EDGAR 10-K Filing

Company CIK: 723646
Filing Year: 2024
Filename: 723646_10-K_2024_0000723646-24-000016.json

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ITEM 1. BUSINESS
Item 1. Business
General
Franklin Financial Services Corporation (the “Corporation”) was organized as a Pennsylvania business corporation on June 1, 1983 and is a registered bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHCA”). On January 16, 1984, pursuant to a plan of reorganization approved by the shareholders of Farmers and Merchants Trust Company of Chambersburg (“F&M Trust” or “the Bank”) and the appropriate regulatory agencies, the Corporation acquired all the shares of F&M Trust and issued its own shares to former F&M Trust shareholders on a share-for-share basis.
The Corporation’s common stock is listed under the symbol “FRAF” on the Nasdaq Capital Market. The Corporation’s internet address is www.franklinfin.com. Electronic copies of the Corporation’s 2023 Annual Report on Form 10-K are available free of charge by visiting the “Investor Information” section of www.franklinfin.com. Electronic copies of quarterly reports on Form 10-Q and current reports on Form 8-K are also available at this internet address. These reports are posted as soon as reasonably practicable after they are electronically filed with the Securities and Exchange Commission (SEC). This reference to the Corporation’s internet address shall not, under any circumstances, be deemed to incorporate the information available at such internet address into this Form 10-K or other SEC filings. The information available at the Corporation’s internet address is not part of this Form 10-K or any other report filed by the Corporation with the SEC. The Corporation’s SEC filings can also be obtained on the SEC’s website on the internet at http://www.sec.gov.
The Corporation conducts substantially all of its business through its wholly owned direct banking subsidiary, F&M Trust. F&M Trust, established in 1906, is a full-service, Pennsylvania-chartered commercial bank and trust company, which is not a member of the Federal Reserve System. F&M Trust operates twenty-two community banking offices in Franklin, Cumberland, Fulton and Huntingdon Counties, Pennsylvania; and Washington County, Maryland. It also has a location in Dauphin County, PA that serves as a regional support center for Commercial, and Wealth Management services. The Bank engages in general commercial, retail banking and trust services normally associated with community banks and its deposits are insured (up to applicable legal limits) by the Federal Deposit Insurance Corporation (the “FDIC”). F&M Trust offers a wide variety of banking services to businesses, individuals, and governmental entities. These services include, but are not necessarily limited to, accepting and maintaining checking, savings, and time deposit accounts, providing wealth management services, making loans and providing safe deposit facilities. Franklin Future Fund Inc., a direct subsidiary of the Corporation, is a non-bank investment company that makes venture capital investments, limited to 5% or less of the outstanding shares of any class of voting securities of any company, within the Corporation’s primary market area. Franklin Financial Properties Corp. is a “qualified real estate subsidiary,” a wholly owned subsidiary of F&M Trust and was established to hold real estate assets used by F&M Trust in its banking operations.
F&M Trust is not dependent upon a single customer or a few customers for a material part of its business. Thus, the loss of any customer or identifiable group of customers would not materially affect the business of the Corporation or the Bank in an adverse manner. Also, none of the Bank’s business is seasonal. The Bank’s lending activities consist primarily of commercial real estate, construction and land development, commercial and industrial loans, installment and revolving loans to consumers and residential mortgage loans. Secured and unsecured commercial and industrial loans, including accounts receivable and inventory financing, and commercial equipment financing, are made to small and medium-sized businesses, individuals, governmental entities, and non-profit organizations.
The Bank classifies loans in this report by the type of collateral, primarily residential or commercial real estate. Loans secured by residential real estate loans may be further broken down into consumer or commercial purposes. Consumer purpose residential real estate loans represent traditional residential mortgages and home equity products. Both of these products are underwritten in generally the same manner; however, home equity products may present greater risk since many of these loans are secured by a second lien position where the Bank may or may not hold the first lien position. Commercial purpose residential real estate loans represent loans made to businesses but are secured by residential real estate. These loans are underwritten as commercial loans and the repayment ability may be dependent on the business operation, despite the residential collateral. In addition to the real estate collateral, it is possible that personal guarantees or other business assets provide additional security. In certain situations, the Bank acquires properties through foreclosure on delinquent loans. The Bank initially records these properties at the estimated fair value less cost to sell with subsequent adjustments to fair value recorded as needed.
Commercial real estate loans are secured by properties such as hotels, office buildings, apartment buildings, retail sites, and farmland or agricultural related properties. These loans are highly dependent on the business operations for repayment. Compared to residential real estate, this collateral may be more difficult to sell in the event of a default.
Construction loans are made to finance the purchase of land and the construction of residential and commercial buildings and are secured by mortgages on real estate. These loans are primarily comprised of loans to consumers to build a home, and loans to contractors and developers to construct residential properties for resale or rental. Construction loans present various risks that include, but are not limited to: schedule delays, cost overruns, changes in economic conditions during the construction period, and the inability to sell or rent the property upon completion.
Commercial loans are made to businesses and government municipalities of various sizes for a variety of purposes including operations, property, plant and equipment, and working capital. These loans are highly dependent on the business operations for repayment and are generally secured by business assets and personal guarantees. As such, this collateral may be more difficult to sell in the event of a delinquency. Commercial lending, including commercial real estate, is concentrated in the Bank’s primary market, but also includes purchased loan participations originated primarily in south-central Pennsylvania.
Consumer loans are comprised of unsecured personal lines of credit and installment loans. While some of these loans are secured, the collateral behind the loans is often comprised of assets that lose value quickly (e.g., automobiles) and if repossessed, may not fully satisfy the loan in the event of default. Repayment of these loans is highly dependent on the borrowers’ financial condition that can be affected by economic factors beyond their control and personal circumstances.
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.
F&M Trust’s Wealth Management Department offers all of the personal and corporate trust services normally associated with community bank trust departments including: estate planning and administration, corporate and personal trust fund management, pension, profit sharing and other employee benefit funds management, custodial services, and non-trust related investment services. F&M Trust through licensed members of its Wealth Management Department sells mutual funds, annuities and selected insurance products.
Competition
The Corporation and its banking subsidiary operate in a highly competitive environment. The principal market of F&M Trust is south central Pennsylvania, primarily the counties of Franklin, Cumberland, Dauphin, Fulton, Huntingdon; and Washington County, MD. There are 35 competing commercial banks that have offices within the Corporation’s primary market area. These banks range from large regional banks to independent community banks. In addition, credit unions, mortgage banks, brokerage firms and other on-line competitors compete within the market.
The following table shows the Bank’s market share where it operates retail banking offices as reported on the June 30, 2023 FDIC Summary of Deposits Report:
(Dollars in thousands)
F&M Trust
County, State
# of Locations
Deposits
Market Deposits
Market Share
Franklin, PA
$
1,027,967
$
2,731,797
37.63%
Cumberland, PA
378,683
11,053,104
3.43%
Fulton, PA
83,735
244,936
34.19%
Huntingdon, PA
27,487
720,626
3.81%
Washington, MD
6,153
3,272,678
0.19%
$
1,524,025
$
18,023,141
8.46%
With increasing competition, many nonbanking institutions offer services similar to those offered by the Bank. Some competitors may have access to resources (e.g., financial and technological) sooner than they are available to the Bank, or that may be unavailable to the Bank, thereby creating a competitive disadvantage for the Bank in terms of product, service pricing and delivery. In addition, credit unions increasingly compete with banks for deposits and certain types of loans. The Bank utilizes various strategies including its long history of local customer service and convenience as part of a relationship management culture, a wide variety of products and services and, to a lesser extent, the pricing of loans and deposits, to compete. F&M Trust is the largest financial institution headquartered in Franklin County, PA and had total assets of approximately $1.8 billion on December 31, 2023.
Human Capital
Company Overview and Values. At F&M Trust, we recognize that our employees are fundamental to the realization of our vision and the execution of our ongoing strategy. We are committed to fostering and maintaining a strong, healthy organizational culture that aligns with our core values and empowers our employees to thrive. Our company values-integrity, excellence, accountability, teamwork, and concern for our customers and communities-guide every aspect of our operations. We believe that by upholding these principles, we not only strengthen our internal cohesion but also enhance our ability to serve our customers, support our communities, and deliver value to our shareholders. Through our unwavering commitment to our employees and our values, we are confident in our ability to sustain our independence as a community bank and continue delivering exceptional service and value to our customers, communities, and shareholders for years to come.
Diversity, Equity, and Inclusion (DEI). At F&M Trust, we are deeply committed to fostering a workplace that values diversity, promotes equity, and embraces inclusion. We recognize that our success as an organization is intrinsically linked to the diverse perspectives, experiences, and talents of our employees. Therefore, we are dedicated to continuously enhancing our DEI efforts to create a more vibrant, innovative, and equitable workplace for all. As of December 31, 2023, we had 306 employees in our workforce, nearly all of whom were full-time and of which the majority were women.
Engagement. To ensure a positive and productive working environment for all our employees, F&M Trust has a robust focus on employee engagement. Central to this initiative is our annual engagement survey conducted by an independent third party. In 2023, we achieved an outstanding survey response rate of 94%, marking the sixth consecutive year of best-in-class participation levels. The survey assesses key engagement drivers, including Organization, Job & Career, Co-worker/Team, Leader, and Diversity, Equity, and Inclusion (DEI) engagement.
Competitive Pay and Benefits. F&M Trust’s compensation program is designed to align the compensation of our employees with the Bank’s performance and to provide the proper incentives to attract, retain, and motivate employees to achieve the Bank’s strategic growth objectives. The Bank’s compensation philosophy is to provide pay opportunities at the median level of prevailing industry practices among community banking companies of similar asset size and market type.
Employee Training and Development. To empower our employees to unleash their full potential, we offer a comprehensive range of training and development programs, opportunities, and resources tailored to their needs. Identifying and nurturing the talents of our next generation of leaders is also a priority for us. We regularly conduct succession planning and talent reviews to identify and nurture top talent within the organization.
Wellness. The well-being of our employees is paramount to the success of our Bank, and we demonstrate our commitment to their holistic wellness through our comprehensive wellness program, which has been a cornerstone of our culture since 2001. Our wellness program boasts high levels of employee participation, with over 75% of our workforce completing health risk assessments and biometric screenings in 2023.
Retention. Monitoring employee turnover rates is crucial for us, as we understand that retaining our talented and committed personnel is essential for our continued success. In 2023, our Total Voluntary Turnover rate was 12.77%. The "Intent to Stay" metric from our most recent employee engagement survey indicated that 85% of our workforce plans to remain with the Bank for at least three years or more. Over 45% of our employees expressed their intention to stay with the Bank for more than ten years. These numbers underscore the strong sense of loyalty and commitment among our employees.
Community Involvement. The Bank’s commitment to community service reflects our core values. We aim to give back to the communities where we live and work and believe this commitment helps in our efforts to attract and retain employees. In 2023, F&M Trust donated over $480 thousand to 296 organizations in our communities and funded 323 scholarships for $156 thousand to kindergarten through 12th grade and Pre-kindergarten schools and organizations through the Pennsylvania Educational Improvement Tax Credit program. In addition, employees of the Bank provided 2,043 volunteer hours to 91 different service organizations.
Supervision and Regulation
Various requirements and restrictions under the laws of the United States and under Pennsylvania law affect the Corporation and its subsidiaries.
General
The Corporation is registered as a bank holding company and is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (Federal Reserve) under the Bank Holding Act of 1956, as amended. The Corporation has also made an effective election to be treated as a "financial holding company." Financial holding companies are bank holding companies that meet certain minimum capital and other standards and are therefore entitled to engage in financially related activities on an expedited basis as further discussed below. Bank holding companies are required to file periodic reports with and are subject to examination by the Federal Reserve. The Federal Reserve has issued regulations under the Bank Holding Company Act that require a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. As a result, the Federal Reserve, pursuant to such regulations, may require the Corporation to stand ready to use its resources to provide adequate capital funds to its Bank subsidiary during periods of financial stress or adversity. In addition to the impact of regulation, commercial banks are affected significantly by the actions of the Federal Reserve Board as it attempts to control the money supply and credit availability in order to influence the economy.
The Bank Holding Company Act prohibits the Corporation from acquiring direct or indirect control of more than 5% of the outstanding shares of any class of voting stock, or substantially all of the assets of any bank, or from merging or consolidating with another bank holding company, without prior approval of the Federal Reserve Board. Additionally, the Bank Holding Company Act prohibits the Corporation from engaging in or from acquiring ownership or control of more than 5% of the outstanding shares of any
class of voting stock of any company engaged in a non-banking business, unless such business is determined by the Federal Reserve to be so closely related to banking as to be a proper incident thereto. Federal law and Pennsylvania law also require persons or entities desiring to acquire certain levels of share ownership (generally, 10% or more, or 5% or more for another bank holding company) of the Corporation to first obtain prior approval from the Federal Reserve and the Pennsylvania Department of Banking and Securities.
As a Pennsylvania bank holding company for purposes of the Pennsylvania Banking Code, the Corporation is also subject to regulation and examination by the Pennsylvania Department of Banking and Securities.
The Bank is a state-chartered bank that is not a member of the Federal Reserve System, and its deposits are insured (up to applicable legal limits) by the Federal Deposit Insurance Corporation (FDIC). Accordingly, the Bank's primary federal regulator is the FDIC, and the Bank is subject to extensive regulation and examination by the FDIC and the Pennsylvania Department of Banking and Securities. The Bank is also subject to requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon, and limitations on the types of investments that may be made and the types of services that may be offered. The Bank is subject to extensive regulation and reporting requirements in a variety of areas, including helping to prevent money laundering, to preserve financial privacy, and to properly report late payments, defaults, and denials of loan applications.
Dodd-Frank Wall Street Reform and Consumer Protection Act
In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) became law. Dodd-Frank is intended to affect a fundamental restructuring of federal banking regulation. Among other things, Dodd-Frank created a new Financial Stability Oversight Council to identify systemic risks in the financial system and gives federal regulators new authority to take control of and liquidate financial firms. Dodd-Frank additionally created a new independent federal regulator to administer federal consumer protection laws. Dodd-Frank has made a significant impact on our business operations as its provisions took effect. Among the provisions that have affected the Corporation are the following:
FDIC Insurance. The insurance limit was increased to $250,000 per depositor. In addition, the assessment base was changed from a deposit-based calculation to an asset-based calculation. Dodd-Frank also eliminated the federal statutory prohibition against the payment of interest on business checking accounts.
Compensation. At least once every three years, companies must conduct a non-binding shareholder vote (say-on-pay) to approve the compensation of the CEO and the company’s “named executive officers.” At least once every 6 years, shareholders must also vote on whether to hold the non-binding vote on executive compensation every 1, 2, or 3 years. Additionally, banking regulators have established guidance that prohibits incentive-based compensation arrangements that encourage inappropriate risks that could lead to material financial loss to the institution.
Consumer Financial Protection Bureau. Dodd-Frank created a new, independent federal agency called the Consumer Financial Protection Bureau (CFPB), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act and certain other statutes. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions are subject to rules promulgated by the CFPB but continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB has authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. Dodd-Frank authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower’s ability to repay. In addition, Dodd-Frank will allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB. Dodd-Frank permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.
Most of the Dodd-Frank rules and regulations have been implemented. These new rules and regulations have and will continue to significantly change the current bank regulatory structure and affect the lending, deposit and operating activities of financial institutions, including the Corporation. It remains difficult to anticipate or predict the overall future financial impact the Dodd-Frank Act will have on the Corporation, our customers, our financial condition and results of operations. The Corporation continues to monitor and implement rules and regulations as they are adopted and modified, and to evaluate their application to our current and future operations.
Community Reinvestment Act
The Community Reinvestment Act (CRA) requires the Bank to help meet the credit needs of the entire community where the Bank operates, including low and moderate-income neighborhoods. The Bank's rating under the Community Reinvestment Act, assigned by the FDIC pursuant to an examination of the Bank, is important in determining whether the bank may receive approval for,
or utilize certain streamlined procedures in applications to engage in new activities. The Bank’s present CRA rating is “satisfactory.” Various consumer laws and regulations also affect the operations of the Bank.
Capital Adequacy Guidelines
The Corporation, as a bank holding company, is required to comply with the capital adequacy standards established by the Federal Reserve Board. The Bank is required to comply with capital adequacy standards established by the FDIC. In addition, the Pennsylvania Department of Banking and Securities also requires state-chartered banks to maintain minimum capital ratios, defined substantially the same as the federal regulations.
Capital adequacy for the Bank is currently defined by regulatory agencies through the use of several minimum required ratios. The capital ratios to be considered “well capitalized” are: (1) Common Equity Tier 1 (CET1) of 6.5%, (2) Tier 1 Leverage of 5%, (3) Tier 1 Risk-Based Capital of 8%, and (4) Total Risk-Based Capital of 10%. 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 at December 31, 2023 was 5.63%. Compliance with the capital conservation buffer is required in order to avoid limitations on certain capital distributions, especially dividends. As of December 31, 2023, 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 QCBO 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 risk-based capital rule described above. The CBLR rule took effect January 1, 2020 and banks could opt-in through an election in the first quarter 2020 regulatory filing. The Bank met the criteria of a QCBO but did not opt-in to the CBLR.
Prompt Corrective Action Rules
The federal banking agencies have regulations defining the levels at which an insured institution would be considered "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." The applicable federal bank regulator for a depository institution could, under certain circumstances, reclassify a "well-capitalized" institution as "adequately capitalized" or require an "adequately capitalized" or "undercapitalized" institution to comply with supervisory actions as if it were in the next lower category. Such a reclassification could be made if the regulatory agency determines that the institution is in an unsafe or unsound condition (which could include unsatisfactory examination ratings). At December 31, 2023, the Bank satisfied the criteria to be classified as "well capitalized" within the meaning of applicable regulations.
Regulatory Restrictions on Dividends
Dividend payments by the Bank to the Corporation are subject to the Pennsylvania Banking Code, the Federal Deposit Insurance Act, and the regulations of the FDIC. Under the Banking Code, no dividends may be paid except from "accumulated net earnings" (generally, retained earnings). The Federal Reserve and the FDIC have formal and informal policies which provide that insured banks and bank holding companies should generally pay dividends only out of current operating earnings, with some exceptions. The Prompt Corrective Action Rules and the Basel III rules, described above, may further limit the ability of banks to pay dividends or make capital distributions if regulatory capital requirements are not met. There are currently no restrictions on the payments of dividends by either the Bank or the Corporation.
Volker Rule
In December 2013, Federal banking regulators issued rules for complying with the Volker Rule provision of the Dodd-Frank Act. The Bank does not engage in, or expect to engage in, any transactions that are considered “covered activities” as defined by the Volker Rule. Therefore, the Bank does not have any compliance obligations under the Volker Rule.
Consumer Laws and Regulations
The CFPB was created under the Dodd-Frank Act to centralize responsibility for consumer financial protection with broad rulemaking, supervision, and enforcement authority for a wide range of consumer protection laws that would apply to all banks and thrifts, including the Equal Credit Opportunity Act, Truth in Lending Act (“TILA”), Real Estate Settlement Procedures Act (“RESPA”), Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act, and certain other statues. Violations of consumer protection laws may result in litigation and liability from consumers and regulators. It is likely that future CFPB rulemaking action will affect the Bank. Banks with total assets less than $10 billion are not subject to examination by the CFPB. However, the CFPB can require any bank to submit reports it deems necessary to fulfill its mission and it can request to be part of any bank examination.
Ability to Repay / Qualified Mortgages
In July 2013, the Consumer Finance Protection Bureau adopted the final rules that implement the Ability to Repay (ATR) / Qualified Mortgages (QM) provisions of the Dodd-Frank Act. Regulators believe that the ATR/QM rules will prevent many of the loose underwriting practices that contributed to the mortgage crisis in 2008. The ATR/QM rule applies to almost all closed-end consumer credit transactions secured by a dwelling. The ATR rule provides eight specific factors that must be considered during the underwriting process. QMs generally have three types of requirements: restrictions on loan features, points and fees, and underwriting criteria. A QM is presumed to comply with the ATR requirements. The ATR/QM rule was effective January 10, 2014.
Commercial Real Estate Guidance
In December 2015, the federal banking agencies released a “Statement on Prudent Risk Management for Commercial Real Estate Lending” (the “CRE Statement”). The agencies stated that financial institutions should review their policies and practices related to CRE lending and should maintain risk management practices and capital levels commensurate with the level and nature of their CRE concentration risk, including maintaining underwriting discipline and exercising prudent risk management practices that identify, measure, monitor and manage the risks arising from their CRE lending activity. Financial institutions were directed to review the interagency guidance on “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” issued in 2006 providing that a financial institution is potentially exposed to significant CRE concentration risk, and should employ enhanced risk management practices where (1) total non-owner occupied CRE loans represent 300% or more of total capital, and (2) the outstanding balance of the CRE loan portfolio has increased by 50% or more during the prior 36 months. The agencies state in the CRE Statement that they will focus on those financial institutions that have recently experienced, or whose lending strategy plans for, substantial growth in CRE lending activity, or that operate in markets or loan segments with increasing growth or risk fundamentals.
Pennsylvania Regulation and Supervision
In December 2012, the “Banking Law Modernization Package” became effective. The law permits banks to disclose formal enforcement actions initiated by the Pennsylvania Department of Banking and Securities, clarifies that the Department has examination and enforcement authority over subsidiaries as well as affiliates of regulated banks, and bolsters the Department’s enforcement authority over its regulated institutions by clarifying its ability to remove directors, officers and employees from institutions for violations of laws or orders or for any unsafe or unsound practice or breach of fiduciary duty. The Department also may assess civil money penalties of up to $25,000 per violation.
FDIC Insurance
The Bank is a member of the Deposit Insurance Fund (DIF), which is administered by the FDIC. The FDIC insures deposit accounts at the Bank, generally up to a maximum of $250,000 for each separately insured depositor. The FDIC charges a premium to depository institutions for deposit insurance. This rate is based on the risk category of the institution and the total premium is based on average total assets less average tangible equity. As of December 31, 2023, the Bank was considered well capitalized and its assessment rate was approximately 5.8 basis points of the assessment base.
Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. We do not currently know of any practice, condition or violation that might lead to termination of our deposit insurance.
New Legislation
Congress is often considering new financial industry legislation, and the federal banking agencies routinely propose new regulations. The Corporation cannot predict how any new legislation, or new rules adopted by the federal banking agencies, may affect its business in the future.
Selected Statistical Information
Certain statistical information is included in this report as part of Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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ITEM 1A. RISK FACTORS
Item 1A. Risk Factors
The following is a summary of the primary risks associated with the Corporation’s business, financial condition and results of operations, and common stock.
Risk Factors Relating to the Corporation
Real estate related loans are a significant portion of our loan portfolio.
The Bank offers a variety of loan products, including residential mortgage, consumer, construction and commercial loans. The Bank requires real estate as collateral for many of its loans. At December 31, 2023, approximately 80% ($1.008 billion) of its loans were secured by real estate. These real estate loans are located primarily in the Bank’s market area of south-central Pennsylvania and Washington County, MD. Real estate values tend to follow changes in general economic cycles. If a loan becomes delinquent as the result of an economic downturn and the Bank becomes dependent on the real estate collateral as a source of repayment, it is likely that the value of the real estate collateral has also declined. A decline in real estate values means it is possible that the real estate collateral may be insufficient to cover the outstanding balance of a delinquent or foreclosed loan, resulting in a loss to the Bank. In addition, the real estate collateral is concentrated in the Bank’s primary market area. Localized events such as plant closures or layoffs may affect real estate prices and collateral values and could have a more negative affect on the Bank as compared to other competitors with a more geographically diverse portfolio. As the Bank grows, it is expected that real estate secured loans will continue to comprise a significant part of its balance sheet. Risk of loan default is unavoidable in the banking industry, and Management tries to limit exposure to this risk by carefully monitoring the amount of loans in specific industries and by exercising prudent lending practices and securing appropriate collateral. However, this risk cannot be eliminated, and substantial credit losses could result in reduced earnings or losses.
Commercial loans are a significant portion of our loan portfolio.
The Bank continues to grow its commercial loan portfolio. Commercial purpose loans account for 82% ($1.026 billion) of the total loan portfolio. These loans are made to businesses for a variety of commercial purposes and may include fixed and variable rate loans, term loans, and lines of credit. Commercial purpose loans may be secured by real estate, business assets and equipment, personal guarantees, or non-real estate collateral. Commercial purpose loans secured by real estate were $782.9 million at December 31, 2023 and account for 76% of the total commercial loan portfolio. These loans contain all the risks associated with real estate lending as discussed above. In addition, commercial real estate collateral may be more difficult to liquidate for repayment purposes than residential real estate. The repayment of commercial loans is highly dependent upon the success of the business activity and as such maybe more susceptible to risk of loss during a downturn in the economy. Because the Bank’s commercial loan portfolio is concentrated in south-central Pennsylvania, the ability to repay these loans could be affected by deterioration of the economy in this region. As commercial lending continues to be the primary driver of loan growth, these new loans may present additional risk due to a lack of repayment history with the Bank. The Bank attempts to mitigate these risks through its underwriting and loan review process; however, this risk cannot be eliminated, and substantial credit losses could result in reduced earnings or losses.
The Bank is subject to commercial real estate volatility that may result in increases in non-performing loans that could have an adverse impact on our financial condition and results of operations.
The commercial real estate market nationally, regionally, and locally has recently been subject to increased levels of volatility. Many believe that commercial real estate in the commercial office sector is undergoing a fundamental transformation and change that started during the recent pandemic but also continues due to evolving workplace environments. These changes in the marketplace affect the demand for commercial office space which in turn may affect the credit status, profitability, and collectability, of existing and future commercial real estate office sector loans. As explained above in greater detail in the risk factor for Credit Risk, volatility and increases in non-performing loans could have an adverse impact on our financial condition and results of operations.
The allowance for credit losses may prove to be insufficient to absorb inherent losses in our loan portfolio.
The Bank maintains an allowance for credit losses (ACL) that Management believes is appropriate to provide for any inherent losses in the loan portfolio. The amount of the allowance is determined through a periodic review and consideration of several factors, including an ongoing review of the quality, size and diversity of our loan portfolio; evaluation of nonperforming loans; historical loan loss experience; economic outlook; and the amount and quality of collateral, including guarantees, securing the loan. This evaluation is inherently subjective, as it requires material assumptions and estimates that may be susceptible to significant change.
Although Management believes the ACL is adequate to absorb inherent losses in the loan portfolio, such losses cannot be predicted, and the allowance may not be adequate. Excessive credit losses could have a material adverse effect on the Bank’s financial condition and results of operations.
The Bank’s lending limit is smaller than many of our competitors, which affects the size of the loans it can offer customers.
The Bank’s lending limit is approximately $47.0 million. Accordingly, the size of the loans that can be offered to customers is less than the size of loans that many of our competitors, with larger lending limits, can offer. This limit affects the Bank’s ability to seek relationships with larger businesses in its market area. Loan amounts in excess of the lending limits can be accommodated through the sale of participations in such loans to other banks. However, there can be no assurance that the Bank will be successful in
attracting or maintaining customers seeking larger loans or that it will be able to engage in participation of such loans or on terms favorable to the Bank.
There is strong competition in the Bank’s primary market areas and its geographic diversification is limited.
The Bank encounters strong competition from other financial institutions in its primary market area, which consists of Franklin, Cumberland, Dauphin, Fulton and Huntingdon Counties, Pennsylvania; and Washington County, MD. In addition, established financial institutions not already operating in the Bank’s primary market area may open branches there at future dates or can compete in the market via the Internet. In the conduct of certain aspects of banking business, the Bank also competes with credit unions, mortgage banking companies, consumer finance companies, insurance companies and other institutions, some of which are not subject to the same degree of regulation or restrictions as are imposed upon the Bank. Many of these competitors have substantially greater resources and lending limits and can offer services that the Bank does not provide. In addition, many of these competitors have numerous branch offices located throughout their extended market areas that provide them with a competitive advantage. No assurance can be given that such competition will not have an adverse effect on the Bank’s financial condition and results of operations.
Changes in interest rates could have an adverse impact upon our results of operations.
The Bank’s profitability is in part a function of the spread between interest rates earned on investments, loans and other interest-earning assets and the interest rates paid on deposits and other interest-bearing liabilities. Interest rates are highly sensitive to many factors that are beyond the Bank’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System. Changes in monetary policy, including changes in interest rates, will influence not only the interest received on loans and investment securities and the amount of interest we pay on deposits and borrowings, but will also affect the Bank’s ability to originate loans and obtain deposits and the value of our investment portfolio. If the rate of interest paid on deposits and other borrowings increases more than the rate of interest earned on loans and other investments, the Bank’s net interest income, and therefore earnings, could be adversely affected. Likewise, recent changes in market interest rates have caused the Bank to quickly raise its rates on deposits. Earnings could also be adversely affected if the rates on loans and other investments fall more quickly than those on deposits and other borrowings. While Management takes measures to guard against interest rate risk, there can be no assurance that such measures will be effective in minimizing the exposure to interest rate risk.
Our operational or security systems may experience interruption or breach in security, including cyber-attacks.
We rely heavily on communications and information systems to conduct our business. These systems include our internal network and data systems, as well as those of third-party vendors. Any failure, interruption or breach in security or these systems, including a cyber-attack, could result in the disclosure or misuse of confidential or proprietary information. Cyber security risks for financial institutions have significantly increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties, including foreign state actors. Financial services institutions have been subject to, and are likely to continue to be the target of, cyber-attacks, including computer viruses, malicious or destructive code, phishing attacks, denial of service or information or other security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of confidential, proprietary and other information of the institution, its employees or customers or of third parties, or otherwise materially disrupt network access or business operations. Cyber threats could result in unauthorized access, loss or destruction of customer data, unavailability, degradation or denial of service, introduction of computer viruses and other adverse events, causing the Corporation to incur additional costs (such as repairing systems or adding new personnel or protection technologies). Cyber threats may also subject the Corporation to regulatory investigations, litigation or enforcement, require the payment of regulatory fines or penalties or undertaking costly remediation efforts. While we have systems, policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of client business, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our business, financial condition and results of operations.
A large component of fee income is dependent on stock market values.
Fee income from the Bank’s Wealth Management Department comprises a large percentage of total noninterest income. Fee income from Wealth Management Department is comprised primarily of asset management fees as measured by the market value of assets under management. As such, the market values are directly related to stock market values. Therefore, any significant negative change in the value of assets under management due to stock market fluctuations could greatly reduce fee income and have a material adverse effect on our financial condition and results of operations.
A large component of fee income is dependent on two deposit services.
Fee income from the Bank’s debit card is a significant contributor of fee income. As technology changes and consumer payment preferences change it is possible that debit card income does not continue to grow or may decline. The Bank’s overdraft protection program has also been a significant contributor of fee income. If usage of this product slows or regulatory changes negatively affect the fees that can be charged for such services, it may greatly reduce fee income and have a material adverse effect on our financial condition and results of operations.
A large percentage of deposits may be highly sensitive to changes in interest rates.
Thirty-seven percent ($572.1 million) of all deposits are in the Bank’s money management product. The interest rate on these deposits generally follows market rates. A large or continuous increase in market rates could result in a rapid increase in the interest expense of these deposits. While the interest rate on this product generally follows market rates, the product is not indexed to a market rate, thereby giving the Bank more control over any rate increases. Nonetheless, interest expense could materially increase and have a material adverse effect on our financial condition and results of operations.
Liquidity contingency funding is highly concentrated.
The Bank is a member of the Federal Home Loan Bank of Pittsburgh (FHLB). Access to funding through the FHLB is the largest component of the Bank’s liquidity stress testing and contingency funding plans. The ability to access funding from FHLB may be critical if a funding need arises. However, there can be no assurance that the FHLB will be able to provide funding when needed, nor can there be assurance that the FHLB will provide funds to the Bank if its financial condition deteriorates. The inability to access FHLB funding, through a restriction on credit or the failure of the FHLB, could have a materially adverse effect on the Bank’s liquidity management. The Bank also has funding available with the Federal Reserve Bank and believes it may be a more stable source of liquidity than the FHLB.
Unrealized losses in the Bank’s investment portfolio could affect liquidity.
The Bank’s access to liquidity sources could be affected by unrealized losses if investments must be sold at a loss, tangible capital ratios decline from an increase in unrealized losses or realized credit losses, the FHLB or other sources reduce capacity, or bank regulators impose restrictions on the Bank such as a limit on interest rates it may pay on deposits or its ability to access brokered deposits. Unrealized losses do not affect regulatory capital ratios.
The Corporation is subject to claims and litigation pertaining to fiduciary responsibility which may result in financial liability or reputation damage.
From time to time, customers make claims and take legal action pertaining to t he Corporation’s performance of its fiduciary responsibilities. Whether customer claims and legal action related to the Corporation’s performance of its fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to the Corporation, they may result in significant financial liability and/or adversely affect the market perception of the Corporation and its products and services, as well as impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect on the Corporation’s business, which, in turn, could have a material adverse effect on the Corporation’s financial condition and results of operations.
Our business and financial results could be impacted materially by adverse results in legal proceedings.
The nature of the Corporation’s business generates a certain amount of litigation involving matters arising in the ordinary course of business (and, in some cases, from the activities of companies we have acquired). These legal proceedings, whether founded or unfounded, could result in reputation damage and have an adverse effect on our financial condition and results of operation if they are not resolved in a manner favorable to the Corporation. Although we establish legal accruals for legal proceedings when information related to the loss contingencies represented by these matters indicates that both a loss is probable and that the amount of the loss can be reasonably estimated, we do not have accruals for all legal proceedings where we face a risk of loss. In addition, due to the inherent subjectivity of the assessments and unpredictability of outcomes of legal proceedings, any amounts that may be accrued or included in estimates of possible losses or ranges of possible losses may not represent the actual loss to the Corporation. We discuss these matters further in Part I Item 3 Legal Proceedings and in Note 21 Commitments and Contingencies in the Notes to Consolidated Financial Statements in Part II Item 8 of this Report.
Public health crises such as epidemics or pandemics could materially and adversely impact our business.
An epidemic or pandemic (such as COVID-19) may cause prolonged global, national, or regional recessionary economic conditions or longer lasting effects on economic conditions than currently exist, which could have a material adverse effect on our business, results of operations and financial condition.
As a result, the demand for our products and services may be significantly impacted, which could adversely affect our revenue and results of operations. Furthermore, the effects of an epidemic or pandemic could result in the recognition of credit losses in our loan portfolios and an increase in our allowance for credit losses, particularly if businesses are restricted or are required to close. Similarly, because of changing economic and market conditions affecting issuers, we may be required to recognize impairments on the securities we hold as well as reductions in other comprehensive income. Our business operations may also be disrupted if significant portions of our workforce are unable to work effectively, including because of illness, quarantines, government actions, or other restrictions in connection with the pandemic. The extent to which an epidemic or pandemic impacts our business, results of operations, and financial conditions, as well as our regulatory capital and liquidity ratios, will depend on factors which are highly uncertain and cannot be predicted, including the scope and duration of an epidemic or pandemic and actions taken by governmental authorities and other third parties in response to the epidemic or pandemic.
The Corporation’s operations could be affected by climate change.
The Corporation’s business, as well as the operations and activities of our clients, could be negatively impacted by climate change. Climate change presents both immediate and long-term risks to the Corporation and its clients, and these risks are expected to increase over time. Climate change presents multi-faceted risks, including: operational risk from the physical effects of climate events on the Corporation and its clients’ facilities and other assets; credit risk from borrowers with significant exposure to climate risk; transition risks associated with the transition to a less carbon-dependent economy; and reputational risk from stakeholder concerns about our practices related to climate change, the Corporation’s carbon footprint, and the Corporation’s business relationships with clients who operate in carbon-intensive industries.
Federal and state banking regulators and supervisory authorities, investors, and other stakeholders have increasingly viewed financial institutions as important in helping to address the risks related to climate change both directly and with respect to their clients, which may result in financial institutions coming under increased pressure regarding the disclosure and management of their climate risks and related lending and investment activities. Given that climate change could impose systemic risks upon the financial sector, either via disruptions in economic activity resulting from the physical impacts of climate change or changes in policies as the economy transitions to a less carbon-intensive environment, the Corporation may face regulatory risk of increasing focus on the Corporation’s resilience to climate-related risks, including in the context of stress testing for various climate stress scenarios. Ongoing legislative or regulatory uncertainties and changes regarding climate risk management and practices may result in higher regulatory, compliance, credit, reputational risks and costs, and potentially affect customer relationships.
Severe weather, natural disasters, acts of war or terrorism, and other external events could negatively impact the Corporation’s business.
The unpredictable nature of events such as severe weather, natural disasters, acts of war or terrorism, and other adverse external events could have a significant impact on the Corporation’s ability to conduct business. If any of its financial, accounting, network or other information processing systems fail or have other significant shortcomings due to external events, the Corporation could be materially adversely affected. Third parties with which the Corporation does business could also be sources of operational risk to the Corporation, including the risk that the third parties' own network and information processing systems could fail. Any of these occurrences could materially diminish the Corporation's ability to operate one or more of its businesses, or result in potential liability to customers, reputational damage, and regulatory intervention, any of which could materially adversely affect the Corporation. Such events could affect the stability of the Corporation's deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, impair the Corporation's liquidity, cause significant property damage, result in loss of revenue, and/or cause the Corporation to incur additional expenses.
The Corporation may be subject to disruptions or failures of the financial, accounting, network and/or other information processing systems arising from events that are wholly or partially beyond the Corporation's control, which may include, for example, computer viruses, electrical or telecommunications outages, natural disasters, disease epidemics or pandemics, damage to property or physical assets, or terrorist acts. While the Corporation believes its business continuity plan and efforts to evaluate the business continuity plans of critical third-party service providers help mitigate risks, disruptions or failures affecting any of these systems may cause interruptions in service to customers, damage to the Corporation's reputation, and loss or liability to the Corporation.
Negative developments affecting the banking industry, including bank failures or concerns regarding liquidity, have eroded customer confidence in the banking system and may have a material adverse effect on the Corporation.
In the recent past, the financial services industry has been impacted by bank failures (Silicon Valley Bank, Signature Bank, and First Republic Bank) and by financial instability at various additional banks. These bank failures and bank instabilities and future bank failures and instabilities have created and may continue to create market and other risks, for all financial institutions and banks, including the Corporation. These risks include, but are not limited to, market risk and loss of confidence in the financial services sector, and/or specific banks; deterioration of securities and loan portfolios; deposit volatility and reductions with higher volumes and
occurring over shorter periods of time; increased liquidity demand and utilization of sources of liquidity; and interest rate volatility and abrupt, sudden and greater than usual rate changes.
These factors individually, or in any combination, could materially and adversely affect financial condition, operations and results thereof; and stock price. In addition, the previously mentioned bank failures and instabilities and future bank failures and instabilities may result in an increase of FDIC deposit insurance premiums and/or result in special FDIC deposit insurance assessments, which also may adversely affect the Corporation’s financial condition, operations, results thereof or stock price. The Corporation cannot predict the impact, timing or duration of such events.
Risk Factors Relating to the Common Stock
The stock market can be volatile, and fluctuations in our operating results and other factors could cause our stock price to decline.
The stock market has experienced, and may continue to experience, fluctuations that significantly impact the market prices of securities issued by many companies and financial institutions specifically. Market fluctuations could adversely affect our stock price. These fluctuations have often been unrelated or disproportionate to the operating performance of particular companies. These broad market fluctuations, as well as general economic, systemic, political and market conditions, such as recessions, loss of investor confidence, interest rate changes, government shutdowns, trade wars, pandemics or epidemics, or international currency fluctuations, may negatively affect the market price of our common stock. Moreover, our operating results may fluctuate and vary from period to period due to the risk factors set forth herein. As a result, period-to-period comparisons should not be relied upon as an indication of future performance. Our stock price could fluctuate significantly in response to our quarterly or annual results, annual projections and the impact of these risk factors on our operating results or financial position.
Although the Company’s common stock is quoted on the Nasdaq Capital Market, the volume of trades on any given day has been limited historically, as a result of which shareholders might not have been able to sell or purchase the Company’s common stock at the volume, price or time desired. From time to time, our Common Stock may be included in certain and various stock market indices. Inclusion in these indices may positively impacted the price, trading volume, and liquidity of our Common Stock, in part, because index funds or other institutional investors often purchase securities that are in these indices. Conversely, if our market capitalization falls below the minimum necessary to be included in any of the indices at any annual reconstitution date, the opposite could occur. Further, our inclusion in indices may be weighted based on the size of our market capitalization, so even if our market capitalization remains above the amount required to be included on these indices, if our market capitalization is below the amount it was on the most recent reconstitution date, our Common Stock could be weighted at a lower level. If our Common Stock is weighted at a lower level, holders attempting to track the composition of these indices will be required to sell our Common Stock to match the reweighting of the indices.
The Bank's ability to pay dividends to the Corporation is subject to regulatory limitations that may affect the Corporation’s ability to pay dividends to its shareholders.
As a financial holding company, the Corporation is a separate legal entity from the Bank and does not have significant operations of its own. It currently depends upon the Bank's cash and liquidity to pay dividends to its shareholders. The Corporation cannot assure you that in the future the Bank will have the capacity to pay dividends to the Corporation. Various statutes and regulations limit the availability of dividends from the Bank. It is possible; depending upon the Bank's financial condition and other factors, that the Bank’s regulators could assert that payment of dividends by the Bank to the Corporation would constitute an unsafe or unsound practice. In the event that the Bank is unable to pay dividends to the Corporation, the Corporation may not be able to pay dividends to its shareholders.

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ITEM 1B. UNRESOLVED STAFF COMMENTS
Item 1B. U nresolved Staff Comments
None

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ITEM 2. PROPERTIES
Item 2. Properties
The Corporation’s headquarters is located at 1500 Nitterhouse Drive, Chambersburg, Pennsylvania. This location also houses F&M Trust’s sales and operations center. The Corporation owns or leases thirty-five properties in Franklin, Cumberland, Dauphin, Fulton and Huntingdon Counties, Pennsylvania; and Washington County, Maryland, for banking operations, as described below:
Property
Owned
Leased
Facilities used in Banking Operations
Remote ATM Sites
The Bank’s properties are adequate for the purposes intended.

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ITEM 3. LEGAL PROCEEDINGS
Item 3. Legal Proceedings
The nature of the Corporation’s business generates a certain amount of litigation.
We establish accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probable and the amount of the loss can be reasonably estimated. When we are able to do so, we also determine estimates of possible losses, whether in excess of any accrued liability or where there is no accrued liability.
These assessments are based on our analysis of currently available information and are subject to significant judgment and a variety of assumptions and uncertainties. As new information is obtained, we may change our assessments and, as a result, take or adjust the amounts of our accruals and change our estimates of possible losses or ranges of possible losses. Due to the inherent subjectivity of the assessments and the unpredictability of outcomes of legal proceedings, any amounts that may be accrued or included in estimates of possible losses or ranges of possible losses may not represent the actual loss to the Corporation from any legal proceeding. Our exposure and ultimate losses may be higher, possibly significantly higher, than amounts we may accrue or amounts we may estimate.
In management’s opinion, we do not anticipate, at the present time, that the ultimate aggregate liability, if any, arising out of all litigation to which the Corporation is a party will have a material adverse effect on our financial position. We cannot now determine, however, whether or not any claim asserted against us will have a material adverse effect on our results of operations in any future reporting period, which will depend on, amount other things, the amount of loss resulting from the claim and the amount of income otherwise reported for the reporting period. Thus, at December 31, 2023, we are unable to provide an evaluation of the likelihood of an unfavorable outcome or an estimate of the amount or range of potential loss with respect to such other matters and, accordingly, have not yet established any specific accrual for such other matters.
No material proceedings are pending or are known to be threatened or contemplated against us by governmental authorities.
In management’s opinion, there are no other proceedings pending to which the Corporation is a party or to which its property is subject which, if determined adversely to the Corporation, would be material.

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ITEM 4. MINE SAFETY DISCLOSURE
Item 4. Mine Safety Disclosures
Not Applicable
Part II

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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
Market and Dividend Information
The Corporation had 1,536 shareholders of record as of December 31, 2023.
Restrictions on the Payment of Dividends
For limitations on the Corporation’s ability to pay dividends, see “Supervision and Regulation - Regulatory Restrictions on Dividends” in Item 1 above.
Securities Authorized for Issuance under Equity Compensation Plans
The information related to equity compensation plans is incorporated by reference to the materials set forth under the heading “Executive Compensation - Compensation Tables” in the Corporation’s Proxy Statement for the 2024 Annual Meeting of Shareholders.
Common Stock Repurchases
The Board of Directors, from time to time, authorizes the repurchase of the Corporation’s $1.00 par value common stock. The repurchased shares will be held as Treasury shares available for issuance in connection with future stock dividends and stock splits, employee benefit plans, executive compensation plans, the Dividend Reinvestment Plan and other appropriate corporate purposes.
There were no shares purchased during the fourth quarter of 2023.
In December 2023, an open market repurchase plan was approved to repurchase 150,000 shares over a one-year period.
Performance Graph
The following graph compares the cumulative total return to shareholders of Franklin Financial with selected market indices and a bank peer group, consisting of Mid-Atlantic Banks with assets between $1 billion - $2 billion as of September 30, 2023; for the five-year period ended December 31, 2023, in each case assuming an initial investment of $100 on December 31, 2018 and the reinvestment of all dividends. Information is provided by S&P Global Market Intelligence.
Period Ending
Index
12/31/18
12/31/19
12/31/20
12/31/21
12/31/22
12/31/23
Franklin Financial Services Corporation
$
100.00
$
126.80
$
92.45
$
117.89
$
133.80
$
122.03
NASDAQ Composite
$
100.00
$
136.69
$
198.10
$
242.03
$
163.28
$
236.17
S&P U.S. BMI Banks - Mid-Atlantic Region Index
$
100.00
$
142.19
$
128.53
$
162.33
$
137.10
$
166.23
Peer Group*
$
100.00
$
112.40
$
90.80
$
116.46
$
121.78
$
120.76
*Peer Group consists of Mid Atlantic Banks with Assets between $1B-$2B as of 12/31/2023
‎
Shareholders’ Information
Dividend Reinvestment Plan:
Franklin Financial Services Corporation offers a dividend reinvestment program whereby shareholders of the Corporation’s common stock may reinvest their dividend, or make optional cash payment, to purchase additional shares of the Corporation. Beneficial owners of shares of the Corporation’s common stock may participate in the program by making appropriate arrangements through their bank, broker or other nominee. Information concerning this optional program is available by contacting the Corporate Secretary at 717-264-6116, or:
Corporate Secretary
1500 Nitterhouse Drive, P.O. Box 6010
Chambersburg, PA 17201-6010
Dividend Direct Deposit Program:
Franklin Financial Services Corporation offers a dividend direct deposit program whereby shareholders of the Corporation’s common stock may choose to have their dividends deposited directly into the bank account of their choice on the dividend payment date. Information concerning this optional program is available by contacting the Corporate Secretary at 717-264-611, or:
Corporate Secretary
1500 Nitterhouse Drive, P.O. Box 6010
Chambersburg, PA 17201-6010
Annual Meeting:
The Annual Meeting of the shareholders of Franklin Financial Services Corporation will be held Tuesday, April 23, 2024 at 9:00 a.m. in a virtual meeting format only. Only shareholders will be granted access to the meeting as described in the Franklin Financial Services Corporation 2024 Proxy Statement.
Websites:
Franklin Financial Services Corporation: www.franklinfin.com
Farmers & Merchants Trust Company: www.fmtrust.bank
Stock Information:
The Corporation’s common stock is traded on the Nasdaq Capital Market under the symbol “FRAF”.
The registrar and transfer agent for Franklin Financial Services Corporation is:
Computershare
P.O. Box 30170
College Station, TX 77842-3170
1-800-368-5948

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ITEM 6. SELECTED FINANCIAL DATA
Item 6. [Reserved]
‎

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Summary of Selected Financial Data as of and for the Year Ended December 31
(Dollars in thousands, except per share)
Balance Sheet Highlights
Total assets
$
1,836,039
$
1,699,579
$
1,773,806
$
1,535,038
$
1,269,157
Debt securities available for sale, at fair value
472,503
487,247
530,292
397,331
187,873
Loans, net
1,240,933
1,036,866
983,746
992,915
922,609
Deposits
1,537,978
1,551,448
1,584,359
1,354,573
1,125,392
Shareholders' equity
132,136
114,197
157,065
145,176
127,528
Summary of Operations
Interest income
$
76,762
$
56,449
$
47,573
$
45,939
$
49,235
Interest expense
23,125
4,863
2,902
3,978
7,113
Net interest income
53,637
51,586
44,671
41,961
42,122
Provision for credit losses - loans
2,589
(2,100)
4,625
Provision for credit losses - unfunded commitments
-
-
-
-
Net interest income after provision for credit losses
50,913
50,936
46,771
37,336
41,885
Noninterest income
14,851
15,250
19,488
15,084
15,424
Noninterest expense
50,011
48,691
43,245
39,362
38,314
Income before income taxes
15,753
17,495
23,014
13,058
18,995
Federal income tax expense
2,155
2,557
3,398
2,880
Net income
$
13,598
$
14,938
$
19,616
$
12,800
$
16,115
Performance Measurements
Return on average assets
0.78%
0.83%
1.17%
0.91%
1.29%
Return on average equity
11.39%
11.64%
13.20%
9.56%
13.17%
Return on average tangible equity (1)
12.32%
12.52%
14.05%
10.24%
14.22%
Efficiency ratio (1)
70.75%
71.21%
66.12%
67.32%
65.36%
Net interest margin, fully tax equivalent
3.31%
3.11%
2.88%
3.21%
3.68%
Shareholders' Value (per common share)
Diluted earnings per share
$
3.10
$
3.36
$
4.42
$
2.93
$
3.67
Basic earnings per share
3.11
3.38
4.44
2.94
3.68
Regular cash dividends paid
1.28
1.28
1.25
1.20
1.17
Book value
30.23
26.01
35.36
33.07
29.30
Tangible book value (1)
28.17
23.96
33.34
31.02
27.23
Market value*
31.55
36.10
33.10
27.03
38.69
Market value/book value ratio
104.37%
138.79%
93.61%
81.74%
132.05%
Market value/tangible book value ratio
112.01%
150.67%
99.29%
87.13%
142.11%
Price/earnings multiple year-to-date
10.18
10.74
7.49
9.23
10.54
Dividend yield**
4.06%
3.55%
3.87%
4.44%
3.10%
Dividend payout ratio
41.15%
37.88%
28.16%
40.83%
31.74%
Safety and Soundness
Average equity/average assets
6.82%
7.17%
8.89%
9.48%
9.78%
Risk-based capital ratio (Total)
14.45%
17.21%
18.41%
17.69%
16.08%
Leverage ratio (Tier 1)
9.01%
8.95%
8.52%
8.69%
9.72%
Common equity ratio (Tier 1)
11.82%
14.22%
15.20%
14.32%
14.82%
Nonperforming loans/gross loans
0.01%
0.01%
0.74%
0.87%
0.42%
Nonperforming assets/total assets
0.01%
0.01%
0.42%
0.57%
0.31%
Allowance for credit loss/loans
1.28%
1.35%
1.51%
1.66%
1.28%
Net loan (charge-offs) recoveries/average loans
-0.02%
-0.15%
0.04%
0.02%
-0.07%
Assets under Management
Wealth Management Services (fair value)
$
1,094,747
$
904,317
$
946,964
$
836,381
$
790,949
Held at third-party brokers (fair value)
135,423
116,398
118,046
112,624
127,976
(1) See the section titled "GAAP versus Non-GAAP Presentation" that follows.
* Based on the closing price of FRAF as quoted on the Nasdaq Capital Market for all years shown.
** Based on annualized 4th quarter dividend and year-end market value.
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.
We caution readers not to place undue reliance on these forward-looking statements. They only reflect Management’s analysis as of this date. The Corporation does not revise or update these forward-looking statements to reflect events or changed circumstances. Please carefully review the risk factors described in other documents the Corporation files from time to time with the Securities and Exchange Commission, including the Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K.
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 Credit Losses (ACL).
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 generate one 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
Return on Average Tangible Equity (non-GAAP)
Net income
$
13,598
$
14,938
$
19,616
$
12,800
$
16,115
Average shareholders' equity
119,408
128,283
148,637
133,958
122,377
Less average intangible assets
(9,016)
(9,016)
(9,016)
(9,016)
(9,016)
Average shareholders' equity (non-GAAP)
110,392
119,267
139,621
124,942
113,361
Return on average tangible equity (non-GAAP)
12.32%
12.52%
14.05%
10.24%
14.22%
Tangible Book Value (per share) (non-GAAP)
Shareholders' equity
$
132,136
$
114,197
$
157,065
$
145,176
$
127,528
Less intangible assets
(9,016)
(9,016)
(9,016)
(9,016)
(9,016)
Shareholders' equity (non-GAAP)
123,120
105,181
148,049
136,160
118,512
Shares outstanding (in thousands)
4,371
4,390
4,441
4,389
4,353
Tangible book value (non-GAAP)
28.17
23.96
33.34
31.02
27.23
Efficiency Ratio (non-GAAP)
Noninterest expense
$
50,011
$
48,691
$
43,245
$
39,362
$
38,314
Net interest income
53,637
51,586
44,671
41,961
42,122
Plus tax equivalent adjustment to net interest income
1,094
1,381
1,466
1,407
1,393
Plus noninterest income, net of securities transactions
15,954
15,410
19,271
15,104
15,102
Total revenue
70,685
68,377
65,408
58,472
58,617
Efficiency ratio (non-GAAP)
70.75%
71.21%
66.12%
67.32%
65.36%
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
Franklin Financial Services Corporation reported consolidated earnings of $13.6 million ($3.10 per diluted share) for 2023 compared with $14.9 million ($3.36 per diluted share) for the same period in 2022.
Year-to-date, net interest income was $53.6 million, an increase of 4.0% compared to $51.6 million for the same period in 2022. On a year-over-year comparison, the net interest margin was 3.31% for 2023 compared to 3.11% in 2022. The increase in the 2023 net interest margin was due primarily to a 1.30% increase in the yield on earning assets from 3.40% in 2022 to 4.70% in 2023 as all asset classes had higher yields in 2023. This increase was primarily the result of action by the Federal Reserve to increase short-term interest rates in 2023. The cost of interest-bearing liabilities increased from 0.36% for 2022 to 1.75% for 2023. Likewise, the cost of all deposits increased from 0.23% in 2022 to 1.23% in 2023.
Average earning assets for 2023 were $1.656 billion compared to $1.702 billion in 2022, a decrease of 2.8%. In 2023, the average balance of interest-earning cash balances decreased $109.2 million (68.4%) to support loan growth and to offset a decrease in average deposits during the year. The average balance of the investment portfolio decreased $48.9 million (9.6%), while the average balance of the loan portfolio increased $111.3 million (10.8%), over the prior year
averages. Within the loan portfolio, average commercial loan balances increased $77.7 million during the year and residential mortgages increased $33.2 million. Total deposits averaged $1.530 billion for 2023, a decrease of $101.4 million (6.2%) from the average balance for 2022. All deposit categories reported a year-over-year decrease in average balances, except for time deposits. On a year-over-year comparison, the yield on earning assets increased 130 basis points from 3.40% in 2022 to 4.70% for 2023, while the cost of interest-bearing liabilities increased 139 basis points from 0.36% to 1.75% over the same period.
On January 1, 2023, the Bank adopted a new accounting standard for the calculation of its allowance for credit losses (ACL), referred to as the current expected credit loss (CECL) model. Upon adoption, the Bank recorded a decrease of $536 thousand to the ACL for loans, an increase of $411 thousand to the ACL for unfunded commitments (carried in Other Liabilities on the consolidated balance sheet), an increase of $98 thousand to retained earnings, and a deferred tax liability of $26 thousand. The provision for credit losses for 2023 was calculated using the CECL model, while the provision for loan losses for 2022 was calculated under the previous methodology. For 2023, the provision for credit losses on loans was $2.6 million compared to $650 thousand for 2022. The increase in the provision for credit loss was due primarily to growth in the loan portfolio. The ACL ratio for loans was 1.28% on December 31, 2023, compared to 1.35% on December 31, 2022. For 2023, the provision for credit losses on unfunded commitments was $135 thousand compared to $0 for 2022. The ACL for unfunded commitments was $2.0 million on December 31, 2023, compared to $1.5 million on December 31, 2022.
Noninterest income was $14.9 million compared to $15.3 million in 2022. The decrease was driven primarily by a loss of $1.1 million from the sale of securities as part of a portfolio restructuring in 2023, partially offset by increases in wealth management fees and debit card income.
‎
Noninterest expense was $50.0 million in 2023 compared to $48.7 million in 2022. The following categories contributed to the year-over-year increase: salaries and benefits increased $720 thousand (primarily salaries due to a highly competitive labor market, merit and performance increases), net occupancy increased $329 thousand (primarily depreciation on the new headquarters building put in service in July 2022), and a lease termination expense of $495 thousand.
‎
The effective federal income tax rate was 13.7% for 2023, which reflects the benefit of $367 thousand in tax credits recorded during the year. Without the tax credits, the effective rate year-to-date would have been 16.0%.
Total assets at December 31, 2023 were $1.836 billion compared to $1.700 billion at December 31, 2022, an increase of 8.0%. Significant balance sheet changes since December 31, 2022, include: 
Short-term interest-bearing deposits in other banks decreased $43.4 million (92.3%) and the investment portfolio decreased $14.3 million (2.9%).
‎
The net loan portfolio increased $204.1 million (19.7%) over the year-end 2022 balance, with commercial purpose loans increasing $149.4 million from year-end 2022.
‎
Deposits decreased $13.5 million (0.9%) over year-end 2022 with decreases in small business checking accounts and interest-bearing accounts.
Total borrowings were $130.0 million at year end, comprised of $40 million from the Federal Home Loan Bank (FHLB) and $90 million from the Federal Reserve Bank through the Bank Term Funding Program (BTFP).
‎
Shareholders’ equity increased $17.9 million from December 31, 2022. Retained earnings increased $8.1 million in 2023 and accumulated other comprehensive income (AOCI) increased $10.3 million as the fair value of the investment portfolio improved during the year. At December 31, 2023, the book value of the Corporation’s common stock was $30.23 per share and tangible book value was $28.17 per share. In December 2023, an open market 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 December 31, 2023.
Other key performance measurements are presented elsewhere 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 4.70% for 2023 from 3.40% for 2022. The benefit provided by tax-exempt income was $1.1 million in 2023.
Table 1. Net Interest Income
Change
(Dollars in thousands)
$
%
Interest income
$
76,762
$
56,449
$
20,313
36.0
Interest expense
23,125
4,863
18,262
375.5
Net interest income
53,637
51,586
2,051
4.0
Tax equivalent adjustment
1,094
1,381
(287)
(20.8)
Tax equivalent net interest income
$
54,731
$
52,967
$
1,764
3.3
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.
Table 2. Rate-Volume Analysis of Tax Equivalent Net Interest Income
2023 Compared to 2022
2022 Compared to 2021
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-earning deposits in other banks
$
(2,571)
$
2,495
$
(76)
$
$
2,070
$
2,234
Investment securities:
Taxable
(434)
5,305
4,871
2,136
2,759
Nontaxable
(885)
(185)
(1,070)
(242)
(68)
Investment securities
(1,319)
5,120
3,801
2,310
2,691
Loans:
Residential real estate 1-4 family:
First liens
1,505
2,283
Junior liens and lines of credit
(19)
1,691
1,672
Residential real estate - construction
(30)
Commercial real estate
3,568
5,834
9,402
1,840
2,167
4,007
Commercial
2,483
2,548
(1,114)
(354)
(1,468)
Consumer
(63)
(21)
Loans
5,115
11,186
16,301
2,953
3,866
Total net change in interest income
1,225
18,801
20,026
1,458
7,333
8,791
Interest expense on:
Interest checking
(155)
1,354
1,199
Money management
(90)
11,349
11,259
1,625
1,712
Savings
(9)
Time deposits
2,313
2,487
(46)
(98)
(144)
Deposits
(80)
15,107
15,027
1,825
1,963
Subordinate notes
(4)
(2)
Federal Reserve Bank borrowings
2,374
-
2,374
-
-
-
Federal Home Loan Bank advances
-
-
-
-
Total net change in interest expense
3,153
15,109
18,262
1,821
1,961
Change in tax equivalent net interest income
$
(1,928)
$
3,692
$
1,764
$
1,318
$
5,512
$
6,830
The following table presents average balances, tax-equivalent (T/E) interest income, interest 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
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
$
50,451
$
2,407
4.77%
$
159,610
$
2,483
1.56%
Investment securities:
Taxable
406,937
14,846
3.65%
424,703
9,975
2.35%
Tax exempt
54,416
1,523
2.80%
85,566
2,593
3.03%
Investment securities
461,353
16,369
3.55%
510,269
12,568
2.46%
Loans:
Residential real estate 1-4 family:
First liens
173,986
7,912
4.55%
139,577
5,629
4.03%
Junior liens and lines of credit
72,623
4,050
5.58%
73,200
2,378
3.25%
Residential real estate - construction
21,124
1,303
6.17%
21,737
1,013
4.66%
Commercial real estate
626,817
33,204
5.30%
550,772
23,802
4.32%
Commercial
243,045
12,080
4.97%
241,395
9,532
3.95%
Consumer
6,285
8.45%
5,938
7.16%
Loans
1,143,880
59,080
5.16%
1,032,619
42,779
4.14%
Total interest-earning assets
1,655,684
$
77,856
4.70%
1,702,499
$
57,830
3.40%
Other assets
95,489
87,300
Total assets
$
1,751,173
$
1,789,799
Interest-bearing liabilities:
Deposits:
Interest checking
$
459,447
$
2,078
0.45%
$
543,553
$
0.16%
Money Management
568,521
13,801
2.43%
588,728
2,542
0.43%
Savings
117,026
0.16%
128,203
0.08%
Time
91,512
2,781
3.04%
64,273
0.46%
Total interest-bearing deposits
1,236,506
18,843
1.52%
1,324,757
3,816
0.29%
Subordinate notes
19,642
1,051
5.35%
19,605
1,047
5.34%
Federal Reserve Bank borrowings
53,041
2,374
4.48%
-
-
0.00%
Federal Home Loan Bank advances
14,704
5.83%
-
-
0.00%
Total interest-bearing liabilities
1,323,893
23,125
1.75%
1,344,362
4,863
0.36%
Noninterest-bearing deposits
293,001
306,102
Other liabilities
14,871
11,052
Shareholders' equity
119,408
128,283
Total liabilities and shareholders' equity
$
1,751,173
$
1,789,799
T/E net interest income/Net interest margin
54,731
3.31%
52,967
3.11%
Tax equivalent adjustment
(1,094)
(1,381)
Net interest income
$
53,637
$
51,586
Net Interest Spread
2.95%
3.04%
Cost of Funds
1.43%
0.29%
Cost of Deposits
1.23%
0.23%
Provision for Credit Losses
In 2023, the Bank recorded gross loan charge-offs of $422 thousand, which were partially offset by $246 thousand of recoveries, resulting in net loan charge-offs of $176 thousand. For 2023, the Corporation recorded $2.7 million as a provision for credit loss expense allocated between the provision for loans of $2.6 million and the provision for unfunded commitments of $135 thousand. Due to loan growth in 2023, the allowance for credit losses increased to $16.1 million at year-end 2023 (1.28% of total loans), compared to $14.2 million at year-end 2022 (1.35% of total loans). Management closely monitors the credit quality of the portfolio in order to ensure that an appropriate ACL is maintained. As part of this process, Management performs a comprehensive analysis of the loan portfolio considering delinquencies trends and events, current economic forecasts and conditions, and other relevant factors to determine the adequacy of the allowance for credit losses and the provision for credit losses. For more information, refer to the Loan Quality discussion and Table 10.
Noninterest Income
The following table presents a comparison of noninterest income for the years ended December 31, 2023 and 2022:
Table 4. Noninterest Income
Change
(Dollars in thousands)
Amount
%
Noninterest Income
Wealth management fees
$
7,512
$
7,152
$
5.0
Loan service charges
12.0
Gain on sale of loans
(571)
(74.2)
Deposit service charges and fees
2,492
2,527
(35)
(1.4)
Other service charges and fees
1,852
1,724
7.4
Debit card income
2,157
1,868
15.5
Increase in cash surrender value of life insurance
2.8
Net (losses) gains on sales of debt securities
(1,119)
(91)
(1,028)
1,129.7
Change in fair value of equity securities
(69)
(123.2)
Other
131.1
Total
$
14,851
$
15,250
$
(399)
(2.6)
The most significant changes in noninterest income are discussed below:
Wealth management 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 $6.9 million for 2023 and $6.5 million for 2022 with fluctuations in value during the year affecting fee income. The fair value of trust assets under management was $1.095 billion at year-end, compared to $904.3 million at the end of 2022. Estate fees were $295 thousand in 2023 compared 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 $167 thousand compared to 2022.
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 residential mortgages with servicing released in the secondary market. Due to lower origination volume, the Bank sold substantially fewer loans in 2023 compared to 2022.
Deposit fees: This category is comprised primarily of fees from overdrafts, an overdraft protection program, service charges, and account analysis fees. The decrease of $35 thousand in this category was due to a lower volume of overdraft 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 $28 thousand while ATM fees increased $83 thousand.
Debit card income: Debit card fees are comprised of both a retail and business card program. Retail fees increased by $289 thousand, while business card fees were flat year over year. 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.
Net (losses) gains on sales of debt securities: The Bank took losses of $1.1 million on the sale of investment securities as part of portfolio restructuring. Due to market conditions, the Bank was able to sell low yielding bonds and reinvest at higher yields.
Noninterest Expense
The following table presents a comparison of noninterest expense for the years ended December 31, 2023 and 2022:
Table 5. Noninterest Expense
(Dollars in thousands)
Change
Noninterest Expense
Amount
%
Salaries and benefits
$
28,813
$
28,094
$
2.6
Net occupancy
4,398
4,069
8.1
Marketing and advertising
2,071
1,915
8.1
Legal and professional
2,301
2,202
4.5
Data processing
4,792
4,751
0.9
Pennsylvania bank shares tax
1,148
(403)
(35.1)
FDIC insurance
15.6
ATM/debit card processing
1,235
1,428
(193)
(13.5)
Telecommunications
2.3
Nonservice pension
(117)
(684)
(120.6)
Lease termination
-
-
Other
4,022
3,385
18.8
Total
$
50,011
$
48,691
$
1,320
2.7
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 $719 thousand compared to the prior year from: salary increases of $1.6 million due to merit and annual increases, and new positions offset by decreases in health insurance expense of $371 thousand, $225 thousand in stock compensation expense, $153 thousand for incentive compensation plans, and $126 thousand in pension service costs. 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 2023 from a full year of depreciation of its new headquarters building.
Legal and professional fees: This category consists of fees paid to outside legal counsel, consultants, and audit fees. Consulting fees increased $44 thousand due to advisory services related to the implementation of a customer relationship management system. Internal and external audit fees increased by $3 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 $2.0 million of the total data processing costs in 2023 and $2.3 million in 2022.
Nonservice pension: The decrease in the nonservice pension expense was due to a $684 thousand reduction in pension settlement costs related to lump-sum pension payouts during 2022 and lower asset returns and amortization.
Lease Termination: The lease termination was for a long-term lease held for a new community office that will not be constructed.
Other: The largest increases in this category were in directors’ fees ($141 thousand) and charitable donations ($135 thousand). All other increases are due primarily to overall higher operating expenses.
Provision for Income Taxes
In 2023, the Corporation recorded a Federal income tax expense of $2.2 million compared to $2.6 million in 2022. The effective tax rate was 14.6% for 2022 and 13.7% for 2023, which reflects the benefit of $367 thousand in tax credits recorded during 2023. Without tax credits, the Bank’s effective tax rate was 16.0%. The Corporation’s 2023 and 2022 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. At December 31, 2023, total assets increased 8.0% over the prior year to $1.84 billion from $1.70 billion at the end of 2022.
Interest Earning Deposits in Other Banks:
Short-term interest-earning deposits, held primarily at the Federal Reserve, decreased to $3.6 million at December 31, 2023 compared to $47.0 million at December 31, 2022, as the excess cash was redeployed into the loan portfolio and deposit balances decreased. Long-term interest-earning deposits decreased from $14.0 million at December 31, 2022 to $6.2 million at December 31, 2023. The average balance of interest-earning deposits decreased to $50.5 million in 2023 compared to $159.3 million in 2022.
Investment Securities:
AFS Securities
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 include U.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 5.0 years, the effective duration (which measures the change in fair value for a 1% change in interest rates) is 3.7%, and $207.4 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 for U.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 at December 31 for the past two years:
Table 6. Investment Securities at Amortized Cost and Estimated Fair Value
Amortized
Fair
Amortized
Fair
(Dollars in thousands)
Cost
value
Cost
value
U.S. Treasury
$
83,494
$
74,091
$
101,980
$
90,257
Municipal
161,339
138,618
186,007
155,455
Corporate
26,336
23,198
26,316
24,239
Agency mortgage & asset-backed
142,565
132,591
163,274
150,935
Non-agency mortgage & asset-backed
108,185
104,005
70,756
65,950
Total
$
521,919
$
472,503
$
548,333
$
486,836
The following table presents investment securities at December 31, 2023 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
$
-
-
$
46,824
1.26%
$
27,267
1.33%
$
-
-
$
74,091
1.28%
Municipal
-
-
4,287
1.96%
43,064
2.32%
91,267
2.23%
138,618
2.25%
Corporate
-
-
3,961
6.86%
18,409
4.77%
4.28%
23,198
5.08%
Agency mortgage & asset-backed
2.84%
12,193
1.62%
27,797
2.77%
92,508
4.64%
132,591
3.95%
Non-agency mortgage & asset-backed
6,723
7.95%
13,306
5.37%
3.92%
82,991
5.63%
104,005
5.72%
Total
$
6,816
7.88%
$
80,571
2.25%
$
117,522
2.59%
$
267,594
4.05%
$
472,503
3.42%
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 2.46% in 2022 to 3.55% in 2023. U.S. Agency mortgage-backed securities and municipal bonds continue to comprise the largest sectors by fair value of the portfolio, approximately 28% and 29% respectively. The
Bank expects that the portfolio will continue to remain concentrated in these investment sectors. The portfolio returned $72.4 million of principal cash flow in 2023 while $50.3 million was invested into the portfolio during the year.
Municipal Bonds: This sector holds $138.6 million or 29% of the total portfolio and the amortized cost decreased by $24.7 million year over year. The Bank’s municipal bond portfolio is well diversified geographically and is comprised of both tax-exempt (35% of the portfolio) and taxable (65% of the portfolio) municipal bonds. Sixty-nine percent of the portfolio are general obligation bonds and thirty-two percent are revenue bonds. The portfolio holds bonds from 154 issuers within 34 states. The largest dollar exposures are in the states of Texas (15%), California (13%) and Pennsylvania (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 $19.2 million of subordinate debt from 44 different community bank issuers.
Agency Mortgage & Asset-backed Securities (MBS): This sector holds $132.6 million, or 28%, of the total portfolio. This sector is comprised of bonds issued and guaranteed by the U.S. Government, a U.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 $104.0 million, or 22%, 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 $83.0 million of its fair value investment grade rated by nationally recognized statistical rating organizations while $21.0 million of its fair value is nonrated.
Impairment: For securities with an unrealized loss, the Bank considers: (1) the extent to which the fair value is less than amortized cost; (2) adverse conditions specifically related to the security, industry or geographic area; (3) the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future; (4) failure of the issuer of the security to make scheduled interest or principal payments; and (5) any changes to the rating of the security by a rating agency. 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 Bank does not have the intent to sell and does not believe it will more likely than not be required to sell any of these securities prior to a recovery of their fair value to amortized cost. The impairment identified on debt securities and subject to evaluation at December 31, 2023, was determined not to be attributable to credit related factors; therefore, the Bank does not have an allowance for credit loss for these investments. During 2023, $40.1 million of securities were sold as part of a portfolio restructuring to take advantage of higher market interest rates. The realized loss on these sales was $1.1 million.
Equity Securities at Fair Value
The Corporation owns one equity investment with a readily determinable fair value. At December 31, 2023, this investment was reported at fair value ($427 thousand) with changes in value reported through income in 2023.
Restricted Stock at Cost
The Bank held $2.4 million of restricted stock at the end of 2023 of which $2.4 million is stock in the FHLB, 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 the U.S. Treasury that can be used to support its operations. There is not a public market for FHLB stock and the benefits of FHLB membership (e.g., liquidity and low-cost funding) add value to the stock beyond purely financial measures. 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 19.6% ($205.9 million) in 2023, due primarily to an increase of $139.5 million in commercial real estate loans. Average gross loans for 2023 increased by $111.3 million to $1.144 billion. Commercial, mortgage and consumer loans showed an increase in average balances during the year, which was partially offset by a decline in home equity loans and lines of credit and construction loans. The yield on the portfolio increased in 2023 to 5.16% from 4.14% in 2022. Table 3, previously presented, shows the average balances and yields earned on loans for the past two years.
The following table shows loans outstanding, by class, as of December 31 for the past 2 years.
Table 8. Loan Portfolio
Change
(Dollars in thousands)
Amount
%
Residential real estate 1-4 family
Consumer first lien
$
142,017
$
85,166
$
56,851
66.8
Commercial first lien
63,271
61,702
1,569
2.5
Total first liens
205,288
146,868
58,420
39.8
Consumer junior lien and lines of credit
68,752
69,561
(809)
(1.2)
Commercial junior liens and lines of credit
3,809
4,127
(318)
(7.7)
Total junior liens and lines of credit
72,561
73,688
(1,127)
(1.5)
Total residential real estate 1-4 family
277,849
220,556
57,293
26.0
Residential real estate construction
Consumer
13,837
13,908
(71)
(0.5)
Commercial
12,063
10,485
1,578
15.1
Total residential real estate construction
25,900
24,393
1,507
6.2
Commercial real estate
703,767
564,291
139,476
24.7
Commercial
242,654
235,602
7,052
3.0
Total commercial
946,421
799,893
146,528
18.3
Consumer
6,815
6,199
9.9
Total loans
1,256,985
1,051,041
205,944
19.6
Less: Allowance for loan losses
(16,052)
(14,175)
(1,877)
13.2
Net loans
$
1,240,933
$
1,036,866
$
204,067
19.7
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, as well as loans made to individuals secured by unimproved noncommercial real estate. Total residential real estate loans increased $57.3 million in 2023, primarily in consumer first lien loans. In 2023, the Bank originated $92.4 million in mortgages compared to $81.7 million in 2022, including approximately $14.0 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, $13.8 million, represents loans for individuals to construct personal residences, while loans to residential real estate developers and home builders totaled $12.1 million at December 31, 2023. The Bank’s exposure to residential construction loans is concentrated primarily in south central Pennsylvania. Real estate construction loans, including residential real estate and land development loans, occasionally provide an interest reserve in order to assist the developer during the development stage when minimal cash flow is generated.
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 $139.5 million over the prior year. The largest sectors (by collateral) are: apartment buildings ($120.2 million), office buildings ($87.1 million), hotel & motel ($80.7 million) and shopping centers ($68.5 million). The majority of the Bank’s hotel and office building exposure is located throughout south-central Pennsylvania. The three largest growth sectors in 2023 were office buildings, apartment units and development land which totaled $71.0 million. Included in commercial real estate are approximately $522 million of nonowner occupied loans.
Also included in CRE are real estate construction loans totaling $131.9 million. At December 31, 2023, the Bank had $63.4 million in real estate construction loans funded with an interest reserve and capitalized $1.4 million of interest in 2023 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.
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 increased $7.1 million over the 2022 ending balance. At December 31, 2023, the Bank had approximately $113 million of tax-free loans in its portfolio. The largest sectors (by industry) are: public administration ($44.7 million), utilities ($42.0 million) real estate, rental and leasing ($25.0 million) and retail trade ($18.6 million). This category also includes $57 thousand of PPP loans that are 100% guaranteed by the SBA, compared to $179 thousand at December 31, 2022.
Participations: At December 31, 2023, the outstanding commercial participations were $97.8 million (9.5% of commercial purpose loans and 7.8% of total gross loans), compared to $70.6 million (8.1% of commercial purpose loans and 6.7% of total gross loans) at the prior year-end. The Bank’s total exposure (including unfunded commitments) to purchased participations was $135.4 million at December 31, 2023 and $90.0 million at December 31, 2022. The loan participations are comprised of $26.0 million of commercial loans and $71.8 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 increased $616 thousand in 2023 over 2022 ending balances.
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 December 31, 2023.
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
$
2,510
$
10,270
$
45,746
$
16,016
$
74,542
Variable rate
2,846
13,218
56,210
131,033
203,307
5,356
23,488
101,956
147,049
277,849
Residential real estate construction
Fixed rate
-
-
13,698
13,837
Variable rate
6,101
5,251
-
12,063
6,240
5,251
13,698
25,900
Commercial real estate
Fixed rate
4,250
71,340
78,590
-
154,180
Variable rate
45,279
120,964
319,889
63,455
549,587
49,529
192,304
398,479
63,455
703,767
Commercial
Fixed rate
1,753
42,372
55,326
99,817
Variable rate
43,214
19,606
31,889
48,128
142,837
44,967
61,978
87,215
48,494
242,654
Consumer
Fixed rate
2,419
1,566
4,603
Variable rate
-
2,212
2,775
1,497
1,566
6,815
$
107,069
$
285,796
$
589,858
$
274,262
$
1,256,985
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.
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 $17.2 million at year-end compared to $11.6 million one year earlier. Included in the watch list are $147 thousand of nonaccrual loans at year-end 2023, compared to $120 thousand at year-end 2022. 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 for 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. 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 an external loan review consultant to assist with internal loan review with a goal of reviewing up to 80% of commercial loans each year. The FDIC defines certain supervisory loan-to-value lending limits. The Bank’s internal loan-to-value limits are all equal to or have a lower loan-to-value limit than the supervisory limits. However, in certain instances, the Bank may make a loan that exceeds the supervisory loan-to-value limit. At December 31, 2022, the Bank had loans of $13.7 million (1.1% of gross loans) that exceeded the supervisory loan-to value limit, compared to 1.2% at the prior year end.
Loan quality, as measured by nonaccrual loans, totaled $147 thousand at December 31, 2023 compared to $120 thousand at December 31, 2022 and the nonperforming loan to total loans ratio was 0.01% at December 31, 2023 and 2022. Loans past due 90-days or more, but still accruing, totaled $5 thousand at December 31, 2023.
In addition to monitoring nonaccrual loans, the Bank also closely monitors loans to borrowers experiencing financial difficulty 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.
Modifications to borrowers experiencing financial difficulty may include interest rate reductions, principal or interest forgiveness, forbearances, term extensions, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral.
Allowance for Credit Losses:
Allowance for Credit Losses - Loans
The ACL for loans is established through provisions for credit losses charged against income. Loans deemed to be uncollectible are charged against the ACL, and subsequent recoveries, if any, are credited to the ACL.
The ACL for loans is an estimate of the losses expected to be realized over the life of the loan portfolio. The ACL is determined for two distinct categories of loans: 1) loans evaluated individually for expected credit losses (specific reserve), and 2) loans evaluated collectively for expected credit losses (pooled reserve). Management’s periodic evaluation of the adequacy of the ACL for loans is based on the Bank’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic forecasts and conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, borrowers’ actual or perceived financial and managerial strengths, and other relevant factors. This evaluation is inherently subjective, as it requires
material assumptions and estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on loans evaluated individually.
Loans evaluated individually for credit losses are primarily commercial purpose loans that do not share similar characteristics with those loans evaluated in the pool. These loans may exhibit performance characteristics where it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. All commercial purpose loans greater than $250 thousand and rated Substandard (7), Doubtful (8) or on nonaccrual status may be considered for individual evaluation. Impairment is measured on a loan-by-loan basis by one of the following methods: the fair value of the collateral if the loan is collateral dependent, the present value of expected future cash flows discounted at the loan’s effective interest rate or the loan’s obtainable market price. Commercial purpose loans with a balance less than $250 thousand, and consumer purpose loans are not evaluated individually for a specific reserve but are included in the pooled reserve calculation. Loans that are evaluated for a specific reserve, but not needing a specific reserve are not included in the pooled reserve calculation.
The Corporation has elected to exclude accrued interest receivable from the measurement of the ACL. When a loan is placed on nonaccrual status, any outstanding current accrued interest is reversed against income and prior year accrued interest is deducted from the ACL.
The pooled reserve represents the ACL for pools of homogenous loans, not evaluated individually. The pooled reserve is calculated using a quantitative and qualitative component for the loan pools.
The following inputs are used to calculate the quantitative component for the loan pool:
Segregating loans into homogeneous pools by the FRB Call Code which is primarily a collateral-based and secondarily a purpose-based segmentation.
The average remaining life of each pool is calculated using the weighted average remaining maturity method (WARM). The WARM method produces an estimated remaining balance by pool, by year, until maturity.
A historical credit loss rate is calculated for each pool, using the average historical loss, by FRB Call Code, for a peer group of Pennsylvania community banks over the last eight quarters. The loss rate is calculated over a historical period the Bank believes best represents a period, based on a reasonable and supportable forecast, that will be similar to the next four quarters.
The historical credit loss rate is applied to each WARM bucket though the initial four quarter forward-looking period.
At the end of the forward-looking period, the credit loss rate applied to each WARM bucket reverts to the peer group historical loss rate for the respective pool.
Collectively these estimated losses represent the quantitative component of the pooled reserve.
The qualitative component for the pool utilizes a risk matrix comprised of eight risk factors and assigns a risk level to each factor. The risk factors give consideration to changes in: lending policy, procedures and practice; economic conditions; nature and volume of loans; experience of lending team; volume of past due loans; quality of the loan review system; concentrations of credit; and other external factors. The risk factors are weighted to reflect Management’s estimate of how the factor affects potential losses. The risk levels within each factor are measured in basis points and range from minimal risk to very high risk and are determined independently for commercial loans, residential mortgage loans and consumer loans.
The ACL for pooled loans is the sum of the quantitative and qualitative loss estimates.
Allowance for Credit Losses - Unfunded Commitments
The ACL for unfunded commitments is recorded in other liabilities on the consolidated balance sheet. The ACL represents management’s estimate of expected losses from unfunded commitments and is determined by estimating future usage of the commitments, based on historical usage. The estimated loss is calculated in a manner similar to that used for the ACL for loans, previously described. The ACL is increased or decreased through the provision for credit losses.
The following table shows the allocation of the allowance for loan losses and other loan performance ratios, by class, as of December 31, 2023 and 2022:
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
Loans at December 31, 2023
$
205,288
$
72,561
$
25,900
$
703,767
$
242,654
$
6,815
$
-
$
1,256,985
Average Loans for 2023
173,986
72,623
21,124
626,817
243,045
6,285
-
1,143,880
Nonaccrual Loans at December 31, 2023
-
-
-
-
-
-
Allowance for Credit Losses at December 31, 2023
1,296
10,657
3,290
-
16,052
Net Recoveries/(Charge-offs) for 2023
-
(193)
(35)
-
(176)
Loans/Total Gross Loans at December 31, 2023
16%
6%
2%
56%
19%
1%
-
100%
Nonaccrual Loans/Total Gross Loans at December 31, 2023
0.00%
0.00%
0.00%
0.00%
0.06%
0.00%
-
0.01%
Allowance for Credit Loss/Gross Loans at December 31, 2023
0.63%
0.58%
1.14%
1.51%
1.36%
1.38%
-
1.28%
Net Recoveries (Charge-offs)/Average Loans for 2023
0.00%
0.00%
0.23%
0.00%
-0.08%
-0.56%
-
-0.02%
Allowance for Credit Loss/Nonaccrual Loans at December 31, 2023
10,919.73%
Loans at December 31, 2022
$
146,868
$
73,688
$
24,393
$
564,291
$
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
-
-
-
-
-
-
Allowance for Loan Losses at December 31, 2022
7,493
4,846
14,175
Net Recoveries/(Charge-offs) for 2022
-
(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%
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, 2023. The 2023 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 2023 and did not make a further assessment.
The 2022 impairment test was also conducted using a qualitative assessment and Management determined the Bank’s goodwill was likely not impaired in 2022 and did not make a further assessment.
At December 31, 2023, 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.
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 at December 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)
Amount
%
Noninterest-bearing checking
$
273,050
$
299,231
$
(26,181)
(8.7)
Interest-bearing checking
454,517
496,533
(42,016)
(8.5)
Money management
572,058
569,585
2,473
0.4
Savings
105,907
128,709
(22,802)
(17.7)
Time deposits
132,446
57,390
75,056
130.8
Total
$
1,537,978
$
1,551,448
$
(13,470)
(0.9)
Noninterest-bearing checking: This category decreased $26.2 million while the average balance decreased by $13.1 million for the year. As a noninterest bearing account, these deposits contributed approximately 36 basis points to the net interest margin.
Interest-bearing checking: This category saw a decrease of $42.0 million in the ending balance compared to the prior year and a decrease of $84.1 million compared to the prior year average primarily in retail accounts in 2023. The cost of these accounts increased by 29 basis points.
Money management: The year over year balance increased $2.5 million and the average balance decreased $20.2 million compared to the 2022 average balance. The cost of this product increased by 200 basis points during the year as market rates increased.
Savings: Savings accounts decreased $22.8 million during the year. The cost of this product increased by 8 basis points during the year as market rates increased.
Time deposits: Time deposits increased by $75.1 million in 2023 with an increase in the average balance of $27.2 million as customers locked in higher interest rates. The cost of these accounts increased from .46% to 3.04% as market rates increased. Included in this category is $8.7 million of brokered CDs.
Reciprocal deposits: At year-end 2023, the Bank had $237.8 million placed in the IntraFi Network deposit program ($137.8 million in interest-bearing checking and $100.0 million in money management) and $6.4 million of time deposits placed into the CDARS program. These programs allow the Bank to offer full FDIC coverage to large depositors, but with the convenience to the customer of only having to deal with one bank. The Bank solicits these deposits from within its market and it believes they present no greater risk than any other local deposit. Only reciprocal deposits that exceed 20% of liabilities are considered brokered deposits. At December 31, 2023, the Bank’s reciprocal deposits were 15.5% 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: Aggregate estimated uninsured deposits at December 31, 2023 were $299.9 million (19.5% of total deposits) compared to $299.2 million (19.3% of total deposits) at December 31, 2022. Certain Bank deposits may not be insured but are fully collateralized by other assets. The Bank estimates that approximately 91% of its deposits are FDIC insured or collateralized as of December 31, 2023.
At December 31, 2023, time deposits in excess of the FDIC insurance limit and time deposits that are otherwise uninsured by maturity were as follows:
Table 12. Time Deposits of $250,000 or More
(Dollars in thousands)
Individual Instruments that Meet or Exceed FDIC Insurance Limit
Time Deposits that Meet or Exceed FDIC Insurance Limit
Maturity distribution:
Within three months
$
21,544
$
17,294
Over three through six months
8,754
6,004
Over six through twelve months
9,626
7,126
Over twelve months
4,475
1,475
Total
$
44,399
$
31,899
Borrowings:
Short-term Borrowings: At December 31, 2023, the Bank had $90.0 million borrowed from the Federal Reserve’s Bank Term Funding Program (BTFP) to temporarily support its liquidity position and $40.0 million in short-term borrowing from the Federal Home Loan Bank of Pittsburgh (FHLB). The BTFP borrowing is comprised of $50.0 million with a rate of 4.38% due March 22, 2024, $20.0 million with a rate of 4.71% due May 10, 2024, and $20.0 million with a rate of 4.93% due December 13, 2024. At December 31, 2023, the fair value of debt securities pledged for the BTFP was $88.4 million. The FHLB borrowings have a blended rate of 5.80% and are due during the third quarter of 2024.
Long-term Debt: On August 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 of September 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 of September 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.
Subsequent to year-end 2023, the Bank borrowed $200 million in a term loan from FHLB for three years at a rate of 4.32%. The term loan was taken to restructure borrowings and to fund expected loan growth. In addition, two outstanding borrowings under the BTFP due in 2024 were refinanced in the amount of $40 million at a fixed rate of 4.81% extending the maturity date to January 2025.
Shareholders’ Equity:
Shareholders’ equity increased by $17.9 million to $132.1 million at December 31, 2023. Retained earnings increased $8.1 million in 2023 from earnings of $13.6 million offset by dividends paid of $5.6 million ($1.28 per share). The dividend payout ratio was 40.2% in 2023 compared to 37.9% in 2022.
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 of Equity 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 2023. This total was comprised of $1.0 million from the reinvestment of quarterly dividends and $312 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.
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 by Federal Reserve Board. The Bank is required to comply with capital adequacy standards established by the FDIC. In addition, the Pennsylvania 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, effective January 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 1 Risk-Based Capital of 8%, and (4) Total Risk-Based Capital of 10%. The CET1 ratio is a new capital ratio under Basel III and the Tier 1 risk-based capital ratio of 8% has been increased from 6%. The rules also included changes in the risk weights of certain assets to better reflect credit and other risk exposures. In addition, a capital conservation buffer of 2.50% 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 at December 31, 2023 was 5.63%. Compliance with the capital conservation buffer is required in order to avoid limitations on certain capital distributions, especially dividends. As of December 31, 2023, the Bank was “well capitalized’ under the Basel III requirements.
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 effective January 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 and Bank at December 31:
Table 13. Capital Ratios
Corporation
Bank
Corporation
Bank
Common Equity Tier 1 risk-based capital ratio
11.82%
12.38%
14.22%
14.63%
Total risk-based capital ratio
14.45%
13.63%
17.21%
15.88%
Tier 1 risk-based capital ratio
11.82%
12.38%
14.22%
14.63%
Tier 1 leverage ratio
9.01%
9.44%
8.95%
9.21%
For additional information on capital adequacy refer to Note 2 of the accompanying consolidated financial statements.
Local Economy
The Corporation’s primary market area includes Franklin, Fulton, Cumberland, Huntingdon, and Dauphin County, PA, and Washington County, MD. This area is diverse in demographic and economic composition. County populations range from a low of approximately 15,000 in Fulton County to over 280,000 in Dauphin County. 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 at December 31:
Economic Data
Unemployment Rate (seasonally adjusted)
Market area range (1)
2.4% - 3.5%
2.4% - 4.1%
Pennsylvania
3.4%
4.0%
Maryland
1.7%
4.3%
United States
3.7%
3.7%
Housing Price Index - year over year change
PA, nonmetropolitan statistical area
4.6%
14.3%
United States
4.8%
16.6%
Building Permits - year over year change -12 months
Harrisburg-Carlisle, PA MSA, Chambersburg-Waynesboro, PA MSA and Hagerstown, MD MSA
Residential, estimated
-15.4%
-3.6%
Multifamily, estimated
-50.7%
260.9%
(1) Franklin, Cumberland, Fulton and Huntingdon County, PA and Washington County, MD
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. In February 2024, the FOMC release included this: “Recent indicators suggest that economic activity has been expanding at a solid pace. Job gains have moderated since early last year but remain strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated. The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. The Committee judges that the risks to achieving its employment and inflation goals are moving into better balance. The economic outlook is uncertain, and the Committee remains highly attentive to inflation risks. The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.” 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 its 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, marketable securities that are unencumbered as collateral for borrowings are an additional source of
readily available liquidity (approximately $164.8 million fair value), 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, it would have a material negative effect on the Bank, and it is highly 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 unsecured lines of credit at correspondent banks.
The following table shows the Bank’s available liquidity at December 31, 2023.
(Dollars in thousands)
Liquidity Source
Capacity
Outstanding
Available
Federal Home Loan Bank
$
484,163
$
40,000
$
444,163
Federal Reserve Bank Discount Window
55,496
-
55,496
Fed Bank Term Funding Program
91,733
90,000
1,733
Correspondent Banks
56,000
-
56,000
Total
$
687,392
$
130,000
$
557,392
Subsequent to year-end 2023, the Bank borrowed $200 million in a term loan from FHLB for three years at a rate of 4.32%. The term loan was taken to restructure borrowings and to fund expected loan growth.
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. At December 31, 2023, the ACL for unfunded commitments was $2.0 million compared to $1.5 million at December 31, 2022. The ACL for unfunded commitments is reported in Other Liabilities on the Consolidated Balance Sheet.
(Dollars in thousands)
Financial instruments whose contract amounts represent credit risk
Commercial commitments to extend credit
$
325,982
$
275,867
Consumer commitments to extend credit (secured)
112,157
93,124
Consumer commitments to extend credit (unsecured)
5,964
5,247
$
444,103
$
374,238
Standby letters of credit
$
19,851
$
30,734
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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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market Risk
In the course of its normal business operations, the Corporation is exposed to certain market risks. The Corporation has no foreign currency exchange rate risk, no commodity price risk or material equity price risk. However, it is exposed to interest rate risk. All interest rate risk arises in connection with financial instruments entered into for purposes other than trading. Financial instruments, which are sensitive to changes in market interest rates, include fixed and variable-rate loans, fixed-income securities, derivatives, interest-bearing deposits and other borrowings.
Changes in interest rates can have an impact on the Corporation’s net interest income and the economic value of equity. The objective of interest rate risk management is to identify and manage the sensitivity of net interest income and economic value of equity to changing interest rates in order to achieve consistent earnings that are not contingent upon favorable trends in interest rates.
The Corporation’s primary tool for analyzing interest rate risk is financial simulation modeling which captures the effect of not only changing interest rates but also other sources of cash flow variability including loan and securities prepayments and customer preferences. Financial simulation modeling forecasts both net interest income and the economic value of equity under a variety of different interest rate environments. The Corporation measures the effects of multiple interest rate change scenarios on at least a quarterly basis. The magnitude of each change scenario may vary depending on the current interest rate environment. In addition, the balance sheet is held static in each scenario so that the effect of an interest rate change can be isolated and not distorted by changes in the balance sheet.
Table 14 presents the results of six different rate change scenarios and measures the change in net interest income against a base (unchanged) scenario over one year. For each scenario, interest rate changes are ramped up or down over a period of 1 year. The Bank believes a ramp scenario is more realistic than an interest rate shock scenario; however, the Bank also runs scenarios using shocks and yield curve twists.
Computations of prospective effects of hypothetical interest rate changes are based on many assumptions, including relative levels of market interest rates, loan prepayments and deposit repricing that cannot be measured with complete precision. Further, the computations do not contemplate any actions Management could undertake in response to changes in market interest rates.
Table 14. Sensitivity to Changes in Market Interest Rates
(Dollars in thousands)
Net Interest Income
Change in rates (basis points)
Projected
% Change
+300
$
48,500
(7.5)%
+200
$
50,000
(4.8)%
+100
$
51,300
(2.3)%
unchanged
$
52,500
-
(100)
$
52,000
(0.9)%
(200)
$
51,700
(1.5)%
(300)
$
51,400
(2.1)%
Impact of Inflation
The impact of inflation upon financial institutions such as the Corporation differs from its effect upon other commercial enterprises. Unlike most other commercial enterprises, virtually all of the assets of the Corporation are monetary in nature. As a result, interest rates have a more significant impact on the Corporation’s performance than do the effects of general levels of inflation. Although inflation (and inflation expectations) may affect the interest rate environment, it is not possible to measure with any precision the impact of future inflation upon the Corporation.
‎

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and the Board of Directors of Franklin Financial Services Corporation
Chambersburg, Pennsylvania
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Franklin Financial Services Corporation (the "Corporation") as of December 31, 2023 and 2022, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years then ended, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Corporation as of December 31, 2023 and 2022, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Change in Accounting Principle
As discussed in Note 1 to the financial statements, the Corporation has changed its method of accounting for credit losses effective January 1, 2023, due to the adoption of ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The Corporation adopted the new credit loss standard using the modified retrospective method such that prior period amounts are not adjusted and continue to be reported in accordance with previously applicable generally accepted accounting principles. The adoption of the new credit loss standard and its subsequent application is also communicated as a critical audit matter below.
Basis for Opinion
These financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on the Corporation’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Corporation in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Allowance for Credit Losses - Adoption of Qualitative Factor Framework and Subsequent Application of Risk Assignments to Qualitative Factors
In accordance with Accounting Standards Update 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (the “ASU”), the Corporation adopted Accounting Standards Codification (“ASC”) 326 as of January 1, 2023 as described in Notes 1 and 6 of the consolidated financial statements. See also the explanatory paragraph above. The ASU required credit losses on loans to be measured using an expected credit loss model (referred to as the current expected credit loss (CECL) model) which estimates credit losses over the expected life of the loan. Estimates of expected credit losses are based on historical experience, adjusted for management’s evaluation of current conditions and reasonable and supportable forecasts. The impact of adoption of this standard on January 1, 2023 was a $536 thousand decrease to the allowance for credit losses, a $412 thousand increase to the allowance for unfunded commitments and a $98 thousand increase to retained earnings for the cumulative effect adjustment recorded upon adoption.
The Corporation measures expected credit losses based on pooled loans when similar risk characteristics exist. The ACL for pooled loans is the sum of quantitative and qualitative loss estimates. The quantitative portion is based on historical loss rates. A historical loss rate is calculated for each pool of loans. Adjustments to the quantitative portion are made for differences in: lending policy, procedures and practice; economic conditions; nature and volume of loans; experience of lending team; volume of past due loans; quality of the loan review system; concentrations of credit; and other external factors. These adjustments are formulated through a qualitative factor framework that comprises the eight aforementioned factors and assigns a risk level to each factor. The risk factors are weighted to reflect management’s estimate of how the factor affects expected losses. The risk levels within each factor are measured in basis points and range from minimal risk to the very high risk. Management assigns risk levels to each factor based on their evaluation of each of the eight risk factors.
Auditing the initial adoption of the qualitative factor framework used in the allowance for credit losses and the subsequent application of risk assignments for the qualitative factors was identified by us as a critical audit matter because of the significant auditor judgement applied and
significant audit effort needed to evaluate the subjective and complex judgements made by management during adoption and subsequent application of the qualitative factor framework.
The primary procedures we performed to address this critical audit matter included substantively evaluating:
oThe appropriateness of significant judgements applied in adopting the qualitative framework, including the risk factors chosen, associated weightings, and allocation range within the framework.
oThe framework for assignment of level of risk and the method for translating those risk assignments into qualitative factors.
oThe application of risk assignments for the individual qualitative factors, including the appropriateness of management’s basis for risk level assignments.
oThe relevance and reliability of data used in developing the qualitative framework at the date of adoption and determining the risk level assignments.
/s/ Crowe LLP
We have served as the Company's auditor since 2019.
Cleveland, Ohio
March 11, 2024
‎
Consolidated Balance Sheets
(Dollars in thousands, except share and per share data)
December 31,
Assets
Cash and due from banks
$
19,505
$
17,883
Short-term interest-earning deposits in other banks
3,635
47,016
Total cash and cash equivalents
23,140
64,899
Long-term interest-earning deposits in other banks
6,229
13,975
Debt securities available for sale, at fair value
472,503
486,836
Equity securities
Restricted stock
2,375
Loans held for sale
Loans
1,256,985
1,051,041
Allowance for loan losses
(16,052)
(14,175)
Net Loans
1,240,933
1,036,866
Premises and equipment, net
28,543
30,026
Right of use asset
4,680
6,010
Bank owned life insurance
22,758
22,311
Goodwill
9,016
9,016
Deferred tax asset, net
11,801
15,630
Other assets
13,421
12,672
Total assets
$
1,836,039
$
1,699,579
Liabilities
Deposits
Non-interest bearing checking
$
273,050
$
299,231
Money management, savings and interest checking
1,132,482
1,194,827
Time
132,446
57,390
Total deposits
1,537,978
1,551,448
Federal Reserve Bank borrowings
90,000
-
Federal Home Loan Bank advances
40,000
-
Subordinate notes
19,661
19,623
Lease liability
4,816
6,144
Other liabilities
11,448
8,167
Total liabilities
1,703,903
1,585,382
Commitments and contingent liabilities
Shareholders' equity
Common stock, $1 par value per share,15,000,000 shares authorized with
4,710,972 shares issued and 4,371,231 shares outstanding at December 31, 2023 and
4,710,972 shares issued and 4,390,397 shares outstanding at December 31, 2022
4,711
4,711
Capital stock without par value, 5,000,000 shares authorized with no
shares issued and outstanding
-
-
Additional paid-in capital
43,646
43,535
Retained earnings
133,993
125,892
Accumulated other comprehensive (loss) income
(40,940)
(51,287)
Treasury stock, 339,741 shares at December 31, 2023 and 320,575 shares at
December 31, 2022, at cost
(9,274)
(8,654)
Total shareholders' equity
132,136
114,197
Total liabilities and shareholders' equity
$
1,836,039
$
1,699,579
The accompanying notes are an integral part of these financial statements.
Consolidated Statements of Income
(Dollars in thousands, except per share data)
Years ended December 31,
Interest income
Loans, including fees
$
58,277
$
41,931
Interest and dividends on investments:
Taxable interest
14,790
9,954
Tax exempt interest
1,232
2,060
Dividend income
Deposits and obligations of other banks
2,407
2,483
Total interest income
76,762
56,449
Interest expense
Deposits
18,843
3,816
Federal Reserve Bank borrowings
2,374
-
FHLB advances
-
Subordinate notes
1,051
1,047
Total interest expense
23,125
4,863
Net interest income
53,637
51,586
Provision for credit losses - loans
2,589
Provision for credit losses - unfunded commitments
-
Net interest income after provision for credit losses
50,913
50,936
Noninterest income
Wealth management fees
7,512
7,152
Loan service charges
Gain on sale of loans
Deposit service charges and fees
2,492
2,527
Other service charges and fees
1,852
1,724
Debit card income
2,157
1,868
Increase in cash surrender value of life insurance
Net (losses) gains on sales of debt securities
(1,119)
(91)
Change in fair value of equity securities
(69)
Other
Total noninterest income
14,851
15,250
Noninterest Expense
Salaries and employee benefits
28,813
28,094
Net occupancy
4,398
4,069
Marketing and advertising
2,071
1,915
Legal and professional
2,301
2,202
Data processing
4,792
4,751
Pennsylvania bank shares tax
1,148
FDIC Insurance
ATM/debit card processing
1,235
1,428
Telecommunications
Nonservice pension
(117)
Lease termination
-
Other
4,022
3,385
Total noninterest expense
50,011
48,691
Income before federal income taxes
15,753
17,495
Federal income tax expense
2,155
2,557
Net income
$
13,598
$
14,938
Per share
Basic earnings per share
$
3.11
$
3.38
Diluted earnings per share
$
3.10
$
3.36
The accompanying notes are an integral part of these financial statements.
Consolidated Statements of Comprehensive Income
Years ended December 31,
(Dollars in thousands)
Net Income
$
13,598
$
14,938
Debt Securities
Unrealized gains (losses) arising during the period
10,962
(65,682)
Reclassification adjustment for losses included in net income (1)
1,119
Net unrealized gains (losses)
12,081
(65,591)
Tax effect
(2,537)
13,774
Net of tax amount
9,544
(51,817)
Pension
Unrealized gains arising during the period
1,017
Reclassification for net actuarial losses included in net income (2)
-
Net unrealized gains
1,017
1,363
Tax effect
(214)
(286)
Net of tax amount
1,077
Total other comprehensive gain (loss)
10,347
(50,740)
Total Comprehensive Income (Loss)
$
23,945
$
(35,802)
(1) Reclassified to net losses on sales of debt securities
(2) Reclassified to other expense
The accompanying notes are an integral part of these financial statements.
Consolidated Statements of Changes in Shareholders' Equity
For years ended December 31, 2023 and 2022:
Accumulated
Additional
Other
Number
Common
Paid-in
Retained
Comprehensive
Treasury
(Dollars in thousands, except per share data)
of Shares
Stock
Capital
Earnings
Income/(Loss)
Stock
Total
Balance at January 1, 2022
4,441,443
$
4,711
$
43,085
$
116,612
$
(547)
$
(6,796)
$
157,065
Net income
-
-
14,938
-
-
14,938
Other comprehensive loss
-
-
-
(50,740)
-
(50,740)
Cash dividends declared, $1.28 per share
-
-
(5,658)
-
-
(5,658)
Acquisition of treasury stock
(107,732)
-
-
-
-
(3,334)
(3,334)
Treasury shares issued under dividend reinvestment plan
44,943
-
-
-
1,175
1,416
Stock Compensation Plans:
Treasury shares issued
11,743
-
(253)
-
-
Compensation expense
-
-
-
-
Balance at December 31, 2022
4,390,397
$
4,711
$
43,535
$
125,892
$
(51,287)
$
(8,654)
$
114,197
Net income
-
-
13,598
-
-
13,598
Cumulative change in accounting principle, net of tax
-
-
-
-
Other comprehensive income
-
-
-
10,347
-
10,347
Cash dividends declared, $1.28 per share
-
-
(5,595)
-
-
(5,595)
Acquisition of treasury stock
(84,414)
-
-
-
-
(2,394)
(2,394)
Treasury shares issued under dividend reinvestment plan
46,458
-
-
-
1,262
1,355
Stock Compensation Plans:
Treasury shares issued
18,790
-
(465)
-
-
Compensation expense
-
-
-
-
Balance at December 31, 2023
4,371,231
$
4,711
$
43,646
$
133,993
$
(40,940)
$
(9,274)
$
132,136
The accompanying notes are an integral part of these financial statements.
Consolidated Statements of Cash Flows
December 31,
(Dollars in thousands)
Cash flows from operating activities
Net income
$
13,598
$
14,938
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
2,016
1,437
Net amortization of loans and investment securities
2,462
4,177
Amortization of subordinate debt issuance costs
Provision for credit losses
2,724
Change in fair value of equity securities
(16)
Realized losses on sales of debt securities
1,119
Loans originated for sale
(13,965)
(51,285)
Proceeds from sale of loans
14,234
54,599
Gain on sale of loans held for sale
(199)
(770)
Increase in fair value of derivative
(1)
(18)
Increase in cash surrender value of life insurance
(448)
(436)
Stock option compensation
Increase in other assets
(534)
(795)
Increase in other liabilities
3,914
Deferred tax expense (benefit)
1,140
1,172
Net cash provided by operating activities
26,565
25,244
Cash flows from investing activities
Net decrease (increase) in long-term interest-earning deposits in other banks
7,746
(3,483)
Proceeds from sales and calls of investment securities available for sale
40,113
19,629
Proceeds from maturities and pay-downs of securities available for sale
32,295
40,924
Purchase of investment securities available for sale
(50,252)
(87,212)
Net increase in restricted stock
(1,731)
(149)
Net increase in loans
(205,939)
(48,866)
Proceeds from loans held for sale previously classified as portfolio loans
-
(3,680)
Capital expenditures
(499)
(12,218)
Net cash used in investing activities
(178,267)
(95,055)
Cash flows from financing activities
Net decrease in demand deposits, interest-bearing checking, and savings accounts
(88,526)
(16,048)
Net increase (decrease) in time deposits
75,056
(16,863)
Net increase in short-term borrowings
130,000
-
Dividends paid
(5,595)
(5,658)
Purchase of Treasury shares
(2,394)
(3,334)
Cash received from option exercises
Treasury shares issued under dividend reinvestment plan
1,355
1,416
Net cash provided by (used in) financing activities
109,943
(40,439)
(Decrease) increase in cash and cash equivalents
(41,759)
(110,250)
Cash and cash equivalents as of January 1
64,899
175,149
Cash and cash equivalents as of December 31
$
23,140
$
64,899
Supplemental Disclosures of Cash Flow Information
Cash paid during the year for:
Interest on deposits and other borrowed funds
$
19,460
$
4,754
Income taxes
$
1,344
$
Noncash Activities:
Lease liabilities arising from obtaining right-of-use assets
$
-
$
1,867
Noncash extinguishment of lease liability
$
$
-
Noncash decrease in right-of-use asset
$
$
-
Transfers from portfolio loans to loans held for sale
$
-
$
5,131
The accompanying notes are an integral part of these financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies
The accounting policies of Franklin Financial Services Corporation and its subsidiaries conform to U.S. generally accepted accounting principles and to general industry practices. A summary of the more significant accounting policies, which have been consistently applied in the preparation of the accompanying consolidated financial statements, follows:
Principles of Consolidation - The consolidated financial statements include the accounts of Franklin Financial Services Corporation (the Corporation) and its wholly-owned subsidiaries; Farmers and Merchants Trust Company of Chambersburg and Franklin Future Fund Inc. Farmers and Merchants Trust Company of Chambersburg is a commercial bank (the Bank) that has one wholly-owned subsidiary, Franklin Financial Properties Corp., which holds real estate assets that are leased by the Bank. Franklin Future Fund Inc. is a non-bank investment company that makes venture capital investments within the Corporation’s primary market area. The activities of non-bank entities are not significant to the consolidated totals. All significant intercompany transactions have been eliminated in consolidation.
Nature of Operations - The Corporation conducts substantially all of its business through its subsidiary bank, Farmers and Merchants Trust Company of Chambersburg, which serves its customer base through twenty-two community-banking offices located in Franklin, Cumberland, Fulton and Huntingdon Counties, Pennsylvania; and Washington County, Maryland. These counties are considered to be the Corporation’s primary market area, but it may do business in the greater South-Central Pennsylvania and Northern Maryland market. The Bank is a community-oriented commercial bank that emphasizes customer service and convenience. As part of its strategy, the Bank has sought to develop a variety of products and services that meet the needs of both its retail and commercial customers. The Corporation and the Bank are subject to the regulations of various federal and state agencies and undergo periodic examinations by these regulatory authorities.
Use of Estimates in the Preparation of Financial Statements - The preparation of financial statements in conformity with generally accepted accounting principles requires Management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses.
Significant Group Concentrations of Credit Risk - Most of the Corporation’s activities are with customers located within its primary market area. Note 4 of the consolidated financial statements shows the types of securities in which the Corporation invests. Note 5 of the consolidated financial statements shows the types of lending in which the Corporation engages. The Corporation does not have any significant concentrations of any one industry or customer.
Statement of Cash Flows - For purposes of reporting cash flows, cash and cash equivalents include Cash and due from banks, interest-bearing deposits in other banks and cash items with original maturities less than 90 days.
Investment Securities - Management classifies its debt securities at the time of purchase as available for sale or held to maturity. At December 31, 2023 and 2022, all debt securities were classified as available for sale, meaning that the Corporation intends to hold them for an indefinite period of time, but not necessarily to maturity. Available for sale debt securities are stated at estimated fair value, adjusted for amortization of premiums and accretion of discounts which are recognized as adjustments of interest income through call date or maturity. The related unrealized gains and losses are reported as other comprehensive income or loss, net of tax, until realized. Realized securities gains and losses are computed using the specific identification method. Gains or losses on the disposition of debt investment securities are recorded on the trade date, based on the net proceeds and the adjusted carrying amount of the specific security sold. Equity investments are carried at fair value with changes in fair value recognized in net income.
On January 1, 2023, the Corporation adopted ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments which eliminated the previous concept of other-than-temporary impairment for AFS securities. (see Allowance for Credit Losses below). Prior to January 1, 2023, declines in the fair value of securities was recorded under the other-than-temporary impairment concept more fully described in the Corporation’s report on Form 10-K as of December 31, 2022.
Restricted Stock - Restricted stock, which is carried at cost, consists of stock of the Federal Home Loan Bank of Pittsburgh (FHLB) and Atlantic Central Bankers Bank (ACBB). The Bank held $2.4 million of restricted stock at the end of 2023. With the exception of $30 thousand, this investment represents stock in the FHLB that the Bank is required to hold in order to be a member of FHLB and is carried at a cost of $100 per share. FHLB stock is divided into two classes: membership stock and activity stock, which is based on outstanding loan balances. Federal law requires a member institution of the FHLB to hold FHLB stock according to a predetermined formula. Management evaluates the restricted stock for impairment in accordance with ASC Topic 320. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their
cost is influenced by criteria such as (1) the significance of the decline in net assets of the banks as compared to the capital stock amount for the banks and the length of time this situation has persisted, (2) commitments by the banks to make payments required by law or regulation and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the banks. As a government sponsored entity, FHLB has the ability to raise funding through the U.S. Treasury that can be used to support its operations. There is not a public market for FHLB or ACBB stock and the benefits of membership (e.g., liquidity and low-cost funding) add value to the stock beyond purely financial measures. Management intends to remain a member of the FHLB and believes that it will be able to fully recover the cost basis of this investment. Management believes no impairment charge is necessary related to the FHLB or ACBB restricted stock as of December 31, 2023.
Financial Derivatives - FASB ASC 815, Derivatives and Hedging (“ASC 815”), provides the disclosure requirements for derivatives and hedging activities with the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how the entity accounts for derivative instruments and related hedged items, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. Further, qualitative disclosures are required that explain the Company’s objectives and strategies for using derivatives, as well as quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.
As required by ASC 815, the Corporation records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Corporation has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Corporation may enter into derivative contracts that are intended to economically hedge certain of its risk, even though hedge accounting does not apply, or the Corporation elects not to apply hedge accounting.
In accordance with the FASB’s fair value measurement guidance (in ASU 2011-04), the Corporation made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio. At December 31, 2023, there were no derivatives subject to a netting agreement.
Loans - Loans, that Management has the intent and ability to hold for the foreseeable future or until maturity or payoff, are stated at the outstanding unpaid principal balances, net of any deferred fees. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (interest income) of the related loans using the interest method. The Corporation is amortizing these amounts over the contractual life of the loan.
The accrual of interest is generally discontinued when the contractual payment of principal or interest has become 90 days past due or Management has serious doubts about further collectability of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in a prior year is charged against the allowance for credit losses. Payments received on nonaccrual loans are applied initially against principal, then interest income, late charges and any other expenses and fees. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectability of the total contractual principal and interest is no longer in doubt. Consumer loans are typically charged off no later than 180 days past due. Past due status is based on contractual terms of the loans.
Loans Held for Sale - Mortgage loans originated and intended for sale in the secondary market at the time of origination are carried at the lower of cost or estimated fair value (determined on an aggregate basis). All sales are made without recourse. Loans held for sale at December 31, 2023 represent loans originated through third-party brokerage agreements for a pre-determined price and present no price risk to the Bank.
Allowance for Credit Losses (ACL)
On January 1, 2023, the Corporation adopted ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (CECL) methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables and held-to-maturity debt securities. It also applies to off-balance sheet credit commitments not accounted for as insurance (loan commitments,
standby letters of credit, financial guarantees, and other similar instruments) and net investments in leases recognized by a lessor in accordance with Topic 842 on leases.
The Company adopted ASC 326 using the modified retrospective method for all financial assets measured at amortized cost, and unfunded credit exposures. Results for reporting periods beginning after January 1, 2023 are presented under ASC 326 while prior period amounts continue to be reported in accordance with the previously applicable incurred loss methodology.
The Corporation has determined this accounting policy to be critical to the results of operations. A summary of the adoption of the new ASU follows:
ACL - Investment Securities
Management classifies its debt securities at the time of purchase as available for sale (AFS) or held to maturity (HTM). At December 31, 2023 and 2022, all debt securities were classified as available for sale, meaning that the Corporation intends to hold them for an indefinite period of time, but not necessarily to maturity. Available for sale debt securities are stated at estimated fair value, adjusted for amortization of premiums and accretion of discounts which are recognized as adjustments of interest income through call date or maturity. The related unrealized gains and losses are reported as other comprehensive income or loss, net of tax, until realized.
With the adoption of CECL on January 1, 2023, the previous concept of other-than-temporary impairment for AFS securities has been eliminated. Under CECL, credit losses on AFS debt securities are recognized in the ACL for investments, through the provision for credit losses, rather than through a direct write-down of the security. In evaluating AFS securities for credit losses, Management considers factors such as delinquency, guarantees, invest grade rating, and specific conditions related to a specific security or industry. If an impaired debt security is sold, any previous ACL on that security is charged-off and any incremental loss will be recognized through earnings. Any improvement in expected credit losses will be recognized by reducing the ACL.
For HTM securities an estimate of current expected credit loss must be established at the time of purchase with changes in estimated credit loss recognized in the ACL through the provision for credit losses.
Prior to January 1, 2023, declines in the fair value of securities was recorded under the other-than-temporary impairment concept more fully described in the Corporation’s report on Form 10-K as of December 31, 2022.
ACL - Loans
The ACL for loans is established through provisions for credit losses charged against income. Loans deemed to be uncollectible are charged against the ACL, and subsequent recoveries, if any, are credited to the ACL.
The ACL for loans is an estimate of the losses expected to be realized over the life of the loan portfolio. The ACL is determined for two distinct categories of loans: 1) loans evaluated individually for expected credit losses (specific reserve), and 2) loans evaluated collectively for expected credit losses (pooled reserve). Management’s periodic evaluation of the adequacy of the ACL for loans is based on the Bank’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, borrowers’ actual or perceived financial and managerial strengths, and other relevant factors. This evaluation is inherently subjective, as it requires material assumptions and estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans.
Loans evaluated individually for credit losses are primarily commercial purpose loans that do not share similar characteristics with those loans evaluated in the pool. These loans may exhibit performance characteristics where it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. All commercial purpose loans greater than $250 thousand and rated Substandard (7), Doubtful (8) or on nonaccrual status may be considered for individual evaluation. Impairment is measured on a loan-by-loan basis by one of the following methods: the fair value of the collateral if the loan is collateral dependent, the present value of expected future cash flows discounted at the loan’s effective interest rate or the loan’s obtainable market price. Commercial purpose loans with a balance less than $250 thousand, and consumer purpose loans are not evaluated individually for a specific reserve but are included in the pooled reserve calculation. Loans that are evaluated for a specific reserve, but not needing a specific reserve are not included in the pooled reserve calculation.
The Corporation has elected to exclude accrued interest receivable from the measurement of the ACL. When a loan is placed on nonaccrual status, any outstanding current accrued interest is reversed against income and prior year accrued interest is deducted from the ACL.
The pooled reserve represents the ACL for pools of homogenous loans, not evaluated individually. The pooled reserve is calculated using a quantitative and qualitative component for the loan pools.
The following inputs are used to calculate the quantitative component for the pool:
Segregating loans into homogeneous pools by the FRB Call Code which is primarily a collateral-based and secondarily a purpose-based segmentation.
The average remaining life of each pool is calculated using the weighted average remaining maturity method (WARM). The WARM method produces an estimated remaining balance by pool, by year, until maturity.
A historical credit loss rate is calculated for each pool, using the average historical loss, by FRB Call Code, for a peer group of Pennsylvania community banks over the last eight quarters. The loss rate is calculated over a historical period the Bank believes best represents a period, based on a reasonable and supportable forecast, that will be similar to the next four quarters.
The historical credit loss rate is applied to each WARM bucket though the initial four quarter forward-looking period.
At the end of the forward-looking period, the credit loss rate applied to each WARM bucket reverts to the historical loss rate for the respective pool.
Collectively these estimated losses represent the quantitative component of the pooled reserve.
The qualitative component for the pool utilizes a risk matrix comprised of eight risk factors and assigns a risk level to each factor. The risk factors consider changes in: lending policy, procedures and practice; economic conditions; nature and volume of loans; experience of lending team; volume of past due loans; quality of the loan review system; concentrations of credit; and other external factors. The risk factors are weighted to reflect Management’s estimate of how the factor affects potential losses. The risk levels within each factor are measured in basis points and range from minimal risk to very high risk and are determined independently for commercial loans, residential mortgage loans and consumer loans.
The ACL for pooled loans is the sum of the quantitative and qualitative loss estimates.
ACL - Unfunded Commitments
The ACL for unfunded commitments is recorded in other liabilities on the consolidated balance sheet. The ACL represents management’s estimate of expected losses from unfunded commitments and is determined by estimating future usage of the commitments, based on historical usage. The estimated loss is calculated in a manner similar to that used for the ACL for loans, previously described. The ACL is increased or decreased through the provision for credit losses.
Prior to January 1, 2023, the allowance for loan losses was recorded using the previous methodology more fully described in the Corporation’s report on Form 10-K as of December 31, 2022.
Premises and Equipment - Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets or the lease term for lease hold improvements, whichever is shorter. When assets are retired or sold, the asset cost and related accumulated depreciation are eliminated from the respective accounts, and any resultant gain or loss is included in net income.
The cost of maintenance and repairs is charged to operating expense as incurred, and the cost of major additions and improvements is capitalized.
Bank Owned Life Insurance - The Bank invests in bank owned life insurance (BOLI) as a source of funding for employee benefit expenses. The Bank purchases life insurance coverage on the lives of a select group of employees. The Bank is the owner and beneficiary of the policies and records the investment at the cash surrender value of the underlying policies. Income from the increase in cash surrender value of the policies is included in noninterest income.
Other Real Estate Owned (OREO) - Foreclosed real estate (OREO) is comprised of property acquired through a foreclosure proceeding or an acceptance of a deed in lieu of foreclosure. Balances are initially reflected at the estimated fair value less any estimated disposition costs, with subsequent adjustments made to reflect further declines in value. Any losses realized upon disposition of the property, and holding costs prior thereto, are charged against income. All properties are actively marketed to potential buyers.
Transfers of Financial Assets - Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Corporation, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Corporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Federal Income Taxes - Deferred income taxes are provided on the liability method whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance, when in the opinion of Management, it is more likely than not that some portion or all deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted through the provision for income taxes for the effects of changes in tax laws and rates on the date of enactment. ASC Topic 740 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Benefits from tax positions should be recognized in the financial statements only when it is more-likely-than-not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously
recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. ASC Topic 740, “Income Taxes” also provides guidance on the accounting for and disclosure of unrecognized tax benefits, interest and penalties.
Advertising Expenses - Advertising costs are expensed as incurred.
Treasury Stock - The acquisition of treasury stock is recorded under the cost method. The subsequent disposition or sale of the treasury stock is recorded using the average cost method.
Wealth Management - Assets held in a fiduciary capacity are not assets of the Corporation and therefore are not included in the consolidated financial statements. The fair value of trust assets under management (including assets held at third party brokers) was $1.2 billion at December 31, 2023 and $1.0 billion at December 31, 2022.
Off-Balance Sheet Financial Instruments - In the ordinary course of business, the Bank has entered into off-balance sheet financial instruments consisting of commitments to extend credit and letters of credit. Such financial instruments are recorded on the balance sheet when they are funded. The amount of any liability for the credit risk associated with off-balance sheet financial instruments is recorded in other liabilities and was $2.0 million at December 31, 2023 and $1.5 million at December 31, 2022.
Stock-Based Compensation - The Corporation accounts for stock-based compensation in accordance with the ASC Topic 718, “Stock Compensation.” ASC Topic 718 requires compensation costs related to share-based payment transactions to be recognized in the financial statements (with limited exceptions). The amount of compensation cost is measured based on the grant-date fair value of the equity or liability instruments issued and forfeitures are accounted for as they occur. Compensation cost is recognized over the period that an employee provides services in exchange for the award. The Corporation allows the employee to use shares to satisfy employer income tax withholding obligations.
Pension - The provision for pension expense was actuarially determined using the projected unit credit actuarial cost method. The funding policy is to contribute an amount sufficient to meet the requirements of ERISA, subject to Internal Revenue Code contribution limitations.
In accordance with ASC Topic 715, “Compensation - Retirement Benefits”, the Corporation recognizes the plan’s over-funded or under-funded status as an asset or liability with an offsetting adjustment to Accumulated Other Comprehensive Income (AOCI). ASC Topic 715 requires the determination of the fair value of a plan’s assets at the company’s year-end and the recognition of actuarial gains and losses, prior service costs or credits, transition assets or obligations as a component of AOCI. These amounts will be subsequently recognized as components of net periodic benefit costs. Further, actuarial gains and losses that arise in subsequent periods that are not initially recognized as a component of net periodic benefit costs will be recognized as a component of AOCI. Those amounts will subsequently be recorded as a component of net periodic benefit costs as they are amortized during future periods.
Earnings per share - Earnings per share are computed based on the weighted average number of shares outstanding during each year. The Corporation’s basic earnings per share are calculated as net income divided by the weighted average number of shares outstanding. For diluted earnings per share, net income is divided by the weighted average number of shares outstanding plus the incremental number of shares added as a result of converting common stock equivalents, calculated using the treasury stock method. The Corporation’s common stock equivalents consist of stock options and restricted stock awards.
A reconciliation of the weighted average shares outstanding used to calculate basic earnings per share and diluted earnings per share follows:
(Dollars and shares in thousands, except per share data)
Weighted average shares outstanding (basic)
4,374
4,421
Impact of common stock equivalents
Weighted average shares outstanding (diluted)
4,381
4,445
Anti-dilutive options excluded from calculation
-
Net income
$
13,598
$
14,938
Basic earnings per share
$
3.11
$
3.38
Diluted earnings per share
$
3.10
$
3.36
Segment Reporting - The Bank acts as an independent community financial services provider and offers traditional banking and related financial services to individual, business and government customers. Through its community offices and electronic banking applications, the Bank offers a full array of commercial and retail financial services, including the taking of time, savings and demand deposits; the making of commercial, consumer and mortgage loans; and the providing of safe deposit services. The Bank also performs personal, corporate, pension and fiduciary services through its Wealth Management Department.
Management does not separately allocate expenses, including the cost of funding loan demand, between the commercial, retail, mortgage banking and trust operations of the Bank. As such, discrete information is not available and segment reporting would not be meaningful.
Comprehensive Income - Comprehensive income is reflected in the Consolidated Statements of Comprehensive Income and includes net income and unrealized gains or losses, net of tax, on investment securities, reclassifications and the change in plan assets and benefit obligations on the Bank’s pension plan, net of tax.
Reclassification - Certain prior period amounts may have been reclassified to conform to the current year’s presentation. Such reclassifications did not affect reported net income.
‎
Recent Accounting Pronouncements:
Recently adopted accounting standards
ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
Description
This standard requires credit losses on most financial assets measured at amortized cost and certain other instruments to be measured using an expected credit loss model (referred to as the current expected credit loss (CECL) model). Under this model, entities will estimate credit losses over the entire contractual term of the instrument (considering estimated prepayments, but not expected extensions or modifications) from the date of initial recognition of that instrument. The ASU replaces the current accounting model for purchased credit impaired loans and debt securities. The allowance for credit losses for purchased financial assets with a more-than insignificant amount of credit deterioration since origination (“PCD assets”), should be determined in a similar manner to other financial assets measured on an amortized cost basis. However, upon initial recognition, the allowance for credit losses is added to the purchase price to determine the initial amortized cost basis. The subsequent accounting for PCD financial assets is the same expected loss model described above.
In addition, ASC 326 made changes to the accounting for available-for-sale debt securities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available-for-sale debt securities. Management does not intend to sell or believes that it is more likely than not they will be required to sell.
The Corporation adopted ASC 326 using the modified retrospective method for all financial assets measured at amortized cost and off-balance-sheet (OBS) credit exposures. Results for reporting periods beginning after January 1, 2023 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP.
Effective Date
January 1, 2023
Effect on the Consolidated Financial Statements
The Corporation adopted the ASU as of January 1, 2023 and recorded a decrease to the allowance for credit loss (ACL) for loans of $536 thousand, an increase of $412 thousand to the ACL for unfunded commitments, an increase of $98 thousand to retained earnings, and a deferred tax liability of $26 thousand.
The following table illustrates the impact of ASC 326:
As Reported
Pre-ASC
Impact of
Under
ASC 326
ASC 326
Adoption
Adoption
(Dollars in thousands)
Assets:
Loans
First liens - residential real estate
$
1,555
$
$
1,096
Junior liens & lines of credit - residential real estate
Construction
(95)
Commercial real estate
8,077
7,493
Commercial
2,939
4,846
(1,907)
Consumer
(40)
Unallocated
-
(667)
Allowance for credit losses on loans
$
13,639
$
14,175
$
(536)
Liabilities:
Allowance for credit losses on OBS credit exposures
$
1,887
$
1,475
$
ASU 2019-05, Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief
Description
This ASU allows entities to irrevocably elect, upon adoption of ASU 2016-13, the fair value option on financial instruments that (1) were previously recorded at amortized cost and (2) are within the scope of ASC 326-20 if the instruments are eligible for the fair value option under ASC 825-10. The fair value option election does not apply to held-to-maturity debt securities. Entities are required to make this election on an instrument-by-instrument basis. ASU 2019-05 has the same effective date as ASU 2016-13.
Effective Date
January 1, 2023
Effect on the Consolidated Financial Statements
The Corporation adopted the ASU on January 1, 2023 and did not elect the fair value option on any financial instruments.
ASU 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructuring and Vintage Disclosures
Description
ASU 2022-02 eliminates the accounting guidance for troubled debt restructurings in Accounting Standards Codification ("ASC") 310-40, "Receivables - Troubled Debt Restructurings by Creditors" for entities that have adopted the current expected credit loss model introduced by ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments." ASU 2022-02 also required that public business entities disclosure current-period gross charge-offs by year of origination for financing receivables and net investments in leases within the scope of Subtopic 326-20, "Financial Instruments - Credit Losses - Measured at Amortized Cost."
Effective Date
January 1, 2023
Effect on the Consolidated Financial Statements
The Corporation adopted the standard on January 1, 2023 and it decreased the balance of loans individually evaluated by $3.0 million, and decreased the balance of performing TDR loans by the same amount.
Recently issued but not yet effective accounting standards
ASU 2023-01, Leases (Topic 842): Common Control Arrangements
Description
This ASU requires entities to determine whether a related party arrangement between entities under common control is a lease. If the arrangement is determined to be a lease, an entity must classify and account for the lease on the same basis as an arrangement with a related party (on the basis of legally enforceable terms and conditions).
Effective Date
January 1, 2024
Effect on the Consolidated Financial Statements
The ASU is not expected to have an impact on the Corporation's financial statements.
ASU 2023-02, Investments - Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method
Description
This ASU permits reporting entities to elect to account for their tax equity investments, regardless of the tax credit program from which the income tax credits are received, using the proportional amortization method if certain conditions are met.
Effective Date
January 1, 2024
Effect on the Consolidated Financial Statements
The ASU is not expected to have an impact on the Corporation's financial statements.
ASU 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures
Description
This ASU is intended to improve the transparency of income tax disclosures by requiring consistent categories and greater disaggregation of information in the rate reocnciliation table and income taxes paid to be disaggregated by jurisdiction. It also includes certain amendments to improve the effectiveness of income tax disclosures.
Effective Date
January 1, 2025
Effect on the Consolidated Financial Statements
The ASU is not expected to have an impact on the Corporation's financial statements.
ASU 2023-07, Segment Reporting (Topic 280): improvements to Reportable Segment Disclosures
Description
This ASU is intended to improve reportable segment disclosure requirements primarily through enhanced disclsoures about significant sement expenses.
Effective Date
Fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024
Effect on the Consolidated Financial Statements
The Corporation is currently evaluating the impact the ASU will have on its consolidated financial statements.
ASU 2023-01, Disclosure Improvements: Codification Amendments in Response to the SEC's Disclosure Update and Simplification Initiative
Description
This ASU incorporates certain U.S. Securities and Exchange Commission (SEC) disclosure requirements into the FASB Accounting Standards Codification. The amendments in the ASU are expected to clarify or improve disclosure and presentation requirements of a variety of Codification Topics, allow users to more easily compare entities subject to the SEC's existing disclosures with those entities that were not previously subject to the requirement, and align the requirements in the Codification with the SEC's regulations.
Effective Date
The effective date for each amendment will be the date on which the SEC's removal of that related disclosure from Regulation S-X or Regulation S-K becomes effective, with early adoption prohibited.
Effect on the Consolidated Financial Statements
The ASU is not expected to have an impact on the Corporation's financial statements.
Note 2. Regulatory Matters
The Bank is limited as to the amount it may lend to the Corporation, unless such loans are collateralized by specific obligations. State regulations also limit the amount of dividends the Bank can pay to the Corporation and are generally limited to the Bank’s accumulated net earnings, which were $152.7 million at December 31, 2023. In addition, dividends paid by the Bank to the Corporation would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below applicable minimum capital requirements. The Bank is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgements by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Although not adopted in regulation form, the Pennsylvania Department of Banking utilizes capital standards requiring a minimum leverage capital ratio of 6% and a total risk-based capital ratio of 10%, defined substantially the same as those by the FDIC. Management believes, as of December 31, 2023, that the Bank met all capital adequacy requirements to which it is subject.
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, effective January 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 1 Risk-Based Capital of 8%, and (4) Total Risk-Based Capital of 10%. The CET1 ratio is a new capital ratio under Basel III and the Tier 1 risk-based capital ratio of 8% has been increased from 6%. The rules also included changes in the risk weights of certain assets to better reflect credit and other risk exposures. In addition, a capital conservation buffer of 2.50% 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 at December 31, 2023 was 5.63%. Compliance with the capital conservation buffer is required in order to avoid limitations on certain capital distributions, especially dividends. As of December 31, 2023, 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.
At December 31, 2023, the Corporation had $20.0 million of unsecured subordinated debt notes payable, $15.0 million which mature on September 1, 2030 and $5.0 million which mature on September 1, 2035. The notes are recorded on the consolidated balance sheet net of remaining debt issuance costs totaling $339 thousand at December 31, 2023, which is being amortized on a pro-rata basis over a 5-year and 10-year period, based on the maturity dates of the notes, on an effective interest method. The subordinated notes totaling $15.0 million have a fixed interest rate of 5.00% through September 1, 2025, then convert to a variable rate of 90-day Secured Overnight Financing Rate (SOFR) plus 4.93% for the applicable interest periods through maturity. The subordinated notes totaling $5.0 million have a fixed interest rate of 5.25% through September 1, 2030, then convert to a variable rate of 90-day SOFR plus 4.92% for the applicable interest periods through maturity. The Corporation may, at its option, redeem the notes, in whole or in part, at any time 5-years prior to the maturity. The notes are structured to qualify as Tier 2 Capital for the Corporation and there are no debt covenants on the notes.
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 effective January 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 the regulatory capital ratio requirements for the Corporation and the Bank.
As of December 31, 2023
Regulatory Ratios
Adequately Capitalized
Well Capitalized
Actual
Minimum
Minimum
(Dollars in thousands)
Amount
Ratio
Amount
Ratio
Amount
Ratio
Common Equity Tier 1
‎Risk-based Capital Ratio (1)
Corporation
$
164,060
11.82%
$
62,463
N/A
N/A
N/A
Bank
171,932
12.38%
62,496
4.50%
$
90,271
6.50%
Tier 1 Risk-based Capital Ratio (2)
Corporation
$
164,060
11.82%
$
83,284
N/A
N/A
N/A
Bank
171,932
12.38%
83,327
6.00%
$
111,103
8.00%
Total Risk-based Capital Ratio (3)
Corporation
$
200,589
14.45%
$
111,046
N/A
N/A
N/A
Bank
189,300
13.63%
111,103
8.00%
$
138,879
10.00%
Tier 1 Leverage Ratio (4)
Corporation
$
164,060
9.01%
$
72,833
N/A
N/A
N/A
Bank
171,932
9.44%
72,871
4.00%
$
91,088
5.00%
‎
As of December 31, 2022
Regulatory Ratios
Adequately Capitalized
Well Capitalized
Actual
Minimum
Minimum
(Dollars in thousands)
Amount
Ratio
Amount
Ratio
Amount
Ratio
Common Equity Tier 1
‎Risk-based Capital Ratio (1)
Corporation
$
156,468
14.22%
$
49,529
N/A
N/A
N/A
Bank
160,975
14.63%
49,523
4.50%
$
71,533
6.50%
Tier 1 Risk-based Capital Ratio (2)
Corporation
$
156,468
14.22%
$
66,039
N/A
N/A
N/A
Bank
160,975
14.63%
66,030
6.00%
$
88,041
8.00%
Total Risk-based Capital Ratio (3)
Corporation
$
189,370
17.21%
$
88,051
N/A
N/A
N/A
Bank
174,754
15.88%
88,041
8.00%
$
110,051
10.00%
Tier 1 Leverage Ratio (4)
Corporation
$
156,468
8.95%
$
69,937
N/A
N/A
N/A
Bank
160,975
9.21%
69,928
4.00%
$
87,411
5.00%
(1)Common equity Tier 1 capital / total risk-weighted assets
(2)Tier 1 capital / total risk-weighted assets
(3)Total risk-based capital / total risk-weighted assets
(4)Tier 1 capital / average quarterly assets
Note 3. Restricted Cash Balances
The Federal Reserve’s reserve requirement on the Bank’s deposit liabilities is 0%. Therefore, the Bank was not required to hold any reserves at December 31, 2023 and 2022.
Note 4. Investments
Available for Sale (AFS) Securities
The following table summarizes the amortized cost and fair value of securities available-for-sale at December 31, 2023 and 2022 and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss).
The amortized cost and estimated fair value of investment securities available for sale as of December 31, 2023 and 2022 is as follows:
(Dollars in thousands)
Gross
Gross
Amortized
unrealized
unrealized
Fair
December 31, 2023
cost
gains
losses
value
U.S. Treasury
$
83,494
$
-
$
(9,403)
$
74,091
Municipal
161,339
-
(22,721)
138,618
Corporate
26,336
-
(3,138)
23,198
Agency mortgage & asset-backed
142,565
(10,064)
132,591
Non-Agency mortgage & asset-backed
108,185
(4,228)
104,005
Total
$
521,919
$
$
(49,554)
$
472,503
(Dollars in thousands)
Gross
Gross
Amortized
unrealized
unrealized
Fair
December 31, 2022
cost
gains
losses
value
U.S. Treasury
$
101,980
$
-
$
(11,723)
$
90,257
Municipal
186,007
(30,566)
155,455
Corporate
26,316
-
(2,077)
24,239
Agency mortgage & asset-backed
163,274
(12,358)
150,935
Non-Agency mortgage & asset-backed
70,756
(4,807)
65,950
Total
$
548,333
$
$
(61,531)
$
486,836
At December 31, 2023 and 2022, the fair value of investment securities pledged to secure public funds and trust deposits totaled $207.4 million and $208.9 million, respectively. The Bank has no investment in a single issuer that exceeds 10% of shareholders equity except U.S. Treasuries.
The amortized cost and estimated fair value of debt securities at December 31, 2023, by contractual maturity are shown below. Actual maturities may differ from contractual maturities because of prepayment or call options embedded in the securities. Mortgage-backed and asset-backed securities without defined maturity dates are reported on a separate line.
(Dollars in thousands)
Amortized
‎cost
Fair
‎value
Due in one year or less
$
-
$
-
Due after one year through five years
61,341
55,072
Due after five years through ten years
101,953
88,740
Due after ten years
107,875
92,095
271,169
235,907
Mortgage-backed and asset-backed
250,750
236,596
Total
$
521,919
$
472,503
The composition of the net realized securities (losses) gains for the years ended December 31 is as follows:
(Dollars in thousands)
Proceeds
$
40,113
$
19,629
Gross gains realized
Gross losses realized
(1,131)
(152)
Net (losses)/gains realized
$
(1,119)
$
(91)
Tax provision on net (losses)/gains realized
$
$
Impairment:
The following table reflects the unrealized losses in the investment portfolio, aggregated by investment category, length of time that individual securities have been in a continuous unrealized loss position and the number of securities in each category as of December 31, 2023 and 2022. Securities in an unrealized loss position are evaluated at least quarterly for impairment. For this evaluation, the Bank considers: (1) the extent to which the fair value is less than amortized cost; (2) adverse conditions specifically related to the security, industry or geographic area; (3) the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future; (4) failure of the issuer of the security to make scheduled interest or principal payments; and (5) any changes to the rating of the security by a rating agency. 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 Bank does not have the intent to sell and does not believe it will more likely than not be required to sell any of these securities prior to a recovery of their fair value to amortized cost. The impairment identified on debt securities and subject to evaluation at December 31, 2023, was determined not to be attributable to credit related factors; therefore, the Bank does not have an allowance for credit loss for these investments.
December 31, 2023
Less than 12 months
12 months or more
Total
Fair
Unrealized
Fair
Unrealized
Fair
Unrealized
(Dollars in thousands)
Value
Losses
Count
Value
Losses
Count
Value
Losses
Count
U.S. Treasury
$
-
$
-
-
$
74,091
$
(9,403)
$
74,091
$
(9,403)
Municipal
-
-
-
138,618
(22,721)
138,618
(22,721)
Corporate
1,483
(167)
21,715
(2,971)
23,198
(3,138)
Agency mortgage & asset-backed
6,227
(186)
118,053
(9,878)
124,280
(10,064)
Non-Agency mortgage & asset-backed
47,928
(560)
50,071
(3,668)
97,999
(4,228)
Total temporarily impaired
$
55,638
$
(913)
$
402,548
$
(48,641)
$
458,186
$
(49,554)
December 31, 2022
Less than 12 months
12 months or more
Total
Fair
Unrealized
Fair
Unrealized
Fair
Unrealized
(Dollars in thousands)
Value
Losses
Count
Value
Losses
Count
Value
Losses
Count
U.S. Treasury
$
17,598
$
(183)
$
72,659
$
(11,540)
$
90,257
$
(11,723)
Municipal
73,644
(9,586)
80,503
(20,981)
154,147
(30,566)
Corporate
12,221
(851)
10,368
(1,226)
22,589
(2,077)
Agency mortgage & asset-backed
55,393
(2,747)
88,953
(9,611)
144,346
(12,358)
Non-Agency mortgage & asset-backed
49,301
(3,092)
14,207
(1,715)
63,508
(4,807)
Total temporarily impaired
$
208,157
$
(16,459)
$
266,690
$
(45,072)
$
474,847
$
(61,531)
Equity Securities at fair value
The Corporation owns one equity investment with a readily determinable fair value. At December 31, 2023 and 2022, this investment was reported at a fair value of $427 thousand and $411 thousand, respectively, with changes in value reported through income.
Note 5. Loans
The Bank reports its loan portfolio based on the primary collateral of the loan. It further classifies these loans by the primary purpose, either consumer or commercial. The Bank’s mortgage loans include long-term loans to individuals and businesses secured by mortgages on the borrower’s real property. Construction loans are made to finance the purchase of land and the construction of residential and commercial buildings thereon and are secured by mortgages on real estate. Commercial loans are made to businesses of various sizes for a variety of purposes including construction, property, plant and equipment, and working capital. Commercial loans also include loans to government municipalities. Commercial lending is concentrated in the Bank’s primary market, but also includes purchased loan participations. Consumer loans are comprised of installment, home equity and unsecured personal lines of credit.
Each class of loans involves a different kind of risk. However, risk factors such as changes in interest rates, general economic conditions and changes in collateral values are common across all classes. The risk of each loan class is presented below.
Residential Real Estate 1-4 family
The largest risk in residential real estate loans to retail customers is the borrower’s inability to repay the loan due to the loss of the primary source of income. The Bank attempts to mitigate this risk through prudent underwriting standards including employment history, current financial condition and credit history. These loans are generally owner occupied and serve as the borrower’s primary residence. The Bank usually holds a first lien position on these properties but may hold a second lien position in some home equity loans or lines of credit. Commercial purpose loans, secured by residential real estate, are usually dependent upon repayment from the rental income or other business purposes. These loans are generally non-owner occupied. In addition to the real estate collateral, these loans may have personal guarantees or UCC filings on other business assets. If a payment default occurs on a 1-4 family residential real estate loan, the collateral serves as a source of repayment, but may be subject to a change in value due to economic conditions.
Residential Real Estate Construction
This class includes loans to individuals for construction of a primary residence and to contractors and developers to improve real estate and construct residential properties. Construction loans to individuals generally bear the same risk as 1-4 family residential loans. Additional risks may include cost overruns, delays in construction or contractor problems.
Loans to contractors and developers are primarily dependent on the sale of improved lots or finished homes for repayment. Risks associated with these loans include the borrower’s character and capacity to complete a development, the effect of economic conditions on the valuation of lots or homes, cost overruns, delays in construction or contractor problems. In addition to real estate collateral, these loans may have personal guarantees or UCC filings on other business assets, depending on the financial strength and experience of the developer. Real estate construction loans are monitored on a regular basis by either an independent third party or the responsible loan officer, depending on the size and complexity of the project. This monitoring process includes at a minimum, the submission of invoices or AIA documents detailing the cost incurred by the borrower, on-site inspections, and an authorizing signature for disbursement of funds.
Commercial Real Estate
Commercial real estate loans may be secured by various types of commercial property including retail space, office buildings, warehouses, hotels and motel, manufacturing facilities and, agricultural land.
Commercial real estate loans present a higher level of risk than residential real estate loans. Repayment of these loans is normally dependent on cash-flow generated by the operation of a business that utilizes the real estate. The successful operation of the business, and therefore repayment ability, may be affected by general economic conditions outside of the control of the operator. On most commercial real estate loans ongoing monitoring of cash flow and other financial performance indictors is completed annually through financial statement analysis. In addition, the value of the collateral may be negatively affected by economic conditions and may be insufficient to repay the loan in the event of default. In the event of foreclosure, commercial real estate may be more difficult to liquidate than residential real estate.
Commercial
Commercial loans are made for various business purposes to finance equipment, inventory, accounts receivables, and operating liquidity. These loans are generally secured by business assets or equipment, non-real estate collateral and/or personal guarantees.
Commercial loans present a higher level of credit risk than other loans because repayment ability is usually dependent on cash-flow from a business operation that can be affected by general economic conditions. On most commercial loans ongoing monitoring of cash flow and other financial performance indicators occur at least annually through financial statement analysis. In the event of a default, collateral for these loans may be more difficult to liquidate, and the valuation of the collateral may decline more quickly than loans secured by other types of collateral.
Loans to governmental municipalities are also included in the Commercial class. These loans generally have less risk than Commercial & Industrial (C&I) loans due to the taxing authority of the municipality and its ability to assess fees on services.
This class also includes loans made as part of the Paycheck Protection Program (PPP). The PPP is a small business loan program, administered by the Small Business Administration (SBA). The PPP loans are 100 percent guaranteed by the SBA and have a maturity of two years or five years with a fixed interest rate of 1.00% for the life of the loan. Because the PPP loans are 100% guaranteed by the SBA, they present no credit risk to the Bank once the SBA guarantee is fulfilled. However, if the SBA does not grant loan forgiveness, the PPP loan would present the same risk factors as any other commercial loan.
Consumer
These loans are made for a variety of reasons to consumers and include term loans and personal lines-of credit. The loans may be secured or unsecured. Repayment is primarily dependent on the income of the borrower and to a lesser extent the sale of collateral. The underwriting of these loans is based on the consumer’s ability and willingness to repay and is determined by the borrower’s employment history, current financial condition and credit background. Collateral for these loans, if any, usually depreciates quickly
and therefore, may not be adequate to repay the loan if it is repossessed. Therefore, the overall health of the economy, including unemployment rates and wages, will have an effect on the credit quality in this loan class.
A summary of loans outstanding, by class, at December 31 is as follows:
(Dollars in thousands)
Residential Real Estate 1-4 Family
Consumer first liens
$
142,017
$
85,166
Commercial first lien
63,271
61,702
Total first liens
205,288
146,868
Consumer junior liens and lines of credit
68,752
69,561
Commercial junior liens and lines of credit
3,809
4,127
Total junior liens and lines of credit
72,561
73,688
Total residential real estate 1-4 family
277,849
220,556
Residential real estate - construction
Consumer
13,837
13,908
Commercial
12,063
10,485
Total residential real estate construction
25,900
24,393
Commercial real estate
703,767
564,291
Commercial
242,654
235,602
Total commercial
946,421
799,893
Consumer
6,815
6,199
1,256,985
1,051,041
Less: Allowance for credit losses
(16,052)
(14,175)
Net Loans
$
1,240,933
$
1,036,866
Included in the loan balances are the following:
Net unamortized deferred loan costs
$
1,615
$
2,027
Loans pledged as collateral for borrowings and commitments from:
FHLB
$
699,527
$
585,601
Federal Reserve Bank
83,482
92,922
Total
$
783,009
$
678,523
Paycheck Protection Program loans (included in Commercial loans)
$
$
Loans to directors and executive officers and related interests and affiliated enterprises were as follows:
(Dollars in thousands)
Balance at beginning of year
$
13,283
$
10,162
New loans made
8,870
4,615
Repayments
(10,608)
(1,494)
Balance at end of year
$
11,545
$
13,283
Note 6. Loan Quality and Allowance for Credit Losses
The Bank categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, and current economic trends, among other factors. 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 performing or nonperforming based on the payment status of the loans. Nonperforming consumer loans are loans that are nonaccrual or 90 days or more past due and still accruing. The Bank uses the following definitions for risk ratings:
Pass (1-5): are considered pass credits with lower or average risk and are not otherwise classified.
OAEM (6): Loans classified as OAEM have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the borrower’s credit position at some future date.
Substandard (7): Loans classified as Substandard are inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
Doubtful (8): Loans classified as Doubtful have all the weaknesses inherent in those classified as Substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.
Loans that do not share risk characteristics are evaluated on an individual basis. Loans evaluated individually are not included in the pool evaluation. When management determines that foreclosure is probable or when the borrower is experiencing financial difficulty at the reporting date and repayment is expected to be provided substantially through the sale of the collateral, the expected credit losses are based on the fair value of the collateral at the reporting date, adjusted for any discounts and selling costs as appropriate.
Management monitors loan performance on a monthly basis and performs a quarterly evaluation of the adequacy of the Allowance for Credit Loss for loans (ACL). 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 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 ACL, 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. Management monitors the adequacy of the ACL on an ongoing basis and reports its adequacy quarterly to the Enterprise Risk Management Committee of the Board of Directors. Management believes the ACL at December 31, 2023 is adequate.
The following table presents loans by year of origination and internally assigned risk ratings:
(Dollars in thousands)
Revolving
Revolving
Term Loans
Loans
Loans
Amortized Cost Basis by Origination Year
Amortized
Converted
As of December 31, 2023
Prior
Cost Basis
to Term
Total
Residential real estate 1-4 family:
Commercial:
Risk rating:
Pass (1-5)
$
9,867
$
9,088
$
11,038
$
9,691
$
2,433
$
22,906
$
2,057
$
-
$
67,080
OAEM (6)
-
-
-
-
-
-
-
-
-
Substandard (7)
-
-
-
-
-
-
-
-
-
Doubtful (8)
-
-
-
-
-
-
-
-
-
Total Commercial
9,867
9,088
11,038
9,691
2,433
22,906
2,057
-
67,080
Consumer:
Performing
53,128
34,136
15,625
10,245
5,222
28,423
43,968
20,022
210,769
Nonperforming
-
-
-
-
-
-
-
-
-
Total Consumer
53,128
34,136
15,625
10,245
5,222
28,423
43,968
20,022
210,769
Total
$
62,995
$
43,224
$
26,663
$
19,936
$
7,655
$
51,329
$
46,025
$
20,022
$
277,849
Current period gross charge-offs
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
Residential real estate construction:
Commercial:
Risk rating:
Pass (1-5)
$
6,845
$
2,209
$
1,289
$
$
-
$
1,506
$
-
$
-
$
12,063
OAEM (6)
-
-
-
-
-
-
-
-
-
Substandard (7)
-
-
-
-
-
-
-
-
-
Doubtful (8)
-
-
-
-
-
-
-
-
-
Total Commercial
6,845
2,209
1,289
-
1,506
-
-
12,063
Consumer:
Performing
13,837
-
-
-
-
-
-
-
13,837
Nonperforming
-
-
-
-
-
-
-
-
-
Total Consumer
13,837
-
-
-
-
-
-
-
13,837
Total
$
20,682
$
2,209
$
1,289
$
$
-
$
1,506
$
-
$
-
$
25,900
Current period gross charge-offs
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
Commercial real estate:
Risk rating:
Pass (1-5)
$
180,052
$
110,886
$
98,540
$
34,307
$
38,603
$
214,179
$
10,567
$
-
$
687,134
OAEM (6)
2,955
1,350
1,000
6,823
-
2,182
-
14,449
Substandard (7)
-
-
-
-
-
2,134
-
2,184
Doubtful (8)
-
-
-
-
-
-
-
-
-
Total
$
183,007
$
112,236
$
99,540
$
41,130
$
38,603
$
218,495
$
10,756
$
-
$
703,767
Current period gross charge-offs
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
Commercial:
Risk rating:
Pass (1-5)
$
34,851
$
33,983
$
45,754
$
22,847
$
3,579
$
64,542
$
36,508
$
-
$
242,064
OAEM (6)
-
-
-
-
-
-
-
-
-
Substandard (7)
-
-
-
-
-
-
Doubtful (8)
-
-
-
-
-
-
-
-
-
Total
$
34,851
$
34,300
$
45,754
$
22,847
$
3,579
$
64,542
$
36,781
$
-
$
242,654
Current period gross charge-offs
$
(125)
$
-
$
(130)
$
-
$
-
$
-
$
(50)
$
-
$
(305)
Consumer:
Performing
1,863
1,985
2,060
-
6,810
Nonperforming
-
-
-
-
-
-
-
Total
$
1,863
$
$
1,985
$
$
$
$
2,065
$
-
$
6,815
Current period gross charge-offs
$
(63)
$
-
$
(10)
$
(2)
$
(6)
$
-
$
(36)
$
-
$
(117)
‎
The following presents the amortized cost basis of loans on nonaccrual status and loans past due over 90 days and still accruing as of December 31, 2023:
(Dollars in thousands)
Nonaccrual and Loans Past Due Over 90 Days+
Loans Past Due
Nonaccrual
Nonaccrual
Over 90 Days
Without ACL
With ACL
Still Accruing
December 31, 2023
Residential Real Estate 1-4 Family
First liens
$
-
$
-
$
-
Junior liens and lines of credit
-
-
-
Total
-
-
-
Residential real estate - construction
-
-
-
Commercial real estate
-
-
-
Commercial
-
-
Consumer
-
-
Total
$
$
-
$
The following table reports on the risk rating for those loans in the portfolio that are assigned an individual risk rating as of December 31, 2022:
Pass
OAEM
Substandard
Doubtful
(Dollars in thousands)
(1-5)
(6)
(7)
(8)
Total
December 31, 2022
Residential Real Estate 1-4 Family
First liens
$
146,748
$
-
$
$
-
$
146,868
Junior liens and lines of credit
73,688
-
-
-
73,688
Total
220,436
-
-
220,556
Residential real estate - construction
24,393
-
-
-
24,393
Commercial real estate
560,294
1,095
2,902
-
564,291
Commercial
228,085
2,751
4,766
-
235,602
Consumer
6,199
-
-
-
6,199
Total
$
1,039,407
$
3,846
$
7,788
$
-
$
1,051,041
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.
The following table presents the aging of payments in the loan portfolio as of December 31, 2023 and 2022:
(Dollars in thousands)
Loans Past Due and Still Accruing
Total
Total
30-59 Days
60-89 Days
90 Days+
Past Due
Current
Loans
December 31, 2023
Residential Real Estate 1-4 Family
First liens
$
$
$
-
$
$
204,832
$
205,288
Junior liens and lines of credit
-
72,094
72,561
Total
-
276,926
277,849
Residential real estate - construction
-
-
-
-
25,900
25,900
Commercial real estate
3,232
-
-
3,232
700,535
703,767
Commercial
241,853
242,654
Consumer
6,777
6,815
Total
$
4,096
$
$
$
4,994
$
1,251,991
$
1,256,985
Total
Past Due &
Total
December 31, 2022
30-59 Days
60-89 Days
90 Days+
Nonaccrual
Nonaccrual
Current
Loans
Residential Real Estate 1-4 Family
First liens
$
$
$
-
$
$
$
146,231
$
146,868
Junior liens and lines of credit
-
-
-
73,198
73,688
Total
-
1,127
219,429
220,556
Residential real estate - construction
-
-
-
-
-
24,393
24,393
Commercial real estate
-
-
-
563,642
564,291
Commercial
-
-
234,871
235,602
Consumer
-
6,152
6,199
Total
$
2,189
$
$
$
$
2,554
$
1,048,487
$
1,051,041
At December 31, 2023, the Bank had $0 of residential properties in the process of foreclosure compared to $120 thousand at the end of 2022. Interest not recognized on nonaccrual loans was $6 thousand for the years ended December 31, 2023 and 2022, respectively.
On January 1, 2023, The Bank adopted ASU 2022-02, “Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures” (“ASU 2022-02”), which eliminated the accounting guidance for troubled debt restructurings (“TDRs”) while enhancing disclosure requirements for certain loan refinancing and restructurings by creditors when a borrower is experiencing financial difficulty. Modifications to borrowers experiencing financial difficulty may include interest rate reductions, principal or interest forgiveness, forbearances, term extensions, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral.
No loan modifications were made to borrowers experiencing financial difficulties during 2023.
Prior to the adoption of ASU 2022-02, certain modified loans were reported as TDRs and impaired.
The following table presents impaired loans as of December 31, 2022:
Impaired Loans
With No Allowance
With Allowance
(Dollars in thousands)
Unpaid
Unpaid
Recorded
Principal
Recorded
Principal
Related
December 31, 2022
Investment
Balance
Investment
Balance
Allowance
Residential Real Estate 1-4 Family
First liens
$
$
$
-
$
-
$
-
Junior liens and lines of credit
-
-
-
-
-
Total
-
-
-
Residential real estate - construction
-
-
-
-
-
Commercial real estate
2,331
2,331
-
-
-
Commercial
-
-
-
-
-
Total
$
2,950
$
2,950
$
-
$
-
$
-
Twelve Months Ended
December 31, 2022
Average
Interest
(Dollars in thousands)
Recorded
Income
Investment
Recognized
Residential Real Estate 1-4 Family
First liens
$
$
Junior liens and lines of credit
-
-
Total
Residential real estate - construction
Commercial real estate
7,765
Commercial
-
-
Total
$
8,512
$
‎
The following table presents TDR loans as of December 31, 2022:
Troubled Debt Restructurings
Within the Last 12 Months
That Have Defaulted
(Dollars in thousands)
Troubled Debt Restructurings
on Modified Terms
Number of
Recorded
Number of
Recorded
Contracts
Investment
Performing*
Nonperforming*
Contracts
Investment
December 31, 2022
Residential real estate - construction
-
$
-
$
-
$
-
-
$
-
Residential real estate
-
-
-
Commercial real estate - owner occupied
-
-
-
Commercial real estate - farmland
1,466
1,466
-
-
-
Commercial real estate - construction and land development
-
-
-
-
-
-
Commercial real estate
-
-
-
Total
$
2,950
$
2,950
$
-
-
$
-
*The performing status is determined by the loan’s compliance with the modified terms.
Allowance for Credit Losses:
The following table shows the activity in the Allowance for Credit Loss (ACL), for the years ended December 31, 2023 and 2022:
Residential Real Estate 1-4 Family
First
Junior Liens &
Commercial
(Dollars in thousands)
Liens
Lines of Credit
Construction
Real Estate
Commercial
Consumer
Unallocated
Total
ALL at December 31, 2022
$
$
$
$
7,493
$
4,846
$
$
$
14,175
Impact of adopting CECL on 1-1-23
1,096
(95)
(1,907)
(40)
(667)
(536)
Charge-offs
-
-
-
-
(305)
(117)
-
(422)
Recoveries
-
-
Provision
(261)
(308)
(1)
2,579
-
2,589
ACL at December 31, 2023
$
1,296
$
$
$
10,657
$
3,290
$
$
-
$
16,052
ALL at December 31, 2021
$
$
$
$
8,168
$
5,127
$
$
$
15,066
Charge-offs
(20)
-
-
(1,451)
(71)
(102)
-
(1,644)
Recoveries
-
-
Provision
(44)
(20)
(236)
ALL at December 31, 2022
$
$
$
$
7,493
$
4,846
$
$
$
14,175
The following table shows the loans that were evaluated for the ACL under a specific reserve (individually) and those that were evaluated under a general reserve (collectively), and the amount of the ACL established in each category as of December 31, 2023 and 2022:
Residential Real Estate 1-4 Family
First
Junior Liens &
Commercial
(Dollars in thousands)
Liens
Lines of Credit
Construction
Real Estate
Commercial
Consumer
Unallocated
Total
December 31, 2023
Loans evaluated for ACL:
Individually
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
Collectively
205,288
72,561
25,900
703,767
242,654
6,815
-
1,256,985
Total
$
205,288
$
72,561
$
25,900
$
703,767
$
242,654
$
6,815
$
-
$
1,256,985
ACL established for
‎ loans evaluated:
Individually
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
Collectively
1,296
10,657
3,290
-
16,052
ACL at December 31, 2023
$
1,296
$
$
$
10,657
$
3,290
$
$
-
$
16,052
December 31, 2022
Loans evaluated for ALL:
Individually
$
$
-
$
-
$
2,331
$
-
$
-
$
-
$
2,950
Collectively
146,249
73,688
24,393
561,960
235,602
6,199
-
1,048,091
Total
$
146,868
$
73,688
$
24,393
$
564,291
$
235,602
$
6,199
$
-
$
1,051,041
ALL established for
‎ loans evaluated:
Individually
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
Collectively
7,493
4,846
14,175
ALL at December 31, 2022
$
$
$
$
7,493
$
4,846
$
$
$
14,175
Note 7. Premises and Equipment
At December 31, 2023 premises and equipment consisted of:
(Dollars in thousands)
Estimated Life
Land
$
3,607
$
3,617
Buildings and leasehold improvements
15 - 30 years, or lease term
33,947
35,751
Furniture, fixtures and equipment
3 - 10 years
11,097
9,767
Total cost
48,651
49,135
Less: Accumulated depreciation
(20,108)
(19,109)
Net premises and equipment
$
28,543
$
30,026
The following table shows the amount of depreciation for the years ended December 31:
Depreciation expense
$
2,137
$
1,382
Note 8. Leases
The Corporation leases various assets in the course of its operations that are subject to recognition on the balance sheet. The Corporation considers all of its leases to be operating leases and it has no finance leases. The leased assets may include equipment, and buildings and land (collectively real estate). The equipment leases are shorter-term than the real estate leases, and generally have a fixed payment over a defined term without renewal options. Certain equipment leases have purchase options and it was determined the option was not reasonably certain to be exercised. The real estate leases are longer-term and may contain renewal options after the initial term, but none of the real estate leases contain a purchase option. The renewal options on real estate leases were reviewed and if it was determined the option was reasonably certain to be renewed, the option term was considered in the determination of the lease
liability. There is only one real estate lease with a variable payment based on an index included in the lease liability. None of the leases contain any restrictive covenants and there are no significant leases that have not yet commenced. The discount rate used to determine the lease liability is based on the Bank’s fully secured borrowing rate from the Federal Home Loan Bank for a term similar to the lease term. Operating lease expense is included in net occupancy expense in the consolidated statements of income.
Lease Cost:
The components of total lease cost were as follows for the period ending:
For the years ended
December 31
(Dollars in thousands)
Operating lease cost
$
$
Short-term lease cost
Variable lease cost
Total lease cost
$
$
1,211
Supplemental Lease Information:
For the years ended
(Dollars in thousands)
December 31
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases
$
$
Weighted-average remaining lease term (years)
12.0
12.0
Weighted-average discount rate
3.40%
3.36%
Lease Obligations:
Future undiscounted lease payments for operating leases with initial terms of one year or more as of December 31, 2023 are as follows:
(Dollars in thousands)
$
2029 and beyond
3,205
Undiscounted cash flows
5,970
Imputed interest
(1,154)
Total lease liability
$
4,816
Note 9. Other Real Estate Owned
The Bank had no other real estate owned at December 31, 2023 and 2022.
Note 10. 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, 2023. The 2023 test was conducted using a qualitative assessment method that requires the use of significant assumptions in order to make a determination of likely 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 not likely impaired in 2023 and did not make a further assessment.
The 2022 impairment test was also conducted using a qualitative assessment and Management determined the Bank’s goodwill was not likely impaired in 2022 and did not make a further assessment.
Note 11. Deposits
Deposits are summarized as follows at December 31:
(Dollars in thousands)
Noninterest-bearing checking
$
273,050
$
299,231
Interest-bearing checking
454,517
496,533
Money management
572,058
569,585
Savings
105,907
128,709
Total interest-bearing checking and savings
1,132,482
1,194,827
Time deposits
132,446
57,390
Total deposits
$
1,537,978
$
1,551,448
Overdrawn deposit accounts reclassified as loans
$
$
Time deposits greater than $250,000 at December 31, 2023 and 2022 were $44.4 million and $8.8 million, respectively.
At December 31, 2023 the scheduled maturities of time deposits are as follows:
(Dollars in thousands)
Time Deposits
$
94,519
19,009
8,104
3,611
7,203
Total
$
132,446
The deposits of directors, executive officers, related interests and affiliated enterprises totaled $4.8 million and $4.3 million at December 31, 2023 and 2022, respectively.
Note 12. Other 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 at December 31, 2023 and 2022.
At December 31, 2023, other borrowings were:
December 31
(Dollars in thousands)
FHLB maturities through 2024, floating with SOFR, at rates from 5.82% to 5.83%, averaging 5.82%
$
40,000
$
-
Federal Reserve Bank maturities through 2024, with fixed rate at rates from 4.38% to 4.93%, averaging 4.58%
90,000
-
$
130,000
$
-
The FHLB borrowing was collateralized by $699.5 million of loans and the Federal Reserve Bank borrowing, through the BTFP, was collateralized by $93.0 million (amortized cost) of investment securities at December 31, 2023. There were no advances at December 31, 2022.
The Bank’s maximum borrowing capacity with the FHLB at December 31, 2023 was $484.2 million with $444.2 million available to borrow. This borrowing capacity is secured by a Blanket Pledge Agreement with FHLB on the Bank’s real estate loan portfolio.
‎
Scheduled payments on other borrowings over the next five years are as follows:
(Dollars in thousands)
$
130,000
-
-
-
-
$
130,000
The Bank has established credit at the Federal Reserve Discount Window and as of year-end had the ability to borrow approximately $56 million. The Bank also has $56.0 million in unsecured lines of credit at two correspondent banks.
Note 13. Subordinate Notes
At December 31, 2023 and 2022, the Corporation had $20.0 million of unsecured subordinated debt notes payable, $15.0 million which mature on September 1, 2030 and $5.0 million which mature on September 1, 2035. The notes are recorded on the consolidated balance sheet net of remaining debt issuance costs totaling $339 thousand at December 31, 2023 and $377.0 thousand at December 31, 2022, which is being amortized on a pro-rata basis, based on the maturity dates of the notes, on an effective interest method. The subordinated notes totaling $15.0 million have a fixed interest rate of 5.00% through September 1, 2025, then convert to a variable rate of 90-day Secured Overnight Financing Rate (SOFR) plus 4.93% for the applicable interest periods through maturity. The subordinated notes totaling $5.0 million have a fixed interest rate of 5.25% through September 1, 2030, then convert to a variable rate of 90-day SOFR plus 4.92% for the applicable interest periods through maturity. The Corporation may, at its option, redeem the notes, in whole or in part, at any time 5-years prior to the maturity. The notes are structured to qualify as Tier 2 Capital for the Corporation and there are no debt covenants on the notes.
Note 14. Federal Income Taxes
The temporary differences which give rise to significant portions of deferred tax assets and liabilities at December 31 are as follows:
(Dollars in thousands)
Deferred Tax Assets
Allowance for loan losses
$
3,440
$
3,021
Deferred compensation
Purchase accounting
Accumulated other comprehensive loss
10,882
13,633
Lease liabilities
1,032
1,309
Other
Total gross deferred tax assets
16,909
19,178
Deferred Tax Liabilities
Depreciation
3,023
1,079
Right-of-use asset
1,002
1,281
Joint ventures and partnerships
Pension
Deferred loan fees and costs, net
Total gross deferred tax liabilities
5,108
3,548
Net deferred tax asset
$
11,801
$
15,630
In assessing the realizability of deferred tax assets, Management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based on the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, Management believes it is more likely than not that the Bank will realize the benefits of these deferred tax assets other than those for which a valuation allowance has been recorded.
The components of income taxes attributable to income from operations were as follows:
For the Years Ended December 31
(Dollars in thousands)
Current tax expense (benefit)
$
1,015
$
1,385
Deferred tax expense (benefit)
1,140
1,172
Income tax provision
$
2,155
$
2,557
For the years ended December 31, 2023 and 2022, the income tax provisions are different from the tax expense which would be computed by applying the Federal statutory rate to pretax operating earnings. The Federal statutory rate was 21% for 2023 and 2022. A reconciliation between the tax provision at the statutory rate and the tax provision at the effective tax rate is as follows:
For the Years Ended December 31
(Dollars in thousands)
Tax provision at statutory rate
$
3,308
$
3,674
Income on tax-exempt loans and securities
(949)
(1,113)
Investment in solar tax credit
(325)
-
Nondeductible interest expense relating to carrying tax-exempt obligations
Income from bank owned life insurance
(88)
(86)
Stock option compensation
(1)
Other, net
(5)
Income tax provision
$
2,155
$
2,557
Effective income tax rate
13.7%
14.6%
The Corporation recognizes interest accrued related to unrecognized tax benefits and penalties in income tax expense for all periods presented. No penalties or interest were recognized in 2023 or 2022. The Corporation had no uncertain tax positions at December 31, 2023. The Corporation is no longer subject to U.S. Federal and state examinations by tax authorities for the years before 2020.
Note 15. Accumulated Other Comprehensive Income/(Loss)
The components of accumulated other comprehensive loss included in shareholders' equity at December 31 are as follows:
For the Years Ended December 31
Net unrealized gains on debt securities
$
(49,416)
$
(61,497)
Tax effect
10,377
12,914
Ending balance
$
(39,039)
$
(48,583)
Accumulated pension adjustment
$
(2,406)
$
(3,423)
Tax effect
Net of tax amount
$
(1,901)
$
(2,704)
Total accumulated other comprehensive (loss) income
$
(40,940)
$
(51,287)
Note 16. Financial Derivatives
The Corporation is exposed to certain risks arising from both its business operations and economic conditions. The Corporation principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Corporation manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its assets and liabilities.
The Corporation’s existing credit derivatives result from participations in interest rate swaps provided by external lenders as part of loan participation arrangements, therefore, are not used to manage interest rate risk in the Corporation’s assets or liabilities.
Derivatives not designated as hedges are not speculative and result from a service the Corporation provides to certain lenders which participate in loans.
The table below presents the fair value of the Corporation’s derivative financial instruments as well as their classification on the Balance Sheet as of December 31, 2023:
Fair Value of Derivative Instruments
Derivative Liabilities
(Dollars in thousands)
As of December 31, 2023
As of December 31, 2022
Notional amount
Balance Sheet Location
Fair Value
Notional amount
Balance Sheet Location
Fair Value
Derivatives not designated as hedging instruments
Other Contracts
$
6,268
Other Liabilities
$
$
6,465
Other Liabilities
$
Total derivatives not designated as hedging instruments
$
$
The table below presents the effect of the Corporation’s derivative financial instruments that are not designated as hedging instruments on the Income Statement as of December 31, 2023:
Effect of Derivatives Not Designated as Hedging Instruments on the Statement of Financial Performance
Derivatives Not Designated as Hedging Instruments under Subtopic 815-20
Location of Gain or (Loss) Recognized in Income on Derivative
Amount of Gain or (Loss) Recognized in Income on Derivatives
(Dollars in thousands)
Year Ended December 31
Other Contracts
Other income
$
$
As of December 31, 2023, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $2 thousand.
Note 17. Benefit Plans
The Bank has a 401(k) plan which includes an auto enrollment feature and covers all employees of the Bank who have completed four months of service. Employee contributions to the plan are matched at 100% up to 4% of each participant’s deferrals plus 50% of the next 2% of deferrals from participants’ eligible compensation. Under this plan, the maximum amount of employee contributions in any given year is defined by Internal Revenue Service regulations. In addition, a 100% discretionary profit-sharing contribution of up to 2% of each employee’s eligible compensation is possible provided net income targets are achieved. The related expense for the 401(k) plan, and the discretionary profit-sharing plan was $1.3 million in 2023 and $1.4 million in 2022. This expense is recorded in the Salary and employee benefits line of the Consolidated Statements of Income.
The Bank has a noncontributory defined benefit pension plan covering employees hired prior to April 1, 2007 and the plan was closed to new participants on this date. Benefits are based on years of service and the employee’s compensation using a career average formula. The Bank’s funding policy is to contribute the annual amount required to meet the minimum funding requirements of the Employee Retirement Income Security Act of 1974. Contributions are intended to provide not only for the benefits attributed to service to date but also for those expected to be earned in the future. Employees who are eligible for pension benefits may elect to receive an annuity style payment or a lump-sum payout of their pension benefits. Pension service costs are recorded in Salary and benefits expense while all other components of net periodic pension costs are recorded in other expense. For the next fiscal year, the estimated net loss for the defined benefit pension plan that will be amortized from accumulated other comprehensive income into net periodic benefit costs is $0. The Bank uses December 31 as the measurement date for its pension plan.
The Bank’s Pension Committee reviews and determines all the assumptions used to determine the benefit obligations and expense annually. Historical investment returns play a significant role in determining the expected long-term rate of return on Plan assets.
The following table sets forth the plan’s funded status, based on the 2022 actuarial valuations:
For the Years Ended December 31
(Dollars in thousands)
Change in projected benefit obligation
Benefit obligation at beginning of measurement year
$
13,865
$
19,002
Service cost
Interest cost
Actuarial (gain) loss
(214)
(4,201)
Benefits paid
(1,544)
(1,950)
Benefit obligation at end of measurement year
13,129
13,865
Change in plan assets
Fair value of plan assets at beginning of measurement year
13,779
18,462
Actual return on plan assets net of expenses
1,727
(2,733)
Benefits paid
(1,544)
(1,950)
Fair value of plan assets at end of measurement year
13,962
13,779
Funded status of projected benefit obligation
$
$
(86)
For the Years Ended December 31
Assumptions used to determine benefit obligations:
Discount rate
5.96%
6.17%
Rate of compensation increase
6.00%
6.00%
Expected long-term return on plan assets
6.00%
6.00%
(Dollars in thousands)
Amounts recognized in accumulated other comprehensive
For the Years Ended December 31
income (loss), net of tax
Net actuarial loss
$
(2,406)
$
(3,423)
Tax effect
Net amount recognized in accumulated other comprehensive loss
$
(1,901)
$
(2,704)
‎
(Dollars in thousands)
For the Years Ended December 31
Components of net periodic pension cost
Service cost
$
$
Interest cost
Expected return on plan assets
(923)
(994)
Recognized net actuarial loss
-
Net periodic pension cost
Settlement expense
-
Total net periodic pension cost
$
$
For the Years Ended December 31
Assumptions used to determine net periodic benefit cost:
Discount rate
6.17%
3.71%
Rate of compensation increase
6.00%
5.00%
Expected long-term return on plan assets
6.00%
6.00%
Asset allocations:
Cash and cash equivalents
3%
3%
Common stocks
36%
33%
Corporate bonds
14%
14%
Municipal bonds
28%
28%
Investment fund - debt
2%
6%
Investment fund - equity
13%
14%
Deposit in immediate participation guarantee contract
4%
2%
Total
100%
100%
The following methods and assumptions were used to estimate the fair values of the assets held by the plan. See Note 22 for additional information on the fair value hierarchy.
Cash and Cash Equivalents: The carrying value of this asset is considered to approximate its fair value (Level 1).
Equity Securities, Investment Funds (Debt and Equity): The fair value of assets in these categories are determined using quoted market prices from nationally recognized markets (Level 1).
Bonds (Corporate and Municipal): Fair values of these assets was primarily measured using information from a third-party pricing service. This service provides pricing information by utilizing evaluated pricing models supported with market data information. Standard inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data from market research publications. Fair values were estimated primarily by obtaining quoted prices for similar assets in active markets or through the use of pricing models (Level 2).
Immediate Participation Guarantee Contract: The carrying value of this asset is considered to approximate its fair value. (Level 1).
Cash Surrender Value of Life Insurance: The cash surrender value of this asset is considered to approximate its fair value. However, the inputs used to determine the cash surrender value are not readily observable in the market (Level 3).
The following table sets forth by level, within the fair value hierarchy, the Plan's investments at fair value as of December 31, 2023 and 2022. For more information on the levels within the fair value hierarchy, please refer to Note 22.
(Dollars in Thousands)
December 31, 2023
Asset Description
Fair Value
Level 1
Level 2
Level 3
Cash and cash equivalents
$
$
$
-
$
-
Equity securities
4,978
4,978
-
-
Corporate bonds
1,961
-
1,961
-
Municipal bonds
3,911
-
3,911
-
Investment fund - debt
-
-
Investment fund - equity
1,831
1,831
-
-
Deposit in immediate participation guarantee contract
-
-
Cash surrender value of life insurance
-
-
Total assets
$
13,962
$
8,077
$
5,872
$
(Dollars in Thousands)
December 31, 2022
Asset Description
Fair Value
Level 1
Level 2
Level 3
Cash and cash equivalents
$
$
$
-
$
-
Equity securities
4,502
4,502
-
-
Corporate bonds
1,915
-
1,915
-
Municipal bonds
3,794
-
3,794
-
Investment fund - debt
-
-
Investment fund - equity
1,935
1,935
-
-
Deposit in immediate participation guarantee contract
-
-
Cash surrender value of life insurance
-
-
Total assets
$
13,779
$
8,042
$
5,709
$
The following table sets forth a summary of the changes in the fair value of the Plan's level 3 investments for the years ended December 31, 2023 and 2022:
Cash Value of Life Insurance
December 31
(Dollars in thousands)
Balance at the beginning of the period
$
$
Unrealized gain (loss) relating to investments held at the reporting date
-
-
Purchases, sales, issuances and settlement, net
(15)
-
Balance at the end of the period
$
$
Contributions
The Bank does not expect to make any contributions in 2024.
Estimated future benefit payments at December 31, 2023 (Dollars in Thousands)
$
1,219
1,562
1,612
1,125
2029-2033
4,823
Note 18. Stock Based Compensation
In 2004, the Corporation adopted the Employee Stock Purchase Plan of 2004 (ESPP). Under the ESPP, options for 250,000 shares of stock can be issued to eligible employees. The number of shares that can be purchased by each participant is defined by the plan and the Board of Directors sets the option price. However, the option price cannot be less than 90% of the fair market value of a share of the Corporation’s common stock on the date the option is granted. The Board of Directors also determines the expiration date of
the options; however, no option may have a term that exceeds one year from the grant date. ESPP options are exercisable immediately upon grant. Any shares related to unexercised options are available for future grant. The Board of Directors may amend, suspend or terminate the ESPP at any time. The exercise price of the 2023 ESPP options was set at 95% of the stock’s fair value at the time of the award.
In 2019, the Corporation approved the 2019 Omnibus Stock Incentive Plan (Stock Plan), replacing the Incentive Stock Option Plan of 2013 (ISOP). No new awards will be made under the 2013 plan; however, any awards made under the 2013 plan remain outstanding under the terms they were issued. Under the Stock Plan, 400,000 shares have been authorized to be issued, inclusive of the remaining shares available under the 2013 plan that were rolled into the Stock Plan and forfeited awards are available for future grants. The Stock Plan allows for various types of awards including incentive stock options, restricted stock and stock appreciation rights.
The ESPP options and the incentive stock options (ISO) awarded under the Stock Plan and outstanding at December 31, 2023 are all exercisable. The ESPP options expire on June 30, 2024 and the ISO options expire 10 years from the grant date. The following table summarizes the activity in the ESPP:
Employee Stock Purchase Plan
ESPP
Weighted Average
Aggregate
(Dollars in thousands except share and per share data)
Options
Price Per Share
Intrinsic Value
Balance Outstanding at December 31, 2021
24,249
$
30.24
$
-
Granted
28,083
28.73
Exercised
(1,458)
29.44
Expired
(24,931)
30.16
Balance Outstanding at December 31, 2022
25,943
$
28.73
$
Granted
34,894
26.35
Exercised
(1,607)
27.21
Expired
(27,306)
27.77
Balance Outstanding at December 31, 2023
31,924
$
26.35
$
Shares available for future grants under the ESPP at December 31, 2023
172,021
The following tables summarize the activity in the Stock Plan:
Incentive Stock Options
Weighted Average
Aggregate
(Dollars in thousands except share and per share data)
ISO
Price Per Share
Intrinsic Value
Balance Outstanding at December 31, 2021
90,254
$
28.46
$
Granted
-
-
Exercised
(300)
21.27
Forfeited
(19,500)
27.22
Balance Outstanding at December 31, 2022
70,454
$
28.84
$
Granted
-
-
Exercised
-
-
Forfeited
-
-
Balance Outstanding at December 31, 2023
70,454
$
28.84
$
‎
Restricted Shares
Weighted Average
Restricted
Grant Date
Shares
Fair Value
Nonvested as of December 31, 2021
11,955
$
29.30
Granted
18,814
33.30
Vested
(9,974)
32.07
Forfeited
(291)
30.40
Nonvested as of December 31, 2022
20,504
$
32.40
Granted
15,734
31.64
Vested
(17,183)
31.56
Forfeited
(548)
32.48
Nonvested as of December 31, 2023
18,507
$
32.53
Shares available for future grants under the Stock Plan at December 31, 2023
253,541
Restricted shares awarded under the Stock Plan fully vest in one year for awards to Directors and ratably over three years for awards to other eligible employees. Compensation expense is based on the grant date fair value and was $483 thousand in 2023 and $462 in 2022. The amount of unrecognized compensation expense for restricted shares was $336 thousand at December 31, 2023.
The following table provides information about the options outstanding at December 31, 2023:
Options
Weighted
Outstanding
Exercise Price
Average Remaining
Stock Option Plan
and Exercisable
per share
Life (years)
Employee Stock Purchase Plan
31,924
$
26.35
0.5
Incentive Stock Options
7,000
22.05
1.2
Incentive Stock Options
14,650
21.27
2.2
Incentive Stock Options
24,050
30.00
3.2
Incentive Stock Options
24,754
34.10
4.2
ISO Total/Average
70,454
$
28.84
3.1
Note 19. Deferred Compensation Agreement
The Bank has a Director’s Deferred Compensation Plan, whereby each director may voluntarily participate and elect each year to defer all or a portion of their Bank director’s fees. Each participant directs the investment of their own account among various publicly available mutual funds designated by the Bank’s Wealth Management department. Changes in the account balance beyond the amount deferred to the account are solely the result of the performance of the selected mutual fund. The Bank maintains an offsetting asset and liability for the deferred account balances and the annual expense is recorded as a component of directors’ fees as if it were a direct payment to the director. The Bank will not incur any expense when the account goes into payout.
Note 20. Shareholders’ Equity
The Board of Directors, from time to time, authorizes the repurchase of the Corporation’s $1.00 par value common stock. The repurchased shares will be held as Treasury shares available for issuance in connection with future stock dividends and stock splits, employee benefit plans, executive compensation plans, the Dividend Reinvestment Plan (DRIP) and other appropriate corporate purposes. The term of the repurchase plans is normally one year. The Corporation held 339,741 and 320,575 treasury shares at cost at December 31, 2023 and 2022, respectively.
The following table provides information about the Corporation’s stock repurchase activity:
Shares Repurchased
Plan Date
Authorized
Expiration
12/22/2022
150,000 shares
12/21/2023
83,058
2,848
The Corporation’s 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 Corporation has authorized one million (1,000,000) shares of its currently authorized but not outstanding common stock to be issued under the plan or it may issue from Treasury shares. The DRIP added $1.4 million to capital during 2023. This total was comprised of $1.0 million from the reinvestment of quarterly dividends and $312 thousand of optional cash purchases. During 2023, 46,458 shares of common stock were purchased through the DRIP and 220,452 shares remain to be issued. In December 2023, an open market repurchase plan was approved to repurchase 150,000 shares over a one-year period.
Note 21. Commitments and Contingencies
In the normal course of business, the Bank is a party to financial instruments that are not reflected in the accompanying financial statements and are commonly referred to as off-balance-sheet instruments. These financial instruments are entered into primarily to meet the financing needs of the Bank’s customers and include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk not recognized in the consolidated balance sheet.
The Corporation’s exposure to credit loss in the event of nonperformance by other parties to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contract or notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as they do for on-balance-sheet instruments.
The Bank had the following outstanding commitments as of December 31:
(Dollars in thousands)
Financial instruments whose contract amounts represent credit risk
Commercial commitments to extend credit
$
325,982
$
275,867
Consumer commitments to extend credit (secured)
112,157
93,124
Consumer commitments to extend credit (unsecured)
5,964
5,247
$
444,103
$
374,238
Standby letters of credit
$
19,851
$
30,734
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses with the exception of home equity lines and personal lines of credit and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank, is based on Management’s credit evaluation of the counterparty. Collateral for most commercial commitments varies but may include accounts receivable, inventory, property, plant, and equipment, and income-producing commercial properties. Collateral for secured consumer commitments consists of liens on residential real estate.
Standby letters of credit are instruments issued by the Bank, which guarantee the beneficiary payment by the Bank in the event of default by the Bank’s customer in the nonperformance of an obligation or service. Most standby letters of credit are extended for one year periods. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds collateral supporting the majority of those commitments for which collateral is deemed necessary primarily in the form of certificates of deposit and liens on real estate. Management believes that the proceeds obtained through a liquidation of such collateral would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees.
Most of the Bank’s business activity is with customers located within its primary market and does not involve any significant concentrations of credit to any one entity or industry.
On January 1, 2023, the Corporation adopted ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, referred to as the current expected credit loss (CECL) methodology. Upon adoption, $412 thousand was added to the allowance for credit losses (ACL) - unfunded commitments. For 2023, the provision for credit losses-unfunded commitments was $135 thousand compared to $0 for 2022. At December 31, 2023, the Bank had a $2.0 million reserve against off balance sheet commitments compared to $1.5 million at December 31, 2022.
Legal Proceedings
The nature of the Corporation’s business generates a certain amount of litigation.
We establish accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probable and the amount of the loss can be reasonably estimated. When we are able to do so, we also determine estimates of probable losses, whether in excess of any accrued liability or where there is no accrued liability.
These assessments are based on our analysis of currently available information and are subject to significant judgment and a variety of assumptions and uncertainties. As new information is obtained, we may change our assessments and, as a result, take or adjust the amounts of our accruals and change our estimates of possible losses or ranges of possible losses. Due to the inherent subjectivity of the assessments and the unpredictability of outcomes of legal proceedings, any amounts that may be accrued or included in estimates of probable losses or ranges of probable losses may not represent the actual loss to the Corporation from any legal proceeding. Our exposure and ultimate losses may be higher, possibly significantly higher, than amounts we may accrue or amounts we may estimate.
In management’s opinion, we do not anticipate, at the present time, that the ultimate aggregate liability, if any, arising out of all litigation to which the Corporation is a party will have a material adverse effect on our financial position. We cannot now determine, however, whether or not any claim asserted against us will have a material adverse effect on our results of operations in any future reporting period, which will depend on, amount other things, the amount of loss resulting from the claim and the amount of income otherwise reported for the reporting period. Thus, at December 31, 2023, we are unable to provide an evaluation of the likelihood of an unfavorable outcome or an estimate of the amount or range of potential loss with respect to such other matters and, accordingly, have not yet established any specific accrual for such other matters.
No material proceedings are pending or are known to be threatened or contemplated against us by governmental authorities.
In management’s opinion, there are no other proceedings pending to which the Corporation is a party or to which its property is subject which, if determined adversely to the Corporation, would be material.
Note 22. Fair Value Measurements and Fair Values of Financial Instruments
Management uses its best judgment in estimating the fair value of the Corporation’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Corporation could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective year-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates maybe different than the amounts reported at each year-end.
FASB ASC Topic 820, “Financial Instruments”, requires disclosure of the fair value of financial assets and liabilities, including those financial assets and liabilities that are not measured and reported at fair value on a recurring and nonrecurring basis. The Corporation does not report any nonfinancial assets at fair value. FASB ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under FASB ASC Topic 820 are as follows:
Level 1: Valuation is based on unadjusted, quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2: Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. There may be substantial differences in the assumptions used for securities within the same level. For example, prices for U.S. Agency securities have fewer assumptions and are closer to level 1 valuations than the private label mortgage-backed securities that require more assumptions and are closer to level 3 valuations.
Level 3: Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Corporation’s assumptions regarding what market participants would assume when pricing a financial instrument.
An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The level within the hierarchy does not represent risk.
The following information regarding the fair value of the Corporation’s financial instruments should not be interpreted as an estimate of the fair value of the entire Corporation since a fair value calculation is only provided for a limited portion of the Corporation’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Corporation’s disclosures and those of other companies may not be meaningful.
The following methods and assumptions were used to estimate the fair values of the Corporation’s financial instruments measured at fair value on a recurring and nonrecurring basis at December 31, 2023 and 2022.
Equity Securities: Equity securities are valued using quoted market prices from nationally recognized markets (Level 1). Equity securities are measured at fair value on a recurring basis.
Investment securities: Fair values of investment securities available-for-sale were primarily measured using information from a third-party pricing service. This service provides pricing information by utilizing evaluated pricing models supported with market data information. Standard inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data from market research publications. Level 2 investment securities are primarily comprised of debt securities issued by states and municipalities, corporations, mortgage-backed securities issued by government agencies, and government-sponsored enterprises. Fair values were estimated primarily by obtaining quoted prices for similar assets in active markets or through the use of pricing models. Investment securities are measured at fair value on a recurring basis.
Collateral Dependent Loans: The fair value of collateral dependent loans with specific allocations of the allowance for credit losses is generally based on recent real estate appraisals conducted by an independent, licensed appraiser, less cost to sell. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach (Level 2). If the appraiser makes an adjustment to account for differences between the comparable sales and income data available for similar loans, or if management adjusts the appraised value, then the fair value is considered Level 3. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Collateral dependent loans are evaluated on a quarterly basis for additional impairment and adjusted in accordance with the allowance policy. No partial charge-offs on these loans was taken in the third quarter of 2023. Collateral dependent loans are measured at fair value on a nonrecurring basis.
Other Real Estate Owned: Assets acquired through or instead of loan foreclosure are initially recorded at the lower of cost or the fair value less costs to sell when acquired. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which are updated no less frequently than annually. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach with data from comparable properties (Level 2). If the appraiser makes an adjustment to account for differences between the comparable sales and income data available for similar loans, or if management adjusts the appraised value, then the fair value is considered Level 3. In connection with the measurement and initial recognition of other real estate owned, losses are recognized through the allowance for loan losses. Subsequent charge-offs are recognized as an expense. Other real estate owned properties are evaluated on a quarterly basis for additional impairment and adjusted accordingly.
Recurring Fair Value Measurements
For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at December 31, 2023 and 2022 are as follows:
(Dollars in Thousands
Fair Value at December 31, 2023
Asset Description
Level 1
Level 2
Level 3
Total
Equity securities, at fair value
$
$
-
$
-
$
Available for sale:
U.S. Treasury
74,091
-
-
74,091
Municipal
-
138,618
-
138,618
Corporate
-
23,198
-
23,198
Agency mortgage & asset-backed
-
132,591
-
132,591
Non-Agency mortgage & asset-backed
-
104,005
-
104,005
Total assets
$
74,518
$
472,503
$
-
$
472,930
(Dollars in Thousands)
Fair Value at December 31, 2022
Asset Description
Level 1
Level 2
Level 3
Total
Equity securities, at fair value
$
$
-
$
-
$
Available for sale:
U.S. Treasury
90,257
-
-
90,257
Municipal
-
155,455
-
155,455
Corporate
-
24,239
-
24,239
Agency mortgage & asset-backed
-
150,935
-
150,935
Non-Agency mortgage & asset-backed
-
65,950
-
65,950
Total assets
$
90,668
$
396,579
$
-
$
487,247
The fair value of derivative liabilities measured at fair value at December 31, 2023 and 2022 was $2 thousand and $3 thousand, respectively and was considered immaterial.
Nonrecurring Fair Value Measurements
There were no financial assets measured at fair value on a nonrecurring basis at December 31, 2023 or 2022.
The Corporation did not record any liabilities at fair value for which measurement of the fair value was made on a nonrecurring basis at December 31, 2023. For financial assets and liabilities measured at fair value on a recurring basis, there were no transfers of financial assets or liabilities between Level 1 and Level 2 during the period ending December 31, 2023.
The Corporation did not record any assets or liabilities at fair value for which measurement of the fair value was made on a nonrecurring basis at December 31, 2023. For financial assets and liabilities measured at fair value on a recurring basis, there were no transfers of financial assets or liabilities between Level 1 and Level 2 during the period ending December 31, 2023.
The carrying amounts and estimated fair value of financial instruments not carried at fair value are as follows:
December 31, 2023
Carrying
Fair
(Dollars in thousands)
Amount
Value
Level 1
Level 2
Level 3
Financial assets, carried at cost:
Cash and cash equivalents
$
23,140
$
23,140
$
23,140
$
-
$
-
Long-term interest-earnings deposits in other banks
6,229
6,229
6,229
Loans held for sale
-
-
Net loans
1,240,933
1,207,403
-
-
1,207,403
Accrued interest receivable
7,506
7,506
-
-
7,506
Financial liabilities:
Deposits
$
1,537,978
$
1,537,480
$
-
$
1,537,480
$
-
Federal Reserve Bank Borrowings
90,000
89,783
89,783
FHLB Advances
40,000
40,110
40,110
Subordinate notes
19,661
18,303
-
18,303
-
Accrued interest payable
3,856
3,856
-
3,856
-
December 31, 2022
Carrying
Fair
(Dollars in thousands)
Amount
Value
Level 1
Level 2
Level 3
Financial assets, carried at cost:
Cash and cash equivalents
$
64,899
$
64,899
$
64,899
$
-
$
-
Long-term interest-earnings deposits in other banks
13,975
13,975
13,975
Loans held for sale
-
-
Net loans
1,036,866
986,141
-
-
986,141
Accrued interest receivable
6,354
6,354
-
-
6,354
Financial liabilities:
Deposits
$
1,551,448
$
1,550,030
$
-
$
1,550,030
$
-
Subordinate notes
19,623
17,876
-
17,876
-
Accrued interest payable
-
-
Note 23. Parent Company (Franklin Financial Services Corporation) Condensed Financial Information
Balance Sheets
December 31
(Dollars in thousands)
Assets:
Cash and cash equivalents
$
10,070
$
13,500
Investment securities
Equity investment in subsidiaries
140,074
118,768
Other assets
1,228
1,153
Total assets
$
151,799
133,832
Liabilities:
Subordinate notes
$
19,661
$
19,623
Other liabilities
Total liabilities
19,663
19,635
Shareholders' equity
132,136
114,197
Total liabilities and shareholders' equity
$
151,799
$
133,832
Statements of Income
Years Ended December 31
(Dollars in thousands)
Income:
Dividends from Bank subsidiary
$
5,607
$
5,670
Change in fair value of equity securities
(69)
Dividends
5,630
5,606
Expenses:
Interest expense
1,051
1,047
Operating expenses
1,887
1,771
Income before income taxes and equity in undistributed income
‎ of subsidiaries
2,692
2,788
Income tax benefit
Equity in undistributed income of subsidiaries
10,012
11,550
Net income
13,598
14,938
Other comprehensive income/(loss) of subsidiary
10,347
(50,740)
Comprehensive income (loss)
$
23,945
$
(35,802)
Statements of Cash Flows
Years Ended December 31
(Dollars in thousands)
Cash flows from operating activities
Net income
$
13,598
$
14,938
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in undistributed (income) of subsidiary
(10,012)
(11,550)
Stock option compensation
Change in fair value of equity security
(16)
Increase in other assets/liabilities
(896)
(528)
Net cash provided by operating activities
3,157
3,391
Cash flows from financing activities
Dividends paid
(5,595)
(5,658)
Cash received from option exercises
Common stock issued under dividend reinvestment plan
1,355
1,416
Treasury stock purchase
(2,394)
(3,334)
Net cash (used in) provided by financing activities
(6,587)
(7,528)
(Decrease) increase in cash and cash equivalents
(3,430)
(4,137)
Cash and cash equivalents as of January 1
13,500
17,637
Cash and cash equivalents as of December 31
$
10,070
$
13,500
Note 24. Revenue Recognition
All of the Corporation’s revenue from contracts with customers within the scope of ASC 606 is recognized in non-interest income as presented in our consolidated statements of income. Revenue generating activities that fall within the scope of ASC 606 are described as follows:
Wealth Management Fees - these represent fees from wealth management (assets under management), fees from the management and settlement of estates and commissions from the sale of investment and insurance products. Asset management fees are generally assessed based on a tiered fee schedule, based on the value of assets under management, and are recognized monthly when the service obligation is completed. Fees for estate management services are based on the estimated fair value of the estate. These fees are generally recognized monthly over an 18-month period that Management has determined to represent the average time to fulfill the performance obligations of the contract. Management has the discretion to adjust this time period as needed based upon the nature and complexity of an individual estate. Commissions from the sale of investment and insurance products are recognized upon the completion of the transaction.
The following table presents Wealth Management Fees for December 31, 2023 and 2022:
For the Twelve Months Ended
(Dollars in thousands)
December 31,
Wealth Management Fees
Asset Management Fees
$
6,889
$
6,485
Estate Management Fees
Commissions
Total
$
7,512
$
7,152
Loan Service Charges - these represent fees on loans for services or charges that occur after the loan has been booked, for example, late payment fees. All of these fees are transactional in nature and are recognized upon completion of the transaction which represents the performance obligation.
Deposit Service Charges and Fees - these represent fees from deposit customers for transaction based, account maintenance, and overdraft services. Transaction based fees include, but are not limited to, stop payment fees and overdraft fees. These fees are recognized at the time of the transaction when the performance obligation has been fulfilled. Account maintenance fees and account analysis fees are earned over the course of a month, representing the period of the performance obligation, and are recognized monthly.
Debit Card Income - this represents interchange fees from cardholder transactions conducted through the card payment network. Cardholders use the debit card to conduct point-of-sale transactions that produce interchange fees. The fees are transaction based and the fee is recognized with the processing of the transaction. These fees are reported net of cardholder rewards.
Other Service Charges and Fees - these are comprised primarily of merchant card fees, credit card fees, ATM surcharges and interchange fees and wire transfer fees. Merchant card fees represent fees the Bank earns from a third party for enrolling a customer in the processor’s program. Credit card fees represent a fee earned by the Bank for a successful referral to a card-issuing company. ATM surcharges and interchange fees are the result of Bank customers conducting ATM transactions that generate fee income and are processed through multiple card networks. All of these fees are transaction based and are recognized at the time of the transaction.
Other Income - these items are transactional in nature and recognized upon completion of the transaction which represents the performance obligation. Certain items included in this category may be excluded from the scope of ASC 606.
Gains/Losses on the Sale of Other Real Estate - these are recognized when control of the property transfers to the buyer.
Contract Balances - A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s noninterest revenue streams are largely based on transactional activity, or standard month-end revenue accruals such as asset management fees based on month-end market values. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into longer-term revenue contracts with customers, and therefore, does not experience significant contract balances.
Contract Acquisition Costs - The Corporation expenses all contract acquisition costs as costs are incurred.
Note 25. Tax Credit Investments
In 2023, the Corporation invested $936 thousand in various solar tax credit limited partnerships or LLCs. These partnerships develop, build and operate solar renewable energy projects. Over the course of these investments, the Corporation expects to receive federal tax credits, tax-related benefits and excess cash distributions, if available. The tax benefits from these investments is generally recognized over six years. During the year ended December 31, 2023, the Corporation recognized federal tax credits of $367 thousand.

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.

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ITEM 9A. CONTROLS AND PROCEDURES
Item 9A. Controls and Procedures
Evaluation of Controls and Procedures
The Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s Management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon the evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer concluded that as of December 31, 2023, the Corporation’s disclosure controls and procedures are effective. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in the Corporation’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
Management Report on Internal Control Over Financial Reporting
The Management of the Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. The Corporation’s internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2023, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework (2013). Based on this assessment, Management concluded that, as of December 31, 2023, the Corporation’s internal control over financial reporting is effective based on those criteria.
There were no changes during the fourth quarter of 2023 in the Corporation’s internal control over financial reporting which materially affected, or which are reasonably likely to affect, the Corporation’s internal control over financial reporting.

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ITEM 9B. OTHER INFORMATION
Item 9B. Other Information
None of our directors or executive officers adopted or terminated a Rule 10b5-1 trading arrangement or adopted or terminated a non-Rule 10b5-1 trading arrangement (as defined in Item 408(c) of Regulation S-K) during the quarter ended December 31, 2023.

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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Item 10. Directors, Executive Officers and Corporate Governance
The information required by this Item relating to the directors and executive officers of the Corporation is incorporated herein by reference to the information set forth under the heading “ELECTION OF DIRECTORS - Information about Nominees and Continuing Directors” and under the heading “ADDITIONAL INFORMATION - Key Employees” appearing in the Corporation's 2024 proxy statement.
The information required by this item relating to compliance with Section 16(a) of the Exchange Act is incorporated herein by reference to the information set forth under the heading “ADDITIONAL INFORMATION - Delinquent Section 16(a) Filings” appearing in the Corporation's 2024 proxy statement.
The information required by this item relating to the Corporation's code of ethics is incorporated herein by reference to the information set forth under the heading “CORPORATE GOVERNANCE POLICIES, PRACTICES AND PROCEDURES” appearing in the Corporation's 2024 proxy statement. The Corporation will file on Form 8-K any amendments to, or waivers from, the code of ethics applicable to any of its directors or executive officers.
There have been no material changes to the procedures by which shareholders may recommend nominees to the Corporation’s Board of Directors.
The information required by this Item relating to the Audit Committee and Audit Committee Financial Expert of the Corporation is incorporated herein by reference to the information set forth under the heading “BOARD STRUCTURE AND COMMITTEES - Audit Committee.”

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ITEM 11. EXECUTIVE COMPENSATION
Item 11. Executive Compensation
The information required by this item relating to executive compensation is incorporated herein by reference to the information set forth under the heading “EXECUTIVE COMPENSATION” appearing in the Corporation's 2024 proxy statement.

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item relating to securities authorized for issuance under executive compensation plans is incorporated herein by reference to the information set forth under the heading “EXECUTIVE COMPENSATION - Compensation Tables and Additional Compensation Disclosure” appearing in the Corporation's 2024 proxy statement.
The information required by this item relating to security ownership of certain beneficial owners is incorporated herein by reference to the information set forth under the heading “GENERAL INFORMATION - Voting of Shares and Principal Holders Thereof'” appearing in the Corporation's 2024 proxy statement.
The information required by this item relating to security ownership of management is incorporated herein by reference to the information set forth under the heading “ELECTION OF DIRECTORS - Common Stock Ownership of Directors, Nominees and Executive Officers” appearing in the Corporation's 2024 proxy statement.

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this item relating to director independence is incorporated herein by reference to the information set forth under the heading “ELECTION OF DIRECTORS - Director Independence” and under the heading “ADDITIONAL INFORMATION - Transactions with Related Persons” appearing in the Corporation's 2024 proxy statement.

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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Item 14. Principal Accountant Fees and Services
The information required by this item relating to principal accountant fees and services is incorporated herein by reference to the information set forth under the heading “RELATIONSHIP WITH INDEPENDENT REGISTERED PUBLIC ACCOUNTANTS” appearing in the Corporation's 2024 proxy statement.
Part IV

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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Item 15. Exhibits and Financial Statement Schedules
(a) The following documents are filed as part of this report:
(1) The following Consolidated Financial Statements of the Corporation:
Report of Independent Registered Public Accounting Firm (PCAOB ID 173)
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Comprehensive Income
Consolidated Statements of Changes in Shareholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements.
(2) All financial statement schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and have therefore been omitted.
(3) The following exhibits are part of this report:
Item
Description
3.1
Amended and Restated Articles of Incorporation of the Corporation (Filed as Exhibit 3.1 to Quarterly Report on Form 10-Q for the quarter ended June 30, 2020 and incorporated herein by reference.)
3.2
Bylaws of the Corporation (Filed Exhibit 99.1 of Current Report on Form 8-K as filed with the Commission on September 2, 2022 and incorporated herein by reference.)
4.
Instruments defining the rights of securities holders, including indentures, are contained in the Articles of Incorporation (Exhibit 3.1) and Bylaws (Exhibit 3.2)
10.1
Deferred Compensation Agreements with Bank Directors* (Filed as Exhibit 10.1 to Annual Report on Form 10-K for the year ended December 31, 2014 and incorporated herein by reference.)
10.2
Director’s Deferred Compensation Plan* (Filed as Exhibit 10.2 to Annual Report on Form 10-K for the year ended December 31, 2014 and incorporated herein by reference.)
10.3
Senior Management Annual Incentive Plan* (Filed as Exhibit 10.3 to Annual Report on Form 10-K for the year ended December 31, 2019 and incorporated herein by reference.)
10.4
Senior Management and Directors Incentive Stock Plan* (Filed as Exhibit 10.4 to Annual Report on Form 10-K for the year ended December 31, 2019 and incorporated herein by reference.)
10.5
Incentive Stock Option Plan of 2013 (Filed as Exhibit 10.1 to Registration Statement No. 333-193655 on Form S-8 filed January 30, 2014 and incorporated herein by reference)*
10.6
2019 Omnibus Stock Incentive Plan (Filed as Appendix A to the Definitive Proxy statement on Schedule 14A as filed with the Commission on March 18, 2019 and incorporated herein by reference.)*
10.7
Employment Agreement by and among Franklin Financial Services Corporation (“Corporation”), Farmers and Merchants Trust Company of Chambersburg (“Bank”), and Timothy G. Henry, incorporated by reference to Exhibit 99.1 to the Registrant’s Form 8-K filed March 4, 2021*
10.9
Employment Agreement by and among Franklin Financial Services Corporation (“Corporation”), Farmers and Merchants Trust Company of Chambersburg (“Bank”), and Mark R. Hollar, incorporated by reference to Exhibit 99.3 to the Registrant’s Form 8-K filed March 4, 2021*
10.11
Employment Agreement by and among Franklin Financial Services Corporation (“Corporation”), Farmers and Merchants Trust Company of Chambersburg (“Bank”) and Charles (Chad) B. Carroll, incorporated by reference to Exhibit 99.2 to the Registrant’s Form 8-K filed January 5, 2023*
Code of Ethics posted on the Corporation’s website
Subsidiaries of Corporation - filed herewith
23.1
Consent of Crowe LLP - filed herewith
31.1
Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer) - filed herewith
31.2
Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer) - filed herewith
32.1
Section 1350 Certification (Chief Executive Officer) - filed herewith
32.2
Section 1350 Certification (Chief Financial Officer) - filed herewith
Policy Relating to Recovery of Erroneously Awarded Compensation (Clawback)
Interactive Data File (XBRL)
* Compensatory plan or arrangement.
(b) The exhibits required to be filed as part of this report are submitted as a separate section of this report.
(c) Financial Statement Schedules: None.