Note 2. Regulatory Matters

The Bank is limited as to the amount it may lend to the Corporation, unless such loans are collateralized by specific obligations. State regulations also limit the amount of dividends the Bank can pay to the Corporation and are generally limited to the Bank’s accumulated net earnings, which were $103.8 million at December 31, 2019. In addition, dividends paid by the Bank to the Corporation would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below applicable minimum capital requirements. The Bank is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgements by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Although not adopted in regulation form, the Pennsylvania Department of Banking utilizes capital standards requiring a minimum leverage capital ratio of 6% and a risk-based capital ratio of 10%, defined substantially the same as those by the FDIC. Management believes, as of December 31, 2019, that the Bank met all capital adequacy requirements to which it is subject.

The Bank is subject to the capital requirements contained in the regulation generally referred to as Basel III. The Basel III standards were effective for 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 included changes in the risk weights of certain assets to better reflect credit and other risk exposures. In addition, a capital conservation buffer of 2.50% for 2019 and thereafter was added. The capital conservation buffer is applicable to all of the capital ratios except for the Tier 1 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 December 31, 2019 was 7.87% (total risk-based capital 15.87% less 8.00%) compared to the 2019 regulatory buffer of 2.50%. Compliance with the capital conservation buffer is required in order to avoid limitations on certain capital distributions. As of December 31, 2019, the Bank was “well capitalized’ under the Basel III. The net unrealized gain or loss on available for sale securities and defined benefit pension items are not included in computing regulatory capital.

In 2019, the Community Bank Leverage Ratio (CBLR) was approved by federal banking agencies as an optional capital measure available to Qualifying Community Banking Organizations (QCBO). If a bank qualifies as a QCBR and maintains a CBLR of 9% or greater, the bank would be considered “well-capitalized” for regulatory capital purposes and exempt from complying with the Basel III risk-based capital rule. The CBLR rule takes effect January 1, 2020 and banks desiring to opt-in can do so through an election in the first quarter 2020 regulatory filings. The Bank meets the criteria of a QCBO but expects not to opt-in to the CBLR.

The consolidated asset limit on small bank holding companies is $3 billion and a company with assets under that limit is not subject to the consolidated capital rules, but may file reports that include capital amounts and ratios. The Corporation has elected to file those reports.

The following table presents the regulatory capital ratio requirements for the Corporation and the Bank.


	As of December 31, 2019
				Regulatory Ratios
				Adequately Capitalized			Well Capitalized
	Actual			Minimum			Minimum
(Dollars in thousands)		Amount	Ratio	Amount		Ratio	Amount		Ratio
Common Equity Tier 1 Risk-based Capital Ratio (1)
Corporation	$	124,498	14.82%	$	37,808	N/A		N/A	N/A
Bank		122,974	14.62%		37,859	4.50%	$	54,682	6.50%

Tier 1 Risk-based Capital Ratio (2)
Corporation	$	124,498	14.82%	$	50,410	N/A		N/A	N/A
Bank		122,974	14.62%		50,479	6.00%	$	67,305	8.00%

Total Risk-based Capital Ratio (3)
Corporation	$	135,061	16.08%	$	67,214	N/A		N/A	N/A
Bank		133,537	15.87%		67,305	8.00%	$	84,131	10.00%

Tier 1 Leverage Ratio (4)
Corporation	$	124,498	9.72%	$	51,216	N/A		N/A	N/A
Bank		122,974	9.59%		51,285	4.00%	$	64,107	5.00%


	As of December 31, 2018
				Regulatory Ratios
				Adequately Capitalized			Well Capitalized
	Actual			Minimum			Minimum
(Dollars in thousands)		Amount	Ratio	Amount		Ratio	Amount		Ratio
Common Equity Tier 1 Risk-based Capital Ratio (1)
Corporation	$	115,760	13.96%	$	37,328	4.50%		N/A	N/A
Bank		115,326	13.80%		37,605	4.50%	$	54,319	6.50%

Tier 1 Risk-based Capital Ratio (2)
Corporation	$	115,760	13.96%	$	49,771	6.00%		N/A	N/A
Bank		115,326	13.80%		50,140	6.00%	$	66,854	8.00%

Total Risk-based Capital Ratio (3)
Corporation	$	126,129	15.21%	$	66,361	8.00%		N/A	N/A
Bank		125,825	15.06%		66,854	8.00%	$	83,567	10.00%

Tier 1 Leverage Ratio (4)
Corporation	$	115,760	9.78%	$	47,323	4.00%		N/A	N/A
Bank		115,326	9.68%		47,675	4.00%	$	59,593	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