |  |
Tier 1 Risk-based Capital Ratio (2) |  |  |  |  |  |  |  |
Franklin Financial Services Corporation |  | 13.78% |  | 13.96% |  | 6.000% |  | N/A
Farmers & Merchants Trust Company |  | 13.69% |  | 13.80% |  | 6.000% |  | 8.00%
﻿ |  |  |  |  |  |  |  |
Total Risk-based Capital Ratio (3) |  |  |  |  |  |  |  |
Franklin Financial Services Corporation |  | 15.04% |  | 15.21% |  | 8.000% |  | N/A
Farmers & Merchants Trust Company |  | 14.95% |  | 15.06% |  | 8.000% |  | 10.00%
﻿ |  |  |  |  |  |  |  |
Tier 1 Leverage Ratio (4) |  |  |  |  |  |  |  |
Franklin Financial Services Corporation |  | 9.88% |  | 9.78% |  | 4.000% |  | N/A
Farmers & Merchants Trust Company |  | 9.82% |  | 9.68% |  | 4.000% |  | 5.00%
﻿ |  |  |  |  |  |  |  |
(1) Common equity Tier 1 capital/ total risk-weighted assets (2) Tier 1 capital / total risk-weighted assets
(3) Total risk-based capital / total risk-weighted assets, (4) Tier 1 capital / average quarterly assets

﻿

Economy

The Corporation’s primary market area includes Franklin, Fulto n, Cumberland and Huntingdon Counties, Pennsylvania. This area is diverse in demographic and economic makeup. County populations range from a low of approximately 1 5,000 in Fulton County to over 2 49,000 in Cumberland County. Unemployment in the Bank’s market area has remained virtually unchanged over the past year and ranges from a low of 3.1% in Cumberland County to 6.4% 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 S outh C entral P A and provides easy access to the major metropolitan markets on the east coast via trucking and rail transportation. Because of this, warehousing and distribution companies continue to find the area attractive. The local economy is not overly dependent on any one industry or business and Management believes that the Bank’s primary market area continues to be well suited for growth.

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

Economic Data

﻿

﻿ |  |  |  |
﻿ |  |  |  |
﻿ |  | March 31, |  | December 31,
﻿ |  | 2019 |  | 2018
Unemployment Rate (seasonally adjusted) |  |  |  |
Market area range (1) |  | 3.1% - 6.4% |  | 3.0 - 4.5%
Pennsylvania |  | 4.0% |  | 4.0%
United States |  | 3.8% |  | 3.7%
﻿ |  |  |  |
Housing Price Index - year over year change |  |  |  |
PA, nonmetropolitan statistical area |  | 3.0% |  | 3.6%
United States |  | 6.0% |  | 6.6%
﻿ |  |  |  |
Building Permits - year over year change -12 months |  |  |  |
Harrisburg-Carlisle, PA MSA & Chambersburg-Waynesboro, PA MSA |  |  |  |
Residential, estimated |  | 6.8% |  | 15.9%
Multifamily, estimated |  | 94.6% |  | 136.0%
﻿ |  |  |  |
(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. FOMC members had estimated in December that two rate hikes would be appropriate in 2019 after four increases in 2018. However, there now appears to be no likelihood of a hike unless conditions change significantly. In its post-meeting statement, the FOMC indicated it would remain “patient” before adopting any further increases.

Liquidity

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

Historically, the Corporation has satisfied its liquidity needs from earnings, repayment of loans and amortizing investment securities, maturing investment securities, loan` sales, deposit growth and its ability to access existing lines of credit. All investment securities are classified as available for sale; therefore, securities that are unencumbered (approximately $65.4 million fair value) 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. The Bank also has access to other wholesale funding via the brokered CD market.

The FHLB system has always been a major funding source for community banks. The Bank’s maximum borrowing capacity with the FHLB at March 31, 2019 was $367.8 million with $367.8 million available to borrow. There are no indicators that lead the Bank to believe the FHLB would discontinue its lending function or restrict the Bank’s ability to borrow. If either of these events would occur, it would have a negative effect on the Bank and it is unlikely that the Bank could replace the level of FHLB funding in a short time.

39

The Bank has established credit at the Federal Reserve Discount Window and as of quarter-end had the ability to borrow approximately $17.5 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 $288.0 million and $271.7 million, respectively, at March 31, 2019 and December 31, 2018. As of June 30, 2018, the Bank established a $2.4 million allowance against letters of credit issued in connection with a commercial borrower that declared bankruptcy in the second quarter of 2018 which remains at March 31, 2019.

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 2018 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 three months ended March 31, 2019. For more information on market risk refer to the Corporation’s 2018 Annual Report on Form 10-K.

﻿

Item 4. Controls and Pr ocedures

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 March 31, 2019, the Corporation’s disclosure controls and procedures are effective. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in the Corporation’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. There were no changes in the Corporation’s internal control over financial reporting during the quarterly period ended March 31, 2019, that have materially affected, or are reasonably likely to materially affect, the internal control over financial reporting.

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

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

﻿

40

Part II – OTHER INFORMATION

Item 1. Legal Proceedings

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

As described in our current report on Form 8-K filed on August 3, 2018, the court entered an order on July 31, 2018 granting final approval of the settlement agreements in the Kalan et al. v. Farmers and Merchants Trust Company of Chambersburg, et al. (Case No. 2:15-CV-01435-WB) case filed against F&M Trust in the United States District Court for the Eastern District of Pennsylvania in March, 2015 and described in our current reports on Form 8-K filed July 29, 2016, July 28, 2017, November 3, 2017, January 2, 2018, April 13, 2018, May 7, 2018 and August 3, 2018. Among other things, the order also dismissed the case against F&M Trust with prejudice; certified the settlement class; and, permanently enjoined the named plaintiffs and the members of the settlement class from asserting any further claims arising out of or related to the claims alleged or that could have been alleged in the case against F&M Trust. The settlement agreements provide for the Bank to make a settlement payment of $10 million in full and final settlement of all such claims. The settlement agreements further provide for general releases by all parties. F&M Trust made the settlement payment in May, 2018, in accordance with the court’s earlier order preliminarily approving the settlement agreements. The Corporation previously accrued the $10 million settlement payment as an expense for the year ended December 31, 2017.

﻿

Item 1A. Risk Factors

There were no material changes in the Corporation’s risk factors during the three months ended March 31, 2019. For more information, refer to the Corporation’s 2018 Annual Report on Form 10-K.

﻿

﻿

41

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

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |
(Dollars in thousands, except per share) |  |  |  |  |  |
Period |  | Number of Shares Purchased as Part of Publically Announced Program |  |  | Weighted Average Price Paid per Share |  |  | Dollar Amount of Shares Purchased as Part of Publically Announced Program |  |  | Shares Yet To Be Purchased Under Program
January 1, 2019 |  | — |  | $ | — |  | $ | — |  |  | 100,000
February 2019 |  | 7,387 |  |  | 37.16 |  |  | 275 |  |  | 92,613
March 2019 |  | 7,166 |  |  | 36.65 |  |  | 263 |  |  | 85,447
﻿ |  | 14,553 |  |  |  |  | $ | 538 |  |  |

﻿

On December 20, 2018, the Board of Directors authorized the 2018 Repurchase Plan for the repurchase of up to 100,000 shares of the Corporation’s $1.00 par value common stock at market prices in open market or privately negotiated transactions beginning December 21, 2018 and continuing through December 21, 2019. No shares were repurchased in the first three months of 2018. The 2017 Repurchase Plan expired on September 30, 2018.

﻿

Item 3. Defaults by the Company on its Senior Securities

None

Item 4. Mine Safety Disclosures

Not Applicable

42

Item 5. Other In formation

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 3.2 to Current Report on Form 8-K, as filed with the commission on December 21, 2018 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)

﻿

43

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

﻿

﻿ |  |
﻿ |  |
May 8, 201 9 |  | /s/ Timothy G. Henry
﻿ |  | Timothy G. Henry
﻿ |  | Chief Executive Office and President
﻿ |  | (Principal Executive Officer)
﻿ |  |
May 8, 201 9 |  | /s/ Mark R. Hollar
﻿ |  | Mark R. Hollar
﻿ |  | Treasurer and Chief Financial Officer
﻿ |  | (Principal Financial and Accounting Officer)

﻿

44