10-Q 1 a20171q17-10xq.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q
 
ý
Quarterly Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

for the Quarterly Period Ended March 31, 2017. 
o
Transition report pursuant to Section 13 or 15 (d) of the Exchange Act

For the Transition Period from                    to                   .

No. 0-17077
(Commission File Number)

PENNS WOODS BANCORP, INC.
(Exact name of Registrant as specified in its charter) 
PENNSYLVANIA
 
23-2226454
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
300 Market Street, P.O. Box 967 Williamsport, Pennsylvania
 
17703-0967
(Address of principal executive offices)
 
(Zip Code)
 

(570) 322-1111
Registrant’s telephone number, including area code

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 ý NO o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  YES ý NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

 
Large accelerated filer o
 
                 Accelerated filer x
  Non-accelerated filer o
 
   Small reporting company o
 
 
Emerging growth company o

If an emerging growth company, indicate by check mark if 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. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  YES o NO ý

On May 1, 2017 there were 4,735,292 shares of the Registrant’s common stock outstanding.



PENNS WOODS BANCORP, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

 
 
Page
 
 
Number
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


Part I.  FINANCIAL INFORMATION
Item 1.  Financial Statements
PENNS WOODS BANCORP, INC.
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
 
 
March 31,
 
December 31,
(In Thousands, Except Share Data)
 
2017
 
2016
ASSETS:
 
 

 
 

Noninterest-bearing balances
 
$
22,494

 
$
26,766

Interest-bearing balances in other financial institutions
 
53,166

 
16,905

Total cash and cash equivalents
 
75,660

 
43,671

 
 
 
 
 
Investment securities, available for sale, at fair value
 
136,910

 
133,492

Investment securities, trading
 

 
58

Loans held for sale
 
1,221

 
1,953

Loans
 
1,111,100

 
1,093,681

Allowance for loan losses
 
(12,905
)
 
(12,896
)
Loans, net
 
1,098,195

 
1,080,785

Premises and equipment, net
 
24,431

 
24,275

Accrued interest receivable
 
3,945

 
3,672

Bank-owned life insurance
 
27,521

 
27,332

Investment in limited partnerships
 
540

 
586

Goodwill
 
17,104

 
17,104

Intangibles
 
1,709

 
1,799

Deferred tax asset
 
8,039

 
8,397

Other assets
 
5,433

 
5,466

TOTAL ASSETS
 
$
1,400,708

 
$
1,348,590

 
 
 
 
 
LIABILITIES:
 
 

 
 

Interest-bearing deposits
 
$
848,272

 
$
791,937

Noninterest-bearing deposits
 
312,392

 
303,277

Total deposits
 
1,160,664

 
1,095,214

 
 
 
 
 
Short-term borrowings
 
8,589

 
13,241

Long-term borrowings
 
75,998

 
85,998

Accrued interest payable
 
387

 
455

Other liabilities
 
15,957

 
15,433

TOTAL LIABILITIES
 
1,261,595

 
1,210,341

 
 
 
 
 
SHAREHOLDERS’ EQUITY:
 
 

 
 

Preferred stock, no par value, 3,000,000 shares authorized; no shares issued
 

 

Common stock, par value $8.33, 15,000,000 shares authorized; 5,007,569 and 5,007,109 shares issued ; 4,735,117 and 4,734,657 shares outstanding
 
41,729

 
41,726

Additional paid-in capital
 
50,091

 
50,075

Retained earnings
 
62,071

 
61,610

Accumulated other comprehensive loss:
 
 

 
 

Net unrealized loss on available for sale securities
 
(281
)
 
(639
)
Defined benefit plan
 
(4,263
)
 
(4,289
)
Treasury stock at cost, 272,452
 
(10,234
)
 
(10,234
)
TOTAL SHAREHOLDERS’ EQUITY
 
139,113

 
138,249

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
 
$
1,400,708

 
$
1,348,590

 
See accompanying notes to the unaudited consolidated financial statements.

3


PENNS WOODS BANCORP, INC.
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
 
 
Three Months Ended March 31,
(In Thousands, Except Per Share Data)
 
2017
 
2016
INTEREST AND DIVIDEND INCOME:
 
 

 
 

Loans, including fees
 
$
10,627

 
$
10,355

Investment securities:
 
 

 
 

Taxable
 
542

 
622

Tax-exempt
 
298

 
475

Dividend and other interest income
 
215

 
274

TOTAL INTEREST AND DIVIDEND INCOME
 
11,682

 
11,726

INTEREST EXPENSE:
 
 

 
 

Deposits
 
902

 
834

Short-term borrowings
 
4

 
26

Long-term borrowings
 
440

 
492

TOTAL INTEREST EXPENSE
 
1,346

 
1,352

NET INTEREST INCOME
 
10,336

 
10,374

PROVISION FOR LOAN LOSSES
 
330

 
350

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
 
10,006

 
10,024

NON-INTEREST INCOME:
 
 

 
 

Service charges
 
528

 
532

Net securities gains, available for sale
 
197

 
435

Net securities gains, trading
 
2

 
40

Bank-owned life insurance
 
172

 
184

Gain on sale of loans
 
358

 
467

Insurance commissions
 
191

 
206

Brokerage commissions
 
331

 
255

Other
 
872

 
878

TOTAL NON-INTEREST INCOME
 
2,651

 
2,997

NON-INTEREST EXPENSE:
 
 

 
 

Salaries and employee benefits
 
4,770

 
4,580

Occupancy
 
638

 
541

Furniture and equipment
 
649

 
701

Pennsylvania shares tax
 
238

 
258

Amortization of investment in limited partnerships
 
46

 
152

Federal Deposit Insurance Corporation deposit insurance
 
170

 
232

Marketing
 
171

 
210

Intangible amortization
 
90

 
87

Other
 
2,213

 
2,300

TOTAL NON-INTEREST EXPENSE
 
8,985

 
9,061

INCOME BEFORE INCOME TAX PROVISION
 
3,672

 
3,960

INCOME TAX PROVISION
 
986

 
882

NET INCOME
 
$
2,686

 
$
3,078

EARNINGS PER SHARE - BASIC
 
$
0.57

 
$
0.65

EARNINGS PER SHARE - DILUTED
 
$
0.56

 
$
0.65

WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC
 
4,734,805

 
4,740,503

WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED
 
4,761,305

 
4,740,503

DIVIDENDS DECLARED PER SHARE
 
$
0.47

 
$
0.47

See accompanying notes to the unaudited consolidated financial statements.

4




PENNS WOODS BANCORP, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(UNAUDITED)
 
 
 
Three Months Ended March 31,
(In Thousands)
 
2017
 
2016
Net Income
 
$
2,686

 
$
3,078

Other comprehensive income:
 
 

 
 

Change in unrealized gain (loss) on available for sale securities
 
739

 
2,050

Tax effect
 
(251
)
 
(697
)
Net realized gain on available for sale securities included in net income
 
(197
)
 
(435
)
Tax effect
 
67

 
148

   Amortization of unrecognized pension loss
 
39

 
39

        Tax effect
 
(13
)
 
(14
)
Total other comprehensive income
 
384

 
1,091

Comprehensive income
 
$
3,070

 
$
4,169

 
See accompanying notes to the unaudited consolidated financial statements.

5


PENNS WOODS BANCORP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
(UNAUDITED)
 
 
 
COMMON STOCK
 
ADDITIONAL
PAID-IN CAPITAL
 
RETAINED EARNINGS
 
ACCUMULATED OTHER
COMPREHENSIVE LOSS (INCOME)
 
TREASURY STOCK
 
TOTAL
SHAREHOLDERS’ EQUITY
(In Thousands, Except Per Share Data)
 
SHARES
 
AMOUNT
 
 
 
 
 
Balance, December 31, 2015
 
5,004,984

 
$
41,708

 
$
49,992

 
$
58,038

 
$
(3,799
)
 
$
(9,660
)
 
$
136,279

Net income
 
 

 
 

 
 

 
3,078

 
 

 
 

 
3,078

Other comprehensive income
 
 

 
 

 
 

 
 

 
1,091

 
 

 
1,091

Dividends declared, ($0.47 per share)
 
 

 
 

 
 

 
(2,228
)
 
 

 
 

 
(2,228
)
Common shares issued for employee stock purchase plan
 
550

 
5

 
12

 
 

 
 

 
 

 
17

Purchase of treasury stock (14,600 shares)
 
 
 
 
 
 
 
 
 
 
 
(574
)
 
(574
)
Balance, March 31, 2016
 
5,005,534

 
$
41,713

 
$
50,004

 
$
58,888

 
$
(2,708
)
 
$
(10,234
)
 
$
137,663


 
 
COMMON STOCK
 
ADDITIONAL
PAID-IN CAPITAL
 
RETAINED EARNINGS
 
ACCUMULATED OTHER
COMPREHENSIVE LOSS (INCOME)
 
TREASURY STOCK
 
TOTAL
SHAREHOLDERS’ EQUITY
(In Thousands, Except Per Share Data)
 
SHARES
 
AMOUNT
 
 
 
 
 
Balance, December 31, 2016
 
5,007,109

 
$
41,726

 
$
50,075

 
$
61,610

 
$
(4,928
)
 
$
(10,234
)
 
$
138,249

Net income
 
 

 
 

 
 

 
2,686

 
 

 
 

 
2,686

Other comprehensive income
 
 

 
 

 
 

 
 

 
384

 
 

 
384

Dividends declared, ($0.47 per share)
 
 

 
 

 
 

 
(2,225
)
 
 

 
 

 
(2,225
)
Common shares issued for employee stock purchase plan
 
460

 
3

 
16

 
 

 
 

 
 

 
19

Balance, March 31, 2017
 
5,007,569

 
$
41,729

 
$
50,091

 
$
62,071

 
$
(4,544
)
 
$
(10,234
)
 
$
139,113

 
See accompanying notes to the unaudited consolidated financial statements.

6


PENNS WOODS BANCORP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED) 
 
 
Three Months Ended March 31,
(In Thousands)
 
2017
 
2016
OPERATING ACTIVITIES:
 
 

 
 

Net Income
 
$
2,686

 
$
3,078

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

 
 

Depreciation and amortization
 
719

 
863

Amortization of intangible assets
 
90

 
87

Provision for loan losses
 
330

 
350

Accretion and amortization of investment security discounts and premiums
 
255

 
228

Net securities gains, available for sale
 
(197
)
 
(435
)
Originations of loans held for sale
 
(10,964
)
 
(12,617
)
Proceeds of loans held for sale
 
12,054

 
13,327

Gain on sale of loans
 
(358
)
 
(467
)
Net securities gains, trading
 
(2
)
 
(40
)
Proceeds from the sale of trading securities
 
169

 
2,930

Purchases of trading securities
 
(109
)
 
(2,877
)
Earnings on bank-owned life insurance
 
(172
)
 
(184
)
Decrease in deferred tax asset
 
174

 
15

Other, net
 
(143
)
 
(1,516
)
Net cash provided by operating activities
 
4,532

 
2,742

INVESTING ACTIVITIES:
 
 

 
 

Proceeds from sales of available for sale securities
 
2,652

 
19,839

Proceeds from calls and maturities of available for sale securities
 
3,958

 
6,535

Purchases of available for sale securities
 
(9,699
)
 
(3,270
)
Net (increase) decrease in loans
 
(18,200
)
 
3,918

Acquisition of premises and equipment
 
(557
)
 
(732
)
Proceeds from the sale of foreclosed assets
 
586

 
6

Purchase of bank-owned life insurance
 
(30
)
 
(27
)
Proceeds from redemption of regulatory stock
 
1,162

 
2,155

Purchases of regulatory stock
 
(1,007
)
 
(989
)
Net cash (used for) provided by investing activities
 
(21,135
)
 
27,435

FINANCING ACTIVITIES:
 
 

 
 

Net increase in interest-bearing deposits
 
56,335

 
38,422

Net increase (decrease) in noninterest-bearing deposits
 
9,115

 
(10,721
)
Repayment of long-term borrowings
 
(10,000
)
 

Net decrease in short-term borrowings
 
(4,652
)
 
(30,764
)
Dividends paid
 
(2,225
)
 
(2,228
)
Issuance of common stock
 
19

 
17

Purchases of treasury stock
 

 
(574
)
Net cash provided by (used for) financing activities
 
48,592

 
(5,848
)
NET INCREASE IN CASH AND CASH EQUIVALENTS
 
31,989

 
24,329

CASH AND CASH EQUIVALENTS, BEGINNING
 
43,671

 
22,796

CASH AND CASH EQUIVALENTS, ENDING
 
$
75,660

 
$
47,125

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 

 
 

Interest paid
 
$
1,414

 
$
1,339

Income taxes paid
 

 
950

Transfer of loans to foreclosed real estate
 
460

 
25

 
See accompanying notes to the unaudited consolidated financial statements.

7


PENNS WOODS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 1.  Basis of Presentation
 
The consolidated financial statements include the accounts of Penns Woods Bancorp, Inc. (the “Company”) and its wholly-owned subsidiaries: Woods Investment Company, Inc., Woods Real Estate Development Company, Inc., Luzerne Bank, and Jersey Shore State Bank (Jersey Shore State Bank and Luzerne Bank are referred to together as the “Banks”) and Jersey Shore State Bank’s wholly-owned subsidiary, The M Group, Inc. D/B/A The Comprehensive Financial Group (“The M Group”).  All significant inter-company balances and transactions have been eliminated in the consolidation.

The interim financial statements are unaudited, but in the opinion of management reflect all adjustments necessary for the fair presentation of results for such periods.  The results of operations for any interim period are not necessarily indicative of results for the full year.  These financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

The accounting policies followed in the presentation of interim financial results are the same as those followed on an annual basis.  These policies are presented on pages 39 through 48 of the Form 10-K for the year ended December 31, 2016.

In reference to the attached financial statements, all adjustments are of a normal recurring nature pursuant to Rule 10-01(b) (8) of Regulation S-X.
 
Note 2.  Accumulated Other Comprehensive Loss

The changes in accumulated other comprehensive loss by component shown net of tax as of March 31, 2017 and 2016 were as follows:
 
 
 
Three Months Ended March 31, 2017
 
Three Months Ended March 31, 2016
(In Thousands)
 
Net Unrealized Gain
on Available
for Sale Securities
 
Defined
Benefit 
Plan
 
Total
 
Net Unrealized Gain
(Loss) on Available
for Sale Securities
 
Defined
Benefit 
Plan
 
Total
Beginning balance
 
$
(639
)
 
$
(4,289
)
 
$
(4,928
)
 
$
258

 
$
(4,057
)
 
$
(3,799
)
Other comprehensive income before reclassifications
 
488

 

 
488

 
1,353

 

 
1,353

Amounts reclassified from accumulated other comprehensive loss
 
(130
)
 
26

 
(104
)
 
(287
)
 
25

 
(262
)
Net current-period other comprehensive income
 
358

 
26

 
384

 
1,066

 
25

 
1,091

Ending balance
 
$
(281
)
 
$
(4,263
)
 
$
(4,544
)
 
$
1,324

 
$
(4,032
)
 
$
(2,708
)

The reclassifications out of accumulated other comprehensive loss shown, net of tax and parenthesis indicating debits to net income, as of March 31, 2017 and 2016 were as follows:
Details about Accumulated Other Comprehensive Loss Components
 
Amount Reclassified from Accumulated Other Comprehensive Loss
 
Affected Line Item
 in the Consolidated 
Statement of Income
 
Three Months Ended March 31, 2017
 
Three Months Ended March 31, 2016
 
Net unrealized gain on available for sale securities
 
$
197

 
$
435

 
Net securities gains, available for sale
Income tax effect
 
(67
)
 
(148
)
 
Income tax provision
Total reclassifications for the period
 
$
130

 
$
287

 
 
 
 
 
 
 
 
 
Net unrecognized pension costs
 
$
(39
)
 
$
(39
)
 
Salaries and employee benefits
Income tax effect
 
13

 
14

 
Income tax provision
Total reclassifications for the period
 
$
(26
)
 
$
(25
)
 
 
 



8



Note 3.  Recent Accounting Pronouncements

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (a new revenue recognition standard). The core principle of the update is that a company will recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, this update specifies the accounting for certain costs to obtain or fulfill a contract with a customer and expands disclosure requirements for revenue recognition. This update is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. The Company is currently evaluating the impact the adoption of the standard will have on the Company's financial position or results of operation.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This update applies to all entities that hold financial assets or owe financial liabilities and is intended to provide more useful information on the recognition, measurement, presentation, and disclosure of financial instruments. Among other things, this update (a) requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (b) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (c) eliminates the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities; (d) eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (e) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (f) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (g) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (h) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. For public business entities, the amendments in this update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. For all other entities including not-for-profit entities and employee benefit plans within the scope of Topics 960 through 965 on plan accounting, the amendments in this update are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. All entities that are not public business entities may adopt the amendments in this update earlier as of the fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The standard requires lessees to recognize the assets and liabilities that arise from leases on the balance sheet.  A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term.  A short-term lease is defined as one in which: (a) the lease term is 12 months or less, and (b) there is not an option to purchase the underlying asset that the lessee is reasonably certain to exercise. For short-term leases, lessees may elect to recognize lease payments over the lease term on a straight-line basis. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within those years. For all other entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2019, and for interim periods within fiscal years beginning after December 15, 2020. The amendments should be applied at the beginning of the earliest period presented using a modified retrospective approach with earlier application permitted as of the beginning of an interim or annual reporting period. The Company is currently assessing the practical expedients it may elect at adoption, but does not anticipate the amendments will have a significant impact on the financial statements. Based on the Company's preliminary analysis of its current portfolio, the impact to the Company's balance sheet is estimated to result in less than a 1 percent increase in assets and liabilities. The Company also anticipates additional disclosures to be provided at adoption, or this update is not expected to have a significant impact on the Company's financial statements.
In March 2016, the FASB issued ASU 2016-04, Liabilities - Extinguishments of Liabilities (Subtopic 405-20). The standard provides that liabilities related to the sale of prepaid stored-value products within the scope of this Update are financial liabilities. The amendments in the Update provide a narrow scope exception to the guidance in Subtopic 405-20 to require that breakage for those liabilities be accounted for consistent with the breakage guidance in Topic 606. The amendments in this update are effective for public business entities, certain not-for-profit entities, and certain employee benefit plans for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. For all other entities, the amendments are effective for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within fiscal

9


years beginning after December 15, 2019. Earlier application is permitted, including adoption in an interim period. This update is not expected to have a significant impact on the Company’s financial statements.

In March 2016, the FASB issued ASU 2016-05, Derivatives and Hedging (Topic 815). The amendments in this update apply to all reporting entities for which there is a change in the counterparty to a derivative instrument that has been designated as a hedging instrument under Topic 815. The standards in this Update clarify that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument under Topic 815 does not, in and of itself, require designation of that hedging relationship provided that all other hedge accounting criteria continue to be met. For public business entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. For all other entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within fiscal years beginning after December 15, 2018. An entity has an option to apply the amendments in this Update on either a prospective basis or a modified retrospective basis. Early adoption is permitted, including adoption in an interim period. This Update is not expected to have a significant impact on the Company’s financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses: Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), which changes the impairment model for most financial assets. This ASU is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The underlying premise of the ASU is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset. The income statement will be effected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted for annual and interim periods beginning after December 15, 2018. With certain exceptions, transition to the new requirements will be through a cumulative effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is adopted. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”), which addresses eight specific cash flow issues with the objective of reducing diversity in practice. Among these include recognizing cash payments for debt prepayment or debt extinguishment as cash outflows for financing activities; cash proceeds received from the settlement of insurance claims should be classified on the basis of the related insurance coverage; and cash proceeds received from the settlement of bank-owned life insurance policies should be classified as cash inflows from investing activities while the cash payments for premiums on bank-owned policies may be classified as cash outflows for investing activities, operating activities, or a combination of investing and operating activities. The amendments in this Update are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. The amendments in this Update should be applied using a retrospective transition method to each period presented. If it is impracticable to apply the amendments retrospectively for some of the issues, the amendments for those issues would be applied prospectively as of the earliest date practicable. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s statement of cash flows.

In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740), which requires recognition of current and deferred income taxes resulting from an intra-entity transfer of any asset (excluding inventory) when the transfer occurs. Consequently, the amendments in this Update eliminate the exception for an intra-entity transfer of an asset other than inventory. The amendments in this Update are effective for public business entities for fiscal years beginning after December 15, 2017, including interim periods within those annual reporting periods. For all other entities, the amendments are effective for annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual periods beginning after December 15, 2019. Early adoption is permitted for all entities as of the beginning of an annual reporting period for which financial statements (interim or annual) have not been issued or made available for issuance. That is, earlier adoption should be in the first interim period if an entity issues interim financial statements. The amendments in this Update should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. This Update is not expected to have a significant impact on the Company’s financial statements.


10


In October 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230), which requires that a statement of cash flows explains the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The amendments in this Update are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The amendments in this Update should be applied using a retrospective transition method to each period presented. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s statement of cash flows.

In December 2016, the FASB issued ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. This Update, among others things, clarifies that guarantee fees within the scope of Topic 460, Guarantees, (other than product or service warranties) are not within the scope of Topic 606. The effective date and transition requirements for ASU 2016-20 are the same as the effective date and transition requirements for the new revenue recognition guidance. For public entities with a calendar year-end, the new guidance is effective in the quarter and year beginning January 1, 2018. For all other entities with a calendar year-end, the new guidance is effective in the year ending December 31, 2019, and interim periods in 2020. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805), Clarifying the Definition of a Business, which provides a more robust framework to use in determining when a set of assets and activities (collectively referred to as a “set”) is a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. This screen reduces the number of transactions that need to be further evaluated. Public business entities should apply the amendments in this Update to annual periods beginning after December 15, 2017, including interim periods within those periods. All other entities should apply the amendments to annual periods beginning after December 15, 2018, and interim periods within annual periods beginning after December 15, 2019. The amendments in this Update should be applied prospectively on or after the effective date. This Update is not expected to have a significant impact on the Company’s financial statements.

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. To simplify the subsequent measurement of goodwill, the FASB eliminated Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, under the amendments in this Update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting units fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. A public business entity that is a U.S. Securities and Exchange Commission (“SEC”) filer should adopt the amendments in this Update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. A public business entity that is not an SEC filer should adopt the amendments in this Update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2020. All other entities, including not-for-profit entities, that are adopting the amendments in this Update should do so for their annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2021.
In February 2017, the FASB issued ASU 2017-05, Other Income-Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20). The amendments in this Update clarify what constitutes a financial asset within the scope of Subtopic 610-20. The amendments also clarify that entities should identify each distinct nonfinancial asset or in substance nonfinancial asset that is promised to a counterparty and to derecognize each asset when the counterparty obtains control. There is also additional guidance provided for partial sales of a nonfinancial asset and when derecognition, and the related gain or loss, should be recognized. The amendments in this Update are effective at the same time as the amendments in Update 2014-09. Therefore, for public entities, the amendments are effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. For all other entities, the amendments in this Update are effective for annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019.


11


In February 2017, the FASB issued ASU 2017-06, Plan Accounting: Defined Benefit Pension Plans (Topic 960), Defined Contribution Pension Plans (Topic 962), and Health and Welfare Benefit Plans (Topic 965). This Update relates primarily to the reporting by an employee benefit plan for its interest in a master trust, which is a trust for which a regulated financial institution serves as a trustee or custodian and in which assets of more than one plan sponsored by a single employer or by a group of employers under common control are held. For each master trust in which a plan holds an interest, the amendments in this Update require a plan's interest in that master trust and any change in that interest to be presented in separate line items in the statement of net assets available for benefits and in the statement of changes in net assets available for benefits, respectively. The amendments in this Update remove the requirement to disclose the percentage interest in the master trust for plans with divided interests and require that all plans disclose the dollar amount of their interest in each of those general types of investments, which supplements the existing requirement to disclose the master trusts balances in each general type of investments. There are also increased disclosure requirements for investments in master trusts. The amendments in this Update are effective for fiscal years beginning after December 15, 2018. Early adoption is permitted.
In March 2017, the FASB issued ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20). The amendments in this Update shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. For public business entities, the amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity should apply the amendments in this Update on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Additionally, in the period of adoption, an entity should provide disclosures about a change in accounting principle. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

Note 4. Per Share Data

There are no convertible securities which would affect the denominator in calculating basic and dilutive earnings per share. There were a total of 96,500 stock options, with an average exercise price of $43.61, outstanding on March 31, 2017. These options were included, on a weighted average basis, in the computation of diluted earnings per share for the period due to the average market price of common shares of $46.94 being in excess of the exercise price of the options. There were a total of 32,500 stock options outstanding for the same period end in 2016 that had an average exercise price of $42.03 and were excluded from the computation of diluted earnings per share because the average market price of common shares was $39.02 for the period. Net income as presented on the consolidated statement of income will be used as the numerator.  The following table sets forth the composition of the weighted average common shares (denominator) used in the basic and dilutive earnings per share computation.
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Weighted average common shares outstanding - basic
 
4,734,805

 
4,740,503

Dilutive effect of outstanding stock options
 
26,500

 

Weighted average common shares outstanding - diluted
 
4,761,305

 
4,740,503

 
















12


Note 5. Investment Securities
 
The amortized cost, gross unrealized gains and losses, and fair values of investment securities available for sale at March 31, 2017 and December 31, 2016 are as follows:
 
 
March 31, 2017
 
 
 
 
Gross
 
Gross
 
 
 
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
(In Thousands)
 
Cost
 
Gains
 
Losses
 
Value
Available for sale (AFS):
 
 

 
 

 
 

 
 

Mortgage-backed securities
 
$
5,057

 
$
128

 
$
(113
)
 
$
5,072

Asset-backed securities
 
56

 

 

 
56

State and political securities
 
64,809

 
758

 
(237
)
 
65,330

Other debt securities
 
56,883

 
120

 
(1,700
)
 
55,303

Total debt securities
 
126,805

 
1,006

 
(2,050
)
 
125,761

Financial institution equity securities
 
9,231

 
667

 

 
9,898

Non-financial institution equity securities
 
1,300

 

 
(49
)
 
1,251

Total equity securities
 
10,531

 
667

 
(49
)
 
11,149

Total investment securities AFS
 
$
137,336

 
$
1,673

 
$
(2,099
)
 
$
136,910


 
 
December 31, 2016
 
 
 
 
Gross
 
Gross
 
 
 
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
(In Thousands)
 
Cost
 
Gains
 
Losses
 
Value
Available for sale (AFS):
 
 

 
 

 
 

 
 

Mortgage-backed securities
 
$
9,295

 
$
182

 
$
(164
)
 
$
9,313

Asset-backed securities
 
109

 

 

 
109

State and political securities
 
60,777

 
666

 
(509
)
 
60,934

Other debt securities
 
53,046

 
137

 
(2,065
)
 
51,118

Total debt securities
 
123,227

 
985

 
(2,738
)
 
121,474

Financial institution equity securities
 
9,566

 
969

 

 
10,535

Non-financial institution equity securities
 
1,667

 

 
(184
)
 
1,483

Total equity securities
 
11,233

 
969

 
(184
)
 
12,018

Total investment securities AFS
 
$
134,460

 
$
1,954

 
$
(2,922
)
 
$
133,492

 
The amortized cost and fair values of trading investment securities at March 31, 2017 and December 31, 2016 are as follows.

 
 
March 31, 2017
 
 
 
 
Gross
 
Gross
 
 
 
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
(In Thousands)
 
Cost
 
Gains
 
Losses
 
Value
Trading:
 
 
 
 
 
 
 
 
Non-financial institution equity securities
 
$

 
$

 
$

 
$

Total trading securities
 
$

 
$

 
$

 
$



13


 
 
December 31, 2016
 
 
 
 
Gross
 
Gross
 
 
 
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
(In Thousands)
 
Cost
 
Gains
 
Losses
 
Value
Trading:
 
 
 
 
 
 
 
 
Non-financial institution equity securities
 
$
56

 
$
2

 
$

 
$
58

Total trading securities
 
$
56

 
$
2

 
$

 
$
58



Total net realized trading gains of $2,000 for the three month period ended March 31, 2017 compared to the net realized trading gain of $40,000 for the three month period ended March 31, 2016 were included in the Consolidated Statement of Income.

The following tables show the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time, that the individual securities have been in a continuous unrealized loss position, at March 31, 2017 and December 31, 2016.

 
 
March 31, 2017
 
 
Less than Twelve Months
 
Twelve Months or Greater
 
Total
 
 
 
 
Gross
 
 
 
Gross
 
 
 
Gross
 
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
(In Thousands)
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
Available for sale (AFS):
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
$
3,480

 
$
(113
)
 
$

 
$

 
$
3,480

 
$
(113
)
Asset-backed securities
 

 

 

 

 

 

State and political securities
 
18,292

 
(237
)
 

 

 
18,292

 
(237
)
Other debt securities
 
29,664

 
(983
)
 
13,391

 
(717
)
 
43,055

 
(1,700
)
Total debt securities
 
51,436

 
(1,333
)
 
13,391

 
(717
)
 
64,827

 
(2,050
)
Financial institution equity securities
 

 

 

 

 

 

Non-financial institution equity securities
 
1,251

 
(49
)
 

 

 
1,251

 
(49
)
Total equity securities
 
1,251

 
(49
)
 

 

 
1,251

 
(49
)
Total investment securities AFS
 
$
52,687

 
$
(1,382
)
 
$
13,391

 
$
(717
)
 
$
66,078

 
$
(2,099
)

 
 
December 31, 2016
 
 
Less than Twelve Months
 
Twelve Months or Greater
 
Total
 
 
 
 
Gross
 
 
 
Gross
 
 
 
Gross
 
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
(In Thousands)
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
Available for sale (AFS):
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
$
3,572

 
$
(106
)
 
$
3,627

 
$
(58
)
 
$
7,199

 
$
(164
)
Asset-backed securities
 

 

 

 

 

 

State and political securities
 
26,113

 
(509
)
 

 

 
26,113

 
(509
)
Other debt securities
 
28,140

 
(1,179
)
 
12,240

 
(886
)
 
40,380

 
(2,065
)
Total debt securities
 
57,825

 
(1,794
)
 
15,867

 
(944
)
 
73,692

 
(2,738
)
Financial institution equity securities
 

 

 

 

 

 

Non-financial institution equity securities
 
727

 
(140
)
 
756

 
(44
)
 
1,483

 
(184
)
Total equity securities
 
727

 
(140
)
 
756

 
(44
)
 
1,483

 
(184
)
Total investment securities AFS
 
$
58,552

 
$
(1,934
)
 
$
16,623

 
$
(988
)
 
$
75,175

 
$
(2,922
)
 

14


At March 31, 2017 there were a total of 55 securities in a continuous unrealized loss position for less than twelve months and 8 individual securities that were in a continuous unrealized loss position for twelve months or greater.

The Company reviews its position quarterly and has determined that, at March 31, 2017, the declines outlined in the above table represent temporary declines and the Company does not intend to sell and does not believe it will be required to sell these securities before recovery of their cost basis, which may be at maturity.  The Company has concluded that the unrealized losses disclosed above are not other than temporary but are the result of interest rate changes, sector credit ratings changes, or company-specific ratings changes that are not expected to result in the non-collection of principal and interest during the period.

The amortized cost and fair value of debt securities at March 31, 2017, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities since borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

(In Thousands)
 
Amortized Cost
 
Fair Value
Due in one year or less
 
$
661

 
$
661

Due after one year to five years
 
40,528

 
40,234

Due after five years to ten years
 
68,969

 
68,020

Due after ten years
 
16,647

 
16,846

Total
 
$
126,805

 
$
125,761


Total gross proceeds from sales of securities available for sale were $2,652,000 and $19,839,000 for the three months ended March 31, 2017 and 2016, respectively. 

The following table represents gross realized gains and losses within the available for sale portfolio:
 
 
 
Three Months Ended March 31,
(In Thousands)
 
2017
 
2016
Gross realized gains:
 
 

 
 

Mortgage-backed securities
 
$
45

 
$

State and political securities
 
14

 
299

Other debt securities
 

 
32

Financial institution equity securities
 
288

 
82

  Non-financial institution equity securities
 

 
144

Total gross realized gains
 
$
347

 
$
557

 
 
 
 
 
Gross realized losses:
 
 

 
 

Mortgage-backed securities
 
$

 
$

Asset-backed securities
 

 

State and political securities
 

 

Other debt securities
 

 
81

Financial institution equity securities
 

 

  Non-financial institution equity securities
 
150

 
41

Total gross realized losses
 
$
150

 
$
122











15


The following table represents gross realized gains and losses within the trading portfolios:

 
 
Three Months Ended March 31,
(In Thousands)
 
2017
 
2016
Gross realized gains:
 
 

 
 

Financial institution equity securities
 
$

 
$
6

  Non-financial institution equity securities
 
2

 
59

Total gross realized gains
 
$
2

 
$
65

 
 
 
 
 
Gross realized losses:
 
 

 
 

Financial institution equity securities
 
$

 
$
13

  Non-financial institution equity securities
 

 
12

Total gross realized losses
 
$

 
$
25


There were no impairment charges included in gross realized losses for the three months ended March 31, 2017 and 2016, respectively.

Investment securities with a carrying value of approximately $91,100,000 and $95,199,000 at March 31, 2017 and December 31, 2016, respectively, were pledged to secure certain deposits, repurchase agreements, and for other purposes as required by law.


Note 6. Loans

Management segments the Banks' loan portfolio to a level that enables risk and performance monitoring according to similar risk characteristics.  Loans are segmented based on the underlying collateral characteristics.  Categories include commercial, financial, and agricultural, real estate, and installment loans to individuals.  Real estate loans are further segmented into three categories: residential, commercial, and construction.

The following table presents the related aging categories of loans, by segment, as of March 31, 2017 and December 31, 2016:
 
 
 
March 31, 2017
 
 
 
 
Past Due
 
Past Due 90
 
 
 
 
 
 
 
 
30 To 89
 
Days Or More
 
Non-
 
 
(In Thousands)
 
Current
 
Days
 
& Still Accruing
 
Accrual
 
Total
Commercial, financial, and agricultural
 
$
141,648

 
$
277

 
$
9

 
$
128

 
$
142,062

Real estate mortgage:
 
 

 
 

 
 

 
 

 
 

Residential
 
558,068

 
5,244

 

 
1,899

 
565,211

Commercial
 
302,700

 
671

 
132

 
8,682

 
312,185

Construction
 
37,289

 
101

 

 

 
37,390

Installment loans to individuals
 
54,950

 
605

 

 
21

 
55,576

 
 
1,094,655

 
$
6,898

 
$
141

 
$
10,730

 
1,112,424

Net deferred loan fees and discounts
 
(1,324
)
 
 

 
 

 
 

 
(1,324
)
Allowance for loan losses
 
(12,905
)
 
 

 
 

 
 

 
(12,905
)
Loans, net
 
$
1,080,426

 
 

 
 

 
 

 
$
1,098,195



16


 
 
December 31, 2016
 
 
 
 
Past Due
 
Past Due 90
 
 
 
 
 
 
 
 
30 To 89
 
Days Or More
 
Non-
 
 
(In Thousands)
 
Current
 
Days
 
& Still Accruing
 
Accrual
 
Total
Commercial, financial, and agricultural
 
$
145,179

 
$
785

 
$
14

 
$
132

 
$
146,110

Real estate mortgage:
 
 

 
 

 
 

 
 

 
 

Residential
 
553,053

 
9,112

 
587

 
1,988

 
564,740

Commercial
 
296,537

 
786

 
268

 
8,591

 
306,182

Construction
 
33,879

 
771

 

 

 
34,650

Installment loans to individuals
 
43,008

 
202

 
1

 
45

 
43,256

 
 
1,071,656

 
$
11,656

 
$
870

 
$
10,756

 
1,094,938

Net deferred loan fees and discounts
 
(1,257
)
 
 

 
 

 
 

 
(1,257
)
Allowance for loan losses
 
(12,896
)
 
 

 
 

 
 

 
(12,896
)
Loans, net
 
$
1,057,503

 
 

 
 

 
 

 
$
1,080,785

 
Purchased loans acquired are recorded at fair value on their purchase date without a carryover of the related allowance for loan losses.

Upon the acquisition of Luzerne Bank on June 1, 2013, the Company evaluated whether each acquired loan (regardless of size) was within the scope of ASC 310-30, Receivables-Loans and Debt Securities Acquired with Deteriorated Credit Quality.  Purchased credit-impaired loans are loans that have evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. There were no material increases or decreases in the expected cash flows of these loans between June 1, 2013 (the “acquisition date”) and March 31, 2017.  The fair value of purchased credit-impaired loans, on the acquisition date, was determined, primarily based on the fair value of loan collateral. 

On the acquisition date, the preliminary estimate of the unpaid principal balance for all loans evidencing credit impairment acquired in the Luzerne Bank acquisition was $1,211,000 and the estimated fair value of the loans was $878,000. Total contractually required payments on these loans, including interest, at the acquisition date was $1,783,000. However, the Company’s preliminary estimate of expected cash flows was $941,000. At such date, the Company established a credit risk related non-accretable discount (a discount representing amounts which are not expected to be collected from either the customer or liquidation of collateral) of $842,000 relating to these impaired loans, reflected in the recorded net fair value. Such amount is reflected as a non-accretable fair value adjustment to loans. The Company further estimated the timing and amount of expected cash flows in excess of the estimated fair value and established an accretable discount of $63,000 on the acquisition date relating to these impaired loans.

The following table presents interest income the Banks would have recorded if interest had been recorded based on the original loan agreement terms and rate of interest for non-accrual loans and interest income recognized on a cash basis for non-accrual loans for the three months ended March 31, 2017 and 2016:
 
 
Three Months Ended March 31,
 
 
2017
 
2016
(In Thousands)
 
Interest Income That
Would Have Been
Recorded Based on
Original Term and Rate
 
Interest
Income
Recorded on
a Cash Basis
 
Interest Income That
Would Have Been
Recorded Based on
Original Term and Rate
 
Interest
Income
Recorded on
a Cash Basis
Commercial, financial, and agricultural
 
$
6

 
$

 
$
4

 
$
1

Real estate mortgage:
 
 

 
 

 
 

 
 

Residential
 
151

 
101

 
32

 
14

Commercial
 
496

 
105

 
169

 
64

Construction
 

 

 
6

 

 
 
$
653

 
$
206

 
$
211

 
$
79

 




17


Impaired Loans

Impaired loans are loans for which it is probable the Banks will not be able to collect all amounts due according to the contractual terms of the loan agreement.  The Banks evaluate such loans for impairment individually and does not aggregate loans by major risk classifications.  The definition of “impaired loans” is not the same as the definition of “non-accrual loans,” although the two categories overlap.  The Banks may choose to place a loan on non-accrual status due to payment delinquency or uncertain collectability, while not classifying the loan as impaired. Factors considered by management in determining impairment include payment status and collateral value.  The amount of impairment for these types of loans is determined by the difference between the present value of the expected cash flows related to the loan, using the original interest rate, and its recorded value, or as a practical expedient in the case of collateralized loans, the difference between the fair value of the collateral and the recorded amount of the loan.  When foreclosure is probable, impairment is measured based on the fair value of the collateral.

Management evaluates individual loans in all of the commercial segments for possible impairment if the loan is greater than $100,000 and if the loan is either on non-accrual status or has a risk rating of substandard.  Management may also elect to measure an individual loan for impairment if less than $100,000 on a case-by-case basis.

Mortgage loans on one-to-four family properties and all consumer loans are large groups of smaller-balance homogeneous loans and are measured for impairment collectively. Loans that experience insignificant payment delays, which are defined as 90 days or less, generally are not classified as impaired.  Management determines the significance of payment delays on a case-by-case basis taking into consideration all circumstances surrounding the loan and the borrower including the length of the delay, the borrower’s prior payment record, and the amount of shortfall in relation to the principal and interest owed.  Interest income for impaired loans is recorded consistent with the Banks' policy on non-accrual loans.

The following table presents the recorded investment, unpaid principal balance, and related allowance of impaired loans by segment as of March 31, 2017 and December 31, 2016:
 
 
March 31, 2017
 
 
Recorded
 
Unpaid Principal
 
Related
(In Thousands)
 
Investment
 
Balance
 
Allowance
With no related allowance recorded:
 
 

 
 

 
 

Commercial, financial, and agricultural
 
$
55

 
$
55

 
$

Real estate mortgage:
 
 

 
 

 
 

Residential
 
1,563

 
1,563

 

Commercial
 
1,564

 
1,564

 

Installment loans to individuals
 

 

 

 
 
3,182

 
3,182

 

With an allowance recorded:
 
 

 
 

 
 

Commercial, financial, and agricultural
 
129

 
129

 
74

Real estate mortgage:
 
 

 
 

 
 

Residential
 
1,674

 
1,674

 
567

Commercial
 
10,571

 
10,666

 
1,723

Installment loans to individuals
 
4

 
4

 
4

 
 
12,378

 
12,473

 
2,368

Total:
 
 

 
 

 
 

Commercial, financial, and agricultural
 
184

 
184

 
74

Real estate mortgage:
 
 

 
 

 
 

Residential
 
3,237

 
3,237

 
567

Commercial
 
12,135

 
12,230

 
1,723

Installment loans to individuals
 
4

 
4

 
4

 
 
$
15,560

 
$
15,655

 
$
2,368



18


 
 
December 31, 2016
 
 
Recorded
 
Unpaid Principal
 
Related
(In Thousands)
 
Investment
 
Balance
 
Allowance
With no related allowance recorded:
 
 

 
 

 
 

Commercial, financial, and agricultural
 
$
109

 
$
109

 
$

Real estate mortgage:
 
 

 
 

 
 

Residential
 
1,584

 
1,584

 

Commercial
 
1,833

 
1,833

 

Installment loans to individuals
 

 

 

 
 
3,526

 
3,526

 

With an allowance recorded:
 
 

 
 

 
 

Commercial, financial, and agricultural
 
132

 
132

 
74

Real estate mortgage:
 
 

 
 

 
 

Residential
 
1,893

 
1,893

 
437

Commercial
 
10,425

 
10,520

 
1,668

Installment loans to individuals
 

 

 

 
 
12,450

 
12,545

 
2,179

Total:
 
 

 
 

 
 

Commercial, financial, and agricultural
 
241

 
241

 
74

Real estate mortgage:
 
 

 
 

 
 

Residential
 
3,477

 
3,477

 
437

Commercial
 
12,258

 
12,353

 
1,668

Installment loans to individuals
 

 

 

 
 
$
15,976

 
$
16,071

 
$
2,179

The following table presents the average recorded investment in impaired loans and related interest income recognized for the three months ended for March 31, 2017 and 2016:
 
 
Three Months Ended March 31,
 
 
2017
 
2016
(In Thousands)
 
Average
Investment in
Impaired Loans
 
Interest Income
Recognized on an
Accrual Basis on
Impaired Loans
 
Interest Income
Recognized on a
Cash Basis on
Impaired Loans
 
Average
Investment in
Impaired Loans
 
Interest Income
Recognized on an
Accrual Basis on
Impaired Loans
 
Interest Income
Recognized on a
Cash Basis on
Impaired Loans
Commercial, financial, and agricultural
 
$
212

 
$
4

 
$

 
$
533

 
$
4

 
$
1

Real estate mortgage:
 
 

 
 

 
 

 
 

 
 

 
 

Residential
 
3,258

 
22

 
16

 
2,899

 
22

 
14

Commercial
 
11,946

 
33

 
10

 
12,829

 
82

 
63

Construction
 

 

 

 
245

 

 
1

Installment loans to individuals
 
2

 

 

 

 

 

 
 
$
15,418

 
$
59

 
$
26

 
$
16,506

 
$
108

 
$
79

 

Currently, there is $26,000 committed to be advanced in connection with impaired loans.

Troubled Debt Restructurings

The loan portfolio also includes certain loans that have been modified in a Troubled Debt Restructuring (“TDR”), where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties.  These concessions typically result from loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions.  Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.


19


There were no loan modifications that were considered TDRs completed during the three months ended March 31 for both 2017 and 2016.
 
 

There were no loan modifications considered to be TDRs made during the twelve months previous to March 31, 2017 that defaulted during the three months ended March 31, 2017.  There were five loan modifications considered TDRs made during the twelve months previous to March 31, 2016 that defaulted during the three months ended March 31, 2016. The defaulted loan types and recorded investments at March 31, 2016 are as follows: one commercial loan with a recorded investment of $103,000, one commercial real estate loan with a recorded investment of $239,000, and three residential real estate loan with a recorded investment of $173,000.

Troubled debt restructurings amounted to $8,998,000 and $9,180,000 as of March 31, 2017 and December 31, 2016.

The amount of foreclosed residential real estate held at March 31, 2017 and December 31, 2016, totaled $547,000 and 839,000, respectively. Consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process at March 31, 2017 and December 31, 2016, totaled $78,000 and 167,000, respectively.


Internal Risk Ratings

Management uses a ten point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first six categories are considered not criticized, and are aggregated as “Pass” rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The special mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a substandard classification. Loans in the substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are evaluated for substandard classification.  Loans in the doubtful category exhibit the same weaknesses found in the substandard loans, however, the weaknesses are more pronounced.  Such loans are static and collection in full is improbable.  However, these loans are not yet rated as loss because certain events may occur which would salvage the debt.  Loans classified loss are considered uncollectible and charge-off is imminent.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Banks have a structured loan rating process with several layers of internal and external oversight.  Generally, consumer and residential mortgage loans are included in the pass category unless a specific action, such as bankruptcy, repossession, or death occurs to raise awareness of a possible credit event.  An external annual loan review of large commercial relationships is performed, as well as a sample of smaller transactions. Confirmation of the appropriate risk category is included in the review. Detailed reviews, including plans for resolution, are performed on loans classified as substandard, doubtful, or loss on a quarterly basis.

The following table presents the credit quality categories identified above as of March 31, 2017 and December 31, 2016:
 
 
March 31, 2017
 
 
Commercial, Financial, and Agricultural
 
Real Estate Mortgages
 
Installment Loans to Individuals
 
 
(In Thousands)
 
 
Residential
 
Commercial
 
Construction
 
 
Totals
Pass
 
$
136,886

 
$
561,995

 
$
283,564

 
$
37,236

 
$
55,576

 
$
1,075,257

Special Mention
 
2,852

 
850

 
9,907

 

 

 
13,609

Substandard
 
2,324

 
2,366

 
18,714

 
154

 

 
23,558

 
 
$
142,062

 
$
565,211

 
$
312,185

 
$
37,390

 
$
55,576

 
$
1,112,424


 
 
December 31, 2016
 
 
Commercial, Financial, and Agricultural
 
Real Estate Mortgages
 
Installment Loans to Individuals
 
 
(In Thousands)
 
 
Residential
 
Commercial
 
Construction
 
 
Totals
Pass
 
$
140,497

 
$
561,440

 
$
277,916

 
$
34,493

 
$
43,256

 
$
1,057,602

Special Mention
 
2,943

 
740

 
11,143

 

 

 
14,826

Substandard
 
2,670

 
2,560

 
17,123

 
157

 

 
22,510

 
 
$
146,110

 
$
564,740

 
$
306,182

 
$
34,650

 
$
43,256

 
$
1,094,938




20


Allowance for Loan Losses

An allowance for loan losses (“ALL”) is maintained to absorb losses from the loan portfolio.  The ALL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated future loss experience, and the amount of non-performing loans.

The Banks' methodology for determining the ALL is based on the requirements of ASC Section 310-10-35 for loans individually evaluated for impairment (previously discussed) and ASC Subtopic 450-20 for loans collectively evaluated for impairment, as well as the Interagency Policy Statements on the Allowance for Loan and Lease Losses and other bank regulatory guidance.  The total of the two components represents the Banks' ALL.

Loans that are collectively evaluated for impairment are analyzed with general allowances being made as appropriate.  Allowances are segmented based on collateral characteristics previously disclosed, and consistent with credit quality monitoring.  Loans that are collectively evaluated for impairment are grouped into two classes for evaluation.  A general allowance is determined for “Pass” rated credits, while a separate pool allowance is provided for “Criticized” rated credits that are not individually evaluated for impairment.

For the general allowances, historical loss trends are used in the estimation of losses in the current portfolio.  These historical loss amounts are modified by other qualitative factors.  A historical charge-off factor is calculated utilizing a twelve quarter moving average.  However, management may adjust the moving average time frame by up to four quarters to adjust for variances in the economic cycle. Management has identified a number of additional qualitative factors which it uses to supplement the historical charge-off factor because these factors are likely to cause estimated credit losses associated with the existing loan pools to differ from historical loss experience.  The additional factors that are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources are: national and local economic trends and conditions; levels of and trends in delinquency rates and non-accrual loans; trends in volumes and terms of loans; effects of changes in lending policies; experience, ability, and depth of lending staff; value of underlying collateral; and concentrations of credit from a loan type, industry and/or geographic standpoint.

Loans in the criticized pools, which possess certain qualities or characteristics that may lead to collection and loss issues, are closely monitored by management and subject to additional qualitative factors.  Management also monitors industry loss factors by loan segment for applicable adjustments to actual loss experience.

Management reviews the loan portfolio on a quarterly basis in order to make appropriate and timely adjustments to the ALL.  When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL.

Activity in the allowance is presented for the three months ended March 31, 2017 and 2016:
 
 
Three Months Ended March 31, 2017
 
 
Commercial, Financial, and Agricultural
 
Real Estate Mortgages
 
Installment Loans to Individuals
 
 
 
 
(In Thousands)
 
 
Residential
 
Commercial
 
Construction
 
 
Unallocated
 
Totals
Beginning Balance
 
$
1,554

 
$
5,383

 
$
4,975

 
$
178

 
$
416

 
$
390

 
$
12,896

Charge-offs
 
(213
)
 
(98
)
 

 

 
(77
)
 

 
(388
)
Recoveries
 
6

 
30

 

 
3

 
28

 

 
67

Provision
 
94

 
256

 
(509
)
 
6

 
181

 
302

 
330

Ending Balance
 
$
1,441

 
$
5,571

 
$
4,466

 
$
187

 
$
548

 
$
692

 
$
12,905

 
 
 
Three Months Ended March 31, 2016
 
 
Commercial, Financial, and Agricultural
 
Real Estate Mortgages
 
Installment Loans to Individuals
 
 
 
 
(In Thousands)
 
 
Residential
 
Commercial
 
Construction
 
 
Unallocated
 
Totals
Beginning Balance
 
$
1,532

 
$
5,116

 
$
4,217

 
$
160

 
$
243

 
$
776

 
$
12,044

Charge-offs
 

 

 

 

 
(51
)
 

 
(51
)
Recoveries
 

 
3

 
5

 
3

 
28

 

 
39

Provision
 
(278
)
 
4

 
250

 
(16
)
 
44

 
346

 
350

Ending Balance
 
$
1,254

 
$
5,123

 
$
4,472

 
$
147

 
$
264

 
$
1,122

 
$
12,382

 


21


The shifts in allocation of the loan provision is due to an increase in residential originations along with a tapering of commercial originations.
 
 
The Company grants commercial, industrial, residential, and installment loans to customers primarily throughout north-east and central Pennsylvania. Although the Company has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent on the economic conditions within this region.

The Company has a concentration of the following to gross loans at March 31, 2017 and 2016:
 
 
 
March 31,
 
 
2017
 
2016
Owners of residential rental properties
 
16.29
%
 
16.27
%
Owners of commercial rental properties
 
14.66
%
 
14.27
%
 
The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based on impairment method as of March 31, 2017 and December 31, 2016:

 
 
March 31, 2017
 
 
Commercial, Financial, and Agricultural
 
Real Estate Mortgages
 
Installment Loans to Individuals
 
Unallocated
 
 
(In Thousands)
 
 
Residential
 
Commercial
 
Construction
 
 
 
Totals
Allowance for Loan Losses:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Ending allowance balance attributable to loans:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
 
$
74

 
$
567

 
$
1,723

 
$

 
$
4

 
$

 
$
2,368

Collectively evaluated for impairment
 
1,367

 
5,004

 
2,743

 
187

 
544

 
692

 
10,537

Total ending allowance balance
 
$
1,441

 
$
5,571

 
$
4,466

 
$
187

 
$
548

 
$
692

 
$
12,905

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
 
$
184

 
$
3,237

 
$
12,135

 
$

 
$
4

 


 
$
15,560

Collectively evaluated for impairment
 
141,878

 
561,974

 
300,050

 
37,390

 
55,572

 


 
1,096,864

Total ending loans balance
 
$
142,062

 
$
565,211

 
$
312,185

 
$
37,390

 
$
55,576

 


 
$
1,112,424


 
 
December 31, 2016
 
 
Commercial, Financial, and Agricultural
 
Real Estate Mortgages
 
Installment Loans to Individuals
 
Unallocated
 
 
(In Thousands)
 
 
Residential
 
Commercial
 
Construction
 
 
 
Totals
Allowance for Loan Losses:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Ending allowance balance attributable to loans:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
 
$
74

 
$
437

 
$
1,668

 
$

 
$

 
$

 
$
2,179

Collectively evaluated for impairment
 
1,480

 
4,946

 
3,307

 
178

 
416

 
390

 
10,717

Total ending allowance balance
 
$
1,554

 
$
5,383

 
$
4,975

 
$
178

 
$
416

 
$
390

 
$
12,896

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
 
$
241

 
$
3,477

 
$
12,258

 
$

 
$

 
 

 
$
15,976

Collectively evaluated for impairment
 
145,869

 
561,263

 
293,924

 
34,650

 
43,256

 
 

 
1,078,962

Total ending loans balance
 
$
146,110

 
$
564,740

 
$
306,182

 
$
34,650

 
$
43,256

 
 

 
$
1,094,938





22


Note 7.  Net Periodic Benefit Cost-Defined Benefit Plans

For a detailed disclosure on the Company’s pension and employee benefits plans, please refer to Note 13 of the Company’s Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2016.

The following sets forth the components of the net periodic benefit/cost of the domestic non-contributory defined benefit plan for the three months ended March 31, 2017 and 2016, respectively:
 
 
 
Three Months Ended March 31,
(In Thousands)
 
2017
 
2016
Service cost
 
$
41

 
$
17

Interest cost
 
189

 
193

Expected return on plan assets
 
(262
)
 
(251
)
Amortization of net loss
 
39

 
39

Net periodic benefit cost
 
$
7

 
$
(2
)

Employer Contributions

The Company previously disclosed in its consolidated financial statements, included in the Annual Report on Form 10-K for the year ended December 31, 2016, that it expected to contribute a minimum of $500,000 to its defined benefit plan in 2017.  As of March 31, 2017, there were contributions of $250,000 made to the plan with additional contributions of at least $250,000 anticipated during the remainder of 2017.
 
Note 8.  Employee Stock Purchase Plan

The Company maintains an Employee Stock Purchase Plan (“Plan”).  The Plan is intended to encourage employee participation in the ownership and economic progress of the Company.  The Plan allows for up to 1,000,000 shares to be purchased by employees.  The purchase price of the shares is 95% of market value with an employee eligible to purchase up to the lesser of 15% of base compensation or $12,000 in market value annually.  During the three months ended March 31, 2017 and 2016, there were 460 and 550 shares issued under the plan, respectively.


Note 9.  Off Balance Sheet Risk

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments are primarily comprised of commitments to extend credit, standby letters of credit, and credit exposure from the sale of assets with recourse.  These instruments involve, to varying degrees, elements of credit, interest rate, or liquidity risk in excess of the amount recognized in the Consolidated Balance Sheet.  The contract amounts of these instruments express the extent of involvement the Company has in particular classes of financial instruments.

The Company’s exposure to credit loss from nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments.  The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.  The Company may require collateral or other security to support financial instruments with off-balance sheet credit risk.

Financial instruments whose contract amounts represent credit risk are as follows at March 31, 2017 and December 31, 2016:

(In Thousands)
 
March 31, 2017
 
December 31, 2016
Commitments to extend credit
 
$
270,275

 
$
263,487

Standby letters of credit
 
7,311

 
6,515

Credit exposure from the sale of assets with recourse
 
6,463

 
6,341

 
 
$
284,049

 
$
276,343

 
Commitments to extend credit are legally binding agreements to lend to customers.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees.  Since many of the commitments are expected to expire without

23


being drawn upon, the total commitment amounts do not necessarily represent future liquidity requirements.  The Company evaluates each customer’s credit worthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by the Company, on an extension of credit is based on management’s credit assessment of the counterparty.

Standby letters of credit represent conditional commitments issued by the Company to guarantee the performance of a customer to a third party.  These instruments are issued primarily to support bid or performance related contracts.  The coverage period for these instruments is typically a one year period with an annual renewal option subject to prior approval by management.  Fees earned from the issuance of these letters are recognized upon expiration of the coverage period.  For secured letters of credit, the collateral is typically Bank deposit instruments or customer business assets.

Note 10.  Fair Value Measurements

The following disclosures show the hierarchal disclosure framework associated with the level of pricing observations utilized in measuring assets and liabilities at fair value.
Level I:
 
Quoted prices are available in active markets for identical assets or liabilities as of the reported date.
 
 
 
Level II:
 
Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but traded less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed.
 
 
 
Level III:
 
Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

This hierarchy requires the use of observable market data when available.

The following table presents the assets reported on the Consolidated Balance Sheet at their fair value on a recurring basis as of March 31, 2017 and December 31, 2016, by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
 
 
March 31, 2017
(In Thousands)
 
Level I
 
Level II
 
Level III
 
Total
Assets measured on a recurring basis:
 
 

 
 

 
 

 
 

Investment securities, available for sale:
 
 

 
 

 
 

 
 

Mortgage-backed securities
 
$

 
$
5,072

 
$

 
$
5,072

Asset-backed securities
 

 
56

 

 
56

State and political securities
 

 
65,330

 

 
65,330

Other debt securities
 

 
55,303

 

 
55,303

Financial institution equity securities
 
9,898

 

 

 
9,898

   Non-financial institution equity securities
 
1,251

 

 

 
1,251


 
 
December 31, 2016
(In Thousands)
 
Level I
 
Level II
 
Level III
 
Total
Assets measured on a recurring basis:
 
 

 
 

 
 

 
 

Investment securities, available for sale:
 
 

 
 

 
 

 
 

Mortgage-backed securities
 
$

 
$
9,313

 
$

 
$
9,313

Asset-backed securities
 

 
109

 

 
109

State and political securities
 

 
60,934

 

 
60,934

Other debt securities
 

 
51,118

 

 
51,118

Financial institution equity securities
 
10,535

 

 

 
10,535

   Non-financial institution equity securities
 
1,483

 

 

 
1,483

 

24


The following table presents the assets reported on the Consolidated Balance Sheet at their fair value on a non-recurring basis as of March 31, 2017 and December 31, 2016, by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. 
 
 
March 31, 2017
(In Thousands)
 
Level I
 
Level II
 
Level III
 
Total
Assets measured on a non-recurring basis:
 
 

 
 

 
 

 
 

Impaired loans
 
$

 
$

 
$
13,192

 
$
13,192

Other real estate owned
 

 

 
547

 
547


 
 
December 31, 2016
(In Thousands)
 
Level I
 
Level II
 
Level III
 
Total
Assets measured on a non-recurring basis:
 
 

 
 

 
 

 
 

Impaired loans
 
$

 
$

 
$
13,797

 
$
13,797

Other real estate owned
 

 

 
839

 
839

 
The following tables present a listing of significant unobservable inputs used in the fair value measurement process for items valued utilizing level III techniques as of March 31, 2017 and December 31, 2016
 
 
March 31, 2017
 
 
Quantitative Information About Level III Fair Value Measurements
(In Thousands)
 
Fair Value
 
Valuation Technique(s)
 
Unobservable Inputs
 
Range
 
Weighted Average
Impaired loans
 
$
5,034

 
Discounted cash flow
 
Temporary reduction in payment amount
 
0 to (70)%
 
(21)%
 
 
8,158

 
Appraisal of collateral
 
Appraisal adjustments (1)
 
0 to (20)%
 
(14)%
Other real estate owned
 
$
547

 
Appraisal of collateral (1)
 
 
 
 
 
 
(1) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.
 
 
December 31, 2016
 
 
Quantitative Information About Level III Fair Value Measurements
(In Thousands)
 
Fair Value
 
Valuation Technique(s)
 
Unobservable Inputs
 
Range
 
Weighted Average
Impaired loans
 
$
5,304

 
Discounted cash flow
 
Temporary reduction in payment amount
 
0 to (70)%
 
20%
 
 
8,493

 
Appraisal of collateral
 
Appraisal adjustments (1)
 
0 to (20)%
 
15%
Other real estate owned
 
$
839

 
Appraisal of collateral (1)
 
 
 
 
 
 
(1) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.

The discounted cash flow valuation technique is utilized to determine the fair value of performing impaired loans, while non-performing impaired loans utilize the appraisal of collateral method.

The significant unobservable inputs used in the fair value measurement of the Company’s impaired loans using the discounted cash flow valuation technique include temporary changes in payment amounts and the probability of default.  Significant increases (decreases) in payment amounts would result in significantly higher (lower) fair value measurements.  The probability of default is 0% for impaired loans using the discounted cash flow valuation technique because all defaulted impaired loans are valued using the appraisal of collateral valuation technique.

The significant unobservable input used in the fair value measurement of the Company’s impaired loans using the appraisal of collateral valuation technique include appraisal adjustments, which are adjustments to appraisals by management for qualitative factors such as economic conditions and estimated liquidation expenses.  The significant unobservable input used in the fair value measurement of the Company’s other real estate owned are the same inputs used to value impaired loans using the appraisal of collateral valuation technique.
 


25


Note 11. Fair Value of Financial Instruments

The Company is required to disclose fair values for its financial instruments.  Fair values are made at a specific point in time, based on relevant market information and information about the financial instrument.  These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument.  Also, it is the Company’s general practice and intention to hold most of its financial instruments to maturity and not to engage in trading or sales activities.  Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors.  These fair values are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision.  Changes in assumptions can significantly affect the fair values.

Fair values have been determined by the Company using historical data and an estimation methodology suitable for each category of financial instruments.  The Company’s fair values, methods, and assumptions are set forth below for the Company’s other financial instruments.

As certain assets and liabilities, such as deferred tax assets, premises and equipment, and many other operational elements of the Company, are not considered financial instruments but have value, this fair value of financial instruments would not represent the full market value of the Company.

The fair values of the Company’s financial instruments are as follows at March 31, 2017 and December 31, 2016:
 
 
Carrying
 
Fair
 
Fair Value Measurements at March 31, 2017
(In Thousands)
 
Value
 
Value
 
Level I
 
Level II
 
Level III
Financial assets:
 
 

 
 

 
 

 
 

 
 

Cash and cash equivalents
 
$
75,660

 
$
75,660

 
$
75,660

 
$

 
$

Investment securities:
 
 

 
 

 
 

 
 

 
 

Available for sale
 
136,910

 
136,910

 
11,149

 
125,761

 

Trading
 

 

 

 

 

Loans held for sale
 
1,221

 
1,221

 
1,221

 

 

Loans, net
 
1,098,195

 
1,119,546

 

 

 
1,119,546

Bank-owned life insurance
 
27,521

 
27,521

 
27,521

 

 

Accrued interest receivable
 
3,945

 
3,945

 
3,945

 

 

 
 
 
 
 
 
 
 
 
 
 
Financial liabilities:
 
 

 
 

 
 

 
 

 
 

Interest-bearing deposits
 
$
848,272

 
$
845,173

 
$
641,024

 
$

 
$
204,149

Noninterest-bearing deposits
 
312,392

 
312,392

 
312,392

 

 

Short-term borrowings
 
8,589

 
8,589

 
8,589

 

 

Long-term borrowings
 
75,998

 
76,172

 

 

 
76,172

Accrued interest payable
 
387

 
387

 
387

 

 



26


 
 
Carrying
 
Fair
 
Fair Value Measurements at December 31, 2016
(In Thousands)
 
Value
 
Value
 
Level I
 
Level II
 
Level III
Financial assets:
 
 

 
 

 
 

 
 

 
 

Cash and cash equivalents
 
$
43,671

 
$
43,671

 
$
43,671

 
$

 
$

Investment securities:
 
 

 
 

 
 

 
 

 
 

Available for sale
 
133,492

 
133,492

 
12,018

 
121,474

 

Trading
 
58

 
58

 
58

 

 

Loans held for sale
 
1,953

 
1,953

 
1,953

 

 

Loans, net
 
1,080,785

 
1,088,122

 

 

 
1,088,122

Bank-owned life insurance
 
27,332

 
27,332

 
27,332

 

 

Accrued interest receivable
 
3,672

 
3,672

 
3,672

 

 

 
 
 
 
 
 
 
 
 
 
 
Financial liabilities:
 
 

 
 

 
 

 
 

 
 

Interest-bearing deposits
 
$
791,937

 
$
789,401

 
$
571,768

 
$

 
$
217,633

Noninterest-bearing deposits
 
303,277

 
303,277

 
303,277

 

 

Short-term borrowings
 
13,241

 
13,241

 
13,241

 

 

Long-term borrowings
 
85,998

 
86,353

 

 

 
86,353

Accrued interest payable
 
455

 
455

 
455

 

 

 
Cash and Cash Equivalents, Loans Held for Sale, Accrued Interest Receivable, Short-term Borrowings, and Accrued Interest Payable:
The fair value is equal to the carrying value.

Investment Securities:
The fair value of investment securities available for sale and trading is equal to the available quoted market price. If no quoted market price is available, fair value is estimated using the quoted market price for similar securities.  Regulatory stocks’ fair value is equal to the carrying value.

Loans:
Fair values are estimated for portfolios of loans with similar financial characteristics.  Loans are segregated by type such as commercial, financial, and agricultural, commercial real estate, residential real estate, construction real estate, and installment loans to individuals.  Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories.

The fair value of performing loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan.  The estimate of maturity is based on the Company’s historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions.

Fair value for significant nonperforming loans is based on recent external appraisals.  If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows.  Assumptions regarding credit risk, cash flows, and discounted rates are judgmentally determined using available market information and specific borrower information.

Bank-Owned Life Insurance:
The fair value is equal to the cash surrender value of the life insurance policies.

Deposits:
The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, NOW, and money market accounts, is equal to the amount payable on demand.  The fair value of certificates of deposit is based on the discounted value of contractual cash flows.

The fair value estimates above do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market, commonly referred to as the core deposit intangible.



27


Long Term Borrowings:
The fair value of long term borrowings is based on the discounted value of contractual cash flows.

Commitments to Extend Credit, Standby Letters of Credit, and Financial Guarantees Written:
There is no material difference between the notional amount and the estimated fair value of off-balance sheet items.  The contractual amounts of unfunded commitments and letters of credit are presented in Note 9 (Off Balance Sheet Risk).
 
Note 12.  Stock Options

In 2014, the Company adopted the 2014 Equity Incentive Plan designed to help the Company attract, retain, and motivate employees and non-employee directors. Incentive stock options, non-qualified stock options, and restricted stock may be granted as part of the plan.

On August 27, 2015, the Company issued 38,750 stock options with a strike price of $42.03 to employees that have a five year vesting period and expire ten years from the grant date. On March 24, 2017, the Company issued 70,000 stock options in total, to a group of employees, that have a strike price of $44.21. The options granted in 2017 all expire ten years from the grant date however, of the 70,000 grants awarded, 46,250 of the options have a three year vesting period while the remaining 23,750 options vest in five years.

Stock Options Granted
Date
 
Shares
 
Forfeited
 
Outstanding
 
Strike Price
 
Vesting Period
 
Expiration
March 24, 2017
 
46,250

 

 
46,250

 
$
44.21

 
3 years
 
10 years
March 24, 2017
 
23,750

 

 
23,750

 
44.21

 
5 years
 
10 years
August 27, 2015
 
38,750

 
(12,250
)
 
26,500

 
42.03

 
5 years
 
10 years

A summary of stock option activity is presented below:

 
 
March 31, 2017
 
March 31, 2016
 
 
Shares
 
Weighted Average Exercise Price
 
Shares
 
Weighted Average Exercise Price
Outstanding, beginning of year
 
26,500

 
$
42.03

 
34,750

 
$
42.03

Granted
 
70,000

 
44.21

 

 

Exercised
 

 

 

 

Forfeited
 

 

 
(2,250
)
 
42.03

Expired
 

 

 

 

Outstanding, end of year
 
96,500

 
$
43.61

 
32,500

 
$
42.03

 
 
 
 
 
 
 
 
 
Exercisable, end of year
 

 
$

 

 
$


The estimated fair value of options, including the effect of estimated forfeitures, is recognized as expense on a straightline basis
over the options’ vesting periods while ensuring that the cumulative amount of compensation cost recognized at least equals the
value of the vested portion of the award at that date. The Company determines the fair value of options granted using the Black-Scholes option-pricing model. The risk-free interest rate is based on the United States Treasury bond with a similar term to the expected life of the options at the grant date. Expected volatility was estimated based on the adjusted historic volatility of the Company’s shares. The expected life was estimated to equal the contractual life of the options. The dividend yield rate was based upon recent historical dividends paid on shares.


Note 13.  Reclassification of Comparative Amounts

Certain comparative amounts for the prior period have been reclassified to conform to current period presentations. Such reclassifications had no effect on net income or shareholders’ equity.
 

28


CAUTIONARY STATEMENT FOR PURPOSES OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

This Report contains certain “forward-looking statements” including statements concerning plans, objectives, future events or performance and assumptions and other statements which are other than statements of historical fact.  The Company cautions readers that the following important factors, among others, may have affected and could in the future affect the Company’s actual results and could cause the Company’s actual results for subsequent periods to differ materially from those expressed in any forward-looking statement made by or on behalf of the Company herein:  (i) the effect of changes in laws and regulations, including federal and state banking laws and regulations, with which the Company must comply, and the associated costs of compliance with such laws and regulations either currently or in the future as applicable; (ii) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as by the Financial Accounting Standards Board, or of changes in the Company’s organization, compensation and benefit plans; (iii) the effect on the Company’s competitive position within its market area of the  increasing consolidation within the banking and financial services industries, including the increased competition from larger regional and out-of-state banking organizations as well as non-bank providers of various financial services; (iv) the effect of changes in interest rates; (v) the effect of changes in the business cycle and downturns in the local, regional or national economies; and (vi) the Risk Factors identified in Item 1A of the Company's Annual Report on Form 10-K for the year ended December 31, 2016 and in other filings made by the Company under the Securities Exchange Act of 1934.

You should not put undue reliance on any forward-looking statements.  These statements speak only as of the date of this Quarterly Report on Form 10-Q, even if subsequently made available by the Company on its website or otherwise.  The Company undertakes no obligation to update or revise these statements to reflect events or circumstances occurring after the date of this Quarterly Report on Form 10-Q.

29


Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operation

EARNINGS SUMMARY

Comparison of the Three Months Ended March 31, 2017 and 2016

Summary Results

Net income for the three months ended March 31, 2017 was $2,686,000 compared to $3,078,000 for the same period of 2016 as after-tax securities gains decreased $183,000 (from a gain of $314,000 to a gain of $131,000). Basic and diluted earnings per share for the three months ended March 31, 2017 and 2016 were $0.54 and $0.58, respectively. Return on average assets and return on average equity were 0.79% and 7.69% for the three months ended March 31, 2017 compared to 0.94% and 8.95% for the corresponding period of 2016. Net income from core operations (“operating earnings”) decreased to $2,555,000 for the three months ended March 31, 2017 compared to $2,764,000 for the same period of 2015. Basic and diluted operating earnings per share for the three months ended March 31, 2017 were $0.57 and $0.56 compared to $0.65 basic and diluted for the corresponding period of 2016. The decline was attributable to several factors including the continued shift of earning assets from the investment portfolio to the loan portfolio as the balance sheet is actively managed to reduce market risk and interest rate risk in a rising rate environment. In addition, the effective tax rate has increased due to the conclusion of the ten year tax credit generation period of seveal low income elderly housing projects in our market footprint of which the company is a partner.

Management uses the non-GAAP measure of net income from core operations, or operating earnings, in its analysis of the Company’s performance.  This measure, as used by the Company, adjusts net income by excluding significant gains or losses that are unusual in nature.  Because certain of these items and their impact on the Company’s performance are difficult to predict, management believes the presentation of financial measures excluding the impact of such items provides useful supplemental information in evaluating the operating results of the Company’s core businesses.  For purposes of this Quarterly Report on Form 10-Q, net income from core operations, or operating earnings, means net income adjusted to exclude after-tax net securities gains or losses and bank-owned life insurance gains on death benefit.  These disclosures should not be viewed as a substitute for net income determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.

Reconciliation of GAAP and Non-GAAP Financial Measures
(Dollars in Thousands, Except Per Share Data)
 
Three Months Ended March 31,
 
 
2017
 
2016
GAAP net income
 
$
2,686

 
$
3,078

Less: net securities, net of tax
 
131

 
314

Non-GAAP operating earnings
 
$
2,555

 
$
2,764

 
 
Three Months Ended March 31,
 
 
2017
 
2016
Return on average assets (ROA)
 
0.79
%
 
0.94
%
Less: net securities, net of tax
 
0.04
%
 
0.10
%
Non-GAAP operating ROA
 
0.75
%
 
0.84
%
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Return on average equity (ROE)
 
7.69
%
 
8.95
%
Less: net securities, net of tax
 
0.37
%
 
0.91
%
Non-GAAP operating ROE
 
7.32
%
 
8.04
%

30


 
 
Three Months Ended March 31,
 
 
2017
 
2016
Basic earnings per share (EPS)
 
$
0.57

 
$
0.65

Less: net securities, net of tax
 
0.03

 
0.07

Non-GAAP basic operating EPS
 
$
0.54

 
$
0.58

 
 
Three Months Ended March 31,
 
 
2017
 
2016
Dilutive EPS
 
$
0.56

 
$
0.65

Less: net securities, net of tax
 
0.02

 
0.07

Non-GAAP dilutive operating EPS
 
$
0.54

 
$
0.58

 
Interest and Dividend Income

Interest and dividend income for the three months ended March 31, 2017 increased to $11,682,000 compared to $11,726,000 for the same period of 2016.  Loan portfolio income increased due to the impact of portfolio growth, primarily in home equity products.  The loan portfolio income increase was offset by a decrease in investment portfolio interest due to a decline in the average taxable equivalent yield of 61 bp as the duration in the investment portfolio continues to be shortened in order to reduce interest rate and market risk in the future. This is being undertaken primarily through the sale of long-term municipal bonds that have a maturity date of 2025 or later and securities with a call date within the next five years. To offset the revenue impact of the declining asset yields, a focus has been placed on increasing earning assets by adding quality short and intermediate term loans such as home equity loans, even though these new earning assets are at lower yields than legacy assets.

Interest and dividend income composition for the three months ended March 31, 2017 and 2016 was as follows:
 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Loans including fees
 
$
10,627

 
90.97
%
 
$
10,355

 
88.31
%
 
$
272

 
2.63

%
Investment securities:
 
 

 
 
 
 
 

 
 
 
 
 

 
 

 
Taxable
 
542

 
4.64
 
 
622

 
5.30
 
 
(80
)
 
(12.86
)
 
Tax-exempt
 
298

 
2.55
 
 
475

 
4.05
 
 
(177
)
 
(37.26
)
 
Dividend and other interest income
 
215

 
1.84
 
 
274

 
2.34
 
 
(59
)
 
(21.53
)
 
Total interest and dividend income
 
$
11,682

 
100.00
%
 
$
11,726

 
100.00
%
 
$
(44
)
 
(0.38
)
%
 
Interest Expense

Interest expense for the three months ended March 31, 2017 decreased $6,000 to $1,346,000 compared to $1,352,000 for the same period of 2016.  The decrease in interest expense is the result of growth within the deposit portfolio and the lengthening of the time deposit portfolio as part of a strategy to build balance sheet protection in a rising rate environment, offset by a decrease in short and long-term borrowing utilization.

Interest expense composition for the three months ended March 31, 2017 and 2016 was as follows:
 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Deposits
 
$
902

 
67.01
%
 
$
834

 
61.69
%
 
$
68

 
8.15

%
Short-term borrowings
 
4

 
0.30
 
 
26

 
1.92
 
 
(22
)
 
(84.62
)
 
Long-term borrowings
 
440

 
32.69
 
 
492

 
36.39
 
 
(52
)
 
(10.57
)
 
Total interest expense
 
$
1,346

 
100.00
%
 
$
1,352

 
100.00
%
 
$
(6
)
 
(0.44
)
%
 




31


Net Interest Margin

The net interest margin (“NIM”) for the three months ended March 31, 2017 was 3.40% compared to 3.57% for the corresponding period of 2016.  The decline in the net interest margin was driven by a decreasing yield on the investment portfolio due to the continued low rate environment. The impact of the declining earning asset yield and decreasing investment portfolio balance was partially offset by 5.47% growth in the balance of the average loan portfolio from March 31, 2016 to March 31, 2017. The primary funding for the loan growth was an increase in core deposits. These deposits represent a lower cost funding source than time deposits and comprise 82.32% of total deposits at March 31, 2017 compared to 79.22% at March 31, 2016. Limiting the positive impact on the net interest margin caused by the growth in core deposits was the lengthening of the time deposit portfolio.

The following is a schedule of average balances and associated yields for the three months ended March 31, 2017 and 2016:

 
 
AVERAGE BALANCES AND INTEREST RATES
 
 
Three Months Ended March 31, 2017
 
Three Months Ended March 31, 2016
(In Thousands)
 
Average Balance (1)
 
Interest
 
Average Rate
 
Average Balance (1)
 
Interest
 
Average Rate
Assets:
 
 

 
 

 
 

 
 

 
 

 
 

Tax-exempt loans (3)
 
$
42,232

 
$
417

 
4.00
%
 
$
54,014

 
$
535

 
3.98
%
All other loans
 
1,057,495

 
10,352

 
3.97
%
 
988,632

 
10,002

 
4.07
%
Total loans (2)
 
1,099,727

 
10,769

 
3.97
%
 
1,042,646

 
10,537

 
4.06
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Taxable securities
 
89,317

 
685

 
3.07
%
 
99,032

 
885

 
3.57
%
Tax-exempt securities (3)
 
46,673

 
452

 
3.87
%
 
63,373

 
720

 
4.54
%
Total securities
 
135,990

 
1,137

 
3.34
%
 
162,405

 
1,605

 
3.95
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
 
33,167

 
72

 
0.88
%
 
12,693

 
11

 
0.35
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Total interest-earning assets
 
1,268,884

 
11,978

 
3.82
%
 
1,217,744

 
12,153

 
4.01
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Other assets
 
99,537

 
 

 
 

 
96,462

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
1,368,421

 
 

 
 

 
$
1,314,206

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and shareholders’ equity:
 
 

 
 

 
 

 
 

 
 

 
 

Savings
 
$
156,423

 
15

 
0.04
%
 
$
148,856

 
14

 
0.04
%
Super Now deposits
 
189,299

 
106

 
0.23
%
 
188,147

 
125

 
0.27
%
Money market deposits
 
262,883

 
191

 
0.29
%
 
219,240

 
139

 
0.25
%
Time deposits
 
210,052

 
590

 
1.14
%
 
220,554

 
556

 
1.01
%
Total interest-bearing deposits
 
818,657

 
902

 
0.45
%
 
776,797

 
834

 
0.43
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Short-term borrowings
 
11,349

 
4

 
0.14
%
 
28,410

 
26

 
0.36
%
Long-term borrowings
 
82,554

 
440

 
2.13
%
 
91,025

 
492

 
2.14
%
Total borrowings
 
93,903

 
444

 
1.89
%
 
119,435

 
518

 
1.72
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Total interest-bearing liabilities
 
912,560

 
1,346

 
0.60
%
 
896,232

 
1,352

 
0.60
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
 
300,102

 
 

 
 

 
265,053

 
 

 
 

Other liabilities
 
16,074

 
 

 
 

 
15,406

 
 

 
 

Shareholders’ equity
 
139,685

 
 

 
 

 
137,515

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Total liabilities and shareholders’ equity
 
$
1,368,421

 
 

 
 

 
$
1,314,206

 
 

 
 

Interest rate spread
 
 

 
 

 
3.22
%
 
 

 
 

 
3.41
%
Net interest income/margin
 
 

 
$
10,632

 
3.40
%
 
 

 
$
10,801

 
3.57
%

1.              Information on this table has been calculated using average daily balance sheets to obtain average balances.
2.              Non-accrual loans have been included with loans for the purpose of analyzing net interest earnings.
3.              Income and rates on a fully taxable equivalent basis include an adjustment for the difference between annual income from tax-exempt obligations and the taxable equivalent of such income at the standard 34% tax rate.
 

32


The following table presents the adjustment to convert net interest income to net interest income on a fully taxable equivalent basis for the three months ended March 31, 2017 and 2016.

 
 
Three Months Ended March 31,
(In Thousands)
 
2017
 
2016
Total interest income
 
$
11,682

 
$
11,726

Total interest expense
 
1,346

 
1,352

Net interest income
 
10,336

 
10,374

Tax equivalent adjustment
 
296

 
427

Net interest income (fully taxable equivalent)
 
$
10,632

 
$
10,801

 
The following table sets forth the respective impact that both volume and rate changes have had on net interest income on a fully taxable equivalent basis for the three months ended March 31, 2017 and 2016:

 
 
Three Months Ended March 31,
 
 
2017 vs. 2016
 
 
Increase (Decrease) Due to
(In Thousands)
 
Volume
 
Rate
 
Net
Interest income:
 
 

 
 

 
 

Tax-exempt loans
 
$
(121
)
 
$
3

 
$
(118
)
All other loans
 
624

 
(274
)
 
350

Taxable investment securities
 
(82
)
 
(118
)
 
(200
)
Tax-exempt investment securities
 
(172
)
 
(96
)
 
(268
)
Interest bearing deposits
 
31

 
30

 
61

Total interest-earning assets
 
280

 
(455
)
 
(175
)
 
 
 
 
 
 
 
Interest expense:
 
 

 
 

 
 

Savings deposits
 
1

 

 
1

Super Now deposits
 
1

 
(20
)
 
(19
)
Money market deposits
 
28

 
24

 
52

Time deposits
 
(30
)
 
64

 
34

Short-term borrowings
 
(11
)
 
(11
)
 
(22
)
Long-term borrowings
 
(49
)
 
(3
)
 
(52
)
Total interest-bearing liabilities
 
(60
)
 
54

 
(6
)
Change in net interest income
 
$
340

 
$
(509
)
 
$
(169
)

Provision for Loan Losses

The provision for loan losses is based upon management’s quarterly review of the loan portfolio.  The purpose of the review is to assess loan quality, identify impaired loans, analyze delinquencies, ascertain loan growth, evaluate potential charge-offs and recoveries, and assess general economic conditions in the markets served.  An external independent loan review is also performed annually for the Banks.  Management remains committed to an aggressive program of problem loan identification and resolution.

The allowance for loan losses is determined by applying loss factors to outstanding loans by type, excluding loans for which a specific allowance has been determined.  Loss factors are based on management’s consideration of the nature of the portfolio segments, changes in mix and volume of the loan portfolio, and historical loan loss experience.  In addition, management considers industry standards and trends with respect to non-performing loans and its knowledge and experience with specific lending segments.

Although management believes it uses the best information available to make such determinations and that the allowance for loan losses is adequate at March 31, 2017, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making the initial determinations.  A downturn in the local economy, increased unemployment, and delays in receiving financial information from borrowers could result in increased levels of nonperforming assets, charge-offs, loan loss provisions, and reductions in income.  Additionally, as an integral part of the examination process,

33


bank regulatory agencies periodically review the Banks' loan loss allowance.  The banking agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination.

When determining the appropriate allowance level, management has attributed the allowance for loan losses to various portfolio segments; however, the allowance is available for the entire portfolio as needed.

The allowance for loan losses increased from $12,896,000 at December 31, 2016 to $12,905,000 at March 31, 2017.  The increase in the allowance for loan losses was driven by growth in the loan portfolio and offset by a decrease in total nonperforming loans. Also limiting the increase in the allowance for loan losses was minimal net charge-offs during the three months ended March 31, 2017 of $321,000.  The majority of the loans charged-off had a specific allowance within the allowance for losses.  At March 31, 2017 and December 31, 2016, the allowance for loan losses to total loans was 1.16% and 1.18%, respectively.

The provision for loan losses totaled $330,000 and $350,000 for the three months ended March 31, 2017 and 2016, respectively.  The amount of the provision for loan losses was primarily the result of loan growth offset by a decrease in non-performing loans and minimal net charge-offs.

Nonperforming loans decreasing to $10,871,000 at March 31, 2017 from $11,648,000 at March 31, 2016.  The majority of nonperforming loans are centered on loans that are either in a secured position and have sureties with a strong underlying financial position or have a specific allocation for any impairment recorded within the allowance for loan losses. The ratio of nonperforming loans to total loans was 0.98% and 1.12% at March 31, 2017 and 2016, respectively, and the ratio of the allowance for loan losses to nonperforming loans was 118.71% and 106.30% at March 31, 2017 and 2016, respectively. Internal loan review and analysis coupled with loan growth dictated a provision for loan losses of $330,000 for the three months ended March 31, 2017.   

The following is a table showing total nonperforming loans as of:

 
 
Total Nonperforming Loans
(In Thousands)
 
90 Days Past Due

Non-accrual

Total
March 31, 2017
 
$
141

 
$
10,730

 
$
10,871

December 31, 2016
 
870

 
10,756

 
11,626

September 30, 2016
 
114

 
11,416

 
11,530

June 30, 2016
 
512

 
11,114

 
11,626

March 31, 2016
 
308

 
11,340

 
11,648

 
Non-interest Income

Total non-interest income for the three months ended March 31, 2017 compared to the same period in 2016 decreased $346,000 to $2,651,000.  Excluding net securities gains, non-interest income for the three months ended March 31, 2017 decreased $70,000 compared to the same period in 2016.  The decrease in gain on sale of loans was driven by a decrease in loan volume. The changes insurance and brokerage commissions is due to a change in the product mix of consumer purchases.

Non-interest income composition for the three months ended March 31, 2017 and 2016 was as follows:
 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Service charges
 
$
528

 
19.92
%
 
$
532

 
17.75
%
 
$
(4
)
 
(0.75
)%
Net securities gains, available for sale
 
197

 
7.43

 
435

 
14.51

 
(238
)
 
(54.71
)
Net securities gains, trading
 
2

 
0.08

 
40

 
1.33

 
(38
)
 
(95.00
)
Bank-owned life insurance
 
172

 
6.49

 
184

 
6.14

 
(12
)
 
(6.52
)
Gain on sale of loans
 
358

 
13.50

 
467

 
15.58

 
(109
)
 
(23.34
)
Insurance commissions
 
191

 
7.20

 
206

 
6.87

 
(15
)
 
(7.28
)
Brokerage commissions
 
331

 
12.49

 
255

 
8.51

 
76

 
29.80

Other
 
872

 
32.89

 
878

 
29.31

 
(6
)
 
(0.68
)
Total non-interest income
 
$
2,651

 
100.00
%
 
$
2,997

 
100.00
%
 
$
(346
)
 
(11.54
)%

34


 

Non-interest Expense

Total non-interest expense increased $76,000 for the three months ended March 31, 2017 compared to the same period of 2016.  The increase in salaries and employee benefits is primarily attributable to routine wage increases.  Amortization of investment in limited partnerships decreased as several of the partnerships have reached the end of their tax credit generating life and have been fully amortized. Occupancy expense increased due to various maintenance projects to refresh facilities.

Non-interest expense composition for the three months ended March 31, 2017 and 2016 was as follows:
 
 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Salaries and employee benefits
 
$
4,770

 
53.10
%
 
$
4,580

 
50.55
%
 
$
190

 
4.15
 %
Occupancy
 
638

 
7.10

 
541

 
5.97

 
97

 
17.93

Furniture and equipment
 
649

 
7.22

 
701

 
7.74

 
(52
)
 
(7.42
)
Pennsylvania shares tax
 
238

 
2.65

 
258

 
2.85

 
(20
)
 
(7.75
)
Amortization of investment in limited partnerships
 
46

 
0.51

 
152

 
1.68

 
(106
)
 
(69.74
)
Federal Deposit Insurance Corporation deposit insurance
 
170

 
1.89

 
232

 
2.56

 
(62
)
 
(26.72
)
Marketing
 
171

 
1.90

 
210

 
2.32

 
(39
)
 
(18.57
)
Intangible amortization
 
90

 
1.00

 
87

 
0.96

 
3

 
3.45

Other
 
2,213

 
24.63

 
2,300

 
25.37

 
(87
)
 
(3.78
)
Total non-interest expense
 
$
8,985

 
100.00
%
 
$
9,061

 
100.00
%
 
$
(76
)
 
(0.84
)%
 

Provision for Income Taxes

Income taxes increased $104,000 for the three months ended March 31, 2017 compared to the same period of 2016.  The primary cause of the increase in tax expense for the three months ended March 31, 2017 compared to 2016 is the impact of a reduction of tax-exempt interest income within the investment portfolio as the portfolio was strategically reduced and a reduction in the amount of federal tax credits recognized from low income elderly housing partnerships. Excluding the impact of the net securities gains, the effective tax rate for the three months ended March 31, 2017 was 26.85% compared to 22.27% for the same period of 2016.  The Company currently is in a deferred tax asset position.  Management has reviewed the deferred tax asset and has determined that the asset will be utilized within the appropriate carry forward period and therefore does not require a valuation allowance.

ASSET/LIABILITY MANAGEMENT

Cash and Cash Equivalents

Cash and cash equivalents increased $31,989,000 from $43,671,000 at December 31, 2016 to $75,660,000 at March 31, 2017 primarily as a result of the following activities during the three months ended March 31, 2017:

Loans Held for Sale

Activity regarding loans held for sale resulted in sales proceeds leading loan originations, less $358,000 in realized gains, by $732,000 for the three months ended March 31, 2017.

Loans

Gross loans increased $17,419,000 since December 31, 2016 due primarily to an increase in installment loans to individuals. The growth in installment loans was driven by automobile indirect lending.

35



The allocation of the loan portfolio, by category, as of March 31, 2017 and December 31, 2016 is presented below:
 
 
 
March 31, 2017
 
December 31, 2016
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Commercial, financial, and agricultural
 
$
142,062

 
12.79
 %
 
$
146,110

 
13.36
 %
 
$
(4,048
)
 
(2.77
)%
Real estate mortgage:
 
 

 
 

 
 

 
 

 
 

 
 

Residential
 
565,211

 
50.87

 
564,740

 
51.63

 
471

 
0.08
 %
Commercial
 
312,185

 
28.10

 
306,182

 
27.99

 
6,003

 
1.96
 %
Construction
 
37,390

 
3.37

 
34,650

 
3.17

 
2,740

 
7.91
 %
Installment loans to individuals
 
55,576

 
5.00

 
43,256

 
3.96

 
12,320

 
28.48
 %
Net deferred loan fees and discounts
 
(1,324
)
 
(0.13
)
 
(1,257
)
 
(0.11
)
 
(67
)
 
5.33
 %
Gross loans
 
$
1,111,100

 
100.00
 %
 
$
1,093,681

 
100.00
 %
 
$
17,419

 
1.59
 %
 
The following table shows the amount of accrual and non-accrual TDRs at March 31, 2017 and December 31, 2016:
 
 
 
March 31, 2017
 
December 31, 2016
(In Thousands)
 
Accrual
 
Non-accrual
 
Total
 
Accrual
 
Non-accrual
 
Total
Commercial, financial, and agricultural
 
$
55

 
$
128

 
$
183

 
$
109

 
$
132

 
$
241

Real estate mortgage:
 
 

 
 

 
 

 
 

 
 

 
 

Residential
 
1,363

 
651

 
2,014

 
1,491

 
541

 
2,032

Commercial
 
4,493

 
2,308

 
6,801

 
4,723

 
2,184

 
6,907

 
 
$
5,911

 
$
3,087

 
$
8,998

 
$
6,323

 
$
2,857

 
$
9,180

 
Investments

The fair value of the investment securities portfolio at March 31, 2017 increased $3,360,000 since December 31, 2016 while the amortized cost of the portfolio increased $2,820,000.  The portfolio continues to be actively managed in order to reduce interest rate and market risk. This is being undertaken primarily through the sale of long-term municipal bonds that have a maturity date of 2025 or later and securities with a call date within the next five years.  The proceeds of the bond sales are being deployed into loans and intermediate term corporate bonds and short and intermediate term municipal bonds.  The strategy to sell a portion of the long-term bond portfolio does negatively impact current earnings, but this action plays a key role in our long-term asset liability management strategy as the balance sheet is shortened to better prepare for a rising rate environment. The unrealized losses within the debt securities portfolio are the result of market activity, not credit issues/ratings, as approximately 83% of the debt securities portfolio on an amortized cost basis is currently rated A or higher by either S&P or Moody’s.

The Company considers various factors, which include examples from applicable accounting guidance, when analyzing the available for sale portfolio for possible other than temporary impairment.  The Company primarily considers the following factors in its analysis: length of time and severity of the fair value being less than carrying value; reduction of dividend paid (equities); continued payment of dividend/interest, credit rating, and financial condition of an issuer; intent and ability to hold until anticipated recovery (which may be maturity); and general outlook for the economy, specific industry, and entity in question.

The bond portion of the portfolio review is conducted with emphases on several factors.  Continued payment of principal and interest is given primary importance with credit rating and financial condition of the issuer following as the next most important.  Credit ratings were reviewed with the ratings of the bonds being satisfactory.  Bonds that were not currently rated were discussed with a third party and/or underwent an internal financial review.  The Company also monitors whether each of the investments incurred a decline in fair value from carrying value of at least 20% for twelve consecutive months or a similar decline of at least 50% for three consecutive months.  Each bond is reviewed to determine whether it is a general obligation bond, which is backed by the credit and taxing power of the issuing jurisdiction, or revenue bond, which is only payable from specified revenues.  Based on the review undertaken by the Company, the Company determined that the decline in value of the various bond holdings were temporary and were the result of the general market downturns and interest rate/yield curve changes, not credit issues.  The fact that almost all of such bonds are general obligation bonds further solidified the Company’s determination that the decline in the value of these bond holdings is temporary.


36


The fair value of the equity portfolio continues to fluctuate as the economic turbulence continues to impact stock pricing and the Company reduces its level of equity holdings.  The amortized cost of the available for sale equity securities portfolio has decreased $702,000 to $10,531,000 at March 31, 2017 from $11,233,000 at December 31, 2016 while the fair value decreased $869,000 over the same time period.

The equity portion of the portfolio is reviewed for possible other than temporary impairment in a similar manner to the bond portfolio with greater emphasis placed on the length of time the fair value has been less than the carrying value and financial sector outlook.  The Company also reviews dividend payment activities.  The starting point for the equity analysis is the length and severity of a market price decline.  The Company monitors two primary measures: 20% decline in fair value from carrying value for twelve consecutive months and 50% decline for three consecutive months.

The distribution of credit ratings by amortized cost and fair values for the debt security portfolio at March 31, 2017 follows:
 
 
 
A- to AAA
 
B- to BBB+
 
Not Rated
 
Total
(In Thousands)
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Available for sale (AFS)
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Mortgage-backed securities
 
$
5,057

 
$
5,072

 
$

 
$

 
$

 
$

 
$
5,057

 
$
5,072

Asset-backed securities
 
56

 
56

 

 

 

 

 
56

 
56

State and political securities
 
63,284

 
63,803

 

 

 
1,525

 
1,527

 
64,809

 
65,330

Other debt securities
 
36,474

 
35,825

 
19,351

 
18,429

 
1,058

 
1,049

 
56,883

 
55,303

Total debt securities AFS
 
$
104,871

 
$
104,756

 
$
19,351

 
$
18,429

 
$
2,583

 
$
2,576

 
$
126,805

 
$
125,761

 
Financing Activities

Deposits

Total deposits increased $65,450,000 from December 31, 2016 to March 31, 2017.  The growth was led by an increase in money market deposit accounts from December 31, 2016 to March 31, 2017 of $33,322,000 or 13.59%.  The increase in core deposits (deposits less time deposits) has provided relationship driven funding for the loan and investment portfolios. While deposit gathering efforts have centered on core deposits, the lengthening of the time deposit portfolio is moving forward as part of the strategy to build balance sheet protection in a rising rate environment. The increase in deposits is the result of our focus on building relationships, not by offering market leading rates. 

Deposit balances and their changes for the periods being discussed follow:

 
 
March 31, 2017
 
December 31, 2016
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Demand deposits
 
$
312,392

 
26.91
%
 
$
303,277

 
27.69
%
 
$
9,115

 
3.01
 %
NOW accounts
 
205,011

 
17.66

 
174,653

 
15.95

 
30,358

 
17.38

Money market deposits
 
278,443

 
23.99

 
245,121

 
22.38

 
33,322

 
13.59

Savings deposits
 
159,652

 
13.76

 
153,788

 
14.04

 
5,864

 
3.81

Time deposits
 
205,166

 
17.68

 
218,375

 
19.94

 
(13,209
)
 
(6.05
)
 Total deposits
 
$
1,160,664

 
100.00
%
 
$
1,095,214

 
100.00
%
 
$
65,450

 
5.98
 %
 











37


Borrowed Funds

Total borrowed funds decreased 14.76% or $14,652,000 to $84,587,000 at March 31, 2017 compared to $99,239,000 at December 31, 2016.  The reduction in long-term borrowings was the result of a maturity. Growth in deposits and a reduction in the size of the investment portfolio allowed for a decrease in the utilization of short-term borrowings.

 
 
March 31, 2017
 
December 31, 2016
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Short-term borrowings:
 
 

 
 

 
 

 
 

 
 

 
 

FHLB repurchase agreements
 
$

 
%
 
$

 
%
 
$

 
 %
Securities sold under agreement to repurchase
 
8,589

 
10.15

 
13,241

 
13.34

 
(4,652
)
 
(35.13
)
Total short-term borrowings
 
8,589

 
10.15

 
13,241

 
13.34

 
(4,652
)
 
(35.13
)
Long-term borrowings:
 
 
 
 
 
 
 
 
 
 
 
 
Long-term FHLB borrowings
 
75,625

 
89.40

 
85,625

 
86.28

 
(10,000
)
 
(11.68
)
Long-term capital lease
 
373

 
0.45

 
373

 
0.38

 

 

Total long-term borrowings
 
75,998

 
89.85

 
85,998

 
86.66

 
(10,000
)
 
(11.63
)%
Total borrowed funds
 
$
84,587

 
100.00
%
 
$
99,239

 
100.00
%
 
$
(14,652
)
 
(14.76
)%

The decline in securities sold under agreement to repurchase is due to the phasing out of a product the bank offers.

Capital

The adequacy of the Company’s capital is reviewed on an ongoing basis with reference to the size, composition, and quality of the Company’s resources and regulatory guidelines.  Management seeks to maintain a level of capital sufficient to support existing assets and anticipated asset growth, maintain favorable access to capital markets, and preserve high quality credit ratings.

Bank holding companies are required to comply with the Federal Reserve Board’s risk-based capital guidelines.  The risk-based capital rules are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies and to minimize disincentives for holding liquid assets.  Specifically, each is required to maintain certain minimum dollar amounts and ratios of common equity tier I risk-based, tier I risk-based, total risk-based, and tier I leverage capital. In addition to the capital requirements, the Federal Deposit Insurance Corporation Improvements Act (FDICIA) established five capital categories ranging from “well capitalized” to “critically undercapitalized.” To be classified as “well capitalized”, common equity tier I risk-based, tier I risked-based, total risk-based, and tier I leverage capital ratios must be at least 6.5%, 8%, 10%, and 5%, respectively.























38


The Company's capital ratios as of March 31, 2017 and December 31, 2016 were as follows:

 
 
March 31, 2017
 
December 31, 2016
(In Thousands)
 
Amount
 
Ratio
 
Amount
 
Ratio
Common Equity Tier I Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
126,217

 
12.451
%
 
$
125,804

 
12.620
%
For Capital Adequacy Purposes
 
45,617

 
4.500

 
44,849

 
4.500

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
58,288

 
5.750

 
51,078

 
5.125

To Be Well Capitalized
 
65,891

 
6.500

 
64,782

 
6.500

Total Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
126,217

 
12.451
%
 
$
133,393

 
13.380
%
For Capital Adequacy Purposes
 
81,097

 
8.000

 
79,732

 
8.000

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
93,768

 
9.250

 
85,961

 
8.625

To Be Well Capitalized
 
101,371

 
10.000

 
99,665

 
10.000

Tier I Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
131,419

 
12.911
%
 
$
125,804

 
12.620
%
For Capital Adequacy Purposes
 
101,371

 
6.000

 
59,799

 
6.000

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
73,797

 
7.250

 
66,028

 
6.625

To Be Well Capitalized
 
81,431

 
8.000

 
79,732

 
8.000

Tier I Capital (to Average Assets)
 
 

 
 

 
 

 
 

Actual
 
$
126,217

 
9.332
%
 
$
125,804

 
9.432
%
For Capital Adequacy Purposes
 
54,101

 
4.000

 
53,352

 
4.000

To Be Well Capitalized
 
67,626

 
5.000

 
66,691

 
5.000

 
Jersey Shore State Bank's capital ratios as of March 31, 2017 and December 31, 2016 were as follows:

 
 
March 31, 2017
 
December 31, 2016
(In Thousands)
 
Amount
 
Ratio
 
Amount
 
Ratio
Common Equity Tier I Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
86,900

 
10.869
%
 
$
86,397

 
11.136
%
For Capital Adequacy Purposes
 
35,978

 
4.500

 
34,914

 
4.500

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
45,972

 
5.750

 
39,763

 
5.125

To Be Well Capitalized
 
51,969

 
6.500

 
50,431

 
6.500

Total Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
88,854

 
11.114
%
 
$
90,992

 
11.728
%
For Capital Adequacy Purposes
 
63,958

 
8.000

 
62,069

 
8.000

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
73,952

 
9.250

 
66,918

 
8.625

To Be Well Capitalized
 
79,948

 
10.000

 
77,587

 
10.000

Tier I Capital (to Risk-weighted Assets)
 
-

 
 

 
 

 
 

Actual
 
$
86,900

 
10.869
%
 
$
86,397

 
11.136
%
For Capital Adequacy Purposes
 
47,971

 
6.000

 
46,552

 
6.000

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
57,965

 
7.250

 
51,401

 
6.625

To Be Well Capitalized
 
63,962

 
8.000

 
62,069

 
8.000

Tier I Capital (to Average Assets)
 
 

 
 

 
 

 
 

Actual
 
$
86,900

 
8.756
%
 
$
86,397

 
8.894
%
For Capital Adequacy Purposes
 
39,698

 
4.000

 
38,856

 
4.000

To Be Well Capitalized
 
49,623

 
5.000

 
48,570

 
5.000






39


Luzerne Bank's capital ratios as of March 31, 2017 and December 31, 2016 were as follows:

 
 
March 31, 2017
 
December 31, 2016
(In Thousands)
 
Amount
 
Ratio
 
Amount
 
Ratio
Common Equity Tier I Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
31,028

 
10.400
%
 
$
31,102

 
10.165
%
For Capital Adequacy Purposes
 
13,426

 
4.500

 
13,769

 
4.500

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
17,155

 
5.750

 
15,682

 
5.125

To Be Well Capitalized
 
19,393

 
6.500

 
19,889

 
6.500

Total Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
33,460

 
11.215
%
 
$
33,589

 
10.977
%
For Capital Adequacy Purposes
 
23,868

 
8.000

 
24,479

 
8.000

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
27,597

 
9.250

 
26,391

 
8.625

To Be Well Capitalized
 
29,835

 
10.000

 
30,599

 
10.000

Tier I Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
31,028

 
10.400
%
 
$
31,102

 
10.165
%
For Capital Adequacy Purposes
 
17,901

 
6.000

 
18,359

 
6.000

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
21,630

 
7.250

 
20,272

 
6.625

To Be Well Capitalized
 
23,868

 
8.000

 
24,479

 
8.000

Tier I Capital (to Average Assets)
 
 

 
 

 
 

 
 

Actual
 
$
31,028

 
8.363
%
 
$
31,102

 
8.535
%
For Capital Adequacy Purposes
 
14,841

 
4.000

 
14,576

 
4.000

To Be Well Capitalized
 
18,551

 
5.000

 
18,220

 
5.000


In July 2013, the federal bank regulatory agencies adopted revisions to the agencies’ capital adequacy guidelines and prompt corrective action rules, which were designed to enhance such requirements and implement the revised standards of the Basel Committee on Banking Supervision, commonly referred to as Basel III.  The July 2013 final rules generally implement higher minimum capital requirements, add a new common equity tier 1 capital requirement, and establish criteria that instruments must meet to be considered common equity tier 1 capital, additional tier 1 capital or tier 2 capital.  The new minimum capital to risk-adjusted assets requirements are a common equity tier 1 capital ratio of 4.5% (6.5% to be considered “well capitalized”) and a tier 1 capital ratio of 6.0%, increased from 4.0% (and increased from 6.0% to 8.0% to be considered “well capitalized”); the total capital ratio remains at 8.0% under the new rules (10.0% to be considered “well capitalized”).  Under the new rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of common equity tier 1 capital above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets.  The new minimum capital requirements were effective beginning on January 1, 2015.  The capital contribution buffer requirements phase in over a three-year period beginning January 1, 2016. The Company and the Banks will continue to analyze these new rules and their effects on the business, operations and capital levels of the Company and the Banks.

Liquidity; Interest Rate Sensitivity and Market Risk

The asset/liability committee addresses the liquidity needs of the Company to ensure that sufficient funds are available to meet credit demands and deposit withdrawals as well as to the placement of available funds in the investment portfolio.  In assessing liquidity requirements, equal consideration is given to the current position as well as the future outlook.

The following liquidity measures are monitored for compliance and were within the limits cited at March 31, 2017:

1.            Net Loans to Total Assets, 85% maximum
2.              Net Loans to Total Deposits, 100% maximum
3.              Cumulative 90 day Maturity GAP %, +/- 20% maximum
4.              Cumulative 1 Year Maturity GAP %, +/- 25% maximum

Fundamental objectives of the Company’s asset/liability management process are to maintain adequate liquidity while minimizing interest rate risk.  The maintenance of adequate liquidity provides the Company with the ability to meet its financial obligations to depositors, loan customers, and shareholders.  Additionally, it provides funds for normal operating expenditures and business

40


opportunities as they arise.  The objective of interest rate sensitivity management is to increase net interest income by managing interest sensitive assets and liabilities in such a way that they can be repriced in response to changes in market interest rates.

The Banks, like other financial institutions, must have sufficient funds available to meet liquidity needs for deposit withdrawals, loan commitments and originations, and expenses.  In order to control cash flow, the Banks estimate future cash flows from deposits, loan payments, and investment security payments.  The primary sources of funds are deposits, principal and interest payments on loans and investment securities, FHLB borrowings, and brokered deposits.  Management believes the Banks have adequate resources to meet their normal funding requirements.

Management monitors the Company’s liquidity on both a long and short-term basis, thereby providing management necessary information to react to current balance sheet trends.  Cash flow needs are assessed and sources of funds are determined.  Funding strategies consider both customer needs and economical cost.  Both short and long-term funding needs are addressed by maturities and sales of available for sale and trading investment securities, loan repayments and maturities, and liquidating money market investments such as federal funds sold.  The use of these resources, in conjunction with access to credit provides core funding to satisfy depositor, borrower, and creditor needs.

Management monitors and determines the desirable level of liquidity.  Consideration is given to loan demand, investment opportunities, deposit pricing and growth potential, as well as the current cost of borrowing funds.  The Company has a total current maximum borrowing capacity at the FHLB of $540,550,000.  In addition to this credit arrangement, the Company has additional lines of credit with correspondent banks of $45,243,000.  Management believes it has sufficient liquidity to satisfy estimated short-term and long-term funding needs.  FHLB borrowings totaled $75,625,000 as of March 31, 2017.

Interest rate sensitivity, which is closely related to liquidity management, is a function of the repricing characteristics of the Company’s portfolio of assets and liabilities.  Asset/liability management strives to match maturities and rates between loan and investment security assets with the deposit liabilities and borrowings that fund them.  Successful asset/liability management results in a balance sheet structure which can cope effectively with market rate fluctuations. The matching process by segments both assets and liabilities into future time periods (usually 12 months, or less) based upon when repricing can be effected.  Repriceable assets are subtracted from repriceable liabilities, for a specific time period to determine the “gap”, or difference. Once known, the gap is managed based on predictions about future market interest rates.  Intentional mismatching, or gapping, can enhance net interest income if market rates move as predicted.  However, if market rates behave in a manner contrary to predictions, net interest income will suffer.  Gaps, therefore, contain an element of risk and must be prudently managed.  In addition to gap management, the Company has an asset/liability management policy which incorporates a market value at risk calculation which is used to determine the effects of interest rate movements on shareholders’ equity and a simulation analysis to monitor the effects of interest rate changes on the Company’s balance sheet.

The Company currently maintains a GAP position of being asset sensitive.  The Company has strategically taken this position as it has decreased the duration of the earning asset portfolio by adding quality short and intermediate term loans such as home equity loans and the selling of long-term municipal bonds.  Lengthening of the liability portfolio is being undertaken to build protection in a rising rate environment.

A market value at risk calculation is utilized to monitor the effects of interest rate changes on the Company’s balance sheet and more specifically shareholders’ equity.  The Company does not manage the balance sheet structure in order to maintain compliance with this calculation.  The calculation serves as a guideline with greater emphases placed on interest rate sensitivity.  Changes to calculation results from period to period are reviewed as changes in results could be a signal of future events.  As of the most recent analysis, the results of the market value at risk calculation were within established guidelines due to the strategic direction being taken.














41


Interest Rate Sensitivity

In this analysis the Company examines the result of a 100, 200, 300, and 400 basis point change in market interest rates and the effect on net interest income. It is assumed that the change is instantaneous and that all rates move in a parallel manner.  Assumptions are also made concerning prepayment speeds on mortgage loans and mortgage securities.

The following is a rate shock forecast for the twelve month period ending March 31, 2018 assuming a static balance sheet as of March 31, 2017.

 
 
Parallel Rate Shock in Basis Points
(In Thousands)
 
-200
 
-100
 
Static
 
+100
 
+200
 
+300
 
+400
Net interest income
 
$
38,830

 
$
41,882

 
$
45,026

 
$
47,501

 
$
49,793

 
$
51,799

 
$
53,689

Change from static
 
(6,196
)
 
(3,144
)
 

 
2,475

 
4,767

 
6,773

 
8,663

Percent change from static
 
-13.76
 %
 
-6.98
 %
 

 
5.50
%
 
10.59
%
 
15.04
%
 
19.24
%
 
The model utilized to create the report presented above makes various estimates at each level of interest rate change regarding cash flow from principal repayment on loans and mortgage-backed securities and/or call activity on investment securities.  Actual results could differ significantly from these estimates which would result in significant differences in the calculated projected change.  In addition, the limits stated above do not necessarily represent the level of change under which management would undertake specific measures to realign its portfolio in order to reduce the projected level of change.  Generally, management believes the Company is well positioned to respond expeditiously when the market interest rate outlook changes.

Inflation

The asset and liability structure of a financial institution is primarily monetary in nature.  Therefore, interest rates rather than inflation have a more significant impact on the Company’s performance.  Interest rates are not always affected in the same direction or magnitude as prices of other goods and services, but are reflective of fiscal policy initiatives or economic factors which are not measured by a price index.
 
Item 3.  Quantitative and Qualitative Disclosures About Market Risk

Market risk for the Company is comprised primarily of interest rate risk exposure and liquidity risk.  Interest rate risk and liquidity risk management is performed at both the level of the Company and the Banks.  The Company’s interest rate sensitivity is monitored by management through selected interest rate risk measures produced by an independent third party.  There have been no substantial changes in the Company’s gap analysis or simulation analysis compared to the information provided in the Annual Report on Form 10-K for the period ended December 31, 2016.  Additional information and details are provided in the “Liquidity, Interest Rate Sensitivity, and Market Risk” section of “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Generally, management believes the Company is well positioned to respond in a timely manner when the market interest rate outlook changes.

Item 4.  Controls and Procedures

Evaluation of Disclosure Controls and Procedures

An analysis was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2017.

Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended March 31, 2017, that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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Part II.  OTHER INFORMATION
Item 1.                           Legal Proceedings
 
None.

Item 1A.  Risk Factors
 
There are no material changes to the risk factors set forth in Part I, Item 1A, “Risk Factors,” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.  Please refer to that section for disclosures regarding the risks and uncertainties related to the Company’s business.

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

The following table provides certain information with respect to the Company's repurchase of common stock during the quarter ended March 31, 2017.
Period
 
Total
Number of
Shares (or
Units) Purchased
 
Average
Price Paid
per Share
(or Units) Purchased
 
Total Number of
Shares (or Units)
Purchased as Part of
Publicly Announced Plans or Programs
 
Maximum Number (or
Approximate Dollar Value)
of Shares (or Units) that
May Yet Be Purchased Under the Plans or Programs
Month #1 (January 1 - January 31, 2017)
 

 
$

 

 
390,144

Month #2 (February 1 - February 28, 2017)
 

 

 

 
390,144

Month #3 (March 1 - March 31, 2017)
 

 

 

 
390,144

 
On April 24, 2017, the Board of Directors extended the previously approved authorization to repurchase up to 482,000 shares, or approximately 10%, of the outstanding shares of the Company for an additional year to April 30, 2018.  As of March 31, 2017 there have been 91,856 shares repurchased under this plan.

Item 3.                           Defaults Upon Senior Securities
 
None.
 
Item 4.                           Mine Safety Disclosures
 
Not applicable.
 
Item 5.                           Other Information
 
None.
 

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Item 6.                           Exhibits
 
3(i)
 
Articles of Incorporation of the Registrant, as presently in effect (incorporated by reference to Exhibit 3(i) of the Registrant’s Quarterly Report on Form 10-Q for the period ended March 31, 2012).
3(ii)
 
Bylaws of the Registrant (incorporated by reference to Exhibit 3(ii) of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2011).
31(i)
 
Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Executive Officer.
31(ii)
 
Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Financial Officer.
32(i)
 
Section 1350 Certification of Chief Executive Officer.
32(ii)
 
Section 1350 Certification of Chief Financial Officer.
101
 
Interactive data file containing the following financial statements formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheet at March 31, 2017 and December 31, 2016; (ii) the Consolidated Statement of Income for the three months ended March 31, 2017 and 2016; (iii) Consolidated Statement of Comprehensive Income for the three months ended March 31, 2017 and 2016; (iv) the Consolidated Statement of Shareholders’ Equity for the three months ended March 31, 2017 and 2016; (v) the Consolidated Statement of Cash Flows for the three months ended March 31, 2017 and 2016; and (vi) the Notes to Consolidated Financial Statements. As provided in Rule 406T of Regulation S-T, this interactive data file shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, and shall not be deemed “filed” or part of any registration statement or prospectus for purposes of Section 11 or 12 under the Securities Act of 1933, or otherwise subject to liability under those sections.

44


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.
 
 
 
PENNS WOODS BANCORP, INC.
 
 
(Registrant)
 
 
 
Date:    
May 9, 2017
/s/ Richard A. Grafmyre
 
 
Richard A. Grafmyre, President and Chief Executive Officer
 
 
(Principal Executive Officer)
 
 
 
 
 
 
Date:
May 9, 2017
/s/ Brian L. Knepp
 
 
Brian L. Knepp, Senior Vice President and Chief Financial Officer
 
 
(Principal Financial Officer and Principal Accounting
 
 
Officer)

45


EXHIBIT INDEX
 
Exhibit 31(i)
 
Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Executive Officer
Exhibit 31(ii)
 
Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Financial Officer
Exhibit 32(i)
 
Section 1350 Certification of Chief Executive Officer
Exhibit 32(ii)
 
Section 1350 Certification of Chief Financial Officer
Exhibit 101
 
Interactive data file containing the following financial statements formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheet at March 31, 2017 and December 31, 2016; (ii) the Consolidated Statement of Income for the three months ended March 31, 2017 and 2016; (iii) Consolidated Statement of Comprehensive Income for the three months ended March 31, 2017 and 2016; (iv) the Consolidated Statement of Shareholders’ Equity for the three months ended March 31, 2017 and 2016; (v) the Consolidated Statement of Cash Flows for the three months ended March 31, 2017 and 2016; and (vi) the Notes to Consolidated Financial Statements. As provided in Rule 406T of Regulation S-T, this interactive data file shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, and shall not be deemed “filed” or part of any registration statement or prospectus for purposes of Section 11 or 12 under the Securities Act of 1933, or otherwise subject to liability under those sections.


46