UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2022
or
¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from__________ to___________
Commission file number 001-38884
FRANKLIN FINANCIAL SERVICES CORPORATION
(Exact name of registrant as specified in its charter)
Pennsylvania
25-1440803
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
20 South Main Street, Chambersburg, PA
17201-0819
(Address of principal executive offices)
(Zip Code)
(717) 264-6116
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of class
Symbol
Name of exchange on which registered
Common stock
FRAF
Nasdaq Capital Market
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act) Yes ¨ No x
There were 4,457,959 outstanding shares of the Registrant’s common stock as of April 29, 2022.
INDEX
Part I - FINANCIAL INFORMATION
Item 1
Financial Statements
Consolidated Balance Sheets as of March 31, 2022 and December 31, 2021 (unaudited)
1
Consolidated Statements of Income for the Three Months ended March 31, 2022
2
and 2021 (unaudited)
Consolidated Statements of Comprehensive Income for the Three Months ended
3
March 31, 2022 and 2021 (unaudited)
Consolidated Statements of Changes in Shareholders’ Equity for the Three Months
ended March 31, 2022 and 2021 (unaudited)
Consolidated Statements of Cash Flows for the Three Months ended March 31, 2022
4
Notes to Consolidated Financial Statements (unaudited)
5
Item 2
Management’s Discussion and Analysis ofResults of Operations and Financial Condition
27
Item 3
Quantitative and Qualitative Disclosures about Market Risk
42
Item 4
Controls and Procedures
Part II - OTHER INFORMATION
Legal Proceedings
43
Item 1A
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5
Other Information
44
Item 6
Exhibits
SIGNATURE PAGE
45
Part I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets
(Dollars in thousands, except share and per share data)
(unaudited)
March 31,
December 31,
2022
2021
Assets
Cash and due from banks
$
18,209
10,463
Short-term interest-bearing deposits in other banks
155,500
164,686
Total cash and cash equivalents
173,709
175,149
Long-term interest-bearing deposits in other banks
10,742
10,492
Debt securities available for sale, at fair value
511,477
529,811
Equity securities
492
481
Restricted stock
507
495
Loans held for sale
3,142
2,827
Loans
1,000,977
998,812
Allowance for loan losses
(15,050)
(15,066)
Net Loans
985,927
983,746
Premises and equipment, net
23,198
19,190
Right of use asset
4,658
4,759
Bank owned life insurance
21,982
21,874
Goodwill
9,016
Deferred tax asset, net
9,135
3,314
Other assets
13,076
12,652
Total assets
1,767,061
1,773,806
Liabilities
Deposits
Noninterest-bearing checking
303,382
298,403
Money management, savings, and interest checking
1,223,753
1,211,703
Time
69,251
74,253
Total deposits
1,596,386
1,584,359
Subordinate notes
19,598
19,588
Lease liability
4,763
4,857
Other liabilities
9,178
7,937
Total liabilities
1,629,925
1,616,741
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 4,456,918 shares outstanding at March 31, 2022 and
4,710,972 shares issued and 4,441,443 shares outstanding at December 31, 2021
4,711
Capital stock no par value, 5,000,000 shares authorized with no
shares issued and outstanding
—
Additional paid-in capital
43,077
43,085
Retained earnings
118,203
116,612
Accumulated other comprehensive loss
(22,444)
(547)
Treasury stock, 254,054 shares at March 31, 2022 and 269,529 shares at
December 31, 2021, at cost
(6,411)
(6,796)
Total shareholders' equity
137,136
157,065
Total liabilities and shareholders' equity
The accompanying notes are an integral part of these unaudited financial statements.
For the Three Months Ended
(Dollars in thousands, except per share data) (unaudited)
Interest income
Loans, including fees
9,067
9,381
Interest and dividends on investments:
Taxable interest
1,843
1,623
Tax exempt interest
525
532
Dividend income
Interesting-bearing deposits in other banks
98
53
Total interest income
11,534
11,592
Interest expense
463
485
263
Total interest expense
726
748
Net interest income
10,808
10,844
Provision for loan losses
(800)
Net interest income after provision for loan losses
11,644
Noninterest income
Investment and trust services fees
1,828
1,636
Loan service charges
116
196
Gain on sale of loans
254
782
Deposit service charges and fees
623
468
Other service charges and fees
412
396
Debit card income
458
517
Increase in cash surrender value of Bank owned life insurance
108
115
Change in fair value of equity securities
11
54
Other
74
63
Total noninterest income
3,884
4,227
Noninterest Expense
Salaries and employee benefits
6,366
5,658
Net occupancy
974
910
Marketing and advertising
497
345
Legal and professional
515
475
Data processing
1,137
929
Pennsylvania bank shares tax
143
92
FDIC Insurance
183
202
ATM/debit card processing
346
296
Telecommunications
129
Nonservice pension
69
205
944
924
Total noninterest expense
11,266
10,165
Income before federal income taxes
3,426
5,706
Federal income tax expense
414
876
Net income
3,012
4,830
Per share
Basic earnings per share
0.68
1.10
Diluted earnings per share
0.67
1.09
(Dollars in thousands) (unaudited)
Net Income
Debt Securities:
Unrealized losses arising during the period
(27,718)
(10,577)
Tax effect
5,821
2,221
Net of tax amount
(21,897)
(8,356)
Total other comprehensive loss
Total Comprehensive Loss
(18,885)
(3,526)
(1) Reclassified to net gains on sales of debt securities
For the three months ended March 31, 2022 and 2021
Accumulated
Additional
Shares
Common
Paid-in
Retained
Comprehensive
Treasury
Outstanding
Stock
Capital
Earnings
Loss
Total
Balance at January 1, 2022
4,441,443
Other comprehensive income
Cash dividends declared, $0.32 per share
(1,421)
Acquisition of treasury stock
(609)
(20)
Treasury shares issued under dividend reinvestment plan
9,379
78
236
314
Stock Compensation Plans:
Treasury shares issued
6,705
(156)
169
13
Compensation expense
70
Balance at March 31, 2022
4,456,918
Balance at January 1, 2021
4,389,355
42,589
102,520
3,190
(7,834)
145,176
Cash dividends declared, $0.30 per share
(1,318)
(474)
(13)
11,682
40
285
325
7,020
(164)
171
7
48
Balance at March 31, 2021
4,407,583
42,513
106,032
(5,166)
(7,391)
140,699
Three Months EndedMarch 31,
Cash flows from operating activities
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
267
324
Net amortization of loans and investment securities
711
124
Amortization of subordinate debt issuance costs
10
(Recovery of) provision for loan losses
(11)
(54)
Loans originated for sale
(14,086)
(28,992)
Proceeds from sale of loans
14,025
34,521
Gain on sale of loans held for sale
(254)
(782)
Increase in cash surrender value of life insurance
(108)
(115)
Increase in fair value of derivative
(8)
(23)
Stock option compensation
(Increase) decrease in other assets
(581)
691
Increase in other liabilities
1,399
667
Net cash provided by operating activities
4,446
10,449
Cash flows from investing activities
Net (increase) decrease in long-term interest-bearing deposits in other banks
(250)
1,746
Proceeds from maturities and pay-downs of securities available for sale
1,227
9,367
Purchase of investment securities available for sale
(11,525)
(45,827)
Net increase in restricted stock
(12)
Net (increase) decrease in loans
(1,978)
9,439
Capital expenditures
(4,261)
(168)
Net cash used in investing activities
(16,799)
(25,443)
Cash flows from financing activities
Net increase in demand deposits, interest-bearing checking, and savings accounts
17,029
69,285
Net decrease in time deposits
(5,002)
(2,816)
Dividends paid
Purchase of Treasury shares
Cash received from option exercises
Net cash provided by financing activities
10,913
65,470
(Decrease) increase in cash and cash equivalents
(1,440)
50,476
Cash and cash equivalents at the beginning of the period
57,146
Cash and cash equivalents at the end of the period
107,622
Supplemental Disclosures of Cash Flow Information
Cash paid during the year for:
Interest on deposits and other borrowed funds
513
Noncash Activities
Lease liabilities arising from obtaining right-of-use assets
30
UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The consolidated financial statements include the accounts of Franklin Financial Services Corporation (the Corporation), and its wholly owned subsidiaries, Farmers and Merchants Trust Company of Chambersburg (the Bank) and Franklin Future Fund Inc. Farmers and Merchants Trust Company of Chambersburg is a commercial bank that has one wholly owned subsidiary, Franklin Financial Properties Corp. Franklin Financial Properties Corp. holds real estate assets that are leased by the Bank. Franklin Future Fund Inc. is a non-bank investment company. The activities of the non-bank subsidiary are not significant to the consolidated totals. All significant intercompany transactions and account balances have been eliminated.
In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the consolidated financial position, results of operations, and cash flows as of March 31, 2022, and for all other periods presented have been made.
Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted. It is suggested that these consolidated financial statements be read in conjunction with the audited consolidated financial statements and notes thereto included in the Corporation’s 2021 Annual Report on Form 10-K. The consolidated results of operations for the three-month period ended March 31, 2022 are not necessarily indicative of the operating results for the full year. Management has evaluated subsequent events for potential recognition and/or disclosure through the date these consolidated financial statements were issued.
The consolidated balance sheet at December 31, 2021 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by GAAP for complete consolidated financial statements.
For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, interest-bearing deposits in other banks and cash items with original maturities less than 90 days.
Earnings per share are computed based on the weighted average number of shares outstanding during each period end. A reconciliation of the weighted average shares outstanding used to calculate basic earnings per share and diluted earnings per share follows:
(Dollars and shares in thousands, except per share data)
Weighted average shares outstanding (basic)
4,396
Impact of common stock equivalents
24
19
Weighted average shares outstanding (diluted)
4,470
4,415
Anti-dilutive options excluded from calculation
61
Recently issued but not yet effective 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 unless reasonable expectation of a troubled debt restructuring exists) from the date of initial recognition of that instrument. The ASU replaces the current accounting model for purchased credit impaired loans and debt securities. The allowance for credit losses for purchased financial assets with a more-than insignificant amount of credit deterioration since origination (“PCD assets”), should be determined in a similar manner to other financial assets measured on an amortized cost basis. However, upon initial recognition, the allowance for credit losses is added to the purchase price to determine the initial amortized cost basis. The subsequent accounting for PCD financial assets is the same expected loss model described above.
Effective Date
January 1, 2023
Effect on the Consolidated Financial Statements
We have formed an implementation team led by the Corporation's Risk Management function. The team is reviewing the requirements of the ASU and evaluating methods and models for implementation. As of the beginning of the first reporting period in which the new standard is adopted, the Corporation expects to recognize a one-time cumulative-effect adjustment to the allowance for loan losses, which will flow through retained earnings. After adoption, the new standard will result in earlier recognition of additions to the allowance for loan losses and possibly a larger allowance for loan loss balance with a corresponding increase in the provision for loan losses in results of operations; however, the Corporation is continuing to evaluate the impact of the pending adoption of the new standard on its consolidated financial statements. A third-party vendor has been selected to assist with the CECL calculations and the implementation process has started. The Corporation is running the CECL model in test mode in 2022.
ASU 2019-05, Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief
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. On October 16, 2019, FASB approved its August 2019 proposal to grant certain small public companies a delay in the effective date of ASU 2016-13. For the Corporation, the delay makes the ASU effective January 2023. Since the Corporation currently meets the SEC definition of a small reporting company, the delay will be applied to the Corporation. Early adoption is permitted.
The Corporation continues to review the ASU as part of its adoption of ASU 2016-13.
ASU 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debit Restructurings and Vintage Disclosures
This ASU will eliminate the recognition and measurement accounting guidance for Troubled Debt Restructurings (TDRs) by creditors in Subtopic 310-40, while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty.
The Corporation is reviewing the ASU as part of its adoption of ASU 2016-13.
ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting
This ASU provides temporary, optional guidance to ease the potential burden in accounting for, or recognizing the effects of, the transition away from the LIBOR or other interbank offered rate on financial reporting. To help with the transition to new reference rates, the ASU provides optional expedients and exceptions for applying GAAP to affected contract modifications and hedge accounting relationships. The main provisions include: (1) a change in a contract's reference interest rate would be accounted for as a continuation of that contract rather than as the creation of a new one for contracts, including loans, debts, leases, and other arrangements that meet specific criteria, and (2) when updating its hedging strategies in response to reference rate reform, an entity would be allowed to preserve its accounting. The guidance is applicable only to contracts or hedge accounting relationships that reference LIBOR or another reference rate expected to be discontinued. Because the guidance is meant to help entities through the transition period, it will be in effect for a limited time and will not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022, except for hedging relationships existing as of December 31, 2022, for which an entity has elected certain optional expedients that are retained through the end of the hedging relationship.
March 12, 2020 through December 31, 2022
The Corporation continues to review the ASU as part of its adoption but does not expect it to have a material effect on the consolidated financial statements.
Note 3. Accumulated Other Comprehensive Income (Loss)
The components of accumulated other comprehensive income (loss), net of income tax effects, included in shareholders' equity are as follows:
(Dollars in thousands)
Net unrealized gains on debt securities
(23,624)
4,094
4,961
(860)
(18,663)
3,234
Accumulated pension adjustment
(4,786)
1,005
(3,781)
Total accumulated other comprehensive loss
Note 4. Investments
Available for Sale (AFS) Securities
The amortized cost and estimated fair value of AFS securities as of March 31, 2022 and December 31, 2021 are as follows:
Gross
Amortized
unrealized
Fair
March 31, 2022
cost
gains
losses
value
U.S. Treasury
84,725
(5,713)
79,012
Municipal
205,912
811
(10,920)
195,803
Corporate
25,300
(639)
24,730
Agency mortgage & asset-backed
174,496
117
(6,208)
168,405
Non-Agency mortgage & asset-backed
44,668
(1,152)
43,527
535,101
1,008
(24,632)
December 31, 2021
84,896
88
(698)
84,286
206,501
7,148
(1,422)
212,227
24,794
333
(188)
24,939
178,614
1,157
(2,086)
177,685
30,912
34
(272)
30,674
525,717
8,760
(4,666)
At March 31, 2022 and December 31, 2021, the fair value of debt securities pledged to secure public funds and trust deposits totaled $153.8 million and $160.3 million, respectively. The Bank has no investment in a single issuer that exceeds 10% of shareholders’ equity, except for securities issued by the U.S. Treasury and U.S. government sponsored entities.
The amortized cost and estimated fair value of debt securities at March 31, 2022, by contractual maturity are shown below. Actual maturities may differ from contractual maturities because of prepayment or call options embedded in the securities. Securities not due at a single maturity date are presented separately.
Amortizedcost
Fairvalue
Due in one year or less
1,667
1,682
Due after one year through five years
8,933
8,848
Due after five years through ten years
144,994
137,312
Due after ten years
160,343
151,703
315,937
299,545
Mortgage & asset-backed
219,164
211,932
Impairment:
The debt securities portfolio contained 464 securities with $442.0 million of temporarily impaired fair value and $24.6 million in unrealized losses at March 31, 2022. The total unrealized loss position has increased $20.0 million since year-end 2021.
For securities with an unrealized loss, Management applies a systematic methodology in order to perform an assessment of the potential for other-than-temporary impairment. In the case of debt securities, investments considered for other-than-temporary impairment: (1) had a specified maturity or repricing date; (2) were generally expected to be redeemed at par; and (3) were expected to achieve a recovery in market value within a reasonable period of time. In addition, the Bank considers whether it intends to sell these securities or whether it will be forced to sell these securities before the earlier of amortized cost recovery or maturity. The municipal bond portfolio, which has the largest unrealized loss, is well diversified geographically (203 issuers) and is comprised primarily of general obligation bonds (63%). Many municipal bonds have credit enhancements in the form of private bond insurance or other credit support. The largest geographic municipal bond exposure is in the states of Texas (14%), California (11%), Pennsylvania (11%), and Michigan (10%). The average rating of the municipal portfolio from Moody’s is AA. No municipal bonds are rated below investment grade. The impairment identified on debt securities and subject to assessment at March 31, 2022, was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted.
The following table reflects temporary impairment in the AFS portfolio, aggregated by investment category, length of time that individual securities have been in a continuous unrealized loss position and the number of securities in each category as of March 31, 2022 and December 31, 2021:
Less than 12 months
12 months or more
Unrealized
Value
Losses
Count
28
143,337
(8,389)
158
18,653
(2,531)
21
161,990
179
13,989
(420)
3,781
(219)
17,770
124,484
(4,592)
165
26,240
(1,616)
150,724
193
28,847
(981)
25
3,698
(171)
32,545
Total temporarily impaired
389,669
(20,095)
403
52,372
(4,537)
442,041
464
76,383
38,997
(910)
15,404
(512)
16
54,401
60
8,954
(132)
17
1,694
(56)
10,648
20
96,923
(1,669)
94
15,991
(417)
18
112,914
112
15,215
(215)
1,964
(57)
17,179
14
236,472
(3,624)
187
35,053
(1,042)
271,525
227
The following table represents the cumulative credit losses on debt securities recognized in earnings for:
Three Months Ended
Balance of cumulative credit-related OTTI at January 1
257
272
Decreases for previously recognized credit losses on securities that paid off
(15)
Balance of credit-related OTTI at March 31
Equity Securities at Fair Value
The Corporation owns one equity investment with a readily determinable fair value. At March 31, 2022 and December 31, 2021, this investment was reported at fair value of $492 thousand and $481 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 residential real estate loans include long-term loans to individuals and businesses secured by mortgages on the borrower’s real property and include home equity loans. Construction loans are made to finance the purchase of land and the construction of residential and commercial buildings thereon and are secured by mortgages on real estate. Commercial real estate loans include construction, owner and non-owner occupied properties and farm real estate. Commercial loans are made to businesses of various sizes for a variety of purposes including property, plant and equipment, working capital and loans to government municipalities. Commercial lending is concentrated in the Bank’s primary market, but also includes purchased loan participations. Consumer loans are comprised of installment loans and unsecured personal lines of credit.
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. 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 tocontractors 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 American Institute of Architects (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 motels, 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 real estate loans ongoing monitoring of cash flow and other financial performance indictors is completed 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% 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 the end of the reporting periods is as follows:
Consumer first liens
72,246
71,828
Commercial first lien
61,814
60,655
Total first liens
134,060
132,483
Consumer junior liens and lines of credit
67,780
67,103
Commercial junior liens and lines of credit
4,538
4,841
Total junior liens and lines of credit
72,318
71,944
Total residential real estate 1-4 family
206,378
204,427
Residential real estate - construction
8,382
8,278
13,050
12,379
Total residential real estate construction
21,432
20,657
Commercial real estate
524,138
522,779
243,008
244,543
Total commercial
767,146
767,322
6,021
6,406
Less: Allowance for loan losses
Included in the loan balances are the following:
Net unamortized deferred loan costs
1,289
Loans pledged as collateral for borrowings and commitments from:
FHLB
605,267
614,828
Federal Reserve Bank
52,480
45,453
657,747
660,281
Paycheck Protection Program (included in commercial loans)
2,932
7,755
Note 6. Loan Quality and Allowance for Loan Losses
The following table presents, by class, the activity in the Allowance for Loan Losses (ALL) for the periods shown:
First
Junior Liens &
Liens
Lines of Credit
Construction
Real Estate
Unallocated
ALL at December 31, 2021
252
8,168
5,127
130
589
15,066
Charge-offs
(1)
(24)
(45)
Recoveries
15
8
29
Provision
(206)
52
ALL at March 31, 2022
480
253
329
7,962
5,183
125
718
15,050
ALL at December 31, 2020
555
226
294
9,163
5,679
97
775
16,789
(5)
(18)
(36)
(184)
(365)
(208)
ALL at March 31, 2021
447
211
318
8,785
5,473
113
789
16,136
The following table presents, by class, loans that were evaluated for the ALL under the specific reserve (individually) and those that were evaluated under the general reserve (collectively) and the amount of the ALL established in each class as of the periods shown:
Loans evaluated for ALL:
Individually
651
422
10,293
11,366
Collectively
133,409
21,010
513,845
989,611
ALL established for loans evaluated:
662
7,300
14,388
661
424
10,520
11,605
131,822
20,233
512,259
987,207
698
7,470
14,368
The following table shows additional information about those loans considered to be impaired as of the periods shown:
Impaired Loans
With No Allowance
With Allowance
Unpaid
Recorded
Principal
Related
Investment
Balance
Allowance
First liens
Junior liens and lines of credit
531
4,751
5,224
5,542
5,796
5,824
729
4,942
5,405
5,578
5,764
6,027
6,795
The following table shows the average balance of impaired loans and related interest income for the periods shown:
Average
Interest
Income
Recognized
656
423
10,256
11,335
50
March 31, 2021
634
512
16,043
91
17,189
99
At March 31, 2022, the Bank had $38.0 thousand of residential properties in the process of foreclosure compared to $38.0 thousand at the end of 2021. The following table presents the aging of payments of the loan portfolio:
Loans Past Due and Still Accruing
Current
30-59 Days
60-89 Days
90 Days+
Non-Accrual
133,720
204
120
340
72,265
12
38
205,985
216
123
355
516,816
446
6,876
242,688
260
6,007
992,506
930
1,075
7,396
132,224
96
209
71,788
118
204,012
214
327
515,487
293
6,812
244,377
106
6,368
990,477
640
311
951
7,384
The following table reports the risk rating for those loans in the portfolio that are assigned an individual risk rating. Consumer purpose loans are assigned a rating of either pass or substandard based on the performance status of the loans. Substandard consumer loans are comprised of loans 90 days or more past due and still accruing, and nonaccrual loans. Commercial purpose loans may be assigned any rating in accordance with the Bank’s internal risk rating system.
Pass
OAEM
Substandard
Doubtful
(1-5)
(6)
(7)
72,280
206,340
488,884
18,722
16,532
240,182
2,647
962,437
21,369
17,171
132,433
71,906
204,339
486,903
19,006
16,870
244,315
49
962,196
19,055
17,561
The following table presents information on the Bank’s Troubled Debt Restructuring (TDR) loans as of:
Troubled Debt Restructurings
Within the Last 12 Months
That Have Defaulted
On Modified Terms
Number of
Contracts
Performing*
Nonperforming*
Residential real estate
650
Commercial real estate - owner occupied
1,147
Commercial real estate - farm land
1,496
Commercial real estate - construction and land development
1,360
287
189
5,362
611
1,161
1,664
5,564
5,140
*The performing status is determined by the loan’s compliance with the modified terms.
There were no new TDR loans during the first quarter of 2022.
The following table reports new TDR loans during 2021, concession granted and the recorded investment as of March 31, 2022:
New During Period
Twelve Months Ended
Pre-TDR
After-TDR
Modification
Concession
41
47
multiple
Note 7. 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 are comprised of equipment, and buildings and land (collectively real estate). The equipment leases are shorter-term than the real estate leases, and generally have a fixed payment over a defined term without renewal options. Certain equipment leases have purchase options and it was determined the option was not reasonably certain to be exercised. 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 costs:
The components of total lease cost were as follows:
Operating lease cost
173
174
Short-term lease cost
Variable lease cost
Total lease cost
321
198
Supplemental Lease Information:
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases
166
162
Weighted-average remaining lease term (years)
10.8
11.5
Weighted-average discount rate
3.37%
3.34%
Lease Obligations:
Future undiscounted lease payments for operating leases with initial terms of one year or more as of March 31, 2022 are as follows:
487
2023
660
2024
639
2025
588
2026
479
2027 and beyond
2,917
Undiscounted cash flow
5,770
Imputed Interest
(1,007)
Total lease liability
Note 8. Other Real Estate Owned
The Bank had no other real estate owned at March 31, 2022 and December 31, 2021.
Note 9. 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. 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.
Fair Value of Derivative Instruments
Derivative Liabilities
Notional amount
Balance Sheet Location
Fair Value
Derivatives not designated as hedging instruments
Other Contracts
6,606
Other Liabilities
6,653
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.
Effect of Derivatives as Hedging Instruments on the Income Statement
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
Other income
23
As of March 31, 2022, 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 $13 thousand.
Note 10. Pension
The components of pension expense for the periods presented are as follows:
Components of net periodic cost:
Service cost
86
Interest cost
168
87
Expected return on plan assets
(249)
(274)
Settlement expense
Recognized net actuarial loss
150
Total pension expense
155
305
The service cost component of pension expense is recorded in the salaries and employee benefits line and all other cost components are recorded in the nonservice pension line of the Consolidated Statements of Income.
Management uses its best judgment in estimating the fair value of the Corporation’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Corporation could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective period-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates maybe different than the amounts reported at each year-end. The Corporation uses the exit price notion to measure the fair value of financial instruments.
FASB ASC Topic 820, “Financial Instruments”, requires disclosure of the fair value of financial assets and liabilities, including those financial assets and liabilities that are not measured and reported at fair value on a recurring and nonrecurring basis. The Corporation does not report any nonfinancial assets at fair value. FASB ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under FASB ASC Topic 820 are as follows:
Level 1: Valuation is based on unadjusted, quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2: Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. There may be substantial differences in the assumptions used for securities within the same level. For example, prices for U.S. Agency securities have fewer assumptions and are closer to level 1 valuations than the private label mortgage-backed securities that require more assumptions and are closer to level 3 valuations.
Level 3: Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Corporation’s assumptions regarding what market participants would assume when pricing a financial instrument.
An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
The following information regarding the fair value of the Corporation’s financial instruments should not be interpreted as an estimate of the fair value of the entire Corporation since a fair value calculation is only provided for a limited portion of the Corporation’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Corporation’s disclosures and those of other companies may not be meaningful.
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.
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.
Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan 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. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted in accordance with the allowance policy. No partial charge-offs on impaired loans were taken in the first quarter of 2022. Impaired loans are measured at fair value on a nonrecurring basis.
Recurring Fair Value Measurements
For financial assets and liabilities measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at March 31, 2022 and December 31, 2021 are as follows:
Fair Value at March 31, 2022
Asset Description
Level 1
Level 2
Level 3
Equity securities, at fair value
Available for sale:
U.S. Government and Agency securities
Municipal securities
Corporate securities
Agency mortgage and asset-backed securities
Non-Agency mortgage and asset-backed securities
79,504
432,465
511,969
Fair Value at December 31, 2021
84,767
445,525
530,292
The fair value of derivative liabilities measured at fair value at March 31, 2022 and December 31, 2021 was $13 thousand and $21 thousand, respectively, and was considered immaterial.
Nonrecurring Fair Value Measurements
For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at March 31, 2022 and December 31, 2021 are as follows:
(Dollars in Thousands)
Impaired loans (1)
4,880
(1)Includes assets that may have been charged-down to fair value during the reporting period or have a specific reserve established.
The Corporation did not record any liabilities at fair value for which measurement of the fair value was made on a nonrecurring basis at March 31, 2022. For financial assets and liabilities measured at fair value on a recurring basis, there were no transfers of financial assets or liabilities between Level 1 and Level 2 during the period ending March 31, 2022.
The following table presents additional quantitative information about Level 3 assets measured at fair value on a nonrecurring basis at March 31, 2022 and December 31, 2021:
Range
Valuation Technique
Unobservable Input
(Weighted Average)
Impaired loans
Appraisal
Appraisal Adjustment on:
Real estate assets
20% (20%)
Cost to sell
8%
Non-real estate assets
50% - 100% (83%)
The carrying amounts and estimated fair value of financial instruments not carried at fair value are as follows:
Carrying
Amount
Financial assets, carried at cost:
Cash and cash equivalents
3,195
Net loans
975,150
Accrued interest receivable
3,080
Financial liabilities:
1,528,444
19,009
Accrued interest payable
334
2,940
1,003,580
5,217
1,616,128
19,909
83
Note 12. Subordinated Notes
At March 31, 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 $402.0 thousand at March 31, 2022, which is being amortized on a pro-rata basis over a 5-year and 10-year period, based on the call 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 13. Capital Ratios
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 for each respective capital measurement. The Bank’s capital conservation buffer at March 31, 2022 was 8.30% compared to the regulatory buffer of 2.50%. Compliance with the capital conservation buffer is required in order to avoid limitations to certain capital distributions and is in addition to the minimum required capital requirements. As of March 31, 2022, the Bank was “well capitalized.”
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.
The consolidated asset limit on small bank holding companies is $3.0 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 summarizes the regulatory capital requirements and results as of March 31, 2022 and December 31, 2021 for the Corporation and the Bank:
Regulatory Ratios
Adequately
Well
Capitalized
Minimum
Common Equity Tier 1 Risk-based Capital Ratio (1)
Franklin Financial Services Corporation
14.94%
15.20%
N/A
Farmers & Merchants Trust Company
15.05%
15.28%
4.50%
6.50%
Tier 1 Risk-based Capital Ratio (2)
6.00%
8.00%
Total Risk-based Capital Ratio (3)
18.09%
18.41%
16.30%
16.54%
10.00%
Tier 1 Leverage Ratio (4)
8.59%
8.52%
8.65%
8.57%
4.00%
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 14. 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 its consolidated statements of income. Revenue generating activities that fall within the scope of ASC 606 are described as follows:
Investment and Trust Service Fees – these represent fees from wealth management (assets under management), fees from the management 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 recognized were $1.6 million for the first quarter of 2022, compared to $1.5 million in the first quarter of 2021.
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. Fees recognized were $173 thousand for the first quarter of 2022, compared to $84 thousand in the first quarter of 2021.
Commissions from the sale of investment and insurance products are recognized upon the completion of the transaction. Commissions recognized were $31 thousand for the first quarter of 2022, compared to $37 thousand for the first quarter of 2021.
Loan Service Charges – these represent fees on loans for services or charges that occur after the loan has been booked, for example, late payment fees. These also include fees for mortgages settled for third-party mortgage companies. 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.
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.
1Note 15. Commitments and Contingencies
In the normal course of business, the Bank is a party to financial instruments that are not reflected in the accompanying financial statements and are commonly referred to as off-balance-sheet instruments. These financial instruments are entered into primarily to meet the financing needs of the Bank’s customers and include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk not recognized in the consolidated balance sheet.
The Corporation’s exposure to credit loss in the event of nonperformance by other parties to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contract or notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as they do for on-balance-sheet instruments.
The Bank had the following outstanding commitments for the periods presented:
Financial instruments whose contract amounts represent credit risk
Commercial commitments to extend credit
281,285
288,075
Consumer commitments to extend credit (secured)
90,243
82,095
Consumer commitments to extend credit (unsecured)
5,310
5,389
376,838
375,559
Standby letters of credit
26,487
23,284
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses with the exception of home equity lines and personal lines of credit and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank, is based on Management’s credit evaluation of the counterparty. Collateral for most commercial commitments varies but may include accounts receivable, inventory, property, plant, and equipment, and income-producing commercial properties. Collateral for secured consumer commitments consists of liens on residential real estate.
Standby letters of credit are instruments issued by the Bank, which guarantee the beneficiary payment by the Bank in the event of default by the Bank’s customer in the nonperformance of an obligation or service. Most standby letters of credit are extended for one-year periods. Generally, 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 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. In the second quarter of 2018, the Bank established a $2.4 million allowance against letters of credit issued in connection with a commercial borrower that declared bankruptcy. In the first quarter of 2020, the Bank reversed $250 thousand of this reserve as one letter of credit was cancelled. In the second quarter of 2021, the Bank reversed $636 thousand of this reserve as a second letter of credit was cancelled. At March 31, 2022, this reserve was $1.5 million. Except for the liability recorded for standby letters of credit, liabilities for credit loss associated with off-balance sheet commitments were not material at March 31, 2022 and December 31, 2021.
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.
The nature of the Corporation’s business generates a certain amount of litigation.
The Corporation establishes 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 the Corporation is able to do so, it also determines estimates of possible losses, whether in excess of any accrued liability or where there is no accrued liability.
These assessments are based on the analysis of currently available information and are subject to significant judgment and a variety of assumptions and uncertainties. As new information is obtained, the Corporation may change its assessments and, as a result, take or adjust the amounts of its accruals and change its 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. Its exposure and ultimate losses may be higher, possibly significantly higher, than amounts it may accrue or amounts it may estimate.
In management’s opinion, the Corporation does 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 at this time will have a material adverse effect on its financial position. The Corporation cannot now determine, however, whether or not any claim asserted against it will have a material adverse effect on its results of operations in any future reporting period, which will depend on, among other things, the amount of loss resulting from the claim and the amount of income otherwise reported for the reporting period. Thus, at March 31, 2022, the Corporation is 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.
Note 16. Reclassification
Certain prior period amounts may have been reclassified to conform to the current year presentation. Such reclassifications did not affect prior year net income or shareholders’ equity.
Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition
Management’s Discussion and Analysis of Results of Operations and Financial Condition
For the Three Months Ended March 31, 2022 and 2021
Certain statements appearing herein which are not historical in nature are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements refer to a future period or periods, reflecting management’s current views as to likely future developments, and use words such as “may,” “will,” “expect,” “believe,” “estimate,” “anticipate,” or similar terms. Because forward-looking statements involve certain risks, uncertainties and other factors over which the Corporation has no direct control, actual results could differ materially from those contemplated in such statements. These factors include (but are not limited to) the following: general economic conditions, particularly with regard to the negative impact of severe, wide-ranging and continuing disruptions caused by, and resulting from, the spread of the coronavirus COVID-19 pandemic and affects thereof, including governmental responses thereto, changes in interest rates, changes in the Corporation’s cost of funds, changes in government monetary policy, changes in government regulation and taxation of financial institutions, changes in the rate of inflation, changes in technology, the intensification of competition within the Corporation’s market area, and other similar factors. We caution readers not to place undue reliance on these forward-looking statements. They only reflect management’s analysis as of this date. The Corporation does not revise or update these forward-looking statements to reflect events or changed circumstances.
Management has identified critical accounting policies for the Corporation. These policies are particularly sensitive, requiring significant judgements, estimates and assumptions to be made by Management. There were no changes to the critical accounting policies disclosed in the 2021 Annual Report on Form 10-K in regards to application or related judgments and estimates used. Please refer to Item 7 of the Corporation’s 2021 Annual Report on Form 10-K for a more detailed disclosure of the critical accounting policies.
Summary
Franklin Financial Services Corporation reported consolidated earnings of $3.0 million ($.67 per diluted share) for the first quarter of 2022 compared to $4.8 million ($1.09 per diluted share) for the same period in 2021, and $3.7 million ($.82 per diluted share) for the fourth quarter of 2021.
A summary of operating results for the first quarter of 2022 are as follows:
Net interest income was $10.8 million, inclusive of $384 thousand of interest and fees from Paycheck Protection Program (PPP) loans, compared to $11.4 million (including $488 thousand of PPP fees and interest) in the fourth quarter of 2021 (including $883 thousand of PPP interest and fees). All deferred PPP fees have been fully recognized as of March 31, 2022. The net interest margin was 2.66% for the first quarter of 2022 compared to 2.79% for the fourth quarter of 2021 and 3.03% for the first quarter of 2021. The net interest margin continued to experience downward pressure into 2022 as the yield on earning assets fell from 3.23% for the first quarter of 2021 to 2.83% for the first quarter of 2022. Over this same period the cost of all deposits only decreased from 0.14% in 2021 to 0.12% in 2022.
Average earning assets for 2022 were $1.7 billion compared to $1.5 billion for the first quarter of 2021, an increase of 12.2%. Over the comparative period, the average balance of interest-bearing cash balances increased $79.0 million (100.1%), the average balance of the investment portfolio increased $117.6 million (28.8%), and the average balance of the loan portfolio decreased $13.3 million (1.3%). Within the loan portfolio, the average balance of PPP loans declined from $54.6 million for the first quarter of 2021 to $5.6 million for the first quarter of 2022. Total deposits averaged $1.6 billion for the first quarter of 2022, an increase of $190.9 million (13.8%) over the average balance for the same period of 2021. All deposit categories reported a year-over-year increase in average balances except for time deposits, which decreased by $1.7 million or 2.3%.
The provision for loan loss was $0 for the first quarter of 2022 compared to a reversal of $800 thousand during the same period of 2021. The negative provision expense in the first quarter of 2021 resulted from the reversal of provision expense previously recorded in 2020 due to the uncertain economic effect of the pandemic as credit quality stabilized. The allowance for loan loss ratio was 1.50% of gross loans as of March 31, 2022, compared to 1.61% one year earlier.
Noninterest income for the first quarter of 2022 was $3.9 million. Compared to the fourth quarter of 2021, this represents a decrease of $704 thousand (15.4%) from $4.6 million. Significant variances to the fourth quarter of 2021 include: loan service charges (down $140 thousand) and gains on the sale of mortgages (down $301 thousand). In comparison to the first quarter for 2021, the current quarter results represent a decrease of $343 thousand (8.1%) from $4.2 million. Significant variances to the first quarter of 2021 include: Investment and Trust Services fees (up $192 thousand), deposit fees (up $155 thousand) and gains on the sale of mortgages (down $528 thousand).
Noninterest expense for the first quarter of 2022 was $11.3 million. Compared to the fourth quarter of 2021, this represents a decrease of $715 thousand (6.0%) from $12.0 million. The most significant variance to the fourth quarter of 2021 was a decrease in salary and benefit expense of $553 thousand, primarily in incentive compensation expense and health insurance expense. In comparison to the first quarter of 2021, the current quarter results represent an increase of $1.1 million (10.8%). Significant variances to the first quarter of 2021 include: salaries and benefits (up $708 thousand, primarily in salary expense and incentive compensation expense), marketing and advertising (up $152 thousand) and data processing (up $208 thousand).
The effective tax rate was 12.1% for the first quarter of 2022, 13.4% for the fourth quarter of 2021, and 15.4% for the first quarter of 2021.
Total assets at March 31, 2022 were $1.767 billion compared to $1.774 billion at December 31, 2021. Significant balance sheet changes since December 31, 2021, include:
Short-term interest-bearing deposits in other banks decreased $9.2 million and the investment portfolio carried at fair value decreased $18.3 million due to decreases in the fair value of securities.
The net loan portfolio increased $2.2 million over the year-end 2021 balance. During the quarter, the balance of PPP loans decreased from $7.8 million at December 31, 2021 to $2.9 million at March 31, 2022. Without the PPP payoffs, net loans would have increased approximately $7.0 million. Commercial loans, net of PPP loans, were unchanged at $767.0 million while mortgage and home equity loans increased slightly.
Deposits increased $12.0 million (0.8%) over year-end 2021, with all deposit products showing an increase except time deposits, which decreased by $5.0 million or 6.7%. Money management accounts and interest-bearing checking products showed the largest increases over the prior year-end.
Shareholders’ equity decreased $19.9 million from December 31, 2021. During the quarter, shareholders’ equity increased by $1.6 million from retained earnings, but this was more than offset by a $22 million decrease in accumulated other comprehensive income (AOCI) as the fair value of the investment portfolio declined as a result of an increase in market interest rates. At March 31, 2022, the book value of the Corporation’s common stock was $30.77 per share, down from $35.36 per share at year-end 2021, reflecting the effect of the decrease in AOCI on book value. The tangible book value fell from $33.34 per share at year-end 2021 to $28.75 at quarter end. In December 2021, an open market repurchase plan was approved to repurchase 150,000 shares over a one-year period and no shares have been repurchased under this program as of March 31, 2022.
Key performance ratios as of, or for the three months ended March 31, 2022 and 2021 and the year ended December 31, 2021 are listed below:
(Dollars in thousands, except per share)
Balance Sheet Highlights
1,597,559
Investment and equity securities
422,622
Loans, net
984,797
1,421,042
Summary of Operations
47,573
2,902
44,671
(2,100)
46,771
19,488
Noninterest expense
43,245
Income before income taxes
23,014
3,398
19,616
Performance Measurements
Return on average assets*
0.69%
1.17%
1.23%
Return on average equity*
7.96%
13.20%
13.47%
Return on average tangible equity (1)*
8.47%
14.05%
14.37%
Efficiency ratio (1)
75.50%
66.12%
66.06%
Net interest margin*
2.66%
2.88%
3.03%
Shareholders' Value (per common share)
4.42
4.44
Regular cash dividends declared
0.32
1.25
0.30
Book value
30.77
35.36
31.92
Tangible book value (1)
28.75
33.34
29.87
Market value
33.58
33.10
31.18
Market value/book value ratio
109.13%
93.61%
97.68%
Market value/tangible book value ratio
116.82%
99.29%
104.37%
Price/earnings multiple*
12.53
7.49
7.15
Current quarter dividend yield*
3.81%
3.87%
3.85%
Dividend payout ratio year-to-date
47.18%
28.16%
27.29%
Safety and Soundness
Average equity/average assets
8.60%
8.89%
9.16%
Risk-based capital ratio (Total)
18.18%
Leverage ratio (Tier 1)
8.76%
Common equity ratio (Tier 1)
14.80%
Nonperforming loans/gross loans
0.74%
0.88%
Nonperforming assets/total assets
0.42%
0.55%
Allowance for loan losses as a % of loans
1.50%
1.51%
1.61%
Net loans (charged-off) recovered/average loans*
-0.01%
0.04%
0.06%
Assets under Management
Trust assets under management (fair value)
920,597
946,964
860,794
Held at third-party brokers (fair value)
111,742
118,046
118,180
*Year-to-date annualized
(1) See the section titled “GAAP versus Non-GAAP Presentation” that follows.
GAAP versus non-GAAP Presentations – The Corporation supplements its traditional GAAP measurements with certain non-GAAP measurements to evaluate its performance and to eliminate the effect of intangible assets. By eliminating intangible assets (Goodwill), the Corporation believes it presents a measurement that is comparable to companies that have no intangible assets or to companies that have eliminated intangible assets in similar calculations. However, not all companies may use the same calculation method for each measurement. The non-GAAP measurements are not intended to be used as a substitute for the related GAAP measurements. Non-GAAP financial measures should be viewed in addition to, and not as an alternative for, our reported results prepared in accordance with GAAP. In the event of such a disclosure or release, the Securities and Exchange Commission’s Regulation G requires: (i) the presentation of the most directly comparable financial measure calculated and presented in accordance with GAAP and (ii) a reconciliation of the differences between the non-GAAP financial measure presented and the most directly comparable financial measure calculated and presented in accordance with GAAP. The following table shows the calculation of the non-GAAP measurements.
Return on Tangible Equity (non-GAAP)
Average shareholders' equity
151,290
148,637
143,439
Less average intangible assets
(9,016)
Average tangible equity (non-GAAP)
142,274
139,621
134,423
Return on average tangible equity (non-GAAP)*
Tangible Book Value (per share) (non-GAAP)
Less intangible assets
Tangible book value (non-GAAP)
128,120
148,049
131,683
Shares outstanding (in thousands)
4,457
4,441
4,408
Tangible book value per share (non-GAAP)
Efficiency Ratio
Plus tax equivalent adjustment to net interest income
240
1,466
370
Plus noninterest income, net of securities transactions
3,873
19,271
4,173
Total revenue
14,921
65,408
15,387
Efficiency ratio (Noninterest expense/total revenue)
* Year-to-date annualized
The largest source of the Corporation’s earnings is net interest income, which is defined as the difference between income on interest-earning assets and the expense of interest-bearing liabilities supporting those assets. Principal categories of interest-earning assets are loans and securities, while deposits, short-term borrowings and long-term debt are the principal categories of interest-bearing liabilities. Demand deposits enhance net interest income because they are noninterest-bearing deposits. For the purpose of this discussion, balance sheet items refer to the average balance for the year and net interest income is adjusted to a fully taxable-equivalent basis. This tax-equivalent adjustment facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Corporation’s 21% Federal statutory rate.
Tax equivalent net interest income decreased $166 thousand to $11.0 million in the first quarter of 2022 compared to $11.2 million for the same period in 2021. Balance sheet volume contributed a $1.2 million increase to tax equivalent net interest income offset by changes in rates of $1.4 million.
The following table presents average balances, tax-equivalent (T/E) interest income, and yields earned or rates paid on the assets or liabilities. Loans are presented by primary loan purpose and nonaccrual loans are included in the average loan balance used to calculate the yield. All nontaxable interest income has been adjusted to a tax-equivalent basis using a tax rate of 21%.
For the Three Months Ended March 31,
Income or
balance
expense
yield/rate
Interest-earning assets:
Interest-bearing obligations in other banks
157,942
0.25%
78,930
0.27%
Investment securities:
Taxable
434,489
1,844
1.72%
315,673
1,626
2.09%
Tax Exempt
91,594
615
2.72%
92,773
668
Investments
526,083
2,459
1.90%
408,446
2,294
2.28%
Loans:
Commercial, industrial and agricultural
845,633
8,017
3.84%
858,360
8,372
3.90%
Residential mortgage
64,550
553
3.47%
67,886
603
3.58%
Home equity loans and lines
85,231
547
2.60%
81,920
6,132
100
6.61%
6,714
6.95%
1,001,546
9,217
3.73%
1,014,880
9,615
3.80%
Total interest-earning assets
1,685,571
11,774
2.83%
1,502,256
11,962
3.23%
72,830
62,905
1,758,401
1,565,161
Interest-bearing liabilities:
Deposits:
Interest-bearing checking
509,049
142
0.11%
426,410
Money Management
580,399
231
0.16%
513,083
199
Savings
123,150
106,046
72,416
73
0.41%
74,146
0.86%
Total interest-bearing deposits
1,285,014
0.15%
1,119,685
0.18%
Subordinated Notes
19,592
5.37%
19,558
Total interest-bearing liabilities
1,304,606
0.23%
1,139,243
Noninterest-bearing deposits
292,041
266,491
10,464
15,988
T/E net interest income/Net interest margin
11,048
11,214
Tax equivalent Adjustment
(240)
(370)
Net Interest Spread
2.96%
Cost of Funds
0.22%
Cost of Deposits
0.12%
0.14%
The Bank had provision for loan loss expense of $0 for the first quarter of 2022, compared to a reversal of $800 thousand in the first quarter of 2021. For more information refer to the Loan Quality and Allowance for Loan Losses discussion in the Financial Condition section.
Noninterest Income
For the first quarter of 2022, noninterest income decreased $343 thousand from the same period in 2021. Investment and trust service fees increased primarily due to an increase in asset management fees. Gains on sale of loans decreased as the volume of mortgages sold decreased. Deposit service charges increased due to increased usage of retail deposit products and overdraft protection.
The following table presents a comparison of noninterest income for the three months ended March 31, 2022 and 2021:
Change
%
192
11.7
(80)
(40.8)
(528)
(67.5)
33.1
4.0
(59)
(11.4)
(6.1)
(43)
(79.6)
17.5
(343)
(8.1)
Noninterest expense for the first quarter of 2022 increased $1.1 million compared to the same period in 2021. Salary expense increased primarily due to additional expense for incentive compensation programs and new positions. Marketing and advertising expense increased primarily from sponsorships of community events. Data processing expenses were higher due primarily to the implementation of a customer relationship management platform that began in the fourth quarter of 2021.
The following table presents a comparison of noninterest expense for the three months ended March 31, 2022 and 2021:
Salaries and benefits
708
12.5
64
7.0
152
44.1
8.4
208
22.4
51
55.4
FDIC insurance
(19)
(9.4)
16.9
(37)
(28.7)
(136)
(66.3)
2.2
1,101
For the first quarter of 2022, the Corporation recorded a Federal income tax expense of $414 thousand compared to $876 thousand for the same quarter in 2021. The effective tax rate for the first quarter of 2022 was 12.1% compared to 15.4% for the first quarter of 2021. The decrease in the effective tax rate was due primarily to lower pre-tax income driven by the reversal in the provision for loan loss expense in 2021 compared to no provision expense in 2022. The federal statutory tax rate is 21% for 2022 and 2021.
Cash and Cash Equivalents:
Cash and cash equivalents totaled $173.7 million at March 31, 2022, a decrease of $1.4 million from the prior year-end balance of $175.1 million. Interest-bearing deposits are held primarily at the Federal Reserve ($153.9 million).
Investment Securities:
AFS Securities: The AFS securities portfolio has increased $9.4 million on a cost basis since year-end 2021. The portfolio is comprised primarily of municipal securities and mortgage and asset-backed securities issued by U.S. Agencies at approximately 38% and 33% of the portfolio fair value, respectively. The average life of the portfolio was 6.0 years.
The AFS securities portfolio had a net unrealized loss of $23.6 million at March 31, 2022 compared to a net unrealized gain of $4.1 million at the prior year-end. The portfolio averaged $526.1 million with a yield of 1.90% for the first three months of 2022. This compares to an average of $408.4 million and a yield of 2.28% for the same period in 2021.
The municipal bond portfolio is well diversified geographically (203 issuers) and is comprised primarily of general obligation bonds (63%). Many municipal bonds have credit enhancements in the form of private bond insurance or other credit support. The largest geographic municipal bond exposure is in the states of Texas (14%), California (11%), Pennsylvania (11%), and Michigan (10%). The average rating of the municipal portfolio from Moody’s is AA. No municipal bonds are rated below investment grade.
Temporary impairment in the investment portfolio, measured by gross unrealized losses, was $24.6 million, compared to $4.7 million at December 31, 2021. The municipal bond portfolio had the largest unrealized loss of $10.9 million, 44% of the total unrealized loss ($24.6 million). There are 179 securities in this portfolio with an unrealized loss and the loss in this portfolio is deemed to be non-credit related and no other-than-temporary impairment charges have been recorded.
The corporate portfolio is comprised of 5 variable rate bank issued trust preferred securities with a fair value of $4.1 million and 43 fixed rate bank issued subordinated notes with a fair value of $20.6 million. This portfolio has an unrealized loss of $639 thousand on 34 securities with a fair value of $17.8 million. The trust-preferred securities held by the Bank are single entity issues, not pooled trust preferred securities. None of these issuers have suspended or missed a dividend or interest payment. At March 31, 2022, the Bank believes it will be able to collect all interest and principal due on these bonds and no other-than-temporary-impairment charges were recorded.
The unrealized loss in the non-agency mortgage and asset-backed securities portfolio increased $880 thousand from December 31, 2021. Many of these securities have credit enhancement in the form of overcollateralization. Management fully expects to be paid back at par and no other-than-temporary impairment charges have been recorded.
Restricted Stock at Cost: The Bank held $507 thousand of restricted stock at March 31, 2022. Except for $30 thousand, this investment represents stock in FHLB Pittsburgh. The Bank is required to hold this stock to be a member of FHLB and it is carried at cost of $100 per share. The level of FHLB stock held is determined by FHLB and is comprised of a minimum membership amount plus a variable activity amount. FHLB stock is evaluated for impairment primarily based on an assessment of the ultimate recoverability of its cost. As a government sponsored entity, FHLB has the ability to raise funding through the U.S. Treasury that can be used to support its operations. There is not a public market for FHLB stock and the benefits of FHLB membership (e.g., liquidity and low-cost funding) add value to the stock beyond purely financial measures. Management intends to remain a member of the FHLB and believes that it will be able to fully recover the cost basis of this investment.
See Note 4 of the accompanying financial statements for additional information on Investment Securities.
Residential real estate: This category is comprised of consumer purpose loans secured by residential real estate and to a lesser extent, commercial purpose loans secured by residential real estate. The consumer purpose category represents traditional residential mortgage loans and home equity products (primarily junior liens and lines of credit). Commercial purpose loans in this category represent loans made for various business needs but are secured with residential real estate. In addition to the real estate collateral, it is possible that additional security is provided by personal guarantees or UCC filings. These loans are underwritten as commercial loans and are not originated to be sold.
Total residential real estate loans increased by $2.0 million over year-end 2021. For the first three months of 2022, the Bank originated $25.5 million and sold $14.0 million in mortgages through third party brokerage agreements. The Bank does not originate or hold any loans that would be considered sub-prime or Alt-A and does not generally originate mortgages outside of its primary market area.
Residential real estate construction: This category contains loans for the vertical construction of 1-4 family residential properties. The largest component of this category represents loans to residential real estate developers ($13.1 million), while loans for individuals to construct personal residences totaled $8.4 million at March 31, 2022. The Bank’s exposure
to residential construction loans is concentrated primarily in south central Pennsylvania. Real estate construction loans, including residential real estate and land development loans, occasionally provide an interest reserve in order to assist the developer during the development stage when minimal cash flow is generated. All real estate construction loans are underwritten in the same manner, regardless of the use of an interest reserve.
Commercial real estate (CRE): This category includes commercial, industrial, farm and agricultural loans and land development loans, where real estate serves as the primary collateral for the loans. Total commercial real estate loans increased to $524.1 million from $522.8 million at the end of 2021. The largest sectors (by collateral) in the commercial real estate category are: hotels and motels ($80.8 million), apartment units ($74.7 million), office buildings ($48.4 million), land development ($46.6 million), and manufacturing facilities ($37.3 million). The majority of the Bank’s hotel exposure is located along the Interstate 81 (I-81) corridor through south-central Pennsylvania. The portfolio is comprised of properties operating under 18 flagged brands and 3 independent operators.
Also included in CRE are real estate construction loans totaling $95.5 million. At March 31, 2022, the Bank had $59.5 million in real estate construction loans funded with an interest reserve and capitalized $131 thousand of interest in 2022 from these reserves on active projects for commercial construction. Real estate construction loans are monitored on a regular basis by either an independent third-party inspector or the assigned loan officer depending on loan amount or complexity of the project. This monitoring process includes at a minimum, the submission of invoices and American Institute of Architects (AIA) documents (depending on the complexity of the project) detailing costs incurred by the borrower, on-site inspections, and a signature by the assigned loan officer for disbursement of funds.
Commercial: This category includes commercial, industrial, farm, agricultural, and municipal loans. Commercial loans decreased $1.5 million to $243.0 million at March 31, 2022, compared to $244.5 million at the end of 2021 primarily due to $4.9 million of PPP forgiveness. At March 31, 2022, the balance of PPP loans was $2.9 million, down from $7.8 million at year-end, which are 100% guaranteed by the SBA. At March 31, 2022, the Bank had approximately $135.0 million in tax-free loans in the commercial portfolio. The largest sectors (by industry) in the commercial category are: public administration ($51.6 million), utilities ($45.4 million), real estate rental and leasing ($20.0 million), finance and insurance ($13.2 million) and manufacturing ($13.2 million).
Participations: The Bank may supplement its own commercial loan production by purchasing loan participations. These participations are primarily located in south-central Pennsylvania. At March 31, 2022, the outstanding commercial participations accounted for 7.9%, or $78.6 million, of total gross loans compared to 7.8% and $77.5 million at December 31, 2021. The Bank’s total exposure (including outstanding balances and unfunded commitments) to purchased participations is $97.2 million, compared to $95.9 million at December 31, 2021. The commercial loan participations are comprised of $27.1 million of Commercial loans and $51.5 million of CRE loans, reported in the respective loan class.
Consumer loans: This category decreased by $385 thousand to $6.0 million at March 31, 2022, compared to $6.4 million at prior year-end and is mainly comprised primarily of unsecured personal lines of credit.
The following table presents a summary of loans outstanding, by class as of:
418
0.6
1,159
1.9
1,577
1.2
677
1.0
(303)
(6.3)
374
0.5
1,951
104
1.3
671
5.4
3.8
1,359
0.3
(1,535)
(0.6)
(176)
(0.0)
(385)
(6.0)
2,165
0.2
(0.1)
2,181
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 rated 5 are Pass credits but 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 factors represent some of the factors used in determining the risk rating of a borrower: cash flow, debt coverage, liquidity, management, and collateral. Risk ratings, for pass credits, are generally reviewed annually for term debt and at renewal for revolving or renewing debt. The Bank monitors loan quality by reviewing three primary measurements: (1) loans rated 6-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 totaled $38.5 million at March 31, 2022 compared to $36.6 million at December 31, 2021. The watch list includes both performing and nonperforming loans. Included in the watchlist total are $7.4 million of nonaccrual loans. The credit 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 a table that presents the aging of payments in the loan portfolio.
Nonaccruing loans generally represent Management’s determination that the borrower will be unable to repay the loan in accordance with its contractual terms and that collateral liquidation may or may not fully repay both interest and principal. It is the Bank’s policy to evaluate the probable collectability of principal and interest due under terms of loan contracts for all loans 90-days or more past due, nonaccrual loans, or impaired loans. Further, it is the Bank’s policy to
discontinue accruing interest on loans that are not adequately secured and in the process of collection. Upon determination of nonaccrual status, the Bank subtracts any current year accrued and unpaid interest from its income, and any prior year accrued and unpaid interest from the allowance for loan losses. Management continually monitors the status of nonperforming loans, the value of any collateral and potential of risk of loss. Nonaccrual loans are rated no better than 7-Substandard.
The Bank’s Loan Management Committee reviews these loans and risk ratings on a quarterly basis in order to proactively identify and manage problem loans. In addition, a committee meets monthly to discuss possible workout strategies for all credits rated 7-Substandard or worse. 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 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 March 31, 2022, the Bank had loans of $18.1 million (1.8% of gross loans) that exceeded the supervisory limit, compared to 1.8% at year-end 2021.
Loan quality, as measured by nonaccrual loans is unchanged during the first three months of 2022 with $7.4 million of nonaccrual loan and a nonaccrual loan to total loans ratio of .74%. Loans past due 90-days or more, but still accruing, totaled $20 thousand at March 31, 2022.
In addition to monitoring nonaccrual loans, the Bank also closely monitors impaired loans and troubled debt restructurings (TDR). A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all interest and principal payments due according to the originally contracted terms of the loan agreement. Nonaccrual loans (excluding consumer purpose loans) and TDR loans are considered impaired.
A loan is considered a TDR if the creditor (the Bank), for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. These concessions may include lowering the rate, extending the maturity, re-amortization of the payment, or a combination of multiple concessions. The Bank reviews all loans rated 6-OAEM or worse when it is providing a loan restructure, modification or new credit facility to determine if the action is a TDR. If a TDR loan is placed on nonaccrual status, it remains on nonaccrual status for at least six months to ensure performance.
In accordance with financial accounting standards, TDR loans are always considered impaired until they are paid off or in certain circumstances, refinanced. At March 31, 2022, there were 17 TDR loans with a balance of $5.4 million, including two TDR loans not performing in accordance with the modified terms for $611 thousand. Impaired loans, including TDR loans, totaled $11.4 million compared to $11.6 million at year-end 2021. There is a specific reserve of $662 thousand established on one impaired loan.
Allowance for Loan Losses:
Management monitors loan performance on a monthly basis and performs a quarterly evaluation of the adequacy of the allowance for loan losses. The ALL is determined by segmenting the loan portfolio based on the loan’s collateral. When calculating the ALL, consideration is given to a variety of factors in establishing this estimate including, but not limited to, current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, historical charge-offs, the adequacy of the underlying collateral (if collateral dependent) and other relevant factors. The Bank begins enhanced monitoring of all loans rated 6-OAEM, or worse, and obtains a new appraisal or asset valuation for any placed on nonaccrual and rated 7-Substandard or worse. Management, at its discretion, may determine that additional adjustments to the appraisal or valuation are required. Valuation adjustments will be made as necessary based on factors, including, but not limited to; the economy, deferred maintenance, industry, type of property/equipment, age of the appraisal, etc. and the knowledge Management has about a particular situation. In addition, the cost to sell or liquidate the collateral is also estimated and deducted from the valuation in order to determine the net realizable value to the Bank. When determining the allowance for loan losses, certain factors involved in the evaluation are inherently subjective and require material estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans. Management monitors the adequacy of the allowance for loan losses on an ongoing basis and reports its adequacy quarterly to the Board Enterprise Risk Management Committee of the Board of Directors. Management believes that the allowance for loan losses at March 31, 2022 is adequate.
The analysis for determining the ALL is consistent with guidance set forth in generally accepted accounting principles (GAAP) and the Interagency Policy Statement on the Allowance for Loan and Lease Losses. The analysis has three components: specific, general and unallocated. The specific component addresses specific reserves established for impaired loans. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all interest and principal payments due according to the originally contracted terms of the loan agreement. Collateral values discounted for market conditions and selling costs are used to establish specific allocations
for impaired loans. However, it is possible that as a result of the credit analysis, a specific reserve is not required for an impaired loan. Commercial loans with a balance less than $250 thousand, and all consumer purpose loans are not included in the specific reserve analysis as impaired loans but are added to the general allocation pool. Loans that are evaluated for a specific reserve, but not needing a specific reserve are not added back to the general allocation pool. There was a $662 thousand specific reserve established for one impaired loan ($5.5 million) at March 31, 2022 compared to a specific reserve of $698 thousand at year-end 2021 on the same loan.
The general allocation component addresses the reserves established for pools of homogenous loans. The general component includes a quantitative and qualitative analysis. When calculating the general allocation, the Bank segregates its loan portfolio into the following segments based primarily on the type of supporting collateral: residential real estate, commercial, industrial or agricultural real estate; commercial and industrial (C&I non-real estate), and consumer. Each segment may be further segregated by type of collateral, lien position, or owner/nonowner occupied properties. The quantitative analysis uses the Bank’s twenty quarter rolling historical loan loss experience as determined for each loan segment to determine a loss factor applicable to each loan segment. PPP loans, because of the SBA guarantee, are excluded from the quantitative analysis. The allowance established as a result of the quantitative analysis was $3.0 million compared to $2.8 million at year-end 2021.
The qualitative analysis utilizes a risk matrix that incorporates four primary risk factors: economic conditions, delinquency, classified loans, and level of risk, and assigns a risk score (as measured in basis points) to each factor. The economic condition factor is primarily based on unemployment rates. The delinquency factor considers the level of past due loans and charge-offs. The classified loan factor considers the internal credit risk score of the portfolio. The level of risk factor considers operational factors such as: loan volume, management, loan review process, credit concentrations, competition, and legal and regulatory issues. The risk score (as measured in basis points) for each of the four risk factors is minimal, low, moderate, high or very high and is determined independently for commercial loans, residential mortgage loans and consumer loans. The qualitative allowance declined to $10.7 million at March 31, 2022 from $11.0 million at year-end 2021. PPP loans, because of the SBA guarantee, were excluded from the qualitative analysis.
The unallocated component is maintained to cover uncertainties that could affect Management’s estimate of probable loss. The unallocated component of the ALL reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. The unallocated allowance was $718 thousand at March 31, 2022.
Real estate appraisals and collateral valuations are an important part of the Bank’s process for determining potential loss on collateral dependent loans and thereby have a direct effect on the determination of loan reserves, charge-offs and the calculation of the allowance for loan losses. As long as the loan remains a performing loan, no further updates to appraisals are required. If a loan or relationship migrates to nonaccrual and a risk rating of 7-Substandard or worse, an evaluation for impairment status is made based on the current information available at the time of downgrade and a new appraisal or collateral valuation is obtained. We believe this practice complies with the regulatory guidance.
In determining the allowance for loan losses, Management, at its discretion, may determine additional adjustments to the fair value obtained from an appraisal or collateral valuation are required. Adjustments will be made as necessary based on factors, including, but not limited to the economy, deferred maintenance, industry, type of property or equipment etc., and the knowledge Management has about a particular situation. In addition, the cost to sell or liquidate the collateral is also estimated and deducted from the valuation in order to determine the net realizable value to the Bank. If an appraisal is not available, Management may make its best estimate of the real value of the collateral or use last known market value and apply appropriate discounts. If an adjustment is made to the collateral valuation, this will be documented with appropriate support and reported to the Loan Management Committee.
The following table shows the allocation of the allowance for loan losses and other loan performance ratios, by class, as of March 31, 2022 and December 31, 2021:
First Liens
Loans at March 31, 2022
Average Loans at March 31, 2022
135,727
71,470
21,308
520,869
246,112
6,060
Nonaccrual Loans at March 31, 2022
Allowance for Loan Loss at March 31, 2022
Net (Charge-offs)/Recoveries at March 31, 2022
(16)
Loans/Total Gross Loans at March 31, 2022
13%
7%
2%
52%
24%
1%
100%
Nonaccrual Loans/Total Gross Loans at March 31, 2022
0.00%
0.05%
1.97%
1.31%
0.02%
0.36%
0.35%
1.54%
1.52%
2.13%
2.08%
Net (Charge-offs) Recoveries/Average Loans at March 31, 2022*
0.01%
-1.06%
Allowance for Loan Loss/Nonaccrual Loans at March 31, 2022
203.49%
Loans at December 31, 2021
Average Loans for 2021
138,249
68,467
19,533
504,441
270,557
6,855
1,008,102
Nonaccrual Loans at December 31, 2021
Allowance for Loan Losses at December 31, 2021
Net Recoveries/(Charge-offs) for 2021
170
(28)
455
377
Loans/Total Gross Loans at December 31, 2021
Nonaccrual Loans/Total Gross Loans at December 31, 2021
2.05%
1.30%
Allowance for Loan Loss/Gross Loans at December 31, 2021
1.57%
1.56%
2.10%
2.03%
Net Recoveries(Charge-offs)/Average Loans for 2021
-0.14%
0.17%
-2.39%
Allowance for Loan Loss/Nonaccrual Loans at December 31, 2021
204.04%
*Annualized
Total deposits increased $12.0 million during the first three months of 2022 to $1.596 billion. Noninterest-bearing deposits increased $5.0 million (primarily in small business deposits) and interest-bearing checking and savings deposits increased $12.1 million, while time deposits decreased $5.0 million. Interest-bearing checking decreased by $6.9 million in commercial deposits, while the Bank’s Money Management increased $10.7 million, and savings increased $8.3 million. The decrease in time deposits is primarily in retail accounts.
As of March 31, 2022, the Bank had deposits of $238.0 million placed in the IntraFi Network deposit program ($166.9 million in interest-bearing checking and $71.1 million in money management) and $4.1 million in reciprocal time deposits in the CDARS program included in time deposits. These programs allow the Bank to offer full FDIC coverage to large depositors, but with the convenience to the customer of only having to deal with one bank. The Bank solicits these deposits from within its market and it believes they present no greater risk than any other local deposit. Only reciprocal deposits that exceed 20% of liabilities are considered brokered deposits. At March 31, 2022, the Bank’s reciprocal deposits were 14.7% of total liabilities compared to 16.0% at year-end 2021.
The following table presents a summary of deposits for the periods ended:
4,979
1.7
505,104
(6,865)
(1.3)
Money management
590,477
579,826
10,651
1.8
128,172
119,908
8,264
6.9
Total interest-bearing checking and savings
12,050
Time deposits
(6.7)
12,027
0.8
Overdrawn deposit accounts reclassified as loans
103
Borrowings:
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 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 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 that will be amortized to the call date of each issue on a pro-rata basis. The proceeds are intended to be used for general corporate purposes.
Shareholders’ Equity:
Total shareholders’ equity decreased $19.9 million to $137.1 million as of March 31, 2022 from December 31, 2021, due primarily to a decrease of $21.9 million in accumulated other comprehensive income (AOCI) as the fair value of the investment portfolio declined during 2022 and was partially offset by an increase of $1.6 million in retained earnings. The Corporation’s net earnings of $3.0 million were partially offset by cash dividends of $1.4 million. The Corporation’s Dividend Reinvestment Plan (DRIP) added $61 thousand in new capital from optional cash contributions and $254 thousand from the reinvestment of quarterly dividends. The Corporation’s dividend payout ratio was 47.2% for the first three months of 2022 compared to 27.3% for the first quarter of 2021.
As part of its quarterly dividend decision, the Corporation considers current and future income projections, dividend yield, payout ratio, and current and future capital ratios. For the first quarter of 2022, the Corporation paid a $0.32 per share dividend, compared to $0.32 paid in the fourth quarter of 2021. On April 14, 2022, the Board of Directors declared a $0.32 per share regular quarterly dividend for the second quarter of 2022, which will be paid on May 25, 2022.
On December 20, 2021, the Board of Directors authorized the 2021 Repurchase Plan for the repurchase of up to 150,000 shares of the Corporation’s $1.00 par value common stock at market prices in open market or privately negotiated transactions beginning December 20, 2021 and expiring on December 19, 2022. No shares were repurchased in the first quarter of 2022. The Corporation is monitoring the market and intends to repurchase shares when and if the opportunity arises in accordance with applicable law, regulations and plan authorizations.
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 for each respective capital measurement. The Bank’s capital conservation buffer at March 31, 2022 was 8.30% compared to the regulatory buffer of 2.50%. Compliance with the capital conservation buffer is required in order to avoid
limitations to certain capital distributions and is in addition to the minimum required capital requirements. As of March 31, 2022, the Bank was “well capitalized.”
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.
Economy
The Corporation’s primary market area includes Franklin, Fulton, Cumberland and Huntingdon Counties, Pennsylvania and Washington County, Maryland. This area is diverse in demographic and economic makeup. County populations range from a low of approximately 15,000 in Fulton County to over 250,000 in Cumberland County. Unemployment in the Bank’s market area ranged from 3.4% in Cumberland County to 6.9% in Huntingdon County, as of the end of February. The market area has a diverse economic base and local industries include warehousing, truck & rail shipping centers, light and heavy manufacturers, healthcare, higher education institutions, farming and agriculture, and a varied service sector. The Corporation’s primary market area is located in South Central PA and provides easy access to the major metropolitan markets on the east coast via trucking and rail transportation. Because of this, warehousing and distribution companies continue to find the area attractive. The local economy is not overly dependent on any one industry or business and Management believes that the Bank’s primary market area continues to be well suited for growth.
Impact of Inflation
The impact of inflation upon financial institutions such as the Corporation differs from its effect upon other commercial enterprises. Unlike many companies, the assets and liabilities of the Corporation are financial in nature. As such, interest rates and changes in interest rates may have a more significant effect on the Corporation’s financial results than on other types of industries. Because of this, the Corporation watches the actions of the Federal Reserve Open Market Committee (FOMC) as it makes decisions about interest rate changes and how such changes affect market rates and the Corporation. Although inflation (and inflation expectations) may affect the interest rate environment, it is not
possible to measure with any precision the effect of inflation on the Corporation.
Liquidity
The Corporation must meet the financial needs of the customers that it serves, while providing a satisfactory return on the shareholders’ investment. In order to accomplish this, the Corporation must maintain sufficient liquidity in order to respond quickly to the changing level of funds required for both loan and deposit activity. The goal of liquidity management is to meet the ongoing cash flow requirements of depositors who want to withdraw funds and of borrowers who request loan disbursements. The Bank regularly reviews its liquidity position by measuring its projected net cash flows (in and out) at a 30 and 90-day interval. The Bank stresses the measurements by assuming a level of deposit out-flows that have not historically been realized. In addition to this forecast, other funding sources are reviewed as a method to provide emergency funding if necessary. The objective of this measurement is to identify the amount of cash that could be raised quickly without the need to liquidate assets. The Bank also stresses its liquidity position utilizing different longer-term scenarios. The varying degrees of stress create pressure on deposit flows in its local market, reduce access to wholesale funding and limit access of funds available through brokered deposit channels. In addition to stressing cash flow, specific liquidity risk indicators are monitored to help identify risk areas. This analysis helps identify and quantify the potential cash surplus/deficit over a variety of time horizons to ensure the Bank has adequate funding resources. Assumptions used for liquidity stress testing are subjective. Should an evolving liquidity situation or business cycle present new data, potential assumption changes will be considered. The Bank believes it can meet all anticipated liquidity demands.
Historically, the Corporation has satisfied its liquidity needs from earnings, repayment of loans and amortizing investment securities, maturing investment securities, loan` sales, deposit growth and its ability to access existing lines of credit. All investment securities are classified as available for sale; therefore, securities that are unencumbered (approximately $356 million fair value) as collateral for borrowings are an additional source of readily available liquidity, either by selling the security or, more preferably, to provide collateral for additional borrowing. The Bank also has access to other wholesale funding via the brokered CD market.
The FHLB system has always been a major funding source for the Bank. There are no current indicators that lead the Bank to believe the FHLB would discontinue its lending function or restrict the Bank’s ability to borrow. If either of these events would occur, it would have a negative effect on the Bank, and it is unlikely that the Bank could replace the level of FHLB funding in a short time. The Bank has established credit at the Federal Reserve Discount Window and at correspondent banks.
The following table shows the Bank’s available liquidity at March 31, 2022.
Liquidity Source
Capacity
Available
Federal Home Loan Bank
360,951
Federal Reserve Bank Discount Window
34,898
Correspondent Banks
56,000
451,849
Off Balance Sheet Commitments
The Corporation’s financial statements do not reflect various commitments that are made in the normal course of business, which may involve some liquidity risk. These commitments consist mainly of unfunded loans and letters of credit made under the same standards as on-balance sheet instruments. Because these instruments have fixed maturity dates, and because many of them will expire without being drawn upon, they do not generally present any significant liquidity risk to the Corporation. Unused commitments and standby letters of credit totaled $403.3 million and $398.8 million, respectively, at March 31, 2022 and December 31, 2021. In the second quarter of 2018, the Bank established a $2.4 million allowance against letters of credit issued in connection with a commercial borrower that declared bankruptcy. In the first quarter of 2020, the Bank reversed $250 thousand of this reserve as one letter of credit was cancelled. In the second quarter of 2021, the Bank reversed $636 thousand of this reserve as a second letter of credit was cancelled. At March 31, 2022, this reserve was $1.5 million.
The Corporation has entered into various contractual obligations to make future payments. These obligations include time deposits, long-term debt, operating leases, deferred compensation and pension payments. These amounts have not changed materially from those reported in the Corporation’s 2021 Annual Report on Form 10-K.
There were no material changes in the Corporation’s exposure to market risk during the three months ended March 31, 2022. For more information on market risk refer to the Corporation’s 2021 Annual Report on Form 10-K.
Item 4. 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 March 31, 2022, the Corporation’s disclosure controls and procedures are effective. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in the Corporation’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. There were no changes in the Corporation’s internal control over financial reporting during the quarterly period ended March 31, 2022, that have materially affected, or are reasonably likely to materially affect, the internal control over financial reporting.
The management of the Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. The Corporation’s internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Part II – OTHER INFORMATION
Item 1. Legal Proceedings
The nature of the Corporation’s business generates a certain amount of litigation in the ordinary course of business.
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 to the Corporation’s financial condition or results of operations. No material proceedings are pending or are known to be threatened or contemplated against us by any governmental authorities.
Item 1A. Risk Factors
There were no material changes in the Corporation’s risk factors during the three months ended March 31, 2022. For more information, refer to the Corporation’s 2021 Annual Report on Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On December 20, 2021, the Board of Directors authorized the 2021 Repurchase Plan for the repurchase of up to 150,000 shares of the Corporation’s $1.00 par value common stock at market prices in open market or privately negotiated transactions beginning December 20, 2021 and expiring on December 19, 2022. There were no purchases made under the plan during the first quarter of 2022.
Item 3. Defaults by the Company on its Senior Securities
None
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
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 on Form 8-K, as Exhibit 99 with the commission on July 9, 2021 and incorporated herein by reference.)
31.1
Rule 13a – 14(a)/15d-14(a) Certifications – Principal Executive Officer
31.2
Rule 13a – 14(a)/15d-14(a) Certifications – Principal Financial Officer
32.1
Section 1350 Certifications – Principal Executive Officer
32.2
Section 1350 Certifications – Principal Financial Officer
101
Interactive Data File (XBRL)
Cover Page Interactive Data File (the cover page XBRL tags are imbedded in the XBRL document)
and SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
May 13, 2022
/s/ Timothy G. Henry
Timothy G. Henry
Chief Executive Officer and President
(Principal Executive Officer)
/s/ Mark R. Hollar
Mark R. Hollar
Treasurer and Chief Financial Officer
(Principal Financial and Accounting Officer)