FRANKLIN FINANCIAL SERVICES CORPORATION Summary of Selected Financial Data as of and for the Year Ended
2022 2021 2020 2019 2018
(Dollars in thousands,
except per share)
Balance Sheet Highlights
Total assets $ 1,699,579 $ 1,773,806 $ 1,535,038 $ 1,269,157 $ 1,209,587
Investment and equity
securities 487,247 530,292 397,331 187,873 131,846
Loans, net 1,036,866 983,746 992,915 922,609 960,960
Deposits 1,551,448 1,584,359 1,354,573 1,125,392 1,082,629
Shareholders' equity 114,197 157,065 145,176 127,528 118,396
Summary of Operations Interest income $ 56,449$ 47,573 $ 45,939 $ 49,235 $ 44,868 Interest expense 4,863 2,902 3,978 7,113 4,214 Net interest income 51,586 44,671 41,961 42,122 40,654 Provision for loan losses 650 (2,100) 4,625 237 9,954 Net interest income after provision for loan losses 50,936 46,771 37,336 41,885 30,700 Noninterest income 15,250 19,488 15,084 15,424 12,629 Noninterest expense 48,691 43,245 39,362 38,314 37,369 Income before income taxes 17,495 23,014 13,058 18,995 5,960 Federal income tax expense (benefit) 2,557 3,398 258 2,880 (165) Net income $ 14,938$ 19,616 $ 12,800 $ 16,115 $ 6,125 Performance Measurements Return on average assets 0.83% 1.17% 0.91% 1.29% 0.52% Return on average equity 11.64% 13.20% 9.56% 13.17% 5.34% Return on average tangible equity (1) 12.52% 14.05% 10.24% 14.22% 5.80% Efficiency ratio (1) 71.21% 66.12% 67.32% 65.36% 68.27% Net interest margin, fully tax equivalent 3.11% 2.88% 3.21% 3.68% 3.78% Shareholders' Value (per common share) Diluted earnings per share $ 3.36$ 4.42 $ 2.93 $ 3.67 $ 1.39 Basic earnings per share 3.38 4.44 2.94 3.68 1.40 Regular cash dividends paid 1.28 1.25 1.20 1.17 1.05 Book value 26.01 35.36 33.07 29.30 26.85 Tangible book value (1) 23.96 33.34 31.02 27.23 24.81 Market value* 36.10 33.10 27.03 38.69 31.50 Market value/book value ratio 138.79% 93.61% 81.74% 132.05% 117.32% Market value/tangible book value ratio 150.67% 99.29% 87.13% 142.11% 126.97% Price/earnings multiple year-to-date 10.74 7.49 9.23 10.54 22.66 Dividend yield 3.55% 3.87% 4.44% 3.10% 3.43% Dividend payout ratio 37.88% 28.16%
40.83% 31.74% 75.07%
Safety and Soundness Average equity/average assets 7.17% 8.89% 9.48% 9.78% 9.73% Risk-based capital ratio (Total) 17.21% 18.41% 17.69% 16.08% 15.21% Leverage ratio (Tier 1) 8.95% 8.52% 8.69% 9.72% 9.78% Common equity ratio (Tier 1) 14.22% 15.20% 14.32% 14.82% 13.96% Nonperforming loans/gross loans 0.01% 0.74% 0.87% 0.42% 0.27% Nonperforming assets/total assets 0.01% 0.42% 0.57% 0.31% 0.44% Allowance for loan loss/loans 1.35% 1.51% 1.66% 1.28% 1.28% Net loan (charge-offs) recoveries/average loans -0.15% 0.04% 0.02% -0.07% -0.97% Assets under Management Trust and Investment Services (fair value)$ 904,317 $ 946,964 $ 836,381 $ 790,949 $ 684,825 Held at third-party brokers (fair value) 116,398 118,046
112,624 127,976 122,213
*Based on the closing price of FRAF as quoted on the Nasdaq Capital Market for 2022, 2021, 2020 and 2019 and
the OTCQX for 2018.
(1) See the section titled "GAAP versus Non-GAAP Presentation"
that follows.
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Table of Contents Forward-Looking Statements Certain statements appearing herein which are not historical in nature are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements refer to a future period or periods, reflecting Management's current views as to likely future developments, and use words "may," "will," "expect," "believe," "estimate," "anticipate," or similar terms. Because forward-looking statements involve certain risks, uncertainties and other factors over which the Corporation has no direct control, actual results could differ materially from those contemplated in such statements. These factors include (but are not limited to) the following: general economic conditions, changes in interest rates, changes in the rate of inflation and product and service prices, change in the Corporation's cost of funds, changes in government monetary policy, changes in government regulation and taxation of financial institutions, effects of government shutdowns and budget negotiations, impacts of the interruption, degradation or breach in security of our information and technology systems or other technological risks and attacks, acts of war, terrorism or geopolitical instabilities, changes in accounting policies or practices, changes in technology, the intensification of competition within the Corporation's market area, and other similar factors.
Application of Critical Accounting Policies:
Disclosure of the Corporation's significant accounting policies is included in Note 1 to the consolidated financial statements. These policies are particularly sensitive requiring significant judgments, estimates and assumptions to be made by Management. Senior management has discussed the development of such estimates, and related Management Discussion and Analysis disclosure, with the Audit Committee of the Board of Directors. The following accounting policy is identified by management to be critical to the results of operations: Allowance for Loan Losses and the Annual Goodwill Impairment Evaluation. GAAP versus non-GAAP Presentations - The Corporation supplements its traditional GAAP measurements with certain non-GAAP measurements to evaluate its performance and to eliminate the effect of intangible assets. By eliminating intangible assets, the Corporation believes it presents a measurement that is comparable to companies that have no intangible assets or to companies that have eliminated intangible assets in similar calculations. However, not all companies may use the same calculation method for each measurement. The Efficiency Ratio measures the cost to generateone dollar of revenue. The non-GAAP measurements are not intended to be used as a substitute for the related GAAP measurements and should not be read in isolation or relied upon as a substitute for GAAP measures. The following table shows the calculation of the non-GAAP measurements. (Dollars in thousands, except per share) For the Year Ended December 31 2022 2021 2019 2018 2017 Return on Average Tangible Equity (non-GAAP) Net income$ 14,938 $ 19,616 $ 12,800 $ 16,115 $ 6,125 Average shareholders' equity 128,283 148,637 133,958 122,377 114,625 Less average intangible assets (9,016) (9,016) (9,016) (9,016) (9,016) Average shareholders' equity (non-GAAP) 119,267 139,621 124,942 113,361 105,609 Return on average tangible equity (non-GAAP) 12.52% 14.05% 10.24% 14.22% 5.80% Tangible Book Value (per share) (non-GAAP) Shareholders' equity$ 114,197 $ 157,065 $ 145,176 $ 127,528 $ 118,396 Less intangible assets (9,016) (9,016) (9,016) (9,016) (9,016) Shareholders' equity (non-GAAP) 105,181 148,049 136,160 118,512 109,380 Shares outstanding (in thousands) 4,390 4,441 4,389 4,353 4,409 Tangible book value (non-GAAP) 23.96 33.34 31.02 27.23 24.81 Efficiency Ratio (non-GAAP) Noninterest expense$ 48,691 $ 43,245 $ 39,362 $ 38,314 $ 37,369 Net interest income 51,586 44,671 41,961 42,122 40,654 Plus tax equivalent adjustment to net interest income 1,381 1,466 1,407 1,393 1,522 Plus noninterest income, net of securities transactions 15,410 19,271 15,104 15,102 12,564 Total revenue 68,377 65,408 58,472 58,617 54,740 Efficiency ratio (non-GAAP) 71.21% 66.12% 67.32% 65.36% 68.27% 21
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Table of Contents Results of Operations: Management's Overview The following discussion and analysis is intended to assist the reader in reviewing the financial information presented and should be read in conjunction with the consolidated financial statements and other financial data presented elsewhere herein. Summary
?Year-to-date, net interest income was$51.6 million (including$388 thousand of PPP interest and fees), an increase of 15.5% compared to$44.7 million for the same period in 2021 (including$3.3 million of PPP interest and fees). On a year-over-year comparison, the net interest margin was 3.11% for 2022 compared to 2.88% in 2021. The increase in the 2022 net interest margin was due primarily to a 0.34% increase in the yield on earning assets from 3.06% in 2021 to 3.40% in 2022 as all asset classes had higher yields in 2022. This increase was primarily the result of action by theFederal Reserve to increase short-term interest rates in 2022. The cost of interest-bearing liabilities increased from 0.16% for 2021 to 0.29% for 2022. Likewise, the cost of all deposits increased from 0.12% in 2021 to 0.23% in 2022. ? ?Average earning assets for 2022 were$1.7 billion compared to$1.6 billion in 2021, an increase of 6.1%. In 2022, the average balance of interest-earning cash balances increased$50.3 million (46.1%), the average balance of the investment portfolio increased$23.7 million (4.9%) and the average balance of the loan portfolio increased$24.5 million (2.4%), over the prior year averages. Within the loan portfolio, average commercial loan balances increased$20.3 million during the year, net of a$39.5 million decrease in the average balance of PPP loans year over year. Total deposits averaged$1.6 billion for 2022, an increase of$143.2 million (9.6%) over the average balance for 2021. All deposit categories reported a year-over-year increase in average balances, except for time deposits. ? ?Year-to-date, the provision for loan loss expense was$650 thousand compared to a$2.1 million provision expense reversal for the same period in 2021. The allowance for loan loss ratio was 1.35% of gross loans as ofDecember 31, 2022 , compared to 1.51% atDecember 31, 2021 due to continued improvement in the credit quality of the loan portfolio. ?Noninterest income was$15.3 million compared to$19.5 million in 2021. Significant year-over-year variances that contributed to the decrease include the$1.8 million gain on the sale of the Bank's former headquarters building in 2021, a decrease in gains on the sale of mortgages ($1.7 million ) and a decrease in debit card income ($302 thousand ). ? ?Noninterest expense was$48.7 million in 2022 compared to$43.2 million in 2021. The following categories contributed to the year-over-year increase: salaries and benefits increased$3.3 million (primarily incentive compensation and health insurance), net occupancy increased$489 thousand (primarily depreciation on the new headquarters building and rent expense from a new community office opened inJuly 2022 inHagerstown, MD ), and data processing expense increased$725 thousand (implementation of a customer relationship management system). ? ?The effective tax rate was 14.6% for 2022. Total assets atDecember 31, 2022 were$1.700 billion compared to$1.774 billion atDecember 31, 2021 , a decrease of 4.2%. Significant balance sheet changes sinceDecember 31, 2021 , include: ?Short-term interest-bearing deposits in other banks decreased$117.7 million (71.5%) and the investment portfolio decreased$43.0 million (8.1%). ? ?The net loan portfolio increased$53.1 million over the year-end 2021 balance, with commercial purpose loans increasing$33.4 million from year-end 2021. ? ?Deposits decreased$32.9 million (2.1%) over year-end 2021 with decreases in commercial money management and interest-bearing accounts, and time deposit balances. ? ?Shareholders' equity decreased$42.9 million fromDecember 31, 2021 . Retained earnings increased$9.3 million in 2022 but was offset by a decrease of$50.7 million in accumulated other comprehensive income (AOCI) as the fair value of the investment portfolio declined during the year. AtDecember 31, 2022 , the book value of the Corporation's common stock was$26.01 per share and tangible book value was$23.96 per share. InDecember 2022 , an open market 22
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repurchase plan was approved to repurchase 150,000 shares over a one-year
period. The Bank is considered to be well-capitalized under the regulatory
guidance as of
Other key performance measurements are presented in Item 7 of this report.
A more detailed discussion of the areas that had the greatest effect on the reported results follows.
Net Interest Income
The most important source of the Corporation's earnings is net interest income, which is defined as the difference between income on interest-earning assets and the expense of interest-bearing liabilities supporting those assets. Principal categories of interest-earning assets are loans and securities, while deposits, short-term borrowings and long-term debt are the principal categories of interest-bearing liabilities. For the purpose of this discussion, balance sheet items refer to the average balance for the year and net interest income is adjusted to a fully taxable-equivalent basis. This tax-equivalent adjustment facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Corporation's 21% Federal statutory rate. The components of net interest income are detailed in Tables 1, 2 and 3. Table 1 shows the change in tax-equivalent net interest income year over year. Changes in interest income and expense are driven by changes in balance (volume) and changes in the average rate on interest-earning assets and interest-bearing liabilities. The changes attributable to rate or volume are shown in Table 2. The yield on earning assets (Table 3) increased to 3.40% for 2022 from 3.06% for 2021. The benefit provided by tax-exempt income was$1.4 million in 2022. Table 1. Net Interest Income Change (Dollars in thousands) 2022 2021 $ % Interest income$ 56,449 $ 47,573 $ 8,876 18.7 Interest expense 4,863 2,902 1,961 67.6 Net interest income 51,586 44,671 6,915 15.5 Tax equivalent adjustment 1,381 1,466 (85) (5.8)
Tax equivalent net interest income
Table 2 identifies increases and decreases in tax equivalent net interest income
due to either changes in average volume or to changes in average rates for
interest-earning assets and interest-bearing liabilities. Numerous and
simultaneous balance and rate changes occur during the year. The amount of
change that is not due solely to volume or rate is allocated proportionally to
both.
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Table 2. Rate-Volume Analysis of Tax Equivalent Net Interest Income
2022 Compared to 2021 2021 Compared to 2020
Increase (Decrease) due to: Increase (Decrease) due to: Increase (Decrease) due to:
(Dollars in thousands) Volume Rate Net Volume Rate Net
Interest earned on:
Interest-bearing
obligations in other banks $ 164 $ 2,070 $ 2,234 $ 159 $ (386) $ (227)
Investment securities:
Taxable 623 2,136 2,759 3,262 (771) 2,491
Nontaxable (242) 174 (68) 877 (168) 709
Loans:
Commercial, industrial and
agriculture 828 2,199 3,027 237 (924) (687)
Residential mortgage 60 48 108 (89) (271) (360)
Home equity loans and lines 88 664 752 397 (849) (452)
Consumer (63) 42 (21) 10 209 219
Loans 913 2,953 3,866 555 (1,835) (1,280)
Total net change in
interest income 1,458 7,333 8,791 4,853 (3,160) 1,693
Interest expense on:
Interest-bearing checking 87 271 358 164 (439) (275)
Money management 87 1,625 1,712 230 (988) (758)
Savings 10 27 37 18 (59) (41)
Time deposits (46) (98) (144) (110) (514) (624)
Subordinate notes 2 (4) (2) 619 3 622
Total net change in
interest expense 140 1,821 1,961 921 (1,997) (1,076)
Change in tax equivalent
net interest income $ 1,318 $ 5,512 $ 6,830 $ 3,932 $ (1,163) $ 2,769
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The following table presents average balances, tax-equivalent (T/E) interest income and expense, and yields earned or rates paid on the assets or liabilities. Nonaccrual loans are included in the average loan balances.
Table 3. Analysis of Net Interest Income
2022 2021
Average Income or Average Average Income or Average
(Dollars in thousands) balance expense yield/rate balance expense yield/rate
Interest-earning assets:
Interest-earning deposits in other banks$ 159,610 $ 2,483 1.56%$ 109,263 $ 249 0.23% Investment securities: Taxable 424,703 9,975 2.35% 392,789 7,216 1.84% Tax exempt 85,566 2,593 3.03% 93,764 2,661 2.84% Investments 510,269 12,568 2.46% 486,553 9,877 2.03% Loans: Commercial, industrial and agricultural 869,536 37,009 4.26% 849,201 33,982 4.00% Residential mortgage 70,294 2,490 3.54% 68,581 2,382 3.47% Home equity loans and lines 86,851 2,855 3.29% 83,465 2,103 2.52% Consumer 5,938 425 7.16% 6,855 446 6.51% Loans 1,032,619 42,779 4.14% 1,008,102 38,913 3.86% Total interest-earning assets 1,702,499$ 57,830 3.40% 1,603,918$ 49,039 3.06% Other assets 87,300 67,381 Total assets$ 1,789,799 $ 1,671,299 Interest-bearing liabilities: Deposits: Interest-bearing checking$ 543,553 $ 879 0.16%$ 472,596 $ 521 0.11% Money Management 588,728 2,542 0.43% 537,010 830 0.15% Savings 128,203 101 0.08% 112,506 64 0.06% Time 64,273 294 0.46% 72,525 438 0.60% Total interest-bearing deposits 1,324,757 3,816 0.29% 1,194,637 1,853 0.16% Subordinate notes 19,605 1,047 5.34% 19,571 1,049 5.36% Total interest-bearing liabilities 1,344,362 4,863 0.36% 1,214,208 2,902 0.24% Noninterest-bearing deposits 306,102 293,027 Other liabilities 11,052 15,427 Shareholders' equity 128,283 148,637 Total liabilities and shareholders' equity$ 1,789,799 $ 1,671,299 T/E net interest income/Net interest margin 52,967 3.11% 46,137 2.88% Tax equivalent adjustment (1,381) (1,466) Net interest income$ 51,586 $ 44,671 Net Interest Spread 3.04% 2.82% Cost of Funds 0.29% 0.19% Cost of Deposits 0.23% 0.12% Provision for Loan Losses In 2022, the Bank recorded gross loan charge-offs of$1.6 million , which were offset by$103 thousand of recoveries, resulting in net loan charge-offs of$1.5 million . For 2022, the Corporation recorded$650 thousand as a provision for loan loss expense. The charge-off was primarily related to the sale of a$5.1 million nonaccrual loan and the sale improved the credit quality of the loan portfolio. Therefore, the allowance for loan losses decreased to$14.2 million at year-end 2022 (1.35% of total loans), compared to$15.1 million at year-end 2021 (1.51% of total loans). Management closely monitors the credit quality of the portfolio in order to ensure that an appropriate ALL is maintained. As part of this process, Management performs a comprehensive analysis of the loan portfolio considering delinquencies trends and events, current economic conditions, and other relevant factors to determine the adequacy of the allowance for loan losses and the provision for loan losses. For more information, refer to the Loan Quality discussion and Table 10. 25
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Table of Contents Noninterest Income
The following table presents a comparison of noninterest income for the years
ended
Table 4. Noninterest Income
Change
(Dollars in thousands) 2022 2021 Amount %
Noninterest Income
Investment and trust services fees $ 7,152 $ 7,111 $ 41 0.6
Loan service charges 724 904 (180) (19.9)
Gain on sale of loans 770 2,430 (1,660) (68.3)
Deposit service charges and fees 2,527 2,258 269 11.9
Other service charges and fees 1,724 1,650 74 4.5
Debit card income 1,868 2,170 (302) (13.9)
Increase in cash surrender value of life insurance 436 446 (10) (2.2)
Bank owned life insurance gain - 295 (295) (100.0)
Net (losses) gains on sales of debt securities (91) 127 (218) (171.7)
Change in fair value of equity securities (69) 90 (159) (176.7)
Gain on sale of bank premises - 1,776 (1,776) (100.0)
Other 209 231 (22) (9.5)
Total $ 15,250 $ 19,488 $ (4,238) (21.7)
The most significant changes in noninterest income are discussed below:
Investment and Trust Service fees: These fees are comprised of asset management fees, estate administration and settlement fees, employee benefit plans, and commissions from the sale of insurance and investment products. Asset management fees are recurring in nature and are affected by the fair value of assets under management at the time the fees are recognized. Asset management fees totaled$6.5 million for 2022 and 2021 with fluctuations in value during the year affecting fee income. The fair value of trust assets under management was$904.3 million at year-end, compared to$947.0 million at the end of 2021. Estate fees increased by$44 thousand , to$498 thousand in 2022. By the nature of an estate settlement, these fees are considered nonrecurring. Commissions from the sale of insurance and investment products increased by$5 thousand compared to 2021.
Loan service charges: This category includes primarily commercial letter of credit fees, commercial loan prepayment penalties, mortgage servicing fees and consumer debt protection fees.
Gain on sale of loans: This category is comprised of fees from the sale of mortgages with servicing released in the secondary market. Due to lower origination volume, the Bank sold fewer loans in 2022 compared to 2021.
Deposit fees: This category is comprised primarily of fees from overdrafts, an overdraft protection program, service charges, and account analysis fees. The increase of$269 thousand in this category was due to the addition of new deposit products and an increase in overdraft program fees partially offset by a reduction due to the elimination of most nonsufficient fund fees.
Other service charges and fees: The most significant items in this category
include fees from the Bank's merchant card program and ATM fees. Merchant card
fees increased
Debit card income: Debit card fees are comprised of both a retail and business card program. Retail fees decreased by$333 thousand , while business card fees increased$31 thousand . The business debit card offers a cash back rewards program based on usage, while the retail debit card offers reward points based on usage. Debit card income is reported net of reward program expense.
Bank owned life insurance gain: The Bank received death benefits from bank-owned life insurance policies in 2021 and none in 2022.
Gain on sale of bank premises: In 2021, the Bank sold its previous headquarters
and operations center at
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Table of Contents Noninterest Expense
The following table presents a comparison of noninterest expense for the years
ended
Table 5. Noninterest Expense(Dollars in thousands) Change Noninterest Expense 2022 2021 Amount % Salaries and benefits$ 28,094 $ 24,780 $ 3,314 13.4 Net occupancy 4,069 3,580 489 13.7 Marketing and advertising 1,915 1,533 382 24.9 Legal and professional 2,202 2,013 189 9.4 Data processing 4,751 4,026 725 18.0 Pennsylvania bank shares tax 1,148 1,017 131 12.9 FDIC insurance 736 735 1 0.1 ATM/debit card processing 1,428 1,305 123 9.4 Telecommunications 396 407 (11) (2.7) Nonservice pension 567 819 (252) (30.8) Other 3,385 3,030 355 11.7 Total$ 48,691 $ 43,245 $ 5,446 12.6
The most significant changes in noninterest expense are discussed below:
Salaries and benefits: This category is the largest noninterest expense category and includes expenses for salaries, health benefits, insurance, pension service, employment taxes and other employee benefit programs. This category increased by$3.3 million compared to the prior year from: salary increases of$1.8 million due to merit and annual increases, and new positions,$354 thousand for incentive compensation plans,$255 thousand in health insurance expense, and$258 thousand in stock compensation expense. See Note 17 of the accompanying consolidated financial statements for additional information on benefit plans. Net Occupancy: This category includes all of the expense associated with the properties and facilities used for bank operations such as depreciation, leases, maintenance, utilities and real estate taxes. Depreciation increased during 2022 as the Bank began to depreciate its new headquarters building and rent expense increased from a new community office opened inJuly 2022 inHagerstown, MD . Legal and professional fees: This category consists of fees paid to outside legal counsel, consultants, and audit fees. Consulting fees increased$128 thousand due to advisory services related to the implementation of a customer relationship management system. Internal and external audit fees increased by$80 thousand . Data processing: The largest cost in this category is the expense associated with the Bank's core processing system and related services and accounted for$2.3 million of the total data processing costs in 2022 and 2021. An increase in software expense for a customer relationship management system contributed$655 thousand to the total increase in this category.
Nonservice pension: The decrease in the nonservice pension expense was due to a$135 thousand reduction in pension settlement costs related to lump-sum pension payouts during 2022 and lower asset returns and amortization.
Provision for Income Taxes
In 2022, the Corporation recorded a Federal income tax expense of$2.6 million compared to$3.4 million in 2021. The effective tax rate for 2022 and 2021 was 14.6% and 14.8%, respectively. The Corporation's 2022 and 2021 effective tax rate was lower than its statutory rate due to the effect of tax-exempt income from certain investment securities, loans, and bank owned life insurance. For a more comprehensive analysis of Federal income tax expense refer to Note 14 of the accompanying consolidated financial statements.
Financial Condition
One method of evaluating the Corporation's condition is in terms of its sources and uses of funds. Assets represent uses of funds while liabilities represent sources of funds. AtDecember 31, 2022 , total assets decreased 4.2% over the prior year to$1.70 billion from$1.77 billion at the end of 2021. 27
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Interest Earning Deposits in Other Banks:
Short-term interest-earning deposits, held primarily at theFederal Reserve , decreased to$47.0 million atDecember 31, 2022 compared to$164.9 million atDecember 31, 2021 , as the excess cash was redeployed into the loan portfolio and deposit balances decreased. Long-term interest-earning deposits increased from$10.5 million atDecember 31, 2021 to$14.0 million atDecember 31, 2022 . The average balance of interest-earning deposits increased to$159.6 million in 2022 compared to$109.3 million in 2021.
The investment portfolio serves as a mechanism to invest funds if funding sources out pace lending activity, to provide liquidity for lending and operations, and provide collateral for deposits and borrowings. The mix of securities and investing decisions are made as a component of balance sheet management. Debt securities includeU.S. Government Agencies,U.S. Government Agency mortgage-backed securities, non-agency mortgage-backed securities, state and municipal government bonds, and corporate debt primarily in the form of bank-issued subordinated debt. The weighted average life of the portfolio is 5.5 years, the effective duration is 4.3%, and$208.9 million (fair value) is pledged as collateral for deposits. The Bank has no investments in a single issuer that exceeds 10% of shareholders equity, except forU.S. Treasuries. All securities are classified as available for sale and all investment balances refer to fair value, unless noted otherwise. The following table presents the amortized cost and estimated fair value of investment securities by type atDecember 31 for the past two years: Table 6.Investment Securities at Amortized Cost and Estimated Fair Value 2022 2021 Amortized Fair Amortized Fair (Dollars in thousands) Cost value Cost value U.S. Treasury$ 101,980 $ 90,257 $ 84,896 $ 84,286 Municipal 186,007 155,455 206,501 212,227 Corporate 26,316 24,239 24,794 24,939 Agency mortgage & asset-backed 163,274 150,935 178,614 177,685 Non-agency mortgage & asset-backed 70,756 65,950 30,912 30,674 Total$ 548,333 $ 486,836 $ 525,717 $ 529,811 The following table presents investment securities atDecember 31, 2022 by maturity, and the weighted average yield for each maturity presented. Actual maturities may differ from contractual maturities because of prepayment or call options embedded in the securities. The yields presented in this table are calculated using tax-equivalent interest and the amortized cost. Table 7. Maturity Distribution of Investment Portfolio After one year After five years After ten One year or less through five years through ten years years Total Fair Fair Fair Fair Fair (Dollars in thousands) Value Yield Value Yield Value Yield Value Yield Value Yield Available for Sale U.S. Treasury$ 12,782 4.25%$ 5,713 2.60%$ 71,762 1.29% $ - -$ 90,257 1.74% Municipal - - 4,842 3.11%
38,516 2.35% 112,097 2.50% 155,455 2.48% Corporate
- - 2,111 6.18% 21,138 4.86% 990 4.28% 24,239 4.95% Agency mortgage & asset-backed
556 2.19% 2,509 1.75% 39,720 2.40% 108,150 3.62% 150,935 3.25%
Non-agency mortgage
& asset-backed 3,098 6.55% 15,525 5.22% 3,994 4.26% 43,333 3.59% 65,950 4.14%
Total $ 16,436 4.62% $ 30,700 4.19% $ 175,130 2.24% $ 264,570 3.11% $ 486,836 2.93%
Table 3, previously presented, shows the two-year trend of average balances and
yields on the investment portfolio. The tax-equivalent yield on the portfolio
increased from 2.03% in 2021 to 2.46% in 2022. U.S. Agency mortgage-backed
securities and municipal bonds continue to comprise the largest sectors by fair
value of the portfolio, approximately 31% and 32% respectively. The Bank expects
that the portfolio will continue to remain concentrated in these investment
sectors. The portfolio produced $60.5 million in cash flows in 2022 while
$87.2 million was invested into the portfolio during the year.
Municipal Bonds: This sector holds $155.5 million or 32% of the total portfolio
and the amortized cost decreased by $20.5 million year over year. The Bank's
municipal bond portfolio is well diversified geographically and is comprised of
both tax-exempt (40% of the portfolio) and taxable (60% of the portfolio)
municipal bonds. Sixty-five percent of the portfolio are general obligation
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bonds and thirty-five percent are revenue bonds. The portfolio holds bonds from 179 issuers within 34 states. The largest dollar exposure is in the states ofTexas (14%),Pennsylvania (13%) andCalifornia (12%). When purchasing municipal bonds, the Bank looks primarily to the underlying credit of the issuer as a sign of credit quality and then to any credit enhancement. The entire portfolio is rated "A" or higher by a nationally recognized statistical rating organization.
Corporate Bonds: This sector is comprised primarily of
Agency Mortgage & Asset-backed Securities (MBS): This sector holds$150.9 million , or 31%, of the total portfolio. This sector is comprised of bonds issued and guaranteed by theU.S. Government , aU.S. Government Agency , or a government sponsored entity securitized by pools of residential mortgages and other loan assets.Non-Agency Mortgage & Asset-backed Securities (ABS): This sector holds$66.0 million , or 14%, of the total portfolio. This sector is comprised of senior private label first-lien commercial and residential mortgages. As senior position bonds, they benefit from credit support in the form of junior tranches and reserve funds that absorb loss prior to the senior bonds. This sector has$42.7 million of its fair value investment grade rated by nationally recognized statistical rating organizations while$23.1 million of its fair value is not rated. Impairment: For securities with an unrealized loss, Management applies a systematic methodology in order to perform an assessment of the potential for other-than-temporary impairment. In the case of debt securities, investments considered for other-than-temporary impairment: (1) had a specified maturity or repricing date, (2) were generally expected to be redeemed at par, and (3) were expected to achieve a recovery in market value within a reasonable period of time. In addition, the Bank considers whether it intends to sell these securities or whether it will be forced to sell these securities before the earlier of amortized cost recovery or maturity. The impairment identified on debt securities and subject to assessment atDecember 31, 2022 , was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted. The Bank recorded no impairment charges in 2022.
The Corporation owns one equity investment with a readily determinable fair
value. At
Restricted Stock at Cost
The Bank held$644 thousand of restricted stock at the end of 2022 of which$614 thousand is stock in theFederal Home Loan Bank of Pittsburgh (FHLB). FHLB stock is carried at a cost of$100 per share. FHLB stock is evaluated for impairment primarily based on an assessment of the ultimate recoverability of its cost. As a government sponsored entity, FHLB has the ability to raise funding through theU.S. Treasury that can be used to support its operations. There is not a public market for FHLB stock and the benefits of FHLB membership (e.g., liquidity and low-cost funding) add value to the stock beyond purely financial measures. If FHLB stock were deemed to be impaired, the write-down for the Bank could be significant. Management intends to remain a member of the FHLB and believes that it will be able to fully recover the cost basis of this investment.
Loans:
The loan portfolio increased by 5.4% ($53.1 million ) in 2022, due primarily to an increase of$43.9 million in commercial real estate loans. Average gross loans for 2022 increased by$24.5 million to$1.0 billion . Commercial, mortgage and home equity loans and lines all showed an increase in average balances during the year, which was partially offset by a decline in consumer loans. The yield on the portfolio increased in 2022 to 4.14% from 3.86% in 2021. Table 3, previously presented, shows the average balances and yields earned on loans for the past two years. 29
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The following table shows loans outstanding, by class, as ofDecember 31 for the past 2 years. Table 8. Loan Portfolio Change (Dollars in thousands) 2022 2021 Amount % Residential real estate 1-4 family Consumer first lien$ 82,795 $ 71,828 $ 10,967 15.3 Commercial first lien 61,702 60,655 1,047 1.7 Total first liens 144,497 132,483 12,014 9.1 Consumer junior lien and lines of credit 69,561 67,103 2,458 3.7 Commercial junior liens and lines of credit 4,127 4,841 (714) (14.7) Total junior liens and lines of credit 73,688 71,944
1,744 2.4 Total residential real estate 1-4 family 218,185 204,427 13,758 6.7
Residential real estate construction Consumer 13,908 8,278 5,630 68.0 Commercial 10,485 12,379 (1,894) (15.3) Total residential real estate construction 24,393 20,657 3,736 18.1 Commercial real estate 566,662 522,779 43,883 8.4 Commercial 235,602 244,543 (8,941) (3.7) Total commercial 802,264 767,322 34,942 4.6 Consumer 6,199 6,406 (207) (3.2) Total loans 1,051,041 998,812 52,229 5.2 Less: Allowance for loan losses (14,175) (15,066) 891 (5.9) Net loans$ 1,036,866 $ 983,746 $ 53,120 5.4 Residential real estate: This category is comprised of first lien loans and, to a lesser extent, junior liens and lines of credit secured by residential real estate. Total residential real estate loans increased$13.8 million in 2022 from 2021, primarily in consumer first lien loans. In 2022, the Bank originated$81.7 million in mortgages compared to$127.6 million in 2021, including approximately$51.3 million for sale in the secondary market. The Bank does not originate or hold any loans that would be considered sub-prime or Alt-A and does not generally originate mortgages outside of its primary market area. Commercial purpose loans in this category represent loans made for various business needs but are secured with residential real estate. In addition to the real estate collateral, it is possible that additional security is provided by personal guarantees or UCC filings. These loans are underwritten as commercial loans and are not originated to be sold. Residential real estate construction: The largest component of this category represents loans for individuals to construct personal residences totaled$13.9 million , while loans to residential real estate developers and home builders totaled$10.5 million atDecember 31, 2022 . The Bank's exposure to residential construction loans is concentrated primarily in south centralPennsylvania . Real estate construction loans, including residential real estate and land development loans, occasionally provide an interest reserve in order to assist the developer during the development stage when minimal cash flow is generated. Commercial real estate (CRE): This category includes commercial, industrial, and farm loans, where real estate serves as the primary collateral for the loan. This loan category increased by$43.9 million over the prior year. The largest sectors (by collateral) are: hotel & motel ($81.3 million ), office buildings ($58.4 million ), shopping center ($55.4 million ) and development land ($43.8 million ). The majority of the Bank's hotel exposure is located along theInterstate 81 (I-81 ) corridor through south-centralPennsylvania . The portfolio is comprised of properties operating under 14 flagged brands and 3 independent operators. Also included in CRE are real estate construction loans totaling$89.2 million . AtDecember 31, 2022 , the Bank had$22.8 million in real estate construction loans funded with an interest reserve and capitalized$776 thousand of interest in 2022 from these reserves on active projects for commercial construction. Real estate construction loans are monitored on a regular basis by either an independent third-party inspector or the assigned loan officer depending on loan amount or complexity of the project. This monitoring process includes, at a minimum, the submission of invoices or AIA documents (depending on the complexity of the project) detailing costs incurred by the borrower, on-site inspections, and a signature by the assigned loan officer for disbursement of funds. All real estate construction loans are underwritten in the same manner, regardless of the use of an interest reserve. 30
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Commercial: This category includes commercial, industrial, farm, agricultural, and tax-free loans. Collateral for these loans may include business assets or equipment, personal guarantees, or other non-real estate collateral. Commercial loans decreased$8.9 million over the 2021 ending balance, primarily due to PPP loan forgiveness of$7.6 million . AtDecember 31, 2022 , the Bank had approximately$118 million of tax-free loans in its portfolio. The largest sectors (by industry) are: utilities ($43.0 million ), public administration ($41.8 million ), real estate, rental and leasing ($24.6 million ) and manufacturing ($16.6 million ). This category also includes$179 thousand of PPP loans that are 100% guaranteed by the SBA, compared to$7.8 million atDecember 31, 2021 . Participations: AtDecember 31, 2022 , the outstanding commercial participations accounted for 10.1% of commercial purpose loans, or$70.6 million , and 6.7% of total gross loans compared to 9.2%, or$77.5 million , and 7.8%, respectively, at the prior year-end. The Bank's total exposure (including unfunded commitments) to purchased participations was$90.0 million atDecember 31, 2022 and$95.9 million atDecember 31, 2021 . The commercial loan participations are comprised of$19.9 million of commercial loans and$50.7 million of CRE loans, reported in the respective loan segment.
Consumer loans: This category is comprised of installment loans and personal
lines of credit, and decreased
Table 9. Maturities and Interest Rate Terms of Selected Loans
The following table presents the stated maturities (or earlier call dates) of
selected loans as of
Less than Over
(Dollars in thousands) 1 year 1-5 years 5-15 years 15 years Total
Loans:
Residential real estate 1-4 family
Fixed rate $ 1,287 $ 8,756 $ 48,546 $ 15,464 $ 74,053
Variable rate 2,744 12,973 52,743 75,672 144,132
4,031 21,729 101,289 91,136 218,185
Residential real estate construction
Fixed rate 143 - - - 143
Variable rate 8,838 1,406 242 13,764 24,250
8,981 1,406 242 13,764 24,393
Commercial real estate
Fixed rate 3,384 58,974 78,165 - 140,523
Variable rate 41,510 84,325 258,030 42,274 426,139
44,894 143,299 336,195 42,274 566,662
Commercial
Fixed rate 3,167 43,735 46,919 8,349 102,170
Variable rate 46,197 7,763 35,003 44,469 133,432
49,364 51,498 81,922 52,818 235,602
Consumer
Fixed rate 203 2,276 115 1,629 4,223
Variable rate 683 446 847 - 1,976
886 2,722 962 1,629 6,199
$ 108,157 $ 220,653 $ 520,610 $ 201,621 $ 1,051,041
Loan Quality:
Management utilizes a risk rating scale ranging from 1-Prime to 9-Loss to
evaluate loan quality. This risk rating scale is used primarily for commercial
purpose loans. Consumer purpose loans are identified as either a pass or
substandard rating based on the performance status of the loans. Substandard
consumer loans are loans that are 90 days or more past due and still accruing.
Loans rated 1 - 4 are considered pass credits. Loans that are rated 5-Pass Watch
are credits that have been identified as credits that are likely to warrant
additional attention and monitoring. Loans rated 6-Other Asset Especially
Mentioned (OAEM) or worse begin to receive enhanced monitoring and reporting by
the Bank. Loans rated 7-Substandard or 8-Doubtful exhibit the greatest financial
weakness and present the greatest possible risk of loss to the Bank. Nonaccrual
loans are rated no better than 7-Substandard. The following represent some of
the factors used in determining the risk rating of a borrower: cash flow, debt
coverage, liquidity, management, and collateral. Risk ratings, for pass credits,
are generally reviewed annually for term debt and at renewal for revolving or
renewing debt. The Bank monitors overall loan quality of the portfolio by
reviewing three primary measurements: (1) loans rated 6-OAEM or worse
(collectively "watch list"), (2) delinquent loans, and (3) net-charge-offs.
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Watch list loans exhibit financial weaknesses that increase the potential risk of default or loss to the Bank. However, inclusion on the watch list, does not by itself, mean a loss is certain. The watch list includes both performing and nonperforming loans. Watch list loans totaled$11.6 million at year-end compared to$36.6 million one year earlier. Included in the watch list are$120 thousand of nonaccrual loans at year-end 2022, compared to$7.4 million at year-end 2021. The composition of the watch list (loans rated 6, 7 or 8), by primary collateral, is shown in Note 6 of the accompanying financial statements. Delinquent loans are a result of borrowers' cash flow and/or alternative sources of cash being insufficient to repay loans. The Bank's likelihood of collateral liquidation to repay the loans becomes more probable the further behind a borrower falls, particularly when loans reach 90 days or more past due. Management monitors the performance status of loans by the use of an aging report. The aging report can provide an early indicator of loans that may become severely delinquent and possibly result in a loss to the Bank. See Note 6 in the accompanying financial statements for information on the aging of payments in the loan portfolio. Nonaccruing loans generally represent Management's determination that the borrower will be unable to repay the loan in accordance with its contractual terms and that collateral liquidation may or may not fully repay both interest and principal. It is the Bank's policy to evaluate the probable collectability of principal and interest due under terms of loan contracts for all loans 90-days or more, nonaccrual loans, or impaired loans. Further, it is the Bank's policy to discontinue accruing interest on loans that are not adequately secured and in the process of collection. Upon determination of nonaccrual status, the Bank subtracts any current year accrued and unpaid interest from its income, and any prior year accrued and unpaid interest from the allowance for loan losses. Management continually monitors the status of nonperforming loans, the value of any collateral and potential of risk of loss. Nonaccrual loans are rated no better than 7-Substandard. The Bank's Loan Management Committee reviews these loans and risk ratings on a quarterly basis in order to proactively identify and manage problem loans. In addition, a committee meets monthly to discuss possible workout strategies for all credits rated 7-Substandard or worse and OREO. Management also tracks other commercial loan risk measurements including high loan to value loans, concentrations, participations and policy exceptions and reports these to the Board Enterprise Risk Management Committee of the Board of Directors. The Bank also uses a third-party consultant to assist with internal loan review with a goal of reviewing 80% of commercial loans each year. TheFDIC defines certain supervisory loan-to-value lending limits. The Bank's internal loan-to-value limits are all equal to or less than the supervisory loan-to-value limits. However, in certain circumstances, the Bank may make a loan that exceeds the supervisory loan-to-value. AtDecember 31, 2022 , the Bank had loans of$12.6 million (1.2% of gross loans) that exceeded the supervisory loan-to value limit, compared to 1.8% at the prior year end. Nonaccrual loans decreased by$7.3 million from year-end 2021, primarily in the commercial real estate category as a result of the sale of one loan and paydowns during the year. The Bank sold a$5.1 million CRE loan that was on nonaccrual status as it did not exhibit long-term performance capacity, resulting in a charge-off of$1.5 million . In addition to monitoring nonaccrual loans, the Bank also closely monitors impaired loans and troubled debt restructurings (TDR). A loan is considered to be impaired when, based on current information and events, it is probable that the Bank will be unable to collect all interest and principal payments due according to the originally contracted terms of the loan agreement. Nonaccrual loans (excluding consumer purpose loans) and TDR loans are considered impaired. A loan is considered a troubled debt restructuring (TDR) if the creditor (the Bank), for economic or legal reasons related to the debtor's financial difficulties, grants a concession to the debtor that it would not otherwise consider. These concessions may include lowering the interest rate, extending the maturity, reamortization of payment, or a combination of multiple concessions. The Bank reviews all loans rated 6-OAEM or worse when it is providing a loan restructure, modification or new credit facility to determine if the action is a TDR. If a TDR loan is placed on nonaccrual status, it remains on nonaccrual status for at least six months to ensure performance. In accordance with financial accounting standards, TDR loans are always considered impaired until they are paid-off or in certain circumstances refinanced. However, an impaired TDR loan can be a performing loan under its modified terms. Impaired loans totaled$3.0 million at year-end compared to$11.6 million at the prior year end. The decrease was due primarily to the loan sale previously discussed. Allowance for Loan Losses: Management monitors loan performance on a monthly basis and performs a quarterly evaluation of the adequacy of the allowance for loan losses (ALL). The ALL is determined by segmenting the loan portfolio based on the loan's collateral. When calculating the ALL, consideration is given to a variety of factors in establishing this estimate including, but not limited to, current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, historical charge-offs, the adequacy of the underlying collateral (if collateral dependent) and other relevant factors. The Bank begins enhanced monitoring of all loans rated 6-OAEM or worse and obtains a new appraisal or asset valuation for any loans placed on nonaccrual and rated 7 - Substandard or worse. Management, at its discretion, may determine that additional adjustments to the appraisal or valuation are 32
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required. Valuation adjustments will be made as necessary based on factors, including, but not limited to: the economy, deferred maintenance, industry, type of property/equipment, age of the appraisal, etc. and the knowledge Management has about a particular situation. In addition, the cost to sell or liquidate the collateral is also estimated and deducted from the valuation in order to determine the net realizable value to the Bank. When determining the allowance for loan losses, certain factors involved in the evaluation are inherently subjective and require material estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans. Management monitors the adequacy of the allowance for loan losses on an ongoing basis and reports its adequacy quarterly to the Board Enterprise Risk Management Committee of the Board of Directors. Management believes that the allowance for loan losses atDecember 31, 2022 is adequate. The analysis for determining the ALL is consistent with guidance set forth in generally accepted accounting principles (GAAP) and the Interagency Policy Statement on the Allowance for Loan and Lease Losses. The analysis has three components: specific, general and unallocated. The specific component addresses specific reserves established for impaired loans. A loan is considered to be impaired when, based on current information and events, it is probable that the Bank will be unable to collect all interest and principal payments due according to the originally contracted terms of the loan agreement. Collateral values discounted for market conditions and selling costs are used to establish specific allocations for impaired loans. However, it is possible that as a result of the credit analysis, a specific reserve is not required for an impaired loan. Commercial loans with a balance less than$250 thousand , and all consumer purpose loans are not included in the specific reserve analysis as impaired loans but are added to the general allocation pool. Loans that are evaluated for a specific reserve, but not needing a specific reserve are not added back to the general allocation pool. The Bank had no loans with specific reserve atDecember 31, 2022 compared to one loan for$5.8 million with a specific reserve ($698 thousand ) atDecember 31, 2021 . Note 6 of the accompanying financial statements provides additional information about the ALL established for impaired loans. The general allocation component addresses the reserves established for pools of homogenous loans. The general component includes a quantitative and qualitative analysis. When calculating the general allocation, the Bank segregates its loan portfolio into the following segments based primarily on the type of supporting collateral: residential real estate, commercial, industrial or agricultural real estate; commercial and industrial (commercial non-real estate), and consumer. Each segment may be further segregated by type of collateral, lien position, or owner/nonowner occupied properties. PPP loans, because of the SBA guarantee, were excluded from the quantitative analysis. The quantitative analysis uses the Bank's twenty quarter rolling historical loan loss experience as determined for each loan segment to determine a loss factor applicable to each loan segment. The allowance established as a result of the quantitative analysis was$3.5 million compared to$2.8 million at year-end 2021. The qualitative analysis utilizes a risk matrix that incorporates four primary risk factors: economic conditions, delinquency, classified loans, and level of risk, and assigns a risk level (as measured in basis points) to each factor. In determining the risk level for these primary factors, consideration is given to operational factors such as: loan volume, management, loan review process, credit concentrations, competition, and legal and regulatory issues. The level of risk (as measured in basis points) for each primary factor is set for six risk levels ranging from minimal risk to extreme risk and is determined independently for commercial loans, residential mortgage loans and consumer loans. The qualitative component of the ALL decreased from$11.0 million at year-end 2021 to$10.0 million atDecember 31, 2022 . The unallocated component is maintained to cover uncertainties that could affect Management's estimate of probable loss. The unallocated component of the ALL reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. The unallocated allowance was$667 thousand atDecember 31, 2022 compared to$589 thousand atDecember 31, 2021 . Real estate appraisals and collateral valuations are an important part of the Bank's process for determining potential loss on collateral dependent loans and thereby have a direct effect on the determination of loan reserves, charge-offs and the calculation of the allowance for loan losses. As long as the loan remains a performing loan, no further updates to appraisals are required. If a loan or relationship migrates to nonaccrual and a risk rating of 7-Substandard or worse, an evaluation for impairment status is made based on the current information available at the time of downgrade and a new appraisal or collateral valuation is obtained. We believe this practice complies with the regulatory guidance. In determining the allowance for loan losses, Management, at its discretion, may determine that additional adjustments to the fair value obtained from an appraisal or collateral valuation are required. Adjustments will be made as necessary based on factors, including, but not limited to the economy, deferred maintenance, industry, type of property or equipment etc., and the knowledge Management has about a particular situation. In addition, the cost to sell or liquidate the collateral is also estimated and deducted from the valuation in order to determine the net realizable value to the Bank. If an appraisal is not available, Management may make its best estimate of the real value of the collateral or use last known market value and apply appropriate discounts. If an adjustment is made to the collateral valuation, this will be documented with appropriate support and reported to the Loan Management Committee. 33
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The following table shows the allocation of the allowance for loan losses and
other loan performance ratios, by class, as of
Table 10. Loan Performance Ratios
(Dollars in thousands) Residential Real Estate 1-4 Family
Junior Liens & Commercial
First Liens Lines of Credit Construction Real Estate Commercial Consumer Unallocated Total
2022
Loans at December 31, 2022 $ 144,497 $ 73,688 $ 24,393 $ 566,662 $ 235,602 $ 6,199 $ - $ 1,051,041
Average Loans for 2022 139,577 73,200 21,737 550,772 241,395 5,938 - 1,032,619
Nonaccrual Loans at December 31, 2022 120 - - - - - - 120
Allowance for Loan Losses at December 31, 2022 459 234 343 7,493 4,846 133 667 14,175 Net Recoveries/(Charge-offs) for 2022 28 2 - (1,450) (45) (76)
- (1,541)
Loans/Total Gross Loans at December 31,
2022 14% 7% 2% 54% 22% 1% - 100%
Nonaccrual Loans/Total Gross Loans at
December 31, 2022 0.08% 0.00% 0.00% 0.00% 0.00% 0.00% - 0.01%
Allowance for Loan Loss/Gross Loans at
December 31, 2022 0.32% 0.32% 1.41% 1.32% 2.06% 2.15% - 1.35%
Net Recoveries (Charge-offs)/Average
Loans for 2022 0.02% 0.00% 0.00% -0.26% -0.02% -1.28% - -0.15%
Allowance for Loan Loss/Nonaccrual Loans
at December 31, 2022 11,812.50%
2021
Loans at December 31, 2021 $ 132,483 $ 71,944 $ 20,657 $ 522,779 $ 244,543 $ 6,406 $ - $ 998,812
Average Loans for 2021 138,249 68,467 19,533
504,441 270,557 6,855 - 1,008,102
Nonaccrual Loans at
50 38 424 6,812 60 - - 7,384
Allowance for Loan Losses at December
31, 2021 475 252 325 8,168 5,127 130 589 15,066 Net Recoveries/(Charge-offs) for 2021
- 170 (28) (56) 455 (164) - 377
Loans/Total Gross Loans at December 31,
2021 13% 7% 2% 52% 24% 1% - 100%
Nonaccrual Loans/Total Gross Loans at
December 31, 2021 0.04% 0.05%
2.05% 1.30% 0.02% 0.00% - 0.74%
Allowance for Loan Loss/Gross Loans at
0.36% 0.35% 1.57% 1.56% 2.10% 2.03% - 1.51% Net Recoveries/(Charge-offs)/Average Loans for 2021
0.00% 0.25% -0.14% -0.01% 0.17% -2.39% - 0.04%
Allowance for Loan Loss/Nonaccrual
Loans at December 31, 2021 204.04%
Goodwill:
The Bank has $9.0 million of goodwill recorded on its balance sheet as the
result of corporate acquisitions. Goodwill is not amortized, nor deductible for
tax purposes. However, goodwill is tested for impairment at least annually in
accordance with ASC Topic 350. Goodwill was tested for impairment as of
August 31, 2022 . The 2022 test was conducted using a qualitative assessment
method that requires the use of significant assumptions in order to make a
determination of impairment. These assumptions may include, but are not limited
to: macroeconomic factors, banking industry conditions, banking merger and
acquisition trends, the Bank's historical financial performance, the
Corporation's stock price, forecast Bank financial performance, and change of
control premiums. Management determined the Bank's goodwill was likely not
impaired in 2022 and did not make a further assessment.
The 2021 impairment test was also conducted using a qualitative assessment and
Management determined the Bank's goodwill was likely not impaired in 2021 and
did not make a further assessment.
At December 31, 2022 , Management subsequently considered certain qualitative
factors affecting the Corporation and determined that it was not likely that the
results of the prior test had changed, and it determined that goodwill was not
impaired at year-end.
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Table of Contents Deposits: The Bank depends on deposits generated in the normal course of business as its primary source of funds. The Bank offers numerous deposit products including demand deposits (noninterest and interest-bearing accounts), savings, money management accounts, and time deposits (certificates of deposits/CDs) to retail, commercial, and municipal customers. Table 11 shows a comparison of the major deposit categories over a two-year period atDecember 31 . Table 3, presented previously, shows the average balance of the major deposit categories and the average cost of these deposits over a two-year period. Table 11. Deposits Change (Dollars in thousands) 2022 2021 Amount % Noninterest-bearing checking$ 299,231 $ 298,403 $ 828 0.3 Interest-bearing checking 496,533 511,969 (15,436) (3.0) Money management 569,585 579,826 (10,241) (1.8) Savings 128,709 119,908 8,801 7.3 Time deposits 57,390 74,253 (16,863) (22.7) Total$ 1,551,448 $ 1,584,359 $ (32,911) (2.1) Noninterest-bearing checking: This category was relatively flat year over year, increasing by only$828 thousand , while the average balance increased by$13.1 million for the year. As a noninterest bearing account, these deposits contributed approximately 7 basis points to the net interest margin. Interest-bearing checking: This category saw a decrease of$15.4 million in the ending balance and an increase of$71.0 million in the average balance for the year compared to prior year-end, while the cost of these accounts increased year over year by 5 basis points. The decrease was primarily in commercial accounts during 2022. Money management: The year over year balance decreased$10.2 million , in both retail and commercial accounts and the average balance increased$51.7 million compared to the 2021 average balance. The cost of this product increased by 28 basis points during the year as market rates increased. Savings: Savings accounts increased$8.8 million during the year and represents the fourteenth consecutive year of growth. The cost of this product increased by 2 basis points during the year as market rates increased.
Time deposits: Time deposits decreased in 2022, as customers moved funds to more liquid accounts.
Reciprocal deposits: At year-end 2022, the Bank had$197.4 million placed in the IntraFi Network deposit program ($133.5 million in interest-bearing checking and$63.9 million in money management) and$868 thousand of time deposits placed into the CDARS program. These programs allow the Bank to offer fullFDIC coverage to large depositors, but with the convenience to the customer of only having to deal with one bank. The Bank solicits these deposits from within its market and it believes they present no greater risk than any other local deposit. Only reciprocal deposits that exceed 20% of liabilities are considered brokered deposits. AtDecember 31, 2022 , the Bank's reciprocal deposits were 12.7% of total liabilities. The Bank continually reviews different methods of funding growth that include traditional deposits and other wholesale sources. Competition from other local financial institutions, internet banks, credit unions and brokerages will continue to be a challenge for the Bank in its efforts to attract new and retain existing deposit accounts. This competition is not expected to lessen in the future. Uninsured deposits: Estimated uninsured deposits atDecember 31, 2022 were$132.0 million (8.5% of total deposits) compared to$142.0 million (9.0% of total deposits) atDecember 31, 2021 . The insured deposit data for 2022 and 2021 reflect deposits at an aggregate level, and do not include public funds secured by collateral. 35
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At
Table 12. Time Deposits of $250,000 or More
Individual
Instruments that Time Deposits
Meet or Exceed that Meet or
FDIC Insurance Exceed FDIC
(Dollars in thousands) Limit Insurance Limit
Maturity distribution:
Within three months $ 1,020 $ 2,770
Over three through six months 1,588 3,088
Over six through twelve months 3 753 Over twelve months 1,426 2,176 Total $ 4,037 $ 8,787 Borrowings: Short-term Borrowings: The Bank has access to short-term borrowings from the FHLB in the form of a revolving term commitment used to fund the short-term liquidity needs of the Bank. These borrowings reprice on a daily basis and the interest rate fluctuates with short-term market interest rates. The Bank had no short-term borrowings atDecember 31, 2022 and 2021. The Bank's maximum borrowing capacity with the FHLB atDecember 31, 2022 was$405.2 million with$403.7 million available to borrow. Long-term Debt: OnAugust 4, 2020 , the Corporation completed the sale of a subordinated debt note offering. The Corporation sold$15.0 million of subordinated debt notes with a maturity date ofSeptember 1, 2030 . These notes are noncallable for 5 years and carry a fixed interest rate of 5% per year for 5 years and then convert to a floating rate of SOFR plus 4.93% per year for the remainder of the term. The notes can be redeemed at par beginning 5 years prior to maturity. The Corporation also sold$5.0 million of subordinated debt notes with a maturity date ofSeptember 1, 2035 . These notes are noncallable for 10 years and carry a fixed interest rate of 5.25% per year for 10 years and then convert to a floating rate of SOFR plus 4.92% per year for the remainder of the term. The notes can be redeemed at par beginning 5 years prior to maturity. The notes are structured to qualify as Tier 2 capital for the Corporation and any funds it invests in the Bank qualify as Tier 1 capital at the Bank. The Corporation paid an issuance fee of 2% of the total issue is being amortized to the maturity date of each issue on a pro-rata basis. The notes are recorded on the consolidated balance sheet net of unamortized debt issuance costs. The proceeds are intended to be used for general corporate purposes.
Shareholders' Equity:
Shareholders' equity decreased by
The Board of Directors frequently authorizes the repurchase of the Corporation's$1.00 par value common stock. Information regarding stock repurchase plans in place during the year are included in Item 5 Market for Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases ofEquity Securities . Additional information on Shareholders' Equity is reported in Note 20 of the accompanying consolidated financial statements. The Corporation's dividend reinvestment plan (DRIP) allows for shareholders to purchase additional shares of the Corporation's common stock by reinvesting cash dividends paid on their shares or through optional cash payments. The Dividend Reinvestment Plan (DRIP) added$1.4 million to capital during 2022. This total was comprised of$1.0 million from the reinvestment of quarterly dividends and$390 thousand of optional cash purchases. A strong capital position is important to the Corporation as it provides a solid foundation for the future growth of the Corporation, as well as instills confidence in the Bank by depositors, regulators and investors, and is considered essential by Management. The Corporation is continually exploring other sources of capital as part of its capital management plan for the Corporation and the Bank. Common measures of adequate capitalization for banking institutions are capital ratios. These ratios indicate the proportion of permanently committed funds to the total asset base. Guidelines issued by federal and state regulatory authorities require both banks and bank holding companies to meet minimum leverage capital ratios and risk-based capital ratios. 36
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The leverage ratio compares Tier 1 capital to average assets while the risk-based ratio compares Tier 1 and total capital to risk-weighted assets and off-balance-sheet activity in order to make capital levels more sensitive to the risk profiles of individual banks. Tier 1 capital is comprised of common stock, additional paid-in capital, retained earnings and components of other comprehensive income, reduced by goodwill and other intangible assets. Total capital is comprised of Tier 1 capital plus the allowable portion of the allowance for loan losses. The Corporation, as a bank holding company, is required to comply with the capital adequacy standards established byFederal Reserve Board . The Bank is required to comply with capital adequacy standards established by theFDIC . In addition, thePennsylvania Department of Banking also requires state-chartered banks to maintain a 6% leverage capital level and 10% risk-based capital, defined substantially the same as the federal regulations. The Corporation and the Bank are subject to the capital requirements contained in the regulation generally referred to as Basel III. The Basel III standards were effective for the Corporation and the Bank, effectiveJanuary 1, 2015 . Basel III imposes significantly higher capital requirements and more restrictive leverage and liquidity ratios than those previously in place. The capital ratios to be considered "well capitalized" under Basel III are: (1) Common Equity Tier 1(CET1) of 6.5%, (2) Tier 1 Leverage of 5%, (3) Tier 1Risk-Based Capital of 8%, and (4)Total Risk-Based Capital of 10%. The CET1 ratio is a new capital ratio under Basel III and the Tier 1 risk-based capital ratio of 8% has been increased from 6%. The rules also included changes in the risk weights of certain assets to better reflect credit and other risk exposures. In addition, a capital conservation buffer of 2.50% is applicable to all of the capital ratios except for the Tier 1 Leverage ratio. The capital conservation buffer is equal to the lowest value of the three applicable capital ratios less the regulatory minimum ("adequately capitalized") for each respective capital measurement. The Bank's capital conservation buffer atDecember 31, 2022 was 7.88%. Compliance with the capital conservation buffer is required in order to avoid limitations on certain capital distributions, especially dividends. As ofDecember 31, 2022 , the Bank was "well capitalized' under the Basel III requirements. For additional information on the capital ratios see the section titled Shareholders' Equity, and Table 13. In 2019, the Community Bank Leverage Ratio (CBLR) was approved by federal banking agencies as an optional capital measure available to Qualifying Community Banking Organizations (QCBO). If a bank qualifies as a QCBR and maintains a CBLR of 9% or greater, the bank would be considered "well-capitalized" for regulatory capital purposes and exempt from complying with the Basel III risk-based capital rule. The CBLR rule was effectiveJanuary 1, 2020 and banks could opt-in through an election in the first quarter 2020 regulatory filings. The Bank meets the criteria of a QCBO but did not opt-in to the CBLR. The consolidated asset limit on small bank holding companies is$3 billion and a company with assets under that limit is not subject to the consolidated capital rules but may file reports that include capital amounts and ratios. The Corporation has elected to file those reports. The following table presents capital ratios for the Corporation atDecember 31 : Table 13. Capital Ratios 2022 2021 Corporation Bank Corporation Bank Common Equity Tier 1 risk-based capital ratio 14.22% 14.63% 15.20% 15.28% Total risk-based capital ratio 17.21% 15.88% 18.41% 16.54% Tier 1 risk-based capital ratio 14.22% 14.63% 15.20% 15.28% Tier 1 leverage ratio 8.95% 9.21% 8.52% 8.57%
For additional information on capital adequacy refer to Note 2 of the accompanying consolidated financial statements.
Local Economy
The Corporation's primary market area includesFranklin ,Fulton ,Cumberland ,Huntingdon , andDauphin County, PA , andWashington County, MD . This area is diverse in demographic and economic composition. County populations range from a low of approximately 15,000 inFulton County to over 260,000 inCumberland County . Unemployment in the Bank's market area decreased during 2022 over 2021 as the local economy recovered from the worst effects of the COVID-19 pandemic shutdowns. The market area has a diverse economic base and local industries include warehousing, truck and rail shipping centers, light and heavy manufacturers, health care, higher education institutions, farming and agriculture, and a varied service sector. The market area provides easy access to the major metropolitan markets on the east coast via trucking and rail transportation. Because of this, warehousing and distribution companies continue to find the area attractive. The local economy is not overly dependent on any one industry or business and Management believes that the Bank's primary market area continues to be well suited for growth. The following provides selected economic data for the Bank's primary market atDecember 31 : 37
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Economic Data
2022 2021
Unemployment Rate (seasonally adjusted)
Market area range (1) 2.4% - 4.1% 3.6% - 5.2%
Pennsylvania 4.0% 5.7%
Maryland 4.3% 5.4%
United States 3.7% 4.2%
Housing Price Index - year over year change
PA, nonmetropolitan statistical area 14.3% 11.5%
United States 16.6%
16.4%
Building Permits - year over year change -12 months Harrisburg-Carlisle, PA MSA, Chambersburg-Waynesboro, PA MSA andHagerstown, MD MSA Residential, estimated -3.6% 7.4% Multifamily, estimated 260.9% -24.0%
(1)
The assets and liabilities of the Corporation are financial in nature, as such, the pricing of products, customer demand for certain types of products, and the value of assets and liabilities are greatly influenced by interest rates. As such, interest rates and changes in interest rates may have a more significant effect on the Corporation's financial results than on other types of industries. Because of this, the Corporation watches the actions of the Federal Reserve Open Market Committee (FOMC) as it makes decisions about interest rate changes and monetary policy. InFebruary 2023 , theFOMC release included this: "Recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation has eased somewhat but remains elevated. The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the long run. In addition, the Committee will continue reducing its holdings ofTreasury securities and agency debt and agency mortgage-backed securities. The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time." In the short-term, any decrease in rates is not expected to have a material effect on the Corporation while any further increase in rates is expected to have a negative impact. Over the long-term, the Corporation benefits from higher interest rates.
Liquidity
The Corporation conducts substantially all of its business through its bank subsidiary. The liquidity needs of the Corporation are funded primarily by the bank subsidiary, supplemented with liquidity from its dividend reinvestment plan.
The Bank must meet the financial needs of the customers that it serves, while providing a satisfactory return on the shareholders' investment. In order to accomplish this, the Corporation must maintain sufficient liquidity in order to respond quickly to the changing level of funds required for both loan and deposit activity. The goal of liquidity management is to meet the ongoing cash flow requirements of depositors who want to withdraw funds and of borrowers who request loan disbursements. The Bank regularly reviews it liquidity position by measuring its projected net cash flows (in and out) at a 30 and 90-day interval. The Bank stress tests this measurement by assuming a level of deposit out-flows that have not historically been realized. In addition to this forecast, other funding sources are reviewed as a method to provide emergency funding if necessary. The objective of this measurement is to identify the amount of cash that could be raised quickly without the need to liquidate assets. The Bank also stresses its liquidity position utilizing different longer-term scenarios. The varying degrees of stress create pressure on deposit flows in its local market, reduce access to wholesale funding and limit access of funds available through brokered deposit channels. In addition to stressing cash flow, specific liquidity risk indicators are monitored to help identify risk areas. This analysis helps identify and quantify the potential cash surplus/deficit over a variety of time horizons to ensure the Bank has adequate funding resources. Assumptions used for liquidity stress testing are subjective. Should an evolving liquidity situation or business cycle present new data, potential assumption changes will be considered. The Bank believes it can meet all anticipated liquidity demands. Historically, the Bank has satisfied its liquidity needs from earnings, repayment of loans, amortizing and maturing investment securities, loan sales, deposit growth and its ability to access existing lines of credit. All investment securities are classified as available for sale; therefore, securities that are unencumbered (approximately$307.6 million fair value) as collateral for borrowings are an additional source of readily available liquidity, either by selling the security or, more preferably, to provide collateral for additional borrowing. The Bank also has access to other wholesale funding via the brokered CD market. The FHLB system has always been a major source of funding for community banks. There are no indicators that lead the Bank to believe the FHLB will discontinue its lending function or restrict the Bank's ability to borrow. If either of these events were to occur, 38
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it would have a negative effect on the Bank, and it is unlikely that the Bank could replace the level of FHLB funding in a short time. The Bank has also established credit at the Federal Reserve Discount Window and an unsecured line of credit at a correspondent bank. The following table shows the Bank's available liquidity atDecember 31, 2022 . (Dollars in thousands) Liquidity Source Capacity Outstanding Available Federal Home Loan Bank$ 403,692 $ -$ 403,692 Federal Reserve Bank Discount Window 60,218 - 60,218 Correspondent Banks 56,000 - 56,000 Total$ 519,910 $ -$ 519,910
Off Balance Sheet Commitments
The Corporation's financial statements do not reflect various commitments that are made in the normal course of business, which may involve some liquidity risk. These commitments consist mainly of unfunded loans and letters of credit made under the same standards as on-balance sheet loans and lines of credit. Because these unfunded instruments have fixed maturity dates and many of them will expire without being drawn upon, they do not generally present any significant liquidity risk to the Corporation. AtDecember 31, 2022 , the Bank had a$1.5 million reserve against off balance sheet commitments. (Dollars in thousands) Financial instruments whose contract amounts represent credit risk 2022
2021
Commercial commitments to extend credit$ 275,867 $
288,075
Consumer commitments to extend credit (secured) 93,124
82,095
Consumer commitments to extend credit (unsecured) 5,247 5,389
$ 374,238 $ 375,559
Standby letters of credit $ 30,734 $ 23,284
Management believes that any amounts actually drawn upon can be funded in the
normal course of operations. The Corporation has no investment in or financial
relationship with any unconsolidated entities that are reasonably likely to have
a material effect on liquidity.
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