Penns Woods Bancorp - 10-Q quarterly report FY

Penns Woods Bancorp - 10-Q quarterly report FY

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Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q



☑	Quarterly Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

for the Quarterly Period Ended June 30, 2019.



☐	Transition report pursuant to Section 13 or 15 (d) of the Exchange Act

For the Transition Period from to .

No. 0-17077

(Commission File Number)

PENNS WOODS BANCORP INC.

(Exact name of Registrant as specified in its charter)



Pennsylvania	300 Market Street, P.O. Box 967	23-2226454
(State or other jurisdiction of	Williamsport	(I.R.S. Employer Identification No.)
incorporation or organization)	Pennsylvania	17703-0967
	(Address of principal executive offices)	(Zip Code)

(570) 322-1111

Registrant’s telephone number, including area code

Securities registered pursuant to Section 12(b) of the Exchange Act:



Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common stock, $8.33 par value	PWOD	The Nasdaq Global Select 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 ☒ 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 ☒ 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 definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):



Large accelerated filer	☐	Accelerated filer	☒
Non-accelerated filer	☐	Smaller reporting company	☒
		Emerging growth company	☐

If an emerging growth company, indicate by check mark if registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

On August 1, 2019 there were 4,692,924 shares of the Registrant’s common stock outstanding.

Table of Contents

PENNS WOODS BANCORP, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q



		Page
		Number

Part I	Financial Information

Item 1.	Financial Statements	3

Consolidated Balance Sheet (Unaudited) as of June 30, 2019 and December 31, 2018		3

Consolidated Statement of Income (Unaudited) for the Three and Six Months Ended June 30, 2019 and 2018		4

Consolidated Statement of Comprehensive Income (Unaudited) for the Three and Six Months Ended June 30, 2019 and 2018		5

Consolidated Statement of Changes in Shareholders’ Equity (Unaudited) for the Three and Six Months Ended June 30, 2019 and 2018		6

Consolidated Statement of Cash Flows (Unaudited) for the Six Months Ended June 30, 2019 and 2018		8

Notes to Consolidated Financial Statements (Unaudited)		9

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	31

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	46

Item 4.	Controls and Procedures	46

Part II	Other Information

Item 1.	Legal Proceedings	47

Item 1A.	Risk Factors	47

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47

Item 3.	Defaults Upon Senior Securities	47

Item 4.	Mine Safety Disclosures	47

Item 5.	Other Information	47

Item 6.	Exhibits	48

Signatures		49

Exhibit Index and Exhibits		50

Table of Contents

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

PENNS WOODS BANCORP, INC.

CONSOLIDATED BALANCE SHEET

(UNAUDITED)



	June 30,			December 31,
(In Thousands, Except Share Data)	2019			2018
ASSETS:
Noninterest-bearing balances	$	21,102		$	24,325
Interest-bearing balances in other financial institutions	58,423			42,417
Total cash and cash equivalents	79,525			66,742

Investment debt securities, available for sale, at fair value	145,689			134,285
Investment equity securities, at fair value	1,841			1,776
Investment securities, trading	44			36
Restricted investment in bank stock, at fair value	15,087			18,862
Loans held for sale	2,880			2,929
Loans	1,379,285			1,384,757
Allowance for loan losses	(14,001		)	(13,837		)
Loans, net	1,365,284			1,370,920
Premises and equipment, net	33,483			27,580
Accrued interest receivable	5,708			5,334
Bank-owned life insurance	28,955			28,627
Goodwill	17,104			17,104
Intangibles	1,022			1,162
Operating lease right-of-use asset	4,279			—
Deferred tax asset	3,712			5,154
Other assets	6,887			4,260
TOTAL ASSETS	$	1,711,500		$	1,684,771

LIABILITIES:
Interest-bearing deposits	$	1,004,331		$	899,089
Noninterest-bearing deposits	322,755			320,814
Total deposits	1,327,086			1,219,903

Short-term borrowings	59,453			167,865
Long-term borrowings	154,597			138,942
Accrued interest payable	1,482			1,150
Operating lease liability	4,286			—
Other liabilities	13,055			13,367
TOTAL LIABILITIES	1,559,959			1,541,227

SHAREHOLDERS’ EQUITY:
Preferred stock, no par value, 3,000,000 shares authorized; no shares issued	—			—
Common stock, par value $8.33, 15,000,000 shares authorized; 5,012,898 and 5,011,698 shares issued; 4,692,748 and 4,691,548 outstanding	41,773			41,763
Additional paid-in capital	51,087			50,737
Retained earnings	73,565			69,787
Accumulated other comprehensive gain (loss):
Net unrealized gain (loss) on available for sale securities	2,419			(1,360		)
Defined benefit plan	(5,202		)	(5,276		)
Treasury stock at cost, 320,150	(12,115		)	(12,115		)
TOTAL PENNS WOODS BANCORP, INC. SHAREHOLDERS' EQUITY	151,527			143,536
Non-controlling interest	14			8
TOTAL SHAREHOLDERS' EQUITY	151,541			143,544
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	1,711,500		$	1,684,771

See accompanying notes to the unaudited consolidated financial statements.

Table of Contents

PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF INCOME

(UNAUDITED)



	Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands, Except Per Share Data)	2019			2018			2019		2018
INTEREST AND DIVIDEND INCOME:
Loans, including fees	$	15,300		$	12,997		$	30,169	$	25,190
Investment securities:
Taxable	967			639			1,901		1,185
Tax-exempt	179			230			353		471
Dividend and other interest income	395			245			852		466
TOTAL INTEREST AND DIVIDEND INCOME	16,841			14,111			33,275		27,312
INTEREST EXPENSE:
Deposits	2,871			1,490			5,171		2,712
Short-term borrowings	178			252			783		476
Long-term borrowings	879			666			1,730		1,268
TOTAL INTEREST EXPENSE	3,928			2,408			7,684		4,456
NET INTEREST INCOME	12,913			11,703			25,591		22,856
PROVISION FOR LOAN LOSSES	315			335			675		495
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES	12,598			11,368			24,916		22,361
NON-INTEREST INCOME:
Service charges	592			592			1,154		1,143
Net debt securities (losses) gains, available for sale	(2		)	14			11		5
Net equity securities gains (losses)	22			6			65		(28		)
Net securities gains (losses), trading	3			(5		)	13		(2		)
Bank-owned life insurance	123			158			291		331
Gain on sale of loans	347			400			663		655
Insurance commissions	119			64			253		181
Brokerage commissions	356			330			679		673
Debit card fees	389			373			699		706
Other	520			430			895		779
TOTAL NON-INTEREST INCOME	2,469			2,362			4,723		4,443
NON-INTEREST EXPENSE:
Salaries and employee benefits	5,523			4,919			11,024		9,967
Occupancy	668			699			1,447		1,440
Furniture and equipment	784			801			1,536		1,548
Software amortization	188			231			395		296
Pennsylvania shares tax	285			278			578		555
Professional fees	727			649			1,249		1,215
Federal Deposit Insurance Corporation deposit insurance	236			200			504		402
Marketing	33			268			135		519
Intangible amortization	69			78			140		158
Other	1,546			1,394			2,865		2,694
TOTAL NON-INTEREST EXPENSE	10,059			9,517			19,873		18,794
INCOME BEFORE INCOME TAX PROVISION	5,008			4,213			9,766		8,010
INCOME TAX PROVISION	759			733			1,571		1,322
CONSOLIDATED NET INCOME	$	4,249		$	3,480		$	8,195	$	6,688
Less: Net loss attributable to noncontrolling interest	4			—			6		(1		)
NET INCOME ATTRIBUTABLE TO PENNS WOODS BANCORP, INC.	$	4,245		$	3,480		$	8,189	$	6,689
EARNINGS PER SHARE - BASIC	$	0.91		$	0.74		$	1.75	$	1.43
EARNINGS PER SHARE - DILUTED	$	0.91		$	0.74		$	1.75	$	1.43
WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC	4,692,335			4,689,932			4,692,045		4,689,656
WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED	4,692,335			4,703,339			4,692,045		4,689,656
DIVIDENDS DECLARED PER SHARE	$	0.47		$	0.47		$	0.94	$	0.94

See accompanying notes to the unaudited consolidated financial statements.

Table of Contents

PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED)



	Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands)	2019			2018			2019			2018
Net Income	$	4,245		$	3,480		$	8,189		$	6,689
Other comprehensive income (loss) income:
Change in unrealized gain (loss) on available for sale securities	2,811			(391		)	4,795			(1,852		)
Tax effect	(590		)	84			(1,007		)	390
Net realized (gain) loss on available for sale securities included in net income	2			(14		)	(11		)	(5		)
Tax effect	(1		)	4			2			1
Amortization of unrecognized pension gain	47			42			94			84
Tax effect	(10		)	(9		)	(20		)	(17		)
Total other comprehensive gain (loss) income	2,259			(284		)	3,853			(1,399		)
Comprehensive income	$	6,504		$	3,196		$	12,042		$	5,290

See accompanying notes to the unaudited consolidated financial statements.

Table of Contents

PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(UNAUDITED)

Three months ended:



	COMMON STOCK			ADDITIONAL PAID-IN CAPITAL		RETAINED EARNINGS			ACCUMULATED OTHER COMPREHENSIVE LOSS			TREASURY STOCK			NON-CONTROLLING INTEREST		TOTAL SHAREHOLDERS’ EQUITY
(In Thousands, Except Per Share Data)	SHARES	AMOUNT		ADDITIONAL PAID-IN CAPITAL		RETAINED EARNINGS			ACCUMULATED OTHER COMPREHENSIVE LOSS			TREASURY STOCK			NON-CONTROLLING INTEREST		TOTAL SHAREHOLDERS’ EQUITY
Balance, March 31, 2019	5,012,273	$	41,767	$	50,890	$	71,526		$	(5,042	)	$	(12,115	)	$	10	$	147,036
Net income						4,245									4		4,249
Other comprehensive income									2,259								2,259
Stock-based compensation				177													177
Dividends declared ($0.47 per share)						(2,206		)									(2,206		)
Common shares issued for employee stock purchase plan	625	6		20													26
Balance, June 30, 2019	5,012,898	$	41,773	$	51,087	$	73,565		$	(2,783	)	$	(12,115	)	$	14	$	151,541



	COMMON STOCK			ADDITIONAL PAID-IN CAPITAL		RETAINED EARNINGS			ACCUMULATED OTHER COMPREHENSIVE LOSS			TREASURY STOCK			NON-CONTROLLING INTEREST		TOTAL SHAREHOLDERS’ EQUITY
(In Thousands, Except Per Share Data)	SHARES	AMOUNT		ADDITIONAL PAID-IN CAPITAL		RETAINED EARNINGS			ACCUMULATED OTHER COMPREHENSIVE LOSS			TREASURY STOCK			NON-CONTROLLING INTEREST		TOTAL SHAREHOLDERS’ EQUITY
Balance, March 31, 2018	5,009,898	$	41,748	$	50,199	$	64,906		$	(6,626	)	$	(12,115	)	$	1	$	138,113
Net income						3,480									—		3,480
Other comprehensive loss									(284		)						(284		)
Stock-based compensation				5													5
Dividends declared ($0.47 per share)						(2,205		)									(2,205		)
Common shares issued for employee stock purchase plan	637	5		21													26
Balance, June 30, 2018	5,010,535	$	41,753	$	50,225	$	66,181		$	(6,910	)	$	(12,115	)	$	1	$	139,135

See accompanying notes to the unaudited consolidated financial statements.

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Six months ended:



	COMMON STOCK			ADDITIONAL PAID-IN CAPITAL		RETAINED EARNINGS			ACCUMULATED OTHER COMPREHENSIVE LOSS			TREASURY STOCK			NON-CONTROLLING INTEREST		TOTAL SHAREHOLDERS’ EQUITY
(In Thousands, Except Per Share Data)	SHARES	AMOUNT		ADDITIONAL PAID-IN CAPITAL		RETAINED EARNINGS			ACCUMULATED OTHER COMPREHENSIVE LOSS			TREASURY STOCK			NON-CONTROLLING INTEREST		TOTAL SHAREHOLDERS’ EQUITY
Balance, December 31, 2018	5,011,698	$	41,763	$	50,737	$	69,787		$	(6,636	)	$	(12,115	)	$	8	$	143,544
Net income						8,189									6		8,195
Other comprehensive income									3,853								3,853
Stock-based compensation				313													313
Dividends declared ($0.94 per share)						(4,411		)									(4,411		)
Common shares issued for employee stock purchase plan	1,200	10		37													47
Balance, June 30, 2019	5,012,898	$	41,773	$	51,087	$	73,565		$	(2,783	)	$	(12,115	)	$	14	$	151,541



	COMMON STOCK			ADDITIONAL PAID-IN CAPITAL		RETAINED EARNINGS			ACCUMULATED OTHER COMPREHENSIVE LOSS			TREASURY STOCK			NON-CONTROLLING INTEREST			TOTAL SHAREHOLDERS’ EQUITY
(In Thousands, Except Per Share Data)	SHARES	AMOUNT		ADDITIONAL PAID-IN CAPITAL		RETAINED EARNINGS			ACCUMULATED OTHER COMPREHENSIVE LOSS			TREASURY STOCK			NON-CONTROLLING INTEREST			TOTAL SHAREHOLDERS’ EQUITY
Balance, December 31, 2017	5,009,339	$	41,744	$	50,173	$	63,364		$	(4,974	)	$	(12,115	)	$	2		$	138,194
Net income						6,689									(1		)	6,688
Adoption of ASU 2016-01						537			(537		)							—
Other comprehensive (loss)									(1,399		)							(1,399		)
Stock-based compensation				12														12
Dividends declared ($0.94 per share)						(4,409		)										(4,409		)
Common shares issued for employee stock purchase plan	1,196	9		40														49
Balance, June 30, 2018	5,010,535	$	41,753	$	50,225	$	66,181		$	(6,910	)	$	(12,115	)	$	1		$	139,135

See accompanying notes to the unaudited consolidated financial statements.

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PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)



	Six Months Ended June 30,
(In Thousands)	2019			2018
OPERATING ACTIVITIES:
Net Income	$	8,195		$	6,688
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	1,376			1,244
Amortization of intangible assets	140			158
Provision for loan losses	675			495
Accretion and amortization of investment security discounts and premiums	326			395
Net securities (gains) losses, available for sale	(11		)	(5		)
Originations of loans held for sale	(21,400		)	(23,436		)
Proceeds of loans held for sale	22,112			23,169
Gain on sale of loans	(663		)	(655		)
Net equity securities (gains) losses	(65		)	28
Net securities gains, trading	(13		)	2
Proceeds from the sale of trading securities	78			254
Purchases of trading securities	(73		)	(309		)
Earnings on bank-owned life insurance	(291		)	(331		)
Decrease (increase) in deferred tax asset	437			(163		)
Other, net	(2,441		)	(93		)
Net cash provided by operating activities	8,382			7,441
INVESTING ACTIVITIES:
Proceeds from sales of available for sale securities	8,132			4,483
Proceeds from calls and maturities of available for sale securities	1,951			3,961
Purchases of available for sale securities	(17,018		)	(21,160		)
Net decrease (increase) in loans	4,680			(85,338		)
Acquisition of premises and equipment	(1,324		)	(948		)
Proceeds from the sale of foreclosed assets	195			181
Purchase of bank-owned life insurance	(26		)	(31		)
Security trades payable	—			(3,669		)
Proceeds from redemption of regulatory stock	10,515			8,744
Purchases of regulatory stock	(6,740		)	(12,128		)
Net cash provided (used) for investing activities	365			(105,905		)
FINANCING ACTIVITIES:
Net increase in interest-bearing deposits	105,242			36,821
Net increase in noninterest-bearing deposits	1,941			7,878
Proceeds from long-term borrowings	25,000			55,000
Repayment of long-term borrowings	(15,317		)	(2,000		)
Net decrease in short-term borrowings	(108,412		)	33,889
Finance lease principal payments	(54		)	—
Dividends paid	(4,411		)	(4,409		)
Issuance of common stock	47			49
Net cash provided by financing activities	4,036			127,228
NET INCREASE IN CASH AND CASH EQUIVALENTS	12,783			28,764
CASH AND CASH EQUIVALENTS, BEGINNING	66,742			27,243
CASH AND CASH EQUIVALENTS, ENDING	$	79,525		$	56,007



SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid	$	7,352	$	4,062
Income taxes paid	—		1,500
Non-cash investing and financing activities:
Right-of-use lease assets obtained in exchange for lessee finance lease liabilities	6,026		—
Right-of-use lease assets obtained in exchange for lessee operating lease liabilities	4,298		—
Transfer of loans to foreclosed real estate	281		560
Transfer due to adoption of ASU 2016-01, equity securities fair value adjust, reclassification from AOCI to Retained Earnings, net of tax	—		537

See accompanying notes to the unaudited consolidated financial statements.

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PENNS WOODS BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Basis of Presentation

The consolidated financial statements include the accounts of Penns Woods Bancorp, Inc. (the “Company”) and its wholly-owned subsidiaries: Woods Investment Company, Inc., Woods Real Estate Development Company, Inc., Luzerne Bank, and Jersey Shore State Bank (Jersey Shore State Bank and Luzerne Bank are referred to together as the “Banks”) and Jersey Shore State Bank’s wholly-owned subsidiary, The M Group, Inc. D/B/A The Comprehensive Financial Group (“The M Group”). The Company also owns a controlling interest in United Insurance Solutions, LLC. All significant inter-company balances and transactions have been eliminated in the consolidation.

The interim financial statements are unaudited, but in the opinion of management reflect all adjustments necessary for the fair presentation of results for such periods. The results of operations for any interim period are not necessarily indicative of results for the full year. These financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.

Newly Adopted Accounting Standards

In February 2016, the FASB issued the Leasing Standard, which is codified in ASC 842, Leases, and is intended to increase transparency and comparability among organizations and require lessees to record a right-of-use (ROU) asset and a liability representing the obligation to make lease payments for long-term leases. Accounting by lessors remains largely unchanged. The Company adopted the standard on January 1, 2019, using the modified retrospective transition under the option to apply the Leasing Standard at its effective date without adjusting the prior period comparative financial statements. Among other things, these updates require lessees to recognize a lease liability, measured on a discounted basis, related to the lessee's obligation to make lease payments arising under a lease contract; and a right-of-use asset related to the lessee’s right to use, or control the use of, a specified asset for the lease term. On January 1, 2019, the Company recorded operating lease liabilities and ROU asset of $4.3 million and finance lease liabilities and ROU asset of $6.0 million upon adoption of the Standard. The balance sheet effects of the new lease accounting standard also impacted regulatory capital ratios, performance ratios and other measures which are dependent upon asset or liability balances. For additional information and required disclosures related to ASC 842, see Note 13, “Leases.”

The accounting policies followed in the presentation of interim financial results are the same as those followed on an annual basis. These policies are presented on pages 41 through 50 of the Form 10-K for the year ended December 31, 2018.

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

Note 2. Accumulated Other Comprehensive Gain (loss)

The changes in accumulated other comprehensive gain (loss) by component shown net of tax and parenthesis indicating debits, as of June 30, 2019 and 2018 were as follows:



	Three Months Ended June 30, 2019								Three Months Ended June 30, 2018
(In Thousands)	Net Unrealized Gain on Available for Sale Securities		Defined Benefit Plan			Total			Net Unrealized Loss on Available for Sale Securities			Defined Benefit Plan			Total
Beginning balance	$	197	$	(5,239	)	$	(5,042	)	$	(1,740	)	$	(4,886	)	$	(6,626	)
Other comprehensive gain (loss) before reclassifications	2,221		—			2,221			(307		)	—			(307		)
Amounts reclassified from accumulated other comprehensive gain (loss)	1		37			38			(10		)	33			23
Net current-period other comprehensive income (loss)	2,222		37			2,259			(317		)	33			(284		)
Ending balance	$	2,419	$	(5,202	)	$	(2,783	)	$	(2,057	)	$	(4,853	)	$	(6,910	)

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	Six Months Ended June 30, 2019									Six Months Ended June 30, 2018
(In Thousands)	Net Unrealized Loss on Available for Sale Securities			Defined Benefit Plan			Total			Net Unrealized Gain (Loss) on Available for Sale Securities			Defined Benefit Plan			Total
Beginning balance	$	(1,360	)	$	(5,276	)	$	(6,636	)	$	(54	)	$	(4,920	)	$	(4,974	)
Other comprehensive (loss) gain before reclassifications	3,788			—			3,788			(1,462		)	—			(1,462		)
Amounts reclassified from accumulated other comprehensive gain (loss)	(9		)	74			65			(4		)	67			63
Net current-period other comprehensive (loss) income	3,779			74			3,853			(1,466		)	67			(1,399		)
Reclassification from adoption of 2016-01	—			—			—			(537		)	—			(537		)
Ending balance	$	2,419		$	(5,202	)	$	(2,783	)	$	(2,057	)	$	(4,853	)	$	(6,910	)

The reclassifications out of accumulated other comprehensive loss shown, net of tax and parenthesis indicating debits to net income, as of June 30, 2019 and 2018 were as follows:



Details about Accumulated Other Comprehensive Loss Components	Amount Reclassified from Accumulated Other Comprehensive Loss						Affected Line Item in the Consolidated Statement of Income
	Three Months Ended June 30, 2019			Three Months Ended June 30, 2018			Affected Line Item in the Consolidated Statement of Income
Net unrealized (loss) gain on available for sale securities	$	(2	)	$	14		Net debt securities gains (losses), available for sale
Income tax effect	1			(4		)	Income tax provision
Total reclassifications for the period	$	(1	)	$	10

Net unrecognized pension costs	$	(47	)	$	(42	)	Salaries and employee benefits
Income tax effect	10			9			Income tax provision
Total reclassifications for the period	$	(37	)	$	(33	)



Details about Accumulated Other Comprehensive Loss Components	Amount Reclassified from Accumulated Other Comprehensive Loss						Affected Line Item in the Consolidated Statement of Income
	Six months ended June 30, 2019			Six months ended June 30, 2018			Affected Line Item in the Consolidated Statement of Income
Net unrealized gain on available for sale securities	$	11		$	5		Net securities gains, available for sale
Income tax effect	(2		)	(1		)	Income tax provision
Total reclassifications for the period	$	9		$	4

Net unrecognized pension costs	$	(94	)	$	(84	)	Salaries and employee benefits
Income tax effect	20			17			Income tax provision
Total reclassifications for the period	$	(74	)	$	(67	)

Note 3. Recent Accounting Pronouncements

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments, which changes the impairment model for most financial assets. This Update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The underlying premise of the Update is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset. The income statement will be effected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted for annual and interim periods beginning after December 15, 2018. With certain exceptions, transition to the new requirements will be through a cumulative effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is adopted. We expect to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements.

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In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. To simplify the subsequent measurement of goodwill, the FASB eliminated Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, under the amendments in this Update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting units fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. A public business entity that is a U.S. Securities and Exchange Commission (SEC) filer should adopt the amendments in this Update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. A public business entity that is not an SEC filer should adopt the amendments in this Update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2020. All other entities, including not-for-profit entities, that are adopting the amendments in this Update should do so for their annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2021. This Update is not expected to have a significant impact on the Company’s financial statements.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes the Disclosure Requirements for Fair Value Measurements. The Update removes the requirement to disclose the amount of and reasons for transfers between Level I and Level II of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level III fair value measurements. The Update requires disclosure of changes in unrealized gains and losses for the period included in other comprehensive income (loss) for recurring Level III fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level III fair value measurements. This Update is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. This Update is not expected to have a significant impact on the Company’s financial statements.

In August 2018, the FASB issued ASU 2018-14, Compensation - Retirement Benefits (Topic 715-20). This Update amends ASC 715 to add, remove and clarify disclosure requirements related to defined benefit pension and other postretirement plans. The Update eliminates the requirement to disclose the amounts in accumulated other comprehensive income expected to be recognized as part of net periodic benefit cost over the next year. The Update also removes the disclosure requirements for the effects of a one-percentage-point change on the assumed health care costs and the effect of this change in rates on service cost, interest cost and the benefit obligation for postretirement health care benefits. This Update is effective for public business entities for fiscal years ending after December 15, 2020, and must be applied on a retrospective basis. For all other entities, this Update is effective for fiscal years ending after December 15, 2021. This Update is not expected to have a significant impact on the Company’s financial statements.

In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40). This Update addresses customers’ accounting for implementation costs incurred in a cloud computing arrangement that is a service contract and also adds certain disclosure requirements related to implementation costs incurred for internal-use software and cloud computing arrangements. The amendment aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). This Update is effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. The amendments in this Update can be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. This Update is not expected to have a significant impact on the Company’s financial statements.

In October 2018, the FASB issued ASU 2018-16, Derivatives and Hedging (Topic 815). The amendments in this Update permit use of the Overnight Index Swap (OIS) rate based on the Secured Overnight Financing Rate (SOFR) as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815, in addition to the interest rates on direct Treasury obligations of the U.S. government, the London Interbank Offered Rate (LIBOR) swap rate, the OIS rate based on the Fed Funds Effective Rate, and the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate. For entities that have not already adopted Update 2017-12, the amendments in this Update are required to be adopted concurrently with the amendments in Update 2017-12. For public business entities that already have adopted the amendments in Update 2017-12, the amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. For all other entities that already have adopted the amendments in Update 2017-12, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted in any interim period upon issuance of this Update if an entity already has adopted Update 2017-12. This Update is not expected to have a significant impact on the Company’s financial statements.

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In November 2018, the FASB issued ASU 018-18, Collaborative Arrangements (Topic 808), which made the following targeted improvements to generally accepted accounting principles (GAAP) for collaborative arrangements (1) clarified that certain transactions between collaborative arrangement participants should be accounted for as revenue under Topic 606 when the collaborative arrangement participant is a customer in the context of a unit of account, (2) add unit-of-account guidance in Topic 808 to align with the guidance in Topic 606 (that is, a distinct good or service) when an entity is assessing whether the collaborative arrangement or a part of the arrangement is within the scope of Topic 606, and (3) require that in a transaction with a collaborative arrangement participant that is not directly related to sales to third parties, presenting the transaction together with revenue recognized under Topic 606 is precluded if the collaborative arrangement participant is not a customer. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. This Update is not expected to have a significant impact on the Company’s financial statements.

In March 2019, the FASB issued ASU 2019-01, Leases (Topic 842): Codification Improvements, which addressed issues lessors sometimes encounter. Specifically addressed in this Update were issues related to (1) determining the fair value of the underlying asset by the lessor that are not manufacturers or dealers (generally financial institutions and captive finance companies), and 2) lessors that are depository and lending institutions should classify principal and payments received under sales-type and direct financing leases within investing activities in the cash flow statement. The ASU also exempts both lessees and lessors from having to provide the interim disclosures required by ASC 250-10-50-3 in the fiscal year in which a company adopts the new leases standard. The amendments addressing the two lessor accounting issues are effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. For all other entities, the effective date is for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. This Update is not expected to have a significant impact on the Company’s financial statements.

In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, which affects a variety of topics in the Codification and applies to all reporting entities within the scope of the affected accounting guidance. Topic 326, Financial Instruments - Credit Losses amendments are effective for SEC registrants for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. For all other public business entities, the effective date is for fiscal years beginning after December 15, 2020, and for all other entities, the effective date is for fiscal years beginning after December 15, 2021. Topic 815, Derivatives and Hedging amendments are effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods beginning after December 15, 2020. For entities that have adopted the amendments in Update 2017- 12, the effective date is as of the beginning of the first annual period beginning after the issuance of this Update. Topic 825, Financial Instruments amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years. This Update is not expected to have a significant impact on the Company’s financial statements.

In May 2019, the FASB issued ASU 2019-05, Financial Instruments - Credit Losses, Topic 326, which allows entities to irrevocably elect the fair value option for certain financial assets previously measured at amortized cost upon adoption of the new credit losses standard. To be eligible for the transition election, the existing financial asset must otherwise be both within the scope of the new credit losses standard and eligible for the applying the fair value option in ASC 825-10.3. The election must be applied on an instrument-by-instrument basis and is not available for either available-for-sale or held-to-maturity debt securities. For entities that elect the fair value option, the difference between the carrying amount and the fair value of the financial asset would be recognized through a cumulative-effect adjustment to opening retained earnings as of the date an entity adopted ASU 2016-13. Changes in fair value of that financial asset would subsequently be reported in current earnings. For entities that have not yet adopted ASU 2016-13, the effective dates and transition requirements are the same as those in ASU 2016-13. For entities that have adopted ASU 2016-13, ASU 2019-05 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted once ASU 2016-13 has been adopted. This Update is not expected to have a significant impact on the Company’s financial statements.

In July 2019, the FASB issued ASU 2019-07, Codification Updates to SEC Sections, Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No. 33-10532, Disclosure Update and Simplification, and Nos. 33-10231 and 33-10442, Investment Company Reporting Modernization, and Miscellaneous Updates. This ASU amends various SEC paragraphs pursuant to the issuance of SEC Final Rule Releases No. 33-10532, Disclosure Update and Simplification, and Nos. 33-10231 and 33-10442, Investment Company Reporting Modernization. Other miscellaneous updates to agree to the electronic Code of Federal Regulations also have been incorporated.

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Note 4. Per Share Data

There are no convertible securities which would affect the denominator in calculating basic and dilutive earnings per share. There were a total of 423,700 stock options, with an average exercise price of $43.95, outstanding on June 30, 2019. All options were excluded, on a weighted average basis, in the computation of diluted earnings per share for the period due to the average market price of common shares being $41.84 for the period. A portion of these options were included, on a weighted average basis, in the computation of diluted earnings per share for the 2018 period end due to the average market price of common shares of $43.37 exceeding the exercise price of the options issued during 2015. Net income as presented on the consolidated statement of income is used as the numerator. The following table sets forth the composition of the weighted average common shares (denominator) used in the basic and dilutive earnings per share computation.



	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Weighted average common shares issued	5,012,485		5,010,082		5,012,195		5,009,806
Weighted average treasury stock shares	(320,150	)	(320,150	)	(320,150	)	(320,150	)
Weighted average common shares outstanding - basic	4,692,335		4,689,932		4,692,045		4,689,656
Dilutive effect of outstanding stock options	—		13,407		—		—
Weighted average common shares outstanding - diluted	4,692,335		4,703,339		4,692,045		4,689,656

Note 5. Investment Securities

The amortized cost, gross unrealized gains and losses, and fair values of our investment securities portfolio at June 30, 2019 and December 31, 2018 are as follows:



	June 30, 2019
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
(In Thousands)	Cost		Gains		Losses			Value
Available for sale (AFS):
Mortgage-backed securities	$	5,927	$	38	$	(61	)	$	5,904
State and political securities	87,078		3,361		(59		)	90,380
Other debt securities	49,622		303		(520		)	49,405
Total debt securities	$	142,627	$	3,702	$	(640	)	$	145,689

Investment equity securities:
Financial institution equity securities	$	328	$	256	$	—		$	584
Other equity securities	1,300		—		(43		)	1,257
Investment equity securities	$	1,628	$	256	$	(43	)	$	1,841

Trading:
Other equity securities	$	50	$	—	$	(6	)	$	44

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	December 31, 2018
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
(In Thousands)	Cost		Gains		Losses			Value
Available for sale (AFS):
Mortgage-backed securities	$	6,385	$	8	$	(240	)	$	6,153
State and political securities	79,358		609		(426		)	79,541
Other debt securities	50,264		17		(1,690		)	48,591
Total debt securities	$	136,007	$	634	$	(2,356	)	$	134,285

Investment equity securities:
Financial institution equity securities	$	328	$	224	$	—		$	552
Other equity securities	1,300		—		(76		)	1,224
Investment equity securities	$	1,628	$	224	$	(76	)	$	1,776

Trading:
Other equity securities	$	49	$	—	$	(13	)	$	36

The following tables show the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time, that the individual debt securities have been in a continuous unrealized loss position, at June 30, 2019 and December 31, 2018.



	June 30, 2019
	Less than Twelve Months					Twelve Months or Greater					Total
			Gross					Gross					Gross
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
(In Thousands)	Value		Losses			Value		Losses			Value		Losses
Available for sale (AFS):
Mortgage-backed securities	$	—	$	—		$	2,807	$	(61	)	$	2,807	$	(61	)
State and political securities	—		—			1,766		(59		)	1,766		(59		)
Other debt securities	2,981		(40		)	31,928		(480		)	34,909		(520		)
Total debt securities	$	2,981	$	(40	)	$	36,501	$	(600	)	$	39,482	$	(640	)



	December 31, 2018
	Less than Twelve Months					Twelve Months or Greater					Total
			Gross					Gross					Gross
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
(In Thousands)	Value		Losses			Value		Losses			Value		Losses
Available for sale (AFS):
Mortgage-backed securities	$	3,023	$	(75	)	$	2,930	$	(165	)	$	5,953	$	(240	)
State and political securities	14,819		(128		)	13,648		(298		)	28,467		(426		)
Other debt securities	10,133		(153		)	34,776		(1,537		)	44,909		(1,690		)
Total debt securities	$	27,975	$	(356	)	$	51,354	$	(2,000	)	$	79,329	$	(2,356	)

At June 30, 2019, there were a total of 3 securities in a continuous unrealized loss position for less than twelve months and 24 individual securities that were in a continuous unrealized loss position for twelve months or greater.

The Company reviews its position quarterly and has determined that, at June 30, 2019, the declines outlined in the above table represent temporary declines and the Company does not intend to sell and does not believe it will be required to sell these securities before recovery of their cost basis, which may be at maturity. The Company has concluded that the unrealized losses disclosed

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above are not other than temporary but are the result of interest rate changes, sector credit ratings changes, or company-specific ratings changes that are not expected to result in the non-collection of principal and interest during the period.

The amortized cost and fair value of debt securities at June 30, 2019, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities since borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.



(In Thousands)	Amortized Cost		Fair Value
Due in one year or less	$	4,065	$	4,067
Due after one year to five years	49,986		49,656
Due after five years to ten years	62,857		65,226
Due after ten years	25,719		26,740
Total	$	142,627	$	145,689

Total gross proceeds from sales of debt securities available for sale for the three and six months ended June 30, 2019 were $1,146,000 and $8,132,000, respectively, an increase from the 2018 totals of $1,120,000 and $4,483,000.

The following table represents gross realized gains and losses from the sales of debt securities available for sale:



	Three Months Ended June 30,				Six Months Ended June 30,
(In Thousands)	2019		2018		2019		2018
Available for sale (AFS):
Gross realized gains:
Mortgage-backed securities	$	—	$	5	$	—	$	5
State and political securities	—		19		15		19
Other debt securities	—		—		4		—
Total gross realized gains	$	—	$	24	$	19	$	24

Gross realized losses:
State and political securities	$	1	$	—	$	3	$	9
Other debt securities	1		10		5		10
Total gross realized losses	$	2	$	10	$	8	$	19

There were no impairment charges included in gross realized losses for the three and six months ended June 30, 2019 and 2018, respectively.

Investment securities with a carrying value of approximately $95,705,000 and $73,327,000 at June 30, 2019 and December 31, 2018, respectively, were pledged to secure certain deposits, repurchase agreements, and for other purposes as required by law.

At June 30, 2019 and December 31, 2018, we had $1,841,000 and $1,776,000, respectively, in equity securities recorded at fair value. Prior to January 1, 2018, equity securities were stated at fair value with unrealized gains and losses reported as a separate component of AOCI, net of tax. The following is a summary of unrealized and realized gains and losses recognized in net income on equity securities during the three and six months ended June 30, 2019 and 2018:



	Three Months Ended June 30,				Six Months Ended June 30,
(In Thousands)	2019		2018		2019		2018
Net gains (losses) recognized in equity securities during the period	$	22	$	6	$	65	$	(28	)
Less: Net gains (losses) realized on the sale of equity securities during the period	—		—		—		—
Unrealized gains (losses) recognized in equity securities held at reporting date	$	22	6		$	65	(28		)

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Net gains and losses on trading account securities are as follows for the three and six months ended June 30, 2019 and 2018:



	Three Months Ended June 30,					Six Months Ended June 30,
(In Thousands)	2019		2018			2019		2018
Net gains (losses) on sale transactions	$	3	$	11		$	8	$	(4	)
Net mark-to-market gains (losses)	—		(16		)	5		2
Net gain (loss) on trading account securities	$	3	$	(5	)	$	13	$	(2	)

Note 6. Loans

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

The following table presents the related aging categories of loans, by segment, as of June 30, 2019 and December 31, 2018:



	June 30, 2019
				Past Due		Past Due 90
				30 To 89		Days Or More		Non-
(In Thousands)	Current			Days		& Still Accruing		Accrual		Total
Commercial, financial, and agricultural	$	185,997		$	78	$	25	$	5,180	$	191,280
Real estate mortgage:
Residential	612,515			3,004		818		2,018		618,355
Commercial	350,655			1,350		227		6,826		359,058
Construction	39,617			171		132		72		39,992
Consumer automobile loans	145,246			190		43		37		145,516
Other consumer installment loans	23,620			464		—		5		24,089
	1,357,650			$	5,257	$	1,245	$	14,138	1,378,290
Net deferred loan fees and discounts	995									995
Allowance for loan losses	(14,001		)							(14,001		)
Loans, net	$	1,344,644								$	1,365,284



	December 31, 2018
				Past Due		Past Due 90
				30 To 89		Days Or More		Non-
(In Thousands)	Current			Days		& Still Accruing		Accrual		Total
Commercial, financial, and agricultural	$	182,651		$	616	$	—	$	5,294	$	188,561
Real estate mortgage:
Residential	611,281			7,688		1,238		2,172		622,379
Commercial	361,624			2,349		—		7,722		371,695
Construction	43,144			305		—		74		43,523
Consumer automobile loans	132,713			412		27		31		133,183
Other consumer installment loans	23,902			636		9		5		24,552
	1,355,315			$	12,006	$	1,274	$	15,298	1,383,893
Net deferred loan fees and discounts	864									864
Allowance for loan losses	(13,837		)							(13,837		)
Loans, net	$	1,342,342								$	1,370,920

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The following table presents interest income the Banks would have recorded if interest had been recorded based on the original loan agreement terms and rate of interest for non-accrual loans and interest income recognized on a cash basis for non-accrual loans for the three and six months ended June 30, 2019 and 2018:



	Three Months Ended June 30,
	2019				2018
(In Thousands)	Interest Income That Would Have Been Recorded Based on Original Term and Rate		Interest Income Recorded on a Cash Basis		Interest Income That Would Have Been Recorded Based on Original Term and Rate		Interest Income Recorded on a Cash Basis
Commercial, financial, and agricultural	$	33	$	44	$	3	$	1
Real estate mortgage:
Residential	33		19		37		23
Commercial	76		34		77		22
Construction	1		1		—		—
Consumer automobile loans	1		1		—		—
Other consumer installment loans	—		—		1		1
	$	144	$	99	$	118	$	47



	Six Months Ended June 30,
	2019				2018
(In Thousands)	Interest Income That Would Have Been Recorded Based on Original Term and Rate		Interest Income Recorded on a Cash Basis		Interest Income That Would Have Been Recorded Based on Original Term and Rate		Interest Income Recorded on a Cash Basis
Commercial, financial, and agricultural	$	57	$	83	$	4	$	1
Real estate mortgage:
Residential	66		42		68		34
Commercial	165		74		138		39
Construction	2		2		—		—
Consumer automobile loans	3		2		—		—
Other consumer installment loans	1		—		1		1
	$	294	$	203	$	211	$	75

Impaired Loans

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

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

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

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The following table presents the recorded investment, unpaid principal balance, and related allowance of impaired loans by segment as of June 30, 2019 and December 31, 2018:



	June 30, 2019
	Recorded		Unpaid Principal		Related
(In Thousands)	Investment		Balance		Allowance
With no related allowance recorded:
Commercial, financial, and agricultural	$	1,239	$	1,239	$	—
Real estate mortgage:
Residential	2,368		2,368		—
Commercial	2,980		2,980		—
Construction	72		72		—
Consumer automobile loans	—		—		—
Installment loans to individuals	5		5		—
	6,664		6,664		—
With an allowance recorded:
Commercial, financial, and agricultural	4,014		4,014		577
Real estate mortgage:
Residential	1,673		1,673		228
Commercial	6,333		6,333		1,161
Construction	—		—		—
Consumer automobile loans	37		37		20
Installment loans to individuals	—		—		—
	12,057		12,057		1,986
Total:
Commercial, financial, and agricultural	5,253		5,253		577
Real estate mortgage:
Residential	4,041		4,041		228
Commercial	9,313		9,313		1,161
Construction	72		72		—
Consumer automobile loans	37		37		20
Installment loans to individuals	5		5		—
	$	18,721	$	18,721	$	1,986

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	December 31, 2018
	Recorded		Unpaid Principal		Related
(In Thousands)	Investment		Balance		Allowance
With no related allowance recorded:
Commercial, financial, and agricultural	$	1,152	$	1,152	$	—
Real estate mortgage:
Residential	2,619		2,619		—
Commercial	2,457		2,457		—
Construction	74		74		—
Consumer automobile loans	31		31		—
Installment loans to individuals	—		—		—
	6,333		6,333		—
With an allowance recorded:
Commercial, financial, and agricultural	4,111		4,111		650
Real estate mortgage:
Residential	1,591		1,591		168
Commercial	9,207		9,207		1,720
Construction	—		—		—
Consumer automobile loans	—		—		—
Installment loans to individuals	5		5		5
	14,914		14,914		2,543
Total:
Commercial, financial, and agricultural	5,263		5,263		650
Real estate mortgage:
Residential	4,210		4,210		168
Commercial	11,664		11,664		1,720
Construction	74		74		—
Consumer automobile loans	31		31		—
Installment loans to individuals	5		5		5
	$	21,247	$	21,247	$	2,543

The following table presents the average recorded investment in impaired loans and related interest income recognized for the three and six months ended for June 30, 2019 and 2018:



	Three Months Ended June 30,
	2019						2018
(In Thousands)	Average Investment in Impaired Loans		Interest Income Recognized on an Accrual Basis on Impaired Loans		Interest Income Recognized on a Cash Basis on Impaired Loans		Average Investment in Impaired Loans		Interest Income Recognized on an Accrual Basis on Impaired Loans		Interest Income Recognized on a Cash Basis on Impaired Loans
Commercial, financial, and agricultural	$	5,298	$	2	$	44	$	1,227	$	17	$	1
Real estate mortgage:
Residential	4,078		27		22		4,255		29		23
Commercial	9,894		30		33		9,170		36		22
Construction	72		—		1		—		—		—
Consumer automobile	55		—		—		—		—		—
Other consumer installment loans	18		—		—		1		—		1
	$	19,415	$	59	$	100	$	14,653	$	82	$	47

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	Six Months Ended June 30,
	2019						2018
(In Thousands)	Average Investment in Impaired Loans		Interest Income Recognized on an Accrual Basis on Impaired Loans		Interest Income Recognized on a Cash Basis on Impaired Loans		Average Investment in Impaired Loans		Interest Income Recognized on an Accrual Basis on Impaired Loans		Interest Income Recognized on a Cash Basis on Impaired Loans
Commercial, financial, and agricultural	$	5,286	$	2	$	82	$	1,241	$	34	$	1
Real estate mortgage:
Residential	4,122		55		39		4,080		67		34
Commercial	10,484		61		69		9,211		94		39
Construction	73		—		2		—		—		—
Consumer automobile	47		—		1		—		—		—
Other consumer installment loans	13		—		—		1		—		1
	$	20,012	$	118	$	193	$	14,533	$	195	$	75

Currently, there is $7,000 committed to be advanced in connection with impaired loans.

Troubled Debt Restructurings

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

There were four loan modifications considered TDR's completed during the six months ended June 30, 2019. Loan modifications that are considered TDRs completed during the three and six months ended June 30, 2019 and 2018 were as follows:



	Three Months Ended June 30,
	2019					2018
(In Thousands, Except Number of Contracts)	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial, financial, and agricultural	2	$	4,014	$	4,014	—	$	—	$	—
Real estate mortgage:
Residential	—	—		—		1	67		67
Commercial	2	2,862		2,862		—	—		—
	4	$	6,876	$	6,876	1	$	67	$	67



	Six Months Ended June 30,
	2019					2018
(In Thousands, Except Number of Contracts)	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial, financial, and agricultural	2	$	4,014	$	4,014	—	$	—	$	—
Real estate mortgage:
Residential	—	—		—		3	169		169
Commercial	2	2,862		2,862		1	106		106
	4	$	6,876	$	6,876	4	$	275	$	275

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There were no loan modifications considered to be TDRs made during the twelve months previous to June 30, 2019 that defaulted during the six months ended June 30, 2019. There was one loan modification considered to be a TDR made during the twelve months previous to June 30, 2018 that defaulted during the six months ended June 30, 2018.The defaulted loan type and recorded investment as of June 30, 2018 are as follows: a residential real estate loan with a recorded investment of $3,750.

Troubled debt restructurings amounted to $14,862,000 and $9,599,000 as of June 30, 2019 and December 31, 2018, respectively.

The amount of foreclosed residential real estate held at June 30, 2019 and December 31, 2018, totaled $639,000 and $624,000, respectively. Consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process at June 30, 2019 and December 31, 2018, totaled $19,000 and $167,000, respectively.

Internal Risk Ratings

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

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

The following table presents the credit quality categories identified above as of June 30, 2019 and December 31, 2018:



	June 30, 2019
	Commercial, Financial, and Agricultural		Real Estate Mortgages						Consumer automobile		Other consumer installment loans
(In Thousands)	Commercial, Financial, and Agricultural		Residential		Commercial		Construction		Consumer automobile		Other consumer installment loans		Totals
Pass	$	182,799	$	613,770	$	342,166	$	39,979	$	145,516	$	24,089	$	1,348,319
Special Mention	3,300		2,750		5,769		—		—		—		11,819
Substandard	5,181		1,835		11,123		13		—		—		18,152
	$	191,280	$	618,355	$	359,058	$	39,992	$	145,516	$	24,089	$	1,378,290



	December 31, 2018
	Commercial, Financial, and Agricultural		Real Estate Mortgages						Consumer automobile		Other consumer installment loans
(In Thousands)	Commercial, Financial, and Agricultural		Residential		Commercial		Construction		Consumer automobile		Other consumer installment loans		Totals
Pass	$	179,840	$	619,800	$	351,703	$	43,523	$	133,183	$	24,552	$	1,352,601
Special Mention	3,426		694		6,587		—		—		—		10,707
Substandard	5,295		1,885		13,405				—		—		20,585
	$	188,561	$	622,379	$	371,695	$	43,523	$	133,183	$	24,552	$	1,383,893

Allowance for Loan Losses

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

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

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

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

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

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

Activity in the allowance is presented for the three and six months ended June 30, 2019 and 2018:



	Three Months Ended June 30, 2019
	Commercial, Financial, and Agricultural			Real Estate Mortgages								Consumer automobile			Other consumer installment
(In Thousands)	Commercial, Financial, and Agricultural			Residential			Commercial			Construction		Consumer automobile			Other consumer installment			Unallocated		Totals
Beginning Balance	$	1,732		$	5,730		$	3,802		$	130	$	1,402		$	278		$	718	$	13,792
Charge-offs	(30		)	(64		)	(11		)	—		(38		)	(66		)	—		(209		)
Recoveries	36			—			1			2		34			30			—		103
Provision	(154		)	83			(269		)	—		37			(2		)	620		315
Ending Balance	$	1,584		$	5,749		$	3,523		$	132	$	1,435		$	240		$	1,338	$	14,001



	Three Months Ended June 30, 2018
	Commercial, Financial, and Agricultural			Real Estate Mortgages									Consumer automobile			Other consumer installment
(In Thousands)	Commercial, Financial, and Agricultural			Residential			Commercial			Construction			Consumer automobile			Other consumer installment			Unallocated		Totals
Beginning Balance	$	1,372		$	5,656		$	4,003		$	156		$	1,016		$	305		$	328	$	12,836
Charge-offs	(3		)	(91		)	—			—			(22		)	(47		)	—		(163		)
Recoveries	8			1			—			3			2			12			—		26
Provision	(322		)	17			(189		)	(41		)	73			47			750		335
Ending Balance	$	1,055		$	5,583		$	3,814		$	118		$	1,069		$	317		$	1,078	$	13,034

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	Six Months Ended June 30, 2019
	Commercial, Financial, and Agricultural			Real Estate Mortgages									Consumer automobile			Other consumer installment
(In Thousands)	Commercial, Financial, and Agricultural			Residential			Commercial			Construction			Consumer automobile			Other consumer installment			Unallocated		Totals
Beginning Balance	$	1,680		$	5,616		$	4,047		$	143		$	1,328		$	259		$	764	$	13,837
Charge-offs	(80		)	(137		)	(150		)	—			(138		)	(162		)	—		(667		)
Recoveries	42			1			1			7			60			45			—		156
Provision	(58		)	269			(375		)	(18		)	185			98			574		675
Ending Balance	$	1,584		$	5,749		$	3,523		$	132		$	1,435		$	240		$	1,338	$	14,001



	Six Months Ended June 30, 2018
	Commercial, Financial, and Agricultural			Real Estate Mortgages									Consumer automobile			Other consumer installment
(In Thousands)	Commercial, Financial, and Agricultural			Residential			Commercial			Construction			Consumer automobile			Other consumer installment			Unallocated		Totals
Beginning Balance	$	1,177		$	5,679		$	4,277		$	155		$	804		$	271		$	495	$	12,858
Charge-offs	(36		)	(142		)	(55		)	—			(52		)	(118		)	—		(403		)
Recoveries	15			25			—			5			3			36			—		84
Provision	(101		)	21			(408		)	(42		)	314			128			583		495
Ending Balance	$	1,055		$	5,583		$	3,814		$	118		$	1,069		$	317		$	1,078	$	13,034

The shift in allocation of the loan provision is primarily due to portfolio segment growth and changes in the credit metrics within the real estate mortgage portfolio.

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

The Company has a concentration of the following to gross loans at June 30, 2019 and 2018:



	June 30,
	2019		2018
Owners of residential rental properties	15.07	%	14.90	%
Owners of commercial rental properties	12.09	%	13.30	%

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based on impairment method as of June 30, 2019 and December 31, 2018:



	June 30, 2019
	Commercial, Financial, and Agricultural		Real Estate Mortgages						Consumer Automobile		Other consumer installment		Unallocated
(In Thousands)	Commercial, Financial, and Agricultural		Residential		Commercial		Construction		Consumer Automobile		Other consumer installment		Unallocated		Totals
Allowance for Loan Losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	577	$	228	$	1,161	$	—	$	20	$	—	$	—	$	1,986
Collectively evaluated for impairment	1,007		5,521		2,362		132		1,415		240		1,338		12,015
Total ending allowance balance	$	1,584	$	5,749	$	3,523	$	132	$	1,435	$	240	$	1,338	$	14,001

Loans:
Individually evaluated for impairment	$	5,253	$	4,041	$	9,313	$	72	$	37	$	5			$	18,721
Collectively evaluated for impairment	186,027		614,314		349,745		39,920		145,479		24,084				1,359,569
Total ending loans balance	$	191,280	$	618,355	$	359,058	$	39,992	$	145,516	$	24,089			$	1,378,290

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	December 31, 2018
	Commercial, Financial, and Agricultural		Real Estate Mortgages						Consumer Automobile		Other consumer installment		Unallocated
(In Thousands)	Commercial, Financial, and Agricultural		Residential		Commercial		Construction		Consumer Automobile		Other consumer installment		Unallocated		Totals
Allowance for Loan Losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	650	$	168	$	1,720	$	—	$	—	$	5	$	—	$	2,543
Collectively evaluated for impairment	1,030		5,448		2,327		143		1,328		254		764		11,294
Total ending allowance balance	$	1,680	$	5,616	$	4,047	$	143	$	1,328	$	259	$	764	$	13,837

Loans:
Individually evaluated for impairment	$	5,263	$	4,210	$	11,664	$	74	$	31	$	5			$	21,247
Collectively evaluated for impairment	183,298		618,169		360,031		43,449		133,152		24,547				1,362,646
Total ending loans balance	$	188,561	$	622,379	$	371,695	$	43,523	$	133,183	$	24,552			$	1,383,893

Note 7. Net Periodic Benefit Cost-Defined Benefit Plans

For a detailed disclosure on the Company’s pension and employee benefits plans, please refer to Note 13 of the Company’s Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2018.

The following sets forth the components of the net periodic benefit/cost of the domestic non-contributory defined benefit plan for the three and six months ended June 30, 2019 and 2018, respectively:



	Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands)	2019			2018			2019			2018
Interest cost	$	191		$	177		$	382		$	353
Expected return on plan assets	(249		)	(274		)	(498		)	(548		)
Amortization of net loss	47			42			94			84
Net periodic benefit	$	(11	)	$	(55	)	$	(22	)	$	(111	)

Employer Contributions

The Company previously disclosed in its consolidated financial statements, included in the Annual Report on Form 10-K for the year ended December 31, 2018, that it expected to contribute a minimum of $500,000 to its defined benefit plan in 2019. As of June 30, 2019, there were contributions of $500,000 made to the plan with additional contributions of at least $250,000 anticipated during the remainder of 2019.

Note 8. Employee Stock Purchase Plan

The Company maintains an Employee Stock Purchase Plan (“Plan”). The Plan is intended to encourage employee participation in the ownership and economic progress of the Company. The Plan allows for up to 1,000,000 shares to be purchased by employees. The purchase price of the shares is 95% of market value with an employee eligible to purchase up to the lesser of 15% of base compensation or $12,000 in market value annually. During the six months ended June 30, 2019 and 2018, there were 1,200 and 1,196 shares issued under the plan, respectively.

Note 9. Off-Balance Sheet Risk

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

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

Financial instruments whose contract amounts represent credit risk are as follows at June 30, 2019 and December 31, 2018:



(In Thousands)	June 30, 2019		December 31, 2018
Commitments to extend credit	$	157,830	$	166,417
Standby letters of credit	10,506		10,566
Credit exposure from the sale of assets with recourse	6,393		6,152
	$	174,729	$	183,135

Commitments to extend credit are legally binding agreements to lend to customers. Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future liquidity requirements. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company, on an extension of credit is based on management’s credit assessment of the counterparty.

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

Note 10. Fair Value Measurements

The following disclosures show the hierarchal disclosure framework associated with the level of pricing observations utilized in measuring assets and liabilities at fair value.



Level I:		Quoted prices are available in active markets for identical assets or liabilities as of the reported date.

Level II:		Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but traded less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed.

Level III:		Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

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

The following table presents the assets reported on the Consolidated Balance Sheet at their fair value on a recurring basis as of June 30, 2019 and December 31, 2018, by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

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	June 30, 2019
(In Thousands)	Level I		Level II		Level III		Total
Assets measured on a recurring basis:
Investment securities, available for sale:
Mortgage-backed securities	$	—	$	5,904	$	—	$	5,904
State and political securities	—		90,380		—		90,380
Other debt securities	—		49,405		—		49,405
Investment equity securities:
Financial institution equity securities	584		—		—		584
Other equity securities	1,257		—		—		1,257
Investment securities, trading:
Other equity securities	44		—		—		44



	December 31, 2018
(In Thousands)	Level I		Level II		Level III		Total
Assets measured on a recurring basis:
Investment securities, available for sale:
Mortgage-backed securities	$	—	$	6,153	$	—	$	6,153
State and political securities	—		79,541		—		79,541
Other debt securities	—		48,591		—		48,591
Financial institution equity securities	552		—		—		552
Other equity securities	1,224		—		—		1,224
Investment securities, trading:
Other equity securities	36		—		—		36

The following table presents the assets reported on the Consolidated Balance Sheet at their fair value on a non-recurring basis as of June 30, 2019 and December 31, 2018, by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.



	June 30, 2019
(In Thousands)	Level I		Level II		Level III		Total
Assets measured on a non-recurring basis:
Impaired loans	$	—	$	—	$	16,735	$	16,735
Other real estate owned	—		—		471		471



	December 31, 2018
(In Thousands)	Level I		Level II		Level III		Total
Assets measured on a non-recurring basis:
Impaired loans	$	—	$	—	$	18,704	$	18,704
Other real estate owned	—		—		402		402

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The following tables present a listing of significant unobservable inputs used in the fair value measurement process for items valued utilizing level III techniques as of June 30, 2019 and December 31, 2018:

June 30, 2019

Quantitative Information About Level III Fair Value Measurements

(In Thousands)

Fair Value

Valuation Technique(s)

Unobservable Inputs

Range

Weighted Average

Impaired loans

11,477

Discounted cash flow

Temporary reduction in payment amount

0% to (70)%

(35)%

5,258

Appraisal of collateral (1)

Appraisal adjustments (1)

0 to (40)%

(2)%

Other real estate owned

471

Appraisal of collateral (1)

Appraisal adjustments (1)

(20)%

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

December 31, 2018

Quantitative Information About Level III Fair Value Measurements

(In Thousands)

Fair Value

Valuation Technique(s)

Unobservable Inputs

Range

Weighted Average

Impaired loans

12,929

Discounted cash flow

Temporary reduction in payment amount

7 to (70)%

(6)%

5,775

Appraisal of collateral (1)

Appraisal adjustments (1)

0 to (90)%

(20)%

Other real estate owned

402

Appraisal of collateral (1)

Appraisal adjustments (1)

(20)%

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

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

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

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

Note 11. Fair Value of Financial Instruments

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

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

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

The fair values of the Company’s financial instruments not recorded at fair value on a recurring or nonrecurring basis are as follows at June 30, 2019 and December 31, 2018:



	Carrying		Fair		Fair Value Measurements at June 30, 2019
(In Thousands)	Value		Value		Level I		Level II		Level III
Financial assets:
Cash and cash equivalents (1)	$	79,525	$	79,525	$	79,525	$	—	$	—
Restricted investment in bank stock (1)	15,087		15,087		15,087		—		—
Loans held for sale (1)	2,880		2,880		2,880		—		—
Loans, net	1,365,284		1,377,063		—		—		1,377,063
Bank-owned life insurance (1)	28,955		28,955		28,955		—		—
Accrued interest receivable (1)	5,708		5,708		5,708		—		—

Financial liabilities:
Interest-bearing deposits	$	1,004,331	$	1,015,799	$	659,464	$	—	$	356,335
Noninterest-bearing deposits (1)	322,755		322,755		322,755		—		—
Short-term borrowings (1)	59,453		59,453		59,453		—		—
Long-term borrowings	154,597		155,968		—		—		155,968
Accrued interest payable (1)	1,482		1,482		1,482		—		—

(1) The financial instrument is carried at cost at June 30, 2019, which approximate the fair value of the instruments



	Carrying		Fair		Fair Value Measurements at December 31, 2018
(In Thousands)	Value		Value		Level I		Level II		Level III
Financial assets:
Cash and cash equivalents (1)	$	66,742	$	66,742	$	66,742	$	—	$	—
Restricted investment in bank stock (1)	18,862		18,862		18,862		—		—
Loans held for sale (1)	2,929		2,929		2,929		—		—
Loans, net	1,370,920		1,381,581		—		—		1,381,581
Bank-owned life insurance (1)	28,627		28,627		28,627		—		—
Accrued interest receivable (1)	5,334		5,334		5,334		—		—

Financial liabilities:
Interest-bearing deposits	$	899,089	$	882,108	$	612,478	$	—	$	269,630
Noninterest-bearing deposits (1)	320,814		320,814		320,814		—		—
Short-term borrowings (1)	167,865		167,865		167,865		—		—
Long-term borrowings	138,942		137,773		—		—		137,773
Accrued interest payable (1)	1,150		1,150		1,150		—		—

(1) The financial instrument is carried at cost at December 31, 2018, which approximate the fair value of the instruments

The methods and assumptions used by the Company in estimating fair values of financial instruments at June 30, 2019 is in accordance with ASC Topic 825, Financial Instruments, as amended by ASU 2016-01 which requires public entities to use exit pricing in the calculation of the above tables.

Loans:

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

The fair value of performing loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the

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Company’s historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions.

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

Deposits:

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

Long Term Borrowings:

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

Commitments to Extend Credit, Standby Letters of Credit, and Financial Guarantees Written:

There is no material difference between the notional amount and the estimated fair value of off-balance sheet items. The contractual amounts of unfunded commitments and letters of credit are presented in Note 9 (Off-Balance Sheet Risk).

Note 12. Stock Options

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

As of January 1, 2019, the Company had a total of 263,700 stock options outstanding. During the period ended June 30, 2019, the Company issued 160,000 stock options with a strike price of $42.01 to a group of employees. The options granted in 2019 all expire ten years from the grant date. Of the 160,000 grants awarded in 2019, 80,600 of the options vest in 3 years while the remaining 79,400 options vest in five years.



Stock Options Granted
Date	Shares	Forfeited		Outstanding	Strike Price		Vesting Period	Expiration
March 15, 2019	80,600	—		80,600	$	42.01	3 years	10 years
March 15, 2019	79,400	—		79,400	42.01		5 years	10 years
August 24, 2018	50,200	—		50,200	46.00		3 years	10 years
August 24, 2018	99,500	—		99,500	46.00		5 years	10 years
January 5, 2018	12,500	—		12,500	45.11		3 years	10 years
January 5, 2018	12,500	—		12,500	45.11		5 years	10 years
March 24, 2017	46,250	(4,500	)	41,750	44.21		3 years	10 years
March 24, 2017	23,750	—		23,750	44.21		5 years	10 years
August 27, 2015	38,750	(15,250	)	23,500	42.03		5 years	10 years

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A summary of stock option activity is presented below:



	June 30, 2019			June 30, 2018
	Shares	Weighted Average Exercise Price		Shares		Weighted Average Exercise Price
Outstanding, beginning of year	263,700	$	45.12	93,500		$	43.59
Granted	160,000	42.01		25,000		45.11
Exercised	—	—		—		—
Forfeited	—	—		(3,500	)	42.96
Expired	—	—		—		—
Outstanding, end of period	423,700	$	43.95	115,000		$	43.94

Exercisable, end of period	—	$	—	—		$	—

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

Compensation expense for stock options is recognized using the fair value when the stock options are granted and is amortized over the options' vesting period. Compensation expense related to stock options was $177,000 and $313,000 for the three and six months ended June 30, 2019 compared to $5,000 and $12,000 for the same periods of 2018. As of June 30, 2019, no stock options were exercisable and the weighted average years to expiration was 8.95 years. The fair value of options granted during the six months ended June 30, 2019 was approximately $1,208,000 or $7.55 per award. Total unrecognized compensation cost for non-vested options was $2,345,000 and will be recognized over their weighted average remaining vesting period of 1.79 years.

Note 13. Leases

The following table shows finance lease right of use assets and finance lease liabilities as of June 30, 2019:



(In Thousands)	Statement of Financial Condition classification	June 30, 2019
Finance lease right of use assets	Premises and equipment, net	$	5,870
Finance lease liabilities	Long-term borrowings	$	5,972

The following table shows the components of finance and operating lease expense for the three and six months ended June 30, 2019:



	Three Months Ended June 30,		Six months ended June 30,
(In Thousands)	2019		2019

Finance Lease Cost:
Amortization of right-of-use asset	$	64	$	129
Interest expense	56		112
Operating lease cost	84		172
Variable lease cost	1		2
Total Lease Cost	$	205	$	415

Gross rental expense for the three and six months ended June 30, 2018 was $125,000 and $255,000.

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A maturity analysis of operating and finance lease liabilities and reconciliation of the undiscounted cash flows to the total operating lease liability is as follows:



(In Thousands)	Operating			Finance
2019	$	183		$	176
2020	370			318
2021	378			320
2022	385			321
2023	360			322
2024 and thereafter	3,969			8,494
Total undiscounted cash flows	5,645			9,951
Discount on cash flows	(1,359		)	(3,979		)
Total lease liability	$	4,286		$	5,972

The following table shows the weighted average remaining lease term and weighted average discount rate for both operating and finance leases outstanding as of June 30, 2019.

Note 14. Reclassification of Comparative Amounts

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

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

This Report contains certain “forward-looking statements” including statements concerning plans, objectives, future events or performance and assumptions and other statements which are other than statements of historical fact. The Company cautions readers that the following important factors, among others, may have affected and could in the future affect the Company’s actual results and could cause the Company’s actual results for subsequent periods to differ materially from those expressed in any forward-looking statement made by or on behalf of the Company herein: (i) the effect of changes in laws and regulations, including federal and state banking laws and regulations, with which the Company must comply, and the associated costs of compliance with such laws and regulations either currently or in the future as applicable; (ii) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as by the Financial Accounting Standards Board, or of changes in the Company’s organization, compensation and benefit plans; (iii) the effect on the Company’s competitive position within its market area of the increasing consolidation within the banking and financial services industries, including the increased competition from larger regional and out-of-state banking organizations as well as non-bank providers of various financial services; (iv) the effect of changes in interest rates; (v) the effect of changes in the business cycle and downturns in the local, regional or national economies; and (vi) the Risk Factors identified in Item 1A of the Company's Annual Report on Form 10-K for the year ended December 31, 2018 and in other filings made by the Company under the Securities Exchange Act of 1934.

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

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

EARNINGS SUMMARY

Comparison of the and Six Months Ended June 30, 2019 and 2018

Summary Results

Net income for the three and six months ended June 30, 2019 was $4,245,000 and $8,189,000 compared to $3,480,000 and $6,689,000 for the same period of 2018, including the effects of an increase in after-tax securities gains of $6,000 (from a gain of $12,000 to a gain of $18,000) for the three month periods and $90,000 (from a loss of $20,000 to a gain of $70,000) for the six month periods. Basic and diluted earnings per share for the three and six months ended June 30, 2019 was $0.91 and $1.75 compared to $0.74 and $1.43 for the corresponding period of 2018. Return on average assets and return on average equity were 1.02% and 11.42% for the three months ended June 30, 2019 compared to 0.91% and 10.07% for the corresponding period of 2018. Return on average assets and return on average equity were 0.99% and 11.27% for the six months ended June 30, 2019, compared to 0.89% and 9.68% for the corresponding period of 2018. Net income from core operations (“core earnings”) was $4,227,000 and $8,119,000 for the three and six months ended June 30, 2019 compared to $3,468,000 and $6,709,000 for the corresponding period of 2018. Basic and diluted adjusted earnings per share for the three and six months ended June 30, 2019 were $0.90 and $1.73 compared to $0.74 and $1.43 basic and diluted for the corresponding periods of 2018.

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

Reconciliation of GAAP and Non-GAAP Financial Measures



(Dollars in Thousands, Except Per Share Data)	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
GAAP net income	$	4,245	$	3,480	$	8,189	$	6,689
Less: net securities gains (losses), net of tax	18		12		70		(20		)
Non-GAAP core earnings	$	4,227	$	3,468	$	8,119	$	6,709



	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Return on average assets (ROA)	1.02	%	0.91	%	0.99	%	0.89	%
Less: net securities gains, net of tax	0.01	%	0.01	%	0.01	%	—	%
Non-GAAP core ROA	1.01	%	0.90	%	0.98	%	0.89	%



	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Return on average equity (ROE)	11.42	%	10.07	%	11.27	%	9.68	%
Less: net securities gains (losses), net of tax	0.05	%	0.03	%	0.09	%	(0.03	)%
Non-GAAP core ROE	11.37	%	10.04	%	11.18	%	9.71	%



	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Basic earnings per share (EPS)	$	0.91	$	0.74	$	1.75	$	1.43
Less: net securities gains, net of tax	0.01		—		0.02		—
Non-GAAP core operating EPS	$	0.90	$	0.74	$	1.73	$	1.43

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	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Diluted EPS	$	0.91	$	0.74	$	1.75	$	1.43
Less: net securities gains (losses), net of tax	0.01		—		0.02		—
Non-GAAP diluted core EPS	$	0.90	$	0.74	$	1.73	$	1.43

Interest and Dividend Income

Interest and dividend income for the three and six months ended June 30, 2019 increased to $16,841,000 and $33,275,000 compared to $14,111,000 and $27,312,000 for the same periods of 2018. Loan portfolio income increased due to the impact of portfolio growth, primarily in consumer automobile lending and commercial real estate mortgages. Investment securities and dividend income increased by $427,000 and $984,000 for the three and six month periods ended June 30, 2019 to $1,541,000 and $3,106,000 as the average balance of the investment portfolio increased by $25,449,000 and $25,880,000, respectively.

Interest and dividend income composition for the three and six months ended June 30, 2019 and 2018 was as follows:



	Three Months Ended
	June 30, 2019				June 30, 2018				Change
(In Thousands)	Amount		% Total		Amount		% Total		Amount			%
Loans including fees	$	15,300	90.85	%	$	12,997	92.11	%	$	2,303		17.72		%
Investment securities:
Taxable	967		5.74		639		4.53		328			51.33
Tax-exempt	179		1.06		230		1.63		(51		)	(22.17	)
Dividend and other interest income	395		2.35		245		1.73		150			61.22
Total interest and dividend income	$	16,841	100.00	%	$	14,111	100.00	%	$	2,730		19.35		%



	Six Months Ended
	June 30, 2019				June 30, 2018				Change
(In Thousands)	Amount		% Total		Amount		% Total		Amount			%
Loans including fees	$	30,169	90.67	%	$	25,190	92.23	%	$	4,979		19.77		%
Investment securities:
Taxable	1,901		5.71		1,185		4.34		716			60.42
Tax-exempt	353		1.06		471		1.72		(118		)	(25.05	)
Dividend and other interest income	852		2.56		466		1.71		386			82.83
Total interest and dividend income	$	33,275	100.00	%	$	27,312	100.00	%	$	5,963		21.83		%

Interest Expense

Interest expense for the three and six months ended June 30, 2019 increased $1,520,000 and $3,228,000 to $3,928,000 and $7,684,000, respectively, compared to $2,408,000 and $4,456,000 for the same periods of 2018. The increase in interest expense is the result of growth within the deposit portfolio and the use of the time deposit portfolio as part of a deposit acquisition strategy in select markets. In addition, short and long-term borrowings have been utilized to assist with the funding of the loan portfolio growth.

Interest expense composition for the three and six months ended June 30, 2019 and 2018 was as follows:



	Three Months Ended
	June 30, 2019				June 30, 2018				Change
(In Thousands)	Amount		% Total		Amount		% Total		Amount			%
Deposits	$	2,871	73.09	%	$	1,490	61.88	%	$	1,381		92.68		%
Short-term borrowings	178		4.53		252		10.47		(74		)	(29.37	)
Long-term borrowings	879		22.38		666		27.65		213			31.98
Total interest expense	$	3,928	100.00	%	$	2,408	100.00	%	$	1,520		63.12		%

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	Six Months Ended
	June 30, 2019				June 30, 2018				Change
(In Thousands)	Amount		% Total		Amount		% Total		Amount		%
Deposits	$	5,171	67.30	%	$	2,712	60.86	%	$	2,459	90.67	%
Short-term borrowings	783		10.19		476		10.68		307		64.50
Long-term borrowings	1,730		22.51		1,268		28.46		462		36.44
Total interest expense	$	7,684	100.00	%	$	4,456	100.00	%	$	3,228	72.44	%

Net Interest Margin

The net interest margin (“NIM”) for the three and six months ended June 30, 2019 was 3.39% and 3.37% compared to 3.32% and 3.31% for the corresponding periods of 2018. The increase in the net interest margin was driven by an increase in the yield on earning assets of 40 and 44 basis points ("bps") for the three and six month periods. The impact of the increase in yield on earning assets was limited by the increase in rate paid on interest-bearing liabilities of 42 bps and 45 bps for the three and six month periods. The increase in the yield on earning assets was driven by an increase in the loan portfolio yield in conjunction with an increase in the average loan portfolio of $83,379,000 and $103,502,000, respectively. The loan growth for the three and six month periods was primarily funded by an increase in average total deposits of $119,236,000 and $108,021,000, respectively. Deposits increased $136,067,000 to $1.3 billion at June 30, 2019 compared to June 30, 2018. Noninterest-bearing deposits increased $11,561,000 million to $322,755,000 million at June 30, 2019 compared to June 30, 2018.

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The following is a schedule of average balances and associated yields for the three and six months ended June 30, 2019 and 2018:



	AVERAGE BALANCES AND INTEREST RATES
	Three Months Ended June 30, 2019						Three Months Ended June 30, 2018
(In Thousands)	Average Balance (1)		Interest		Average Rate		Average Balance (1)		Interest		Average Rate
Assets:
Tax-exempt loans (3)	$	71,193	$	548	3.09	%	$	75,859	$	563	2.98	%
All other loans	1,313,388		14,867		4.54	%	1,225,343		12,552		4.11	%
Total loans (2)	1,384,581		15,415		4.47	%	1,301,202		13,115		4.04	%

Taxable securities	130,802		1,300		4.03	%	93,024		871		3.75	%
Tax-exempt securities (3)	27,971		227		3.29	%	40,300		291		2.89	%
Total securities	158,773		1,527		3.90	%	133,324		1,162		3.49	%

Interest-bearing deposits	10,431		62		2.38	%	3,034		13		1.72	%

Total interest-earning assets	1,553,785		17,004		4.39	%	1,437,560		14,290		3.99	%

Other assets	113,443						97,034

Total assets	$	1,667,228					$	1,534,594

Liabilities and shareholders’ equity:
Savings	$	170,142	51		0.12	%	$	165,231	16		0.04	%
Super Now deposits	246,454		453		0.74	%	234,731		242		0.41	%
Money market deposits	249,169		596		0.96	%	243,771		290		0.48	%
Time deposits	335,721		1,771		2.12	%	253,398		942		1.49	%
Total interest-bearing deposits	1,001,486		2,871		1.15	%	897,131		1,490		0.67	%

Short-term borrowings	32,086		178		2.23	%	56,530		252		1.76	%
Long-term borrowings	147,571		879		2.24	%	123,970		666		2.12	%
Total borrowings	179,657		1,057		2.23	%	180,500		918		2.01	%

Total interest-bearing liabilities	1,181,143		3,928		1.31	%	1,077,631		2,408		0.89	%

Demand deposits	317,623						302,742
Other liabilities	19,747						16,024
Shareholders’ equity	148,715						138,197

Total liabilities and shareholders’ equity	$	1,667,228					$	1,534,594
Interest rate spread					3.08	%					3.10	%
Net interest income/margin			$	13,076	3.39	%			$	11,882	3.32	%

1. Information on this table has been calculated using average daily balance sheets to obtain average balances.

2. Non-accrual loans have been included with loans for the purpose of analyzing net interest earnings.

3. Income and rates on a fully taxable equivalent basis include an adjustment for the difference between annual income from tax-exempt obligations and the taxable equivalent of such income at the standard tax rate of 21%.

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	AVERAGE BALANCES AND INTEREST RATES
	Six Months Ended June 30, 2019						Six Months Ended June 30, 2018
(In Thousands)	Average Balance (1)		Interest		Average Rate		Average Balance (1)		Interest		Average Rate
Assets:
Tax-exempt loans (3)	$	71,874	$	1,087	3.05	%	$	75,548	$	1,130	3.02	%
All other loans	1,313,121		29,310		4.50	%	1,205,945		24,297		4.06	%
Total loans (2)	1,384,995		30,397		4.43	%	1,281,493		25,427		4.00	%

Taxable securities	128,431		2,650		4.18	%	88,670		1,630		3.68	%
Tax-exempt securities	27,344		447		3.31	%	41,225		596		2.89	%
Total securities	155,775		3,097		4.03	%	129,895		2,226		3.43	%

Interest-bearing deposits	8,493		103		2.45	%	2,603		21		1.63	%

Total interest-earning assets	1,549,263		33,597		4.38	%	1,413,991		27,674		3.94	%

Other assets	112,806						97,318

Total assets	$	1,662,069					$	1,511,309

Liabilities and shareholders’ equity:
Savings	$	168,543	81		0.10	%	$	164,140	32		0.04	%
Super Now deposits	239,022		832		0.70	%	230,930		449		0.39	%
Money market deposits	245,307		1,068		0.88	%	240,127		500		0.42	%
Time deposits	317,782		3,190		2.02	%	244,805		1,731		1.43	%
Total interest-bearing deposits	970,654		5,171		1.07	%	880,002		2,712		0.62	%

Short-term borrowings	63,881		783		2.47	%	59,152		476		1.60	%
Long-term borrowings	145,890		1,730		2.24	%	119,274		1,268		2.11	%
Total borrowings	209,771		2,513		2.31	%	178,426		1,744		1.94	%

Total interest-bearing liabilities	1,180,425		7,684		1.29	%	1,058,428		4,456		0.84	%

Demand deposits	315,380						298,011
Other liabilities	20,953						16,645
Shareholders’ equity	145,311						138,225

Total liabilities and shareholders’ equity	$	1,662,069					$	1,511,309
Interest rate spread					3.09	%					3.10	%
Net interest income/margin			$	25,913	3.37	%			$	23,218	3.31	%

The following table presents the adjustment to convert net interest income to net interest income on a fully taxable equivalent basis for the three and six months ended June 30, 2019 and 2018:



	Three Months Ended June 30,				Six Months Ended June 30,
(In Thousands)	2019		2018		2019		2018
Total interest income	$	16,841	$	14,111	$	33,275	$	27,312
Total interest expense	3,928		2,408		7,684		4,456
Net interest income	12,913		11,703		25,591		22,856
Tax equivalent adjustment	163		179		322		362
Net interest income (fully taxable equivalent)	$	13,076	$	11,882	$	25,913	$	23,218

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The following table sets forth the respective impact that both volume and rate changes have had on net interest income on a fully taxable equivalent basis for the three and six months ended June 30, 2019 and 2018:



	Three Months Ended June 30,								Six Months Ended June 30,
	2019 vs. 2018								2019 vs. 2018
	Increase (Decrease) Due to								Increase (Decrease) Due to
(In Thousands)	Volume			Rate		Net			Volume			Rate		Net
Interest income:
Tax-exempt loans	$	(36	)	$	21	$	(15	)	$	(54	)	$	11	$	(43	)
All other loans	943			1,372		2,315			2,259			2,754		5,013
Taxable investment securities	362			67		429			783			237		1,020
Tax-exempt investment securities	(99		)	35		(64		)	(224		)	75		(149		)
Interest bearing deposits	42			7		49			48			34		82
Total interest-earning assets	1,212			1,502		2,714			2,812			3,111		5,923

Interest expense:
Savings deposits	—			35		35			1			48		49
Super Now deposits	12			199		211			17			366		383
Money market deposits	6			300		306			11			557		568
Time deposits	361			468		829			609			850		1,459
Short-term borrowings	(128		)	54		(74		)	40			267		307
Long-term borrowings	164			49		213			365			97		462
Total interest-bearing liabilities	415			1,105		1,520			1,043			2,185		3,228
Change in net interest income	$	797		$	397	$	1,194		$	1,769		$	926	$	2,695

Provision for Loan Losses

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

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

Although management believes it uses the best information available to make such determinations and that the allowance for loan losses is adequate at June 30, 2019, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making the initial determinations. A downturn in the local economy, increased unemployment, and delays in receiving financial information from borrowers could result in increased levels of nonperforming assets, charge-offs, loan loss provisions, and reductions in income. Additionally, as an integral part of the examination process, bank regulatory agencies periodically review the Banks' loan loss allowance. The banking agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination.

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

The allowance for loan losses increased slightly from $13,837,000 at December 31, 2018 to $14,001,000 at June 30, 2019. The slight increase in the allowance for loan losses was driven by an increase in the consumer automobile segment of the loan portfolio. The majority of the loans charged-off during the six month period had a specific allowance within the allowance for losses. At June 30, 2019 and December 31, 2018, the allowance for loan losses to total loans was 1.02% and 1.00%, respectively.

The provision for loan losses totaled $315,000 and $675,000 for the three and six months ended June 30, 2019 and the respective amounts for the corresponding 2018 periods were $335,000 and $495,000. The decrease in the provision for loans for the three months ended June 30, 2019 compared to the corresponding 2018 period was due to the change in loan balance outstanding. The

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increase in the provision for loan losses for the six months ended June 30, 2019 compared to the same period of 2018 was primarily due to an increase in net charge-offs.

Nonperforming loans increased to $15,383,000 at June 30, 2019 from $7,132,000 at June 30, 2018. The majority of nonperforming loans are centered on loans that are either in a secured position and have sureties with a strong underlying financial position or have a specific allocation for any impairment recorded within the allowance for loan losses. The ratio of nonperforming loans to total loans was 1.12% and 0.44% at June 30, 2019 and 2018, respectively, and the ratio of the allowance for loan losses to nonperforming loans was 91.00% and 182.75% at June 30, 2019 and 2018, respectively. Internal loan review and analysis coupled with loan growth dictated a provision for loan losses of $315,000 and $675,000 for the three and six months ended June 30, 2019.

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



	Total Nonperforming Loans
(In Thousands)	90 Days Past Due		Non-accrual		Total
June 30, 2019	$	1,245	$	14,138	$	15,383
March 31, 2019	1,268		14,526		15,794
December 31, 2018	1,274		15,298		16,572
September 30, 2018	512		8,227		8,739
June 30, 2018	463		6,669		7,132

Non-interest Income

Total non-interest income for the three and six months ended June 30, 2019 compared to the same periods in 2018 increased $107,000 and $280,000, respectively, to $2,469,000 and $4,723,000. Excluding net securities gains, non-interest income for the three and six months ended June 30, 2019 increased $99,000 and $166,000 compared to the same periods in 2018. The changes in insurance commissions is primarily the result of continued growth in United Insurance Solution, LLC. The increase in brokerage commissions are due to a change in the product mix of consumer purchases. The fluctuation in other income consists primarily due to increases in loans sold on the secondary market.

Non-interest income composition for the three and six months ended June 30, 2019 and 2018 was as follows:



	Three Months Ended
	June 30, 2019					June 30, 2018					Change
(In Thousands)	Amount			% Total		Amount			% Total		Amount			%
Service charges	$	592		23.99	%	$	592		25.07	%	$	—		—	%
Net debt securities (losses) gains, available for sale	(2		)	(0.08	)	14			0.59		(16		)	(114.29	)
Net equity securities gains (losses)	22			0.89		6			0.25		16			266.67
Net securities gains (losses), trading	3			0.12		(5		)	(0.21	)	8			(160.00	)
Bank-owned life insurance	123			4.98		158			6.69		(35		)	(22.15	)
Gain on sale of loans	347			14.05		400			16.93		(53		)	(13.25	)
Insurance commissions	119			4.82		64			2.71		55			85.94
Brokerage commissions	356			14.42		330			13.97		26			7.88
Debit card fees	389			15.76		373			15.79		16			4.29
Other	520			21.05		430			18.21		90			20.93
Total non-interest income	$	2,469		100.00	%	$	2,362		100.00	%	$	107		4.53	%

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	Six Months Ended
	June 30, 2019				June 30, 2018					Change
(In Thousands)	Amount		% Total		Amount			% Total		Amount			%
Service charges	$	1,154	24.43	%	$	1,143		25.73	%	$	11		0.96	%
Net debt securities (losses) gains, available for sale	11		0.23		5			0.11		6			120.00
Net equity securities gains (losses)	65		1.38		(28		)	(0.63	)	93			332.14
Net securities gains (losses), trading	13		0.28		(2		)	(0.05	)	15			750.00
Bank-owned life insurance	291		6.16		331			7.45		(40		)	(12.08	)
Gain on sale of loans	663		14.04		655			14.74		8			1.22
Insurance commissions	253		5.36		181			4.07		72			39.78
Brokerage commissions	679		14.38		673			15.15		6			0.89
Debit card fees	699		14.80		706			15.89		(7		)	(0.99	)
Other	895		18.94		779			17.54		116			14.89
Total non-interest income	$	4,723	100.00	%	$	4,443		100.00	%	$	280		6.30	%

Non-interest Expense

Total non-interest expense increased $542,000 and $1,079,000 for the three and six months ended June 30, 2019 compared to the same period of 2018. The increase in salaries and employee benefits is primarily attributable to routine wage increases coupled with an increase in the number of employees. Occupancy and furniture and equipment expenses have decreased slightly as maintenance costs were reduced. Software amortization increased for the six month period due to updating software programs that require new licensing fee structures. Marketing expenses decreased as targeted marketing has replaced mass marketing. The fluctuation in professional fees consists primarily of an increase in legal fees.

Non-interest expense composition for the three and six months ended June 30, 2019 and 2018 was as follows:



	Three Months Ended
	June 30, 2019				June 30, 2018				Change
(In Thousands)	Amount		% Total		Amount		% Total		Amount			%
Salaries and employee benefits	$	5,523	54.91	%	$	4,919	51.69	%	$	604		12.28	%
Occupancy	668		6.64		699		7.34		(31		)	(4.43	)
Furniture and equipment	784		7.79		801		8.42		(17		)	(2.12	)
Software amortization	188		1.87		231		2.43		(43		)	(18.61	)
Pennsylvania shares tax	285		2.83		278		2.92		7			2.52
Professional fees	727		7.23		649		6.82		78			12.02
Federal Deposit Insurance Corporation deposit insurance	236		2.35		200		2.10		36			18.00
Marketing	33		0.33		268		2.82		(235		)	(87.69	)
Intangible amortization	69		0.69		78		0.82		(9		)	(11.54	)
Other	1,546		15.36		1,394		14.64		152			10.90
Total non-interest expense	$	10,059	100.00	%	$	9,517	100.00	%	$	542		5.70	%

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	Six Months Ended
	June 30, 2019				June 30, 2018				Change
(In Thousands)	Amount		% Total		Amount		% Total		Amount			%
Salaries and employee benefits	$	11,024	55.47	%	$	9,967	53.03	%	$	1,057		10.60	%
Occupancy	1,447		7.28		1,440		7.66		7			0.49
Furniture and equipment	1,536		7.73		1,548		8.24		(12		)	(0.78	)
Software amortization	395		1.99		296		1.57		99			33.45
Pennsylvania shares tax	578		2.91		555		2.95		23			4.14
Professional fees	1,249		6.28		1,215		6.46		34			2.80
Federal Deposit Insurance Corporation deposit insurance	504		2.54		402		2.14		102			25.37
Marketing	135		0.68		519		2.76		(384		)	(73.99	)
Intangible amortization	140		0.70		158		0.84		(18		)	(11.39	)
Other	2,865		14.42		2,694		14.35		171			6.35
Total non-interest expense	$	19,873	100.00	%	$	18,794	100.00	%	$	1,079		5.74	%

Provision for Income Taxes

Income taxes increased $26,000 and $249,000 for the three and six months ended June 30, 2019 compared to the same periods of 2018. The effective tax rate for the three and six months ended June 30, 2019 was 15.16% and 16.09%, respectively, compared to 17.40% and 16.50% for the same periods of 2018. The Company currently is in a deferred tax asset position. Management has reviewed the deferred tax asset and has determined that the asset will be utilized within the appropriate carry forward period and therefore does not require a valuation allowance.

ASSET/LIABILITY MANAGEMENT

Cash and Cash Equivalents

Cash and cash equivalents increased $12,783,000 from $66,742,000 at December 31, 2018 to $79,525,000 at June 30, 2019, primarily as a result of the following activities during the six months ended June 30, 2019.

Loans Held for Sale

Activity regarding loans held for sale resulted in sales proceeds trailing loan originations, less $663,000 in realized gains, by $49,000 for the six months ended June 30, 2019.

Loans

Gross loans decreased $5,472,000 since December 31, 2018 due primarily to a decrease across all three real estate mortgage categories. The decrease in the real estate mortgage portfolio was partially offset by the growth in the consumer automobile loan segment.

The allocation of the loan portfolio, by category, as of June 30, 2019 and December 31, 2018 is presented below:



	June 30, 2019				December 31, 2018				Change
(In Thousands)	Amount		% Total		Amount		% Total		Amount			%
Commercial, financial, and agricultural	$	191,280	13.87	%	$	188,561	13.62	%	$	2,719		1.44	%
Real estate mortgage:
Residential	618,355		44.83		622,379		44.94		(4,024		)	(0.65	)%
Commercial	359,058		26.03		371,695		26.84		(12,637		)	(3.40	)%
Construction	39,992		2.90		43,523		3.14		(3,531		)	(8.11	)%
Consumer automobile loans	145,516		10.55		133,183		9.63		12,333			9.26	%
Other consumer installment loans	24,089		1.75		24,552		1.77		(463		)	(1.89	)%
Net deferred loan fees and discounts	995		0.07		864		0.06		131			15.16	%
Gross loans	$	1,379,285	100.00	%	$	1,384,757	100.00	%	$	(5,472	)	(0.40	)%

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The following table shows the amount of accrual and non-accrual TDRs at June 30, 2019 and December 31, 2018:



	June 30, 2019						December 31, 2018
(In Thousands)	Accrual		Non-accrual		Total		Accrual		Non-accrual		Total
Commercial, financial, and agricultural	$	—	$	5,131	$	5,131	$	—	$	1,127	$	1,127
Real estate mortgage:
Residential	2,100		156		2,256		2,225		159		2,384
Commercial	2,563		4,912		7,475		3,959		2,129		6,088
	$	4,663	$	10,199	$	14,862	$	6,184	$	3,415	$	9,599

Investments

The fair value of the investment debt securities portfolio at June 30, 2019 increased $11,404,000 since December 31, 2018 while the amortized cost of the portfolio increased $6,620,000. The growth in the investment portfolio has occurred within the municipal segment as bonds with a final maturity of inside of ten years have been purchased. The portfolio continues to be actively managed in order to reduce interest rate and market risk. The unrealized losses within the debt securities portfolio are the result of market activity, not credit issues/ratings, as approximately 79.28% of the debt securities portfolio on an amortized cost basis is currently rated A or higher by either S&P or Moody’s.

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

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

The fair value of the equity portfolio continues to fluctuate as the economic and political environment continues to impact stock pricing. The amortized cost of the available for sale equity securities portfolio has remained flat at $1,628,000 for June 30, 2019 and December 31, 2018 while the fair value increased $65,000 over the same time period.

The distribution of credit ratings by amortized cost and fair values for the debt security portfolio at June 30, 2019 follows:



	A- to AAA				B- to BBB+				Not Rated				Total
(In Thousands)	Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value
Available for sale (AFS):
Mortgage-backed securities	$	5,927	$	5,904	$	—	$	—	$	—	$	—	$	5,927	$	5,904
State and political securities	84,895		88,175		2,183		2,205		—		—		87,078		90,380
Other debt securities	22,247		21,931		19,111		19,201		8,264		8,273		49,622		49,405
Total debt securities AFS	$	113,069	$	116,010	$	21,294	$	21,406	$	8,264	$	8,273	$	142,627	$	145,689

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Financing Activities

Deposits

Total deposits increased $107,183,000 from December 31, 2018 to June 30, 2019. The increase in core deposits (deposits less time deposits) has provided relationship driven funding for the loan and investment portfolios. While deposit gathering efforts have centered on core deposits, the growth of the time deposit portfolio is the result of targeted marketing efforts in select markets. The increase in deposits is the result of our focus on building relationships, not by offering market leading rates.

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



	June 30, 2019				December 31, 2018				Change
(In Thousands)	Amount		% Total		Amount		% Total		Amount			%
Demand deposits	$	322,755	24.32	%	$	320,814	26.30	%	$	1,941		0.61	%
NOW accounts	238,410		17.96		207,819		17.04		30,591			14.72
Money market deposits	238,352		17.96		238,596		19.56		(244		)	(0.10	)
Savings deposits	171,992		12.96		166,063		13.61		5,929			3.57
Time deposits	355,577		26.80		286,611		23.49		68,966			24.06
Total deposits	$	1,327,086	100.00	%	$	1,219,903	100.00	%	$	107,183		8.79	%

Borrowed Funds

Total borrowed funds decreased 30.23%, or $92,757,000, to $214,050,000 at June 30, 2019 compared to $306,807,000 at December 31, 2018. The decrease in total borrowing occurred due to the strong growth in deposits as a funding source as the loan portfolio remained flat. The long-term borrowings originating during the six months ended June 30, 2019 have a blended interest rate of 2.94% and mature by 2024.



	June 30, 2019				December 31, 2018				Change
(In Thousands)	Amount		% Total		Amount		% Total		Amount			%
Short-term borrowings:
FHLB repurchase agreements	$	52,553	24.55	%	$	162,203	52.87	%	$	(109,650	)	(67.60	)%
Securities sold under agreement to repurchase	6,900		3.22		5,662		1.85		1,238			21.87
Total short-term borrowings	59,453		27.77		167,865		54.72		(108,412		)	(64.58	)
Long-term borrowings:
Long-term FHLB borrowings	148,625		69.43		138,625		45.18		10,000			7.21
Long-term finance lease	5,972		2.79		—		—		5,972			n/a
Long-term capital lease	—		—		317		0.10		(317		)	(100.00	)
Total long-term borrowings	154,597		72.23		138,942		45.28		15,655			11.27
Total borrowed funds	$	214,050	100.00	%	$	306,807	100.00	%	$	(92,757	)	(30.23	)%

Short-Term Borrowings

The following table provides further information in regards to secured borrowings that have been accounted for as repurchase agreements.



	Remaining Contractual Maturity Overnight and Continuous
(In Thousands)	June 30, 2019		December 31, 2018
Investment debt securities pledged, fair value	$	9,729	$	8,380
Repurchase agreements	6,900		5,662

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Capital

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

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

Under existing capital rules, the minimum capital to risk-adjusted assets requirements for banking organizations, are a common equity tier 1 capital ratio of 4.5% (6.5% to be considered “well capitalized”), a tier 1 capital ratio of 6.0% (8.0% to be considered “well capitalized”), and total capital ratio of 8.0% (10.0% to be considered “well capitalized”). Under existing capital rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of common equity tier 1 capital above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets. The capital contribution buffer requirements phased in over a three-year period beginning January 1, 2016.

The Company's capital ratios as of June 30, 2019 and December 31, 2018 were as follows:



	June 30, 2019				December 31, 2018
(In Thousands)	Amount		Ratio		Amount		Ratio
Common Equity Tier I Capital (to Risk-weighted Assets)
Actual	$	136,821	10.390	%	$	132,543	10.178	%
For Capital Adequacy Purposes	59,258		4.500		58,601		4.500
Minimum To Maintain Capital Conservation Buffer At Reporting Date	92,180		7.000		83,018		6.375
To Be Well Capitalized	85,595		6.500		84,646		6.500
Total Capital (to Risk-weighted Assets)
Actual	$	147,875	11.230	%	$	142,876	10.972	%
For Capital Adequacy Purposes	105,343		8.000		104,175		8.000
Minimum To Maintain Capital Conservation Buffer At Reporting Date	138,262		10.500		128,591		9.875
To Be Well Capitalized	131,679		10.000		130,219		10.000
Tier I Capital (to Risk-weighted Assets)
Actual	$	136,821	10.390	%	$	132,543	10.178	%
For Capital Adequacy Purposes	79,011		6.000		78,135		6.000
Minimum To Maintain Capital Conservation Buffer At Reporting Date	111,932		8.500		102,552		7.875
To Be Well Capitalized	105,348		8.000		104,180		8.000
Tier I Capital (to Average Assets)
Actual	$	136,821	8.320	%	$	132,543	8.176	%
For Capital Adequacy Purposes	65,779		4.000		64,845		4.000
To Be Well Capitalized	82,224		5.000		81,056		5.000

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Jersey Shore State Bank's capital ratios as of June 30, 2019 and December 31, 2018 were as follows:



	June 30, 2019				December 31, 2018
(In Thousands)	Amount		Ratio		Amount		Ratio
Common Equity Tier I Capital (to Risk-weighted Assets)
Actual	$	96,911	10.056	%	$	94,105	9.879	%
For Capital Adequacy Purposes	43,367		4.500		42,866		4.500
Minimum To Maintain Capital Conservation Buffer At Reporting Date	67,460		7.000		60,727		6.375
To Be Well Capitalized	62,641		6.500		61,917		6.500
Total Capital (to Risk-weighted Assets)
Actual	$	105,673	10.965	%	$	102,534	10.764	%
For Capital Adequacy Purposes	77,098		8.000		76,205		8.000
Minimum To Maintain Capital Conservation Buffer At Reporting Date	101,192		10.500		94,066		9.875
To Be Well Capitalized	96,373		10.000		95,256		10.000
Tier I Capital (to Risk-weighted Assets)	-
Actual	$	96,911	10.056	%	$	94,105	9.879	%
For Capital Adequacy Purposes	57,823		6.000		57,155		6.000
Minimum To Maintain Capital Conservation Buffer At Reporting Date	81,916		8.500		75,015		7.875
To Be Well Capitalized	77,097		8.000		76,206		8.000
Tier I Capital (to Average Assets)
Actual	$	96,911	7.874	%	$	94,105	7.724	%
For Capital Adequacy Purposes	49,231		4.000		48,734		4.000
To Be Well Capitalized	61,539		5.000		60,917		5.000

Luzerne Bank's capital ratios as of June 30, 2019 and December 31, 2018 were as follows:



	June 30, 2019				December 31, 2018
(In Thousands)	Amount		Ratio		Amount		Ratio
Common Equity Tier I Capital (to Risk-weighted Assets)
Actual	$	37,108	10.384	%	$	35,378	10.061	%
For Capital Adequacy Purposes	16,081		4.500		15,824		4.500
Minimum To Maintain Capital Conservation Buffer At Reporting Date	25,015		7.000		22,417		6.375
To Be Well Capitalized	23,228		6.500		22,856		6.500
Total Capital (to Risk-weighted Assets)
Actual	$	39,400	11.026	%	$	37,283	10.603	%
For Capital Adequacy Purposes	28,587		8.000		28,130		8.000
Minimum To Maintain Capital Conservation Buffer At Reporting Date	37,520		10.500		34,723		9.875
To Be Well Capitalized	35,734		10.000		35,163		10.000
Tier I Capital (to Risk-weighted Assets)
Actual	$	37,108	10.384	%	$	35,378	10.061	%
For Capital Adequacy Purposes	21,441		6.000		21,098		6.000
Minimum To Maintain Capital Conservation Buffer At Reporting Date	30,375		8.500		27,691		7.875
To Be Well Capitalized	28,589		8.000		28,131		8.000
Tier I Capital (to Average Assets)
Actual	$	37,108	8.581	%	$	35,378	8.655	%
For Capital Adequacy Purposes	17,298		4.000		16,350		4.000
To Be Well Capitalized	21,622		5.000		20,438		5.000

Liquidity; Interest Rate Sensitivity and Market Risk

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

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The following liquidity measures are monitored for compliance and were within the limits cited, except for net loans to total deposits, at June 30, 2019:

1. Net Loans to Total Assets, 85% maximum

2. Net Loans to Total Deposits, 100% maximum

3. Cumulative 90 day Maturity GAP %, +/- 20% maximum

4. Cumulative 1 Year Maturity GAP %, +/- 25% maximum

Fundamental objectives of the Company’s asset/liability management process are to maintain adequate liquidity while minimizing interest rate risk. The maintenance of adequate liquidity provides the Company with the ability to meet its financial obligations to depositors, loan customers, and shareholders. Additionally, it provides funds for normal operating expenditures and business opportunities as they arise. The objective of interest rate sensitivity management is to increase net interest income by managing interest sensitive assets and liabilities in such a way that they can be repriced in response to changes in market interest rates.

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

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

Management monitors and determines the desirable level of liquidity. Consideration is given to loan demand, investment opportunities, deposit pricing and growth potential, as well as the current cost of borrowing funds. The Company has a total current maximum borrowing capacity at the FHLB of $603,404,000. In addition to this credit arrangement, the Company has additional lines of credit with correspondent banks of $57,000,000. Management believes it has sufficient liquidity to satisfy estimated short-term and long-term funding needs. FHLB borrowings totaled $201,178,000 as of June 30, 2019.

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

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

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

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Interest Rate Sensitivity

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

The following is a rate shock forecast for the twelve month period ending June 30, 2020 assuming a static balance sheet as of June 30, 2019.



	Parallel Rate Shock in Basis Points
(In Thousands)	-200			-100			Static		+100			+200			+300			+400
Net interest income	$	47,706		$	50,569		$	52,948	$	54,710		$	56,391		$	57,898		$	59,444
Change from static	(5,242		)	(2,379		)	—		1,762			3,443			4,950			6,496
Percent change from static	-9.90		%	-4.49		%	—		3.33		%	6.50		%	9.35		%	12.27		%

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

Inflation

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market risk for the Company is comprised primarily of interest rate risk exposure and liquidity risk. Interest rate risk and liquidity risk management is performed at both the level of the Company and the Banks. The Company’s interest rate sensitivity is monitored by management through selected interest rate risk measures produced by an independent third party. There have been no substantial changes in the Company’s gap analysis or simulation analysis compared to the information provided in the Annual Report on Form 10-K for the period ended December 31, 2018. Additional information and details are provided in the “Liquidity, Interest Rate Sensitivity, and Market Risk” section of “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

An analysis was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2019.

Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended June 30, 2019 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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Part II. OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors

There are no material changes to the risk factors set forth in Part I, Item 1A, “Risk Factors,” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. Please refer to that section for disclosures regarding the risks and uncertainties related to the Company’s business.

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

The following table provides certain information with respect to the Company's repurchase of common stock during the quarter ended June 30, 2019.



Period	Total Number of Shares (or Units) Purchased	Average Price Paid per Share (or Units) Purchased	Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs	Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs
Month #1 (April 1 - April 30, 2019)	—	—	—	342,446
Month #2 (May 1 - May 31, 2019)	—	—	—	342,446
Month #3 (June 1 - June 30, 2019)	—	—	—	342,446

On April 29, 2019, the Board of Directors extended the previously approved authorization to repurchase up to 482,000 shares, or approximately 10%, of the outstanding shares of the Company for an additional year to April 30, 2020. As of June 30, 2019 there have been 139,554 shares repurchased under this plan.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

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Item 6. Exhibits



3(i)		Articles of Incorporation of the Registrant, as presently in effect (incorporated by reference to Exhibit 3(i) of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2018).
3(ii)		Bylaws of the Registrant (incorporated by reference to Exhibit 3(ii) of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2011).
10(i)		Amended and Restated Employment Agreement, dated as of July 23, 2019, between Karen S. Young, Penns Woods Bancorp, Inc. and Jersey Shore State Bank.
31(i)		Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Executive Officer.
31(ii)		Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Financial Officer.
32(i)		Section 1350 Certification of Chief Executive Officer.
32(ii)		Section 1350 Certification of Chief Financial Officer.
101		Interactive data file containing the following financial statements formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheet at June 30, 2019 and December 31, 2018; (ii) the Consolidated Statement of Income for the three and six months ended June 30, 2019 and 2018; (iii) Consolidated Statement of Comprehensive Income for the three and six months ended June 30, 2019 and 2018; (iv) the Consolidated Statement of Shareholders’ Equity for the three and six months ended June 30, 2019 and 2018; (v) the Consolidated Statement of Cash Flows for the six months ended June 30, 2019 and 2018 and (vi) the Notes to Consolidated Financial Statements. As provided in Rule 406T of Regulation S-T, this interactive data file shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, and shall not be deemed “filed” or part of any registration statement or prospectus for purposes of Section 11 or 12 under the Securities Act of 1933, or otherwise subject to liability under those sections.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



		PENNS WOODS BANCORP, INC.
		(Registrant)

Date:	August 9, 2019	/s/ Richard A. Grafmyre
		Richard A. Grafmyre, Chief Executive Officer
		(Principal Executive Officer)


Date:	August 9, 2019	/s/ Brian L. Knepp
		Brian L. Knepp, President and Chief Financial Officer
		(Principal Financial Officer and Principal Accounting
		Officer)

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EXHIBIT INDEX



Exhibit 3(i)		Articles of Incorporation of the Registrant, as presently in effect (incorporated by reference to Exhibit 3(i) of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2018).
Exhibit 3(ii)		Bylaws of the Registrant (incorporated by reference to Exhibit 3(ii) of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2011).
10(i)		Amended and Restated Employment Agreement, dated as of July 23, 2019, between Karen S. Young, Penns Woods Bancorp, Inc. and Jersey Shore State Bank.
Exhibit 31(i)		Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Executive Officer
Exhibit 31(ii)		Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Financial Officer
Exhibit 32(i)		Section 1350 Certification of Chief Executive Officer
Exhibit 32(ii)		Section 1350 Certification of Chief Financial Officer
Exhibit 101		Interactive data file containing the following financial statements formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheet at June 30, 2019 and December 31, 2018; (ii) the Consolidated Statement of Income for the three and six months ended June 30, 2019 and 2018; (iii) Consolidated Statement of Comprehensive Income for the three and six months ended June 30, 2019 and 2018; (iv) the Consolidated Statement of Shareholders’ Equity for the three and six months ended June 30, 2019 and 2018; (v) the Consolidated Statement of Cash Flows for the six months ended June 30, 2019 and 2018 and (vi) the Notes to Consolidated Financial Statements. As provided in Rule 406T of Regulation S-T, this interactive data file shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, and shall not be deemed “filed” or part of any registration statement or prospectus for purposes of Section 11 or 12 under the Securities Act of 1933, or otherwise subject to liability under those sections.

Weighted-average term (years)

Weighted-average discount rate