Attached files

file filename
EX-32.2 - EXHIBIT 32.2 - PENNS WOODS BANCORP INCex322-201710xk.htm
EX-32.1 - EXHIBIT 32.1 - PENNS WOODS BANCORP INCex321-201710xk.htm
EX-31.2 - EXHIBIT 31.2 - PENNS WOODS BANCORP INCex312-201710xk.htm
EX-31.1 - EXHIBIT 31.1 - PENNS WOODS BANCORP INCex311-201710xk.htm
EX-23 - EXHIBIT 23 - PENNS WOODS BANCORP INCex23-201710xk.htm
EX-21 - EXHIBIT 21 - PENNS WOODS BANCORP INCex21-201710xk.htm

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC. 20549
 
FORM 10-K
 
ý      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2017
 
OR
 
o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
 
For the transition period from                                to                                
 
Commission file number 0-17077
 
PENNS WOODS BANCORP, INC.
(Exact name of registrant as specified in its charter)
 
Pennsylvania
 
23-2226454
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
300 Market Street, P.O. Box 967
Williamsport, Pennsylvania
 
17703-0967
 
Registrant’s telephone number, including area code (570) 322-1111
 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange which registered
Common Stock, par value $8.33 per share
 
The NASDAQ Stock Market LLC
 
Securities registered pursuant to Section 12(g) of the Act: None

 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes ý No
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes ý No
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, or emerging growth company. See definitions 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 o
 
                 Accelerated filer x
  Non-accelerated filer o
 
Smaller reporting company o
 
 
Emerging growth company o
 

If an emerging growth company, indicate by check mark if registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
  
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes ý No
 
State the aggregate market value of the voting stock held by non-affiliates of the registrant $193,053,570 at June 30, 2017.
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
 
Outstanding at March 1, 2018
Common Stock, $8.33 Par Value
 
4,689,563 Shares
 

DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the registrant’s definitive proxy statement prepared in connection with its annual meeting of shareholders to be held on April 24, 2018 are incorporated by reference in Part III hereof.




INDEX
 
ITEM
 
PAGE
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


PART I
ITEM 1
BUSINESS
 
A. General Development of Business and History
 
On January 7, 1983, Penns Woods Bancorp, Inc. (the “Company”) was incorporated under the laws of the Commonwealth of Pennsylvania as a bank holding company. In connection with the organization of the Company, Jersey Shore State Bank ("JSSB"), a Pennsylvania state-chartered bank, became a wholly owned subsidiary of the Company.  On June 1, 2013, the Company acquired Luzerne Bank ("Luzerne") with Luzerne operating as a subsidiary of the Company (JSSB and Luzerne are collectively referred to as the "Banks"). The Company’s two other wholly-owned subsidiaries are Woods Real Estate Development Company, Inc. and Woods Investment Company, Inc.  The Company is also a partner in United Insurance Solutions, LLC. The Company’s business has consisted primarily of managing and supervising the Banks, and its principal source of income has been dividends paid by the Banks and Woods Investment Company, Inc.
 
The Banks are engaged in commercial and retail banking which includes the acceptance of time, savings, and demand deposits, the funding of commercial, consumer, and mortgage loans, and safe deposit services.  Utilizing a branch office network, ATMs, Internet, and telephone banking delivery channels, the Banks deliver their products and services to the communities they reside in.

In October 2000, JSSB acquired The M Group, Inc. D/B/A The Comprehensive Financial Group (“The M Group”). The M Group, which operates as a subsidiary of JSSB, offers insurance and securities brokerage services. Securities are offered by The M Group through Voya Financial, a registered broker-dealer.

Neither the Company nor the Banks anticipate that compliance with environmental laws and regulations will have any material effect on capital expenditures, earnings, or their competitive position.  The Banks are not dependent on a single customer or a few customers, the loss of whom would have a material effect on the business of the Banks.

JSSB employed 242 persons, Luzerne employed 73 persons, and The M Group employed 4 persons as of December 31, 2017 in either a full-time or part-time capacity.  The Company does not have any employees.  The principal officers of the Banks also serve as officers of the Company.

Woods Investment Company, Inc., a Delaware holding company, maintains an investment portfolio that is managed for total return and to fund dividend payments to the Company.

Woods Real Estate Development Company, Inc. serves the Company through its acquisition and ownership of certain properties utilized by the Bank.
 
United Insurance Solutions, LLC., has been formed and will be offering property and casualty and auto insurance products within the Company's market footprint during 2018.

We post publicly available reports required to be filed with the SEC on our website, www.jssb.com, as soon as reasonably practicable after filing such reports with the SEC.  The required reports are available free of charge through our website.  Information available on our website is not part of or incorporated by reference into this Report or any other report filed by this Company with the SEC.

B. Regulation and Supervision
 
The Company is a registered bank holding company and, as such is subject to the provisions of the Bank Holding Company Act of 1956, as amended (the “BHCA”) and to supervision and examination by the Board of Governors of the Federal Reserve System (the “FRB”).  During 2017, the Company elected to become a financial holding company under the BHCA and the regulations of the FRB. The Banks are also subject to the supervision and examination by the Federal Deposit Insurance Corporation (the “FDIC”), as their primary federal regulator and as the insurer of the Banks' deposits.  The Banks are also regulated and examined by the Pennsylvania Department of Banking and Securities (the “Department”).

The insurance activities of The M Group are subject to regulation by the insurance departments of the various states in which The M Group conducts business, including principally the Pennsylvania Department of Insurance. The securities brokerage activities of The M Group are subject to regulation by federal and state securities commissions.

The insurance activities of United Insurance Solutions, LLC are subject to regulation by the Pennsylvania Department of Insurance.


3


The FRB has issued regulations under the BHCA that require a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks.  As a result, the FRB, pursuant to such regulations, may require the Company to stand ready to use its resources to provide adequate capital funds to the Banks during periods of financial stress or adversity.  The BHCA requires the Company to secure the prior approval of the FRB before it can acquire all or substantially all of the assets of any bank, or acquire ownership or control of 5% or more of any voting shares of any bank.  Such a transaction would also require approval of the Department.

A bank holding company is prohibited under the BHCA from engaging in, or acquiring direct or indirect control of, more than 5% of the voting shares of any company engaged in non-banking activities unless the FRB, by order or regulation, has found such activities to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.  Under the BHCA, the FRB has the authority to require a bank holding company to terminate any activity or relinquish control of a non-bank subsidiary (other than a non-bank subsidiary of a bank) upon the FRB’s determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company.

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

In addition to the risk-based capital guidelines, the FRB requires each bank holding company to comply with the leverage ratio, under which the bank holding company must maintain a minimum level of Tier 1 capital to average total consolidated assets of 4.0% (5.0% to be considered "well capitalized"). The Banks are subject to similar capital requirements adopted by the FDIC.
 
Dividends
 
Federal and state laws impose limitations on the payment of dividends by the Banks.  The Pennsylvania Banking Code restricts the availability of capital funds for payment of dividends by the Banks to their additional paid-in capital.

In addition to the dividend restrictions described above, the banking regulators have the authority to prohibit or to limit the payment of dividends by the Banks if, in the banking regulator’s opinion, payment of a dividend would constitute an unsafe or unsound practice in light of the financial condition of the Banks.

Under Pennsylvania law, the Company may not pay a dividend, if, after giving effect thereto, it would be unable to pay its debts as they become due in the usual course of business and, after giving effect to the dividend, the total assets of the Company would be less than the sum of its total liabilities plus the amount that would be needed, if the Company were to be dissolved at the time of distribution, to satisfy the preferential rights upon dissolution of shareholders whose rights are superior to those receiving the dividend.

It is also the policy of the FRB that a bank holding company generally may only pay dividends on common stock out of net income available to common shareholders over the past twelve months and only if the prospective rate of earnings retention appears consistent with a bank holding company’s capital needs, asset quality, and overall financial condition.  In the current financial and economic environment, the FRB has indicated that bank holding companies should carefully review their dividend policy and has discouraged dividend pay-out ratios at the 100% level unless both asset quality and capital are very strong.  A bank holding company also should not maintain a dividend level that places undue pressure on the capital of such institution’s subsidiaries, or that may undermine the bank holding company’s ability to serve as a source of strength for such subsidiaries.




 

4


C. Regulation of the Banks
 
The Banks are highly regulated by the FDIC and the Department.  The laws that such agencies enforce limit the specific types of businesses in which the Banks may engage, and the products and services that the Banks may offer to customers.  Generally, these limitations are designed to protect the insurance fund of the FDIC and/or the customers of the Banks, and not the Banks or their shareholders.  From time to time, various types of new federal and state legislation have been proposed that could result in additional regulation of, and restrictions on, the business of the Banks. It cannot be predicted whether any such legislation will be adopted or how such legislation would affect business of the Banks.  As a consequence of the extensive regulation of commercial banking activities in the United States, the Banks' business is particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business.  Some of the major regulatory provisions that affect the business of the Banks are discussed briefly below.

Prompt Corrective Action

The FDIC has specified the levels at which an insured institution will be considered “well-capitalized,” “adequately capitalized,” “undercapitalized,” and “critically undercapitalized.” In the event an institution’s capital deteriorates to the “undercapitalized” category or below, the Federal Deposit Insurance Act (the “FDIA”) and FDIC regulations prescribe an increasing amount of regulatory intervention, including: (1) the institution of a capital restoration plan by a bank and a guarantee of the plan by a parent institution and liability for civil money damages for failure to fulfill its commitment on that guarantee; and (2) the placement of a hold on increases in assets, number of branches, or lines of business.  If capital has reached the significantly or critically undercapitalized levels, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management and (in critically undercapitalized situations) appointment of a receiver.  For well-capitalized institutions, the FDIA provides authority for regulatory intervention where the institution is deemed to be engaging in unsafe or unsound practices or receives a less than satisfactory examination report rating for asset quality, management, earnings or liquidity.

Deposit Insurance

The FDIC maintains the Deposit Insurance Fund ("DIF") by assessing depository institutions an insurance premium. The FDIC has set the amount of deposits it insures at $250,000.

As mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the assessment base that the FDIC uses to calculate assessment premiums is a bank’s average assets minus average tangible equity.  The range of assessment rates is a low of 2.5 basis points to a high of 45 basis points, per $100 of assets.

The FDIC is required under the Dodd-Frank Act to establish assessment rates that will allow the DIF to achieve a reserve ratio of 1.35% of insured deposits by September 2020.  In addition, the FDIC has established a “designated reserve ratio” of 2.0%, a target ratio that, until it is achieved, will not likely result in the FDIC reducing assessment rates.  In attempting to achieve the mandated 1.35% ratio, the FDIC is required to implement assessment formulas that charge banks over $10 billion in asset size more than banks under that size.  Under the Dodd-Frank Act, the FDIC is authorized to make reimbursements from the insurance fund to banks if the reserve ratio exceeds 1.50%, but the FDIC has adopted the “designated reserve ratio” of 2.0% and has announced that any reimbursements from the fund are indefinitely suspended.

Federal Home Loan Bank System

The Banks are members of the Federal Home Loan Bank of Pittsburgh (the “FHLB”), which is one of 12 regional Federal Home Loan Banks. Each Federal Home Loan Bank serves as a reserve or central bank for its members within its assigned region.  It is funded primarily from funds deposited by member institutions and proceeds from the sale of consolidated obligations of the Federal Home Loan Bank System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of directors of the Federal Home Loan Bank.  At December 31, 2017, the Banks had $70,625,000 in FHLB advances.

As a member, the Banks are required to purchase and maintain stock in the FHLB. The amount of required stock varies based on the FHLB products utilized by the Banks and the amount of the products utilized.  At December 31, 2017, the Banks had $12,826,600 in stock of the FHLB, which was in compliance with this requirement.







5


Other Legislation

The 2010 Dodd-Frank Act significantly changed the bank regulatory structure and affected the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies.  The federal agencies are given significant discretion in drafting rules and regulations to implement the Dodd-Frank Act, and consequently, much of the impact of the Dodd-Frank Act may not be known for some time.

Certain provisions of the Dodd-Frank Act have already impacted the Company. For example, effective July 21, 2011, a provision of the Dodd-Frank Act eliminated the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts. Depending on competitive responses, this significant change to existing law could have an adverse impact on the Company’s interest expense. The Dodd-Frank Act also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008.

Bank and thrift holding companies with assets of less than $15 billion as of December 31, 2009, such as the Company, will be permitted to include trust preferred securities that were issued before May 19, 2010, as Tier 1 capital; however, trust preferred securities issued by a bank or thrift holding company (other than those with assets of less than $500 million) after May 19, 2010, will no longer count as Tier 1 capital. Trust preferred securities still will be entitled to be treated as Tier 2 capital.

The Dodd-Frank Act requires publicly traded companies to give shareholders a non-binding vote on executive compensation and so-called “golden parachute” arrangements, and may allow greater access by shareholders to the company’s proxy material by authorizing the SEC to promulgate rules that would allow shareholders to nominate their own candidates using a company’s proxy materials. The legislation also directs the FRB to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded.

The Dodd-Frank Act created a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets such as the Banks will continue to be examined for compliance with the consumer laws by their primary bank regulators. The Dodd-Frank Act also weakens the federal preemption rules that have been applicable for national banks and federal savings associations, and gives state attorneys general the ability to enforce federal consumer protection laws.

The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements.

The Sarbanes-Oxley Act of 2002 was enacted to enhance penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures under the federal securities laws.  The Sarbanes-Oxley Act generally applies to all companies, including the Company, that file or are required to file periodic reports with the Securities and Exchange Commission under the Securities Exchange Act of 1934, or the Exchange Act.  The legislation includes provisions, among other things, governing the services that can be provided by a public company’s independent auditors and the procedures for approving such services, requiring the chief executive officer and principal accounting officer to certify certain matters relating to the company’s periodic filings under the Exchange Act, requiring expedited filings of reports by insiders of their securities transactions and containing other provisions relating to insider conflicts of interest, increasing disclosure requirements relating to critical financial accounting policies and their application, increasing penalties for securities law violations, and creating a new public accounting oversight board, a regulatory body subject to SEC jurisdiction with broad powers to set auditing, quality control, and ethics standards for accounting firms.  In response to the legislation, the national securities exchanges and NASDAQ have adopted new rules relating to certain matters, including the independence of members of a company’s audit committee as a condition to listing or continued listing.

Congress is often considering financial industry legislation, and the federal banking agencies routinely propose new regulations.  The Company cannot predict how any new legislation, or new rules adopted by federal or state banking agencies, may affect the business of the Company and its subsidiaries in the future.





6


Environmental Laws

Environmentally related hazards have become a source of high risk and potential liability for financial institutions relating to their loans. Environmentally contaminated properties owned by an institution’s borrowers may result in a drastic reduction in the value of the collateral securing the institution’s loans to such borrowers, high environmental clean up costs to the borrower affecting its ability to repay the loans, the subordination of any lien in favor of the institution to a state or federal lien securing clean up costs, and liability to the institution for clean up costs if it forecloses on the contaminated property or becomes involved in the management of the borrower. The Company is not aware of any borrower who is currently subject to any environmental investigation or clean up proceeding which is likely to have a material adverse effect on the financial condition or results of operations of the Company.

Effect of Government Monetary Policies

The earnings of the Company are and will be affected by domestic economic conditions and the monetary and fiscal policies of the United States Government and its agencies.   The monetary policies of the FRB have had, and will likely continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The FRB has a major effect upon the levels of bank loans, investments, and deposits through its open market operations in the United States Government securities and through its regulation of, among other things, the discount rate on borrowings by member banks and the reserve requirements against member bank deposits.  It is not possible to predict the nature and impact of future changes in monetary and fiscal policies.
 
DESCRIPTION OF THE BANKS
 
History and Business
 
JSSB was incorporated under the laws of the Commonwealth of Pennsylvania as a state bank in 1934 and became a wholly owned subsidiary of the Company on July 12, 1983. As of December 31, 2017, JSSB had total assets of $1,092,014,000; total shareholders’ equity of $86,112,000; and total deposits of $809,955,000. JSSB's deposits are insured by the FDIC for the maximum amount provided under current law.

Luzerne was acquired by the Company on June 1, 2013. As of December 31, 2017, Luzerne had total assets of $398,786,000; total shareholders’ equity of $45,525,000; and total deposits of $338,121,000. Luzerne's deposits are insured by the FDIC for the maximum amount provided under current law.

The Banks engage in business as commercial banks, doing business at locations in Lycoming, Clinton, Centre, Montour, Union and Luzerne Counties, Pennsylvania.  The Banks offer insurance, securities brokerage services, annuity and mutual fund investment products, and financial planning through the M Group.

Services offered by the Banks include accepting time, demand and savings deposits including Super NOW accounts, statement savings accounts, money market accounts, and fixed rate certificates of deposit.  Their services also include making secured and unsecured business and consumer loans that include financing commercial transactions as well as construction and residential mortgage loans and revolving credit loans with overdraft protection.

The Banks' loan portfolio mix can be classified into three principal categories: commercial and agricultural, real estate, and consumer.  Real estate loans can be further segmented into residential, commercial, and construction.  Qualified borrowers are defined by our loan policy and our underwriting standards. Owner provided equity requirements range from 0% to 35%, depending on the collateral offered for the loan.  Terms are generally restricted to 30 years or less with the exception of construction and land development, which are generally limited to one and five years, respectively.  Real estate appraisals, property construction verifications, and site visitations comply with our loan policy and with industry regulatory standards.
 
Prospective residential mortgage customer’s repayment ability is determined from information contained in the application and recent income tax returns, or other verified income sources.  Emphasis is on credit, employment, income, and residency verification.  Broad hazard insurance is always required and flood insurance where applicable.  In the case of construction mortgages, builders risk insurance is requested.
 
Agricultural loans for the purchase or improvement of real estate must meet the Banks' real estate underwriting criteria.  Agricultural loans made for the purchase of equipment are usually payable in five years, but never more than ten, depending upon the useful life of the purchased asset. Minimum borrower equity ranges from 0% to 35% depending on the purpose.  Livestock financing criteria depends upon the nature of the operation. Agricultural loans are also made for crop production purposes.  Such loans are structured to repay within the production cycle and not carried over into a subsequent year.

7


 
Commercial loans are made for the acquisition and improvement of real estate, purchase of equipment, and for working capital purposes on a seasonal or revolving basis.  General purpose working capital loans are also available with repayment expected within one year.  Equipment loans are generally amortized over three to ten years. Insurance coverage with the Banks as loss payee is required, especially in the case where the equipment is rolling stock.  It is also a general policy to collateralize non-real estate loans with the asset purchased and, depending upon loan terms, junior liens are filed on other available assets.  Financial information required on all commercial mortgages includes the most current three years balance sheets and income statements and projections on income to be developed through the project. In the case of corporations and partnerships, the principals are often asked to personally guaranty the entity’s debt.
 
Seasonal and revolving lines of credit are offered for working capital purposes.  Collateral for such a loan may vary but often includes the pledge of inventory and/or receivables.  Drawing availability is usually 50% of inventory and 80% of eligible receivables.  Eligible receivables are defined as invoices less than 90 days delinquent.  Exclusive reliance is very seldom placed on such collateral; therefore, other lienable assets are also taken into the collateral pool.  Where reliance is placed on inventory and accounts receivable, the applicant must provide financial information including agings on a specified basis.  In addition, the guaranty of the principals is usually obtained.
 
Letter of credit availability is usually limited to standby or performance letters of credit where the customer is well known to the Banks.  The credit criteria is the same as that utilized in making a direct loan. Collateral is obtained in most cases.
 
Consumer loan products include residential mortgages, home equity loans and lines, automobile financing, personal loans and lines of credit, overdraft and check lines.  Our policy includes standards used in the industry on debt service ratios and terms are consistent with prudent underwriting standards and the use of proceeds. Verifications are made of employment and residency, along with credit history.
 
Second mortgages are confined to equity borrowing and home improvements.  Terms are generally fifteen years or less.  Loan to collateral value criteria is 90% or less and verifications are made to determine values.   Automobile financing is generally restricted to five years and done on both an indirect and direct basis.  The Banks, as a practice, do not floor plan and therefore do not discount dealer paper.  Small loan requests are to accommodate personal needs such as debt consolidation or the purchase of small appliances.  Overdraft check lines are usually limited to $5,000 or less.

The Banks' investment portfolios are analyzed and priced on a monthly basis. Investments are made in U.S. Treasuries, U.S. Agency issues, bank qualified tax-exempt municipal bonds, taxable municipal bonds, corporate bonds, and corporate stocks which consist of Pennsylvania bank stocks.  Bonds with BBB or better ratings are used, unless a local issue is purchased that has a lesser or no rating.  Factors taken into consideration when investments are purchased include liquidity, the Company’s tax position, tax equivalent yield, third party investment ratings, and the policies of the Asset/Liability Committee.

The banking environment in Lycoming, Clinton, Centre, Montour, Union and Luzerne Counties, Pennsylvania is highly competitive.  The Banks operate twenty-five full service offices in these markets and compete for loans and deposits with numerous commercial banks, savings and loan associations, and other financial institutions. The economic base of the region is developed around small business, health care, educational facilities (college and public schools), light manufacturing industries, and agriculture.

The Banks have a relatively stable deposit base and no material amount of deposits is obtained from a single depositor or group of depositors, excluding public entities that account for approximately 11% of total deposits.  Although the Banks have regular opportunities to bid on pools of funds of $100,000 or more in the hands of municipalities, hospitals, and others, it does not rely on these monies to fund loans or intermediate or longer-term investments.

The Banks have not experienced any significant seasonal fluctuations in the amount of deposits. The Banks have experienced an outflow of deposits related to municipalities and school districts due to the ongoing Commonwealth of Pennsylvania budget impasse.
 
Supervision and Regulation
 
As referenced elsewhere, the banking business is highly regulated, and the Banks are only able to engage in business activities, and to provide products and services, that are permitted by applicable law and regulation.  In addition, the earnings of the Banks are affected by the policies of regulatory authorities including the FDIC and the FRB. An important function of the FRB is to regulate the money supply and interest rates.  Among the instruments used to implement these objectives are open market operations in U.S. Government Securities, changes in reserve requirements against member bank deposits, and limitations on interest rates

8


that member banks may pay on time and savings deposits.  These instruments are used in varying combinations to influence overall growth and distribution of bank loans, and their use may also affect interest rates charged on loans or paid for deposits.

The policies and regulations of the FRB have had and will probably continue to have a significant effect on the Banks' deposits, loans and investment growth, as well as the rate of interest earned and paid, and are expected to affect the Banks' operation in the future. The effect of such policies and regulations upon the future business and earnings of the Banks cannot accurately be predicted.

ITEM 1A
RISK FACTORS

The following sets forth several risk factors that may affect the Company's financial condition or results of operations.

Changes in interest rates could reduce our income, cash flows and asset values.
 
Our income and cash flows and the value of our assets depend to a great extent on the difference between the interest rates we earn on interest-earning assets, such as loans and investment securities, and the interest rates we pay on interest-bearing liabilities such as deposits and borrowings.  These rates are highly sensitive to many factors which are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System. Changes in monetary policy, including changes in interest rates, will influence not only the interest we receive on our loans and investment securities and the amount of interest we pay on deposits and borrowings but will also affect our ability to originate loans and obtain deposits and the value of our investment portfolio.  If the rate of interest we pay on our deposits and other borrowings increases more than the rate of interest we earn on our loans and other investments, our net interest income, and therefore our earnings, could be adversely affected.  Our earnings also could be adversely affected if the rates on our loans and other investments fall more quickly than those on our deposits and other borrowings.

Economic conditions either nationally or locally in areas in which our operations are concentrated may adversely affect our business.

Deterioration in local, regional, national, or global economic conditions could cause us to experience a reduction in deposits and new loans, an increase in the number of borrowers who default on their loans, and a reduction in the value of the collateral securing their loans, all of which could adversely affect our performance and financial condition. Unlike larger banks that are more geographically diversified, we provide banking and financial services locally. Therefore, we are particularly vulnerable to adverse local economic conditions.

Our financial condition and results of operations would be adversely affected if our allowance for loan losses is not sufficient to absorb actual losses or if we are required to increase our allowance.

Despite our underwriting criteria, we may experience loan delinquencies and losses.  In order to absorb losses associated with nonperforming loans, we maintain an allowance for loan losses based on, among other things, historical experience, an evaluation of economic conditions, and regular reviews of delinquencies and loan portfolio quality.  Determination of the allowance inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes.  At any time there are likely to be loans in our portfolio that will result in losses but that have not been identified as nonperforming or potential problem credits. We cannot be sure that we will be able to identify deteriorating credits before they become nonperforming assets or that we will be able to limit losses on those loans that are identified. We may be required to increase our allowance for loan losses for any of several reasons.  Federal regulators, in reviewing our loan portfolio as part of a regulatory examination, may request that we increase our allowance for loan losses.  Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in our allowance.  In addition, if charge-offs in future periods exceed our allowance for loan losses, we will need additional increases in our allowance for loan losses.  Any increases in our allowance for loan losses will result in a decrease in our net income and, possibly, our capital, and may materially affect our results of operations in the period in which the allowance is increased.

Many of our loans are secured, in whole or in part, with real estate collateral which is subject to declines in value.

In addition to considering the financial strength and cash flow characteristics of a borrower, we often secure our loans with real estate collateral. Real estate values and the real estate market are generally affected by, among other things, changes in local, regional or national economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax laws and other governmental statutes, regulations and policies, and acts of nature.  The real estate collateral provides an alternate source of repayment in the event of default by the borrower.  If real estate prices in our markets decline, the value of the

9


real estate collateral securing our loans could be reduced. If we are required to liquidate real estate collateral securing loans during a period of reduced real estate values to satisfy the debt, our earnings and capital could be adversely affected.

Our information systems may experience an interruption or breach in security.
We rely heavily on communications and information systems to conduct our business.  Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer-relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur; or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny or expose us to civil litigation and possible financial liability; any of which could have a material adverse effect on our financial condition and results of operations.

We face the risk of cyber-attack to our computer systems.

Our computer systems, software and networks have been and will continue to be vulnerable to unauthorized access, loss or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses or other malicious code, cyber-attacks and other events. These threats may derive from human error, fraud or malice on the part of employees or third parties, or may result from accidental technological failure. If one or more of these events occurs, it could result in the disclosure of confidential client information, damage to our reputation with our clients and the market, additional costs to us (such as repairing systems or adding new personnel or protection technologies), regulatory penalties and financial losses, to both us and our clients and customers. Such events could also cause interruptions or malfunctions in our operations (such as the lack of availability of our online banking system), as well as the operations of our clients, customers or other third parties. Although we maintain safeguards to protect against these risks, there can be no assurance that we will not suffer losses in the future that may be material in amount.

Competition may decrease our growth or profits.

We face substantial competition in all phases of our operations from a variety of different competitors, including commercial banks, savings and loan associations, mutual savings banks, credit unions, consumer finance companies, factoring companies, leasing companies, insurance companies, and money market mutual funds.  There is very strong competition among financial services providers in our principal service area.  Our competitors may have greater resources, higher lending limits, or larger branch systems than we do.  Accordingly, they may be able to offer a broader range of products and services as well as better pricing for those products and services than we can.

In addition, some of the financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on federally insured financial institutions.  As a result, those non-bank competitors may be able to access funding and provide various services more easily or at less cost than we can, adversely affecting our ability to compete effectively.

The value of certain investment securities is volatile and future declines or other-than-temporary impairments could materially adversely affect our future earnings and regulatory capital.

Continued volatility in the market value for certain of our investment securities, whether caused by changes in market perceptions of credit risk, as reflected in the expected market yield of the security, or actual defaults in the portfolio could result in significant fluctuations in the value of the securities. This could have a material adverse impact on our accumulated other comprehensive income/loss and shareholders’ equity depending on the direction of the fluctuations. Furthermore, future downgrades or defaults in these securities could result in future classifications of investment securities as other than temporarily impaired. This could have a material impact on our future earnings.

We may be adversely affected by government regulation.

The banking industry is heavily regulated. Banking regulations are primarily intended to protect the federal deposit insurance funds and depositors, not shareholders. Changes in the laws, regulations, and regulatory practices affecting the banking industry may increase our costs of doing business or otherwise adversely affect us and create competitive advantages for others. Regulations affecting banks and financial services companies undergo continuous change, and we cannot predict the ultimate effect of these changes, which could have a material adverse effect on our profitability or financial condition.


10


In response to the financial crisis that commenced in 2008, Congress has taken actions that are intended to strengthen confidence and encourage liquidity in financial institutions, and the FDIC has taken actions to increase insurance coverage on deposit accounts.  The Dodd-Frank Act provides for the creation of a consumer protection division at the Board of Governors of the Federal Reserve System that will have broad authority to issue regulations governing the services and products we provide consumers.  This additional regulation could increase our compliance costs and otherwise adversely impact our operations.  That legislation also contains provisions that, over time, could result in higher regulatory capital requirements (including through the implementation of the capital standards of Basel III) and loan loss provisions for the Banks, and may increase interest expense due to the ability granted in July 2011 to pay interest on all demand deposits.  In addition, there have been proposals made by members of Congress and others that would reduce the amount delinquent borrowers are otherwise contractually obligated to pay under their mortgage loans and limit an institution’s ability to foreclose on mortgage collateral.  These proposals could result in credit losses or increased expense in pursuing our remedies as a creditor. 

The potential exists for additional federal or state laws and regulations, or changes in policy, affecting many aspects of our operations, including capital levels, lending and funding practices, and liquidity standards.  New laws and regulations may increase our costs of regulatory compliance and of doing business and otherwise affect our operations, and may significantly affect the markets in which we do business, the markets for and value of our loans and investments, the fees we can charge and our ongoing operations, costs and profitability.

We rely on our management and other key personnel, and the loss of any of them may adversely affect our operations.

We are and will continue to be dependent upon the services of our executive management team. In addition, we will continue to depend on our ability to retain and recruit key commercial loan officers. The unexpected loss of services of any key management personnel or commercial loan officers could have an adverse effect on our business and financial condition because of their skills, knowledge of our market, years of industry experience, and the difficulty of promptly finding qualified replacement personnel.

Environmental liability associated with lending activities could result in losses.

In the course of our business, we may foreclose on and take title to properties securing our loans.  If hazardous substances were discovered on any of these properties, we could be liable to governmental entities or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage.  Many environmental laws can impose liability regardless of whether we knew of, or were responsible for, the contamination.  In addition, if we arrange for the disposal of hazardous or toxic substances at another site, we may be liable for the costs of cleaning up and removing those substances from the site even if we neither own nor operate the disposal site.  Environmental laws may require us to incur substantial expenses and may materially limit use of properties we acquire through foreclosure, reduce their value or limit our ability to sell them in the event of a default on the loans they secure.  In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability.

Failure to implement new technologies in our operations may adversely affect our growth or profits.

The market for financial services, including banking services and consumer finance services, is increasingly affected by advances in technology, including developments in telecommunications, data processing, computers, automation, Internet-based banking, and telebanking. Our ability to compete successfully in our markets may depend on the extent to which we are able to exploit such technological changes. However, we can provide no assurance that we will be able to properly or timely anticipate or implement such technologies or properly train our staff to use such technologies.  Any failure to adapt to new technologies could adversely affect our business, financial condition, or operating results.

The Company is required to adopt the FASB's accounting standard which requires measurement of certain financial assets (including loans) using the current expected credit losses (CECL) beginning in calendar year 2020.
Current GAAP requires an incurred loss methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. The FASB's amendment replaces the current incurred loss methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonableness and supportable information to inform credit loss estimates. The Company is in the process of evaluating the impact of the adoption of this guidance on the Company's financial statements; however, it is anticipated that the allowance will increase upon the adoption of CECL and that the increased allowance level will have the effect of decreasing shareholders' equity and the Company's and Bank's regulatory capital ratios.


11


The effects of the Tax Cuts and Jobs Act of 2017 on our business have not yet been fully analyzed and could have an adverse effect on our net income.
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 was enacted into law. The Tax Cuts and Jobs Act makes significant changes to U.S. corporate income tax laws including a decrease in the corporate income tax rate from 35% to 21% effective January 1, 2018. As a result of the Tax Cuts and Jobs Act, the Company recorded an additional provisional income tax expense of $2,724,000 in the fourth quarter of 2017 due to a remeasurement of the Company’s deferred tax assets and liabilities. Reasonable estimates were made based on the Company’s analysis of the Tax Cuts and Jobs Act. This provisional amount may be adjusted in future periods during 2018 when additional information is obtained. Additional information that may affect the Company’s provisional amount would include further clarification and guidance on how the IRS will implement tax reform, further clarification and guidance on how state taxing authorities will implement tax reform and the related effect on the Company’s state income tax returns, completion of the Company’s 2017 tax return filings, and the potential for additional guidance from the SEC or the FASB related to the Tax Cuts and Jobs Act. The Company cannot determine at this time the full effects of the Tax Act on its business and financial results.
An investment in our common stock is not an insured deposit.

Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund, or by any other public or private entity.  Investment in our common stock is subject to the same market forces that affect the price of common stock in any company.

ITEM 1B
UNRESOLVED STAFF COMMENTS
 
None.
 
ITEM 2
PROPERTIES
 
The Company owns or leases its properties.  Listed herewith are the locations of properties owned or leased as of December 31, 2017, in which the banking offices are located; all properties are in good condition and adequate for the Company's purposes:


12


Jersey Shore State Bank & Subsidiaries
Office
 
Address
 
Ownership
Main Street
 
115 South Main Street, PO Box 5098
 
Owned
 
 
Jersey Shore, Pennsylvania 17740
 
 
 
 
 
 
 
Bridge Street
 
112 Bridge Street
 
Owned
 
 
Jersey Shore, Pennsylvania 17740
 
 
 
 
 
 
 
DuBoistown
 
2675 Euclid Avenue
 
Owned
 
 
Williamsport, Pennsylvania 17702
 
 
 
 
 
 
 
Williamsport
 
300 Market Street
 
Owned
 
 
P.O. Box 967
 
 
 
 
Williamsport, Pennsylvania 17703-0967
 
 
 
 
 
 
 
Montgomery
 
9094 Rt. 405 Highway
 
Owned
 
 
Montgomery, Pennsylvania 17752
 
 
 
 
 
 
 
Lock Haven
 
4 West Main Street
 
Owned
 
 
Lock Haven, Pennsylvania 17745
 
 
 
 
 
 
 
Mill Hall
 
(Inside Wal-Mart), 173 Hogan Boulevard
 
Under Lease
 
 
Mill Hall, Pennsylvania 17751
 
 
 
 
 
 
 
Spring Mills
 
3635 Penns Valley Road, P.O. Box 66
 
Under Lease
 
 
Spring Mills, Pennsylvania 16875
 
 
 
 
 
 
 
Centre Hall
 
2842 Earlystown Road
 
Land Under Lease
 
 
Centre Hall, Pennsylvania 16828
 
 
 
 
 
 
 
Zion
 
100 Cobblestone Road
 
Under Lease
 
 
Bellefonte, Pennsylvania 16823
 
 
 
 
 
 
 
State College
 
2050 North Atherton Street
 
Land Under Lease
 
 
State College, Pennsylvania 16803
 
 
 
 
 
 
 
Montoursville
 
820 Broad Street
 
Under Lease
 
 
Montoursville, Pennsylvania 17754
 
 
 
 
 
 
 
Danville
 
150 Continental Boulevard
 
Under Lease
 
 
Danville, Pennsylvania 17821
 
 
 
 
 
 
 
Loyalsock
 
1720 East Third Street
 
Owned
 
 
Williamsport, PA 17701
 
 
 
 
 
 
 
Lewisburg
 
550 North Derr Drive
 
Land Under Lease
 
 
Lewisburg, PA 17837
 
 
 
 
 
 
 
Muncy-Hughesville
 
3081 Route 405 Highway
 
Owned
 
 
Muncy, PA 17756
 
 
 
 
 
 
 
Mansfield Mortgage Office
 
102 West Wellsboro Street, Suite 2
 
Under Lease
 
 
Mansfield, PA 16933
 
 
 
 
 
 
 
The M Group, Inc.
 
1720 East Third Street

 
Owned
D/B/A The Comprehensive Financial Group
 
Williamsport, PA 17701

 
 


13


Luzerne Bank
Office
 
Address
 
Ownership
Dallas
 
509 Main Road
 
Owned
 
 
Memorial Highway
 
 
 
 
Dallas, PA 18612
 
 
 
 
 
 
 
Lake
 
Corners of Rt. 118 & 415
 
Owned
 
 
Dallas, PA 18612
 
 
 
 
 
 
 
Hazle Twp.
 
10 Dessen Drive
 
Owned
 
 
Hazle Twp., PA 18202
 
 
 
 
 
 
 
Luzerne
 
118 Main Street
 
Owned
 
 
Luzerne, PA 18709
 
 
 
 
 
 
 
Plains
 
1077 Hwy. 315
 
Under Lease
 
 
Wilkes Barre, PA 18702
 
 
 
 
 
 
 
Swoyersville
 
801 Main Street
 
Owned
 
 
Swoyersville, PA 18704
 
 
 
 
 
 
 
Wilkes-Barre
 
67 Public Square
 
Under Lease
 
 
Wilkes-Barre, PA 18701
 
 
 
 
 
 
 
Wyoming
 
324 Wyoming Ave.
 
Owned
 
 
Wyoming, PA 18644
 
 
 
 
 
 
 
Conyngham Valley
 
669 State Route 93 STE 5
 
Under Lease
 
 
Sugarloaf, PA 18249
 
 

ITEM 3
LEGAL PROCEEDINGS
 
The Company is subject to lawsuits and claims arising out of its business in the ordinary course.  In the opinion of management, after review and consultation with counsel, there are no legal proceedings currently pending or threatened that are reasonably likely to have a material adverse effect on the consolidated financial position or results of operations of the Company.

ITEM 4 
MINE SAFETY DISCLOSURES
 
Not applicable.
 
PART II
 
ITEM 5
MARKET FOR THE REGISTRANT’S COMMON STOCK, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
 
The Company’s common stock is listed on the NASDAQ Global Select Market under the symbol “PWOD”.  The following table sets forth (1) the quarterly high and low closing sale prices for a share of the Company’s common stock during the periods indicated, and (2) quarterly dividends on a share of the common stock with respect to each quarter since January 1, 2015. 

14


 
Price Range
 
Dividends
 
High
 
Low
 
Declared
2017
 

 
 

 
 

First quarter
$
49.45

 
$
43.28

 
$
0.47

Second quarter
43.60

 
38.17

 
0.47

Third quarter
46.47

 
41.08

 
0.47

Fourth quarter
49.79

 
45.65

 
0.47

2016
 

 
 

 
 

First quarter
$
41.32

 
$
36.73

 
$
0.47

Second quarter
44.70

 
37.82

 
0.47

Third quarter
44.75

 
40.34

 
0.47

Fourth quarter
52.03

 
41.00

 
0.47

2015
 

 
 

 
 

First quarter
$
48.91

 
$
44.41

 
$
0.47

Second quarter
48.28

 
41.84

 
0.47

Third quarter
44.56

 
40.41

 
0.47

Fourth quarter
45.28

 
40.47

 
0.47

 
The Company has paid dividends since the effective date of its formation as a bank holding company.  It is the present intention of the Company’s board of directors to continue the dividend payment policy; however, further dividends must necessarily depend upon earnings, financial condition, appropriate legal restrictions, and other factors relevant at the time the board of directors of the Company considers dividend policy.  Cash available for dividend distributions to shareholders of the Company primarily comes from dividends paid by Jersey Shore State Bank and Luzerne Bank to the Company. Therefore, the restrictions on the Banks' dividend payments are directly applicable to the Company.  See also the information appearing in Note 20 to “Notes to Consolidated Financial Statements” for additional information related to dividend restrictions.

Under the Pennsylvania Business Corporation Law of 1988 a corporation may not pay a dividend, if after giving effect thereto, the corporation would be unable to pay its debts as they become due in the usual course of business and after giving effect thereto the total assets of the corporation would be less than the sum of its total liabilities plus the amount that would be needed, if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of the shareholders whose preferential rights are superior to those receiving the dividend.

As of March 1, 2017, the Company had approximately 1,285 shareholders of record.

Following is a schedule of the shares of the Company’s common stock purchased by the Company during the fourth quarter of 2017.
Period
 
Total
Number of
Shares (or
Units)
Purchased
 
Average
Price Paid
per Share
(or Units)
Purchased
 
Total Number of
Shares (or Units)
Purchased as Part of
Publicly Announced
Plans or Programs
 
Maximum Number (or
Approximate Dollar Value)
of Shares (or Units) that
May Yet Be Purchased
Under the Plans or Programs
Month #1 (October 1 - October 31, 2017)
 

 
$

 

 
342,446

Month #2 (November 1 - November 30, 2017)
 

 

 

 
342,446

Month #3 (December 1 - December 31, 2017)
 

 

 

 
342,446

 
Set forth below is a line graph comparing the yearly dollar changes in the cumulative shareholder return on the Company’s common stock against the cumulative total return of the S&P 500 Stock Index, NASDAQ Composite, Russell 2000, and SNL U.S. Bank NASDAQ Index for the period of five fiscal years assuming the investment of $100.00 on December 31, 2012 and assuming the reinvestment of dividends. The shareholder return shown on the graph below is not necessarily indicative of future performance.


15


chart-bf7b32e07bcc54b2bb6.jpg
 
 
Period Ending
Index
 
12/31/2012

 
12/31/2013

 
12/31/2014

 
12/31/2015

 
12/31/2016

 
12/31/2017

Penns Woods Bancorp, Inc.
 
100.00

 
143.07

 
143.94

 
129.53

 
160.84

 
153.22

S&P 500
 
100.00

 
132.39

 
150.51

 
152.59

 
170.84

 
208.14

NASDAQ Composite
 
100.00

 
140.12

 
160.78

 
171.97

 
187.22

 
242.71

SNL U.S. Bank NASDAQ
 
100.00

 
143.73

 
148.86

 
160.70

 
222.81

 
234.58

Russell 2000
 
100.00

 
138.82

 
145.62

 
139.19

 
168.85

 
193.58



16


ITEM 6
SELECTED FINANCIAL DATA
 
The following table sets forth certain financial data for each of the years in the five-year period ended December 31, 2017:

(In Thousands, Except Per Share Data Amounts)
 
2017
 
2016
 
2015
 
2014
 
2013
Consolidated Statement of Income Data:
 
 

 
 

 
 

 
 

 
 

Interest income
 
$
49,977

 
$
46,813

 
$
46,124

 
$
45,606

 
$
43,299

Interest expense
 
5,897

 
5,567

 
5,219

 
4,962

 
5,264

Net interest income
 
44,080

 
41,246

 
40,905

 
40,644

 
38,035

Provision for loan losses
 
730

 
1,196

 
2,300

 
2,850

 
2,275

Net interest income after provision for loan losses
 
43,350

 
40,050

 
38,605

 
37,794

 
35,760

Non-interest income
 
10,744

 
12,113

 
12,765

 
14,508

 
12,042

Non-interest expense
 
36,862

 
35,091

 
33,736

 
33,890

 
30,267

Income before income tax provision
 
17,232

 
17,072

 
17,634

 
18,412

 
17,535

Income tax provision
 
7,459

 
4,597

 
3,736

 
3,804

 
3,451

Net income
 
$
9,773

 
$
12,475

 
$
13,898

 
$
14,608

 
$
14,084

 
 
 
 
 
 
 
 
 
 
 
Consolidated Balance Sheet at End of Period:
 
 

 
 

 
 

 
 

 
 

Total assets
 
$
1,474,492

 
$
1,348,590

 
$
1,320,057

 
$
1,245,011

 
$
1,211,995

Loans
 
1,246,614

 
1,093,681

 
1,045,207

 
915,579

 
818,344

Allowance for loan losses
 
(12,858
)
 
(12,896
)
 
(12,044
)
 
(10,579
)
 
(10,144
)
Deposits
 
1,146,320

 
1,095,214

 
1,031,880

 
981,419

 
973,002

Long-term debt
 
70,970

 
85,998

 
91,025

 
71,176

 
71,202

Shareholders’ equity
 
138,192

 
138,249

 
136,279

 
135,967

 
127,815

 
 
 
 
 
 
 
 
 
 
 
Per Share Data:
 
 

 
 

 
 

 
 

 
 

Earnings per share - basic
 
$
2.08

 
$
2.64

 
$
2.91

 
$
3.03

 
$
3.19

Earnings per share - diluted
 
2.08

 
2.64

 
2.91

 
3.03

 
3.19

Cash dividends declared
 
1.88

 
1.88

 
1.88

 
1.88

 
2.13

Book value
 
29.47

 
29.20

 
28.71

 
28.30

 
26.52

Number of shares outstanding, at end of period
 
4,689,189

 
4,734,657

 
4,747,132

 
4,804,815

 
4,819,333

Weighted average number of shares outstanding - basic and diluted
 
4,705,602

 
4,735,457

 
4,772,239

 
4,816,149

 
4,410,626

 
 
 
 
 
 
 
 
 
 
 
Selected Financial Ratios:
 
 

 
 

 
 

 
 

 
 

Return on average shareholders’ equity
 
6.91
%
 
8.96
%
 
10.11
%
 
10.79
%
 
12.36
%
Return on average total assets
 
0.69
%
 
0.93
%
 
1.08
%
 
1.19
%
 
1.32
%
Net interest margin
 
3.47
%
 
3.44
%
 
3.61
%
 
3.81
%
 
4.13
%
Dividend payout ratio
 
82.05
%
 
71.37
%
 
64.52
%
 
61.99
%
 
67.88
%
Average shareholders’ equity to average total assets
 
10.05
%
 
10.36
%
 
10.68
%
 
11.05
%
 
10.70
%
Loans to deposits, at end of period
 
108.75
%
 
99.86
%
 
101.29
%
 
93.29
%
 
84.11
%


17


ITEM 7
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
RESULTS OF OPERATIONS
 
NET INTEREST INCOME
 
Net interest income is determined by calculating the difference between the yields earned on interest-earning assets and the rates paid on interest-bearing liabilities. To compare the tax-exempt asset yields to taxable yields, amounts are adjusted to taxable equivalents based on the marginal corporate federal tax rate of 34%.  The tax equivalent adjustments to net interest income for 2017, 2016, and 2015 were $1,281,000, $1,402,000, and $2,011,000, respectively.

2017 vs. 2016

Reported net interest income increased $2,834,000 to $44,080,000 for the year ended December 31, 2017 compared to the year ended December 31, 2016, as growth in the earning asset portfolio was coupled with the yield on earning assets increasing to 3.92% from 3.88%.  Total interest income increased $3,164,000 as the impact of growth in the average balance of the loan portfolio was limited by a decline in the average balance of the investment portfolio as the investment portfolio is actively managed to reduce interest rate and market risk. Interest income on a tax equivalent basis recognized on the loan portfolio increased $3,801,000 due to a $92,281,000 increase in the average balance in the loan portfolio.  Interest and dividend income generated from the investment portfolio on a tax equivalent basis decreased $808,000 due to a $14,277,000 decrease in the average balance in the investment portfolio and a 22 basis point ("bp") reduction in the average rate. 

Interest expense increased $330,000 to $5,897,000 for the year ended December 31, 2017 compared to 2016.  The increase in interest expense was driven by growth in total deposits, the primary source of funding for the earning asset portfolio growth. The impact of the growth in interest-bearing liabilities was limited by a minimal increase of 1 bp in cost of funds. The average rate paid on time deposits increased 13 bp as the time deposit portfolio was lengthened in preparation for a rising rate environment.

2016 vs. 2015

Reported net interest income increased $341,000 to $41,246,000 for the year ended December 31, 2016 compared to the year ended December 31, 2015, as the growth in the earning asset portfolio offset the impact of the yield on earning assets decreasing to 3.88% from 4.04%.  Total interest income increased $689,000 as the impact of growth in the average balance of the loan portfolio was limited by a decline in the average balance of the investment portfolio as the portfolio is actively managed to reduce interest rate and market risk. Interest income on a tax equivalent basis recognized on the loan portfolio increased $2,981,000 due to a $81,592,000 increase in the average balance in the loan portfolio.  Interest and dividend income generated from the investment portfolio on a tax equivalent basis decreased $3,076,000 due to a $61,820,000 decrease in the average balance in the investment portfolio and a 40 basis point ("bp") reduction in the average rate.  The decrease in the portfolio was driven by a strategic plan that started in 2014 to sell off long-term municipal bonds with a maturity date greater than 10 years and securities with a call date within the next five years, in order to reduce interest rate risk and market risk.

Interest expense increased $348,000 to $5,567,000 for the year ended December 31, 2016 compared to 2015. Growth in total interest earning assets was funded primarily through the organic growth in total deposits, of which, the rate paid on time deposits was the primary driver of the increase in interest expense. The impact of the growth in interest-bearing liabilities was limited by a minimal increase of 2 bp in cost of funds. The average rate paid on time deposits increased 16 bp as the time deposit portfolio was lengthened in preparation for a rising rate environment.




18


AVERAGE BALANCES AND INTEREST RATES

The following tables set forth certain information relating to the Company’s average balance sheet and reflect the average yield on assets and average cost of liabilities for the periods indicated and the average yields earned and rates paid.  Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented.

 
 
2017
 
2016
 
2015
(Dollars In Thousands)
 
Average Balance
 
Interest
 
Average Rate
 
Average 
Balance
 
Interest
 
Average Rate
 
Average
Balance
 
Interest
 
Average Rate
Assets:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Tax-exempt loans
 
$
49,982

 
$
1,924

 
3.85
%
 
$
47,782

 
$
1,852

 
3.87
%
 
$
43,395

 
$
1,679

 
3.87
%
All other loans
 
1,099,465

 
44,563

 
4.05
%
 
1,009,384

 
40,834

 
4.05
%
 
932,179

 
38,026

 
4.08
%
Total loans
 
1,149,447

 
46,487

 
4.04
%
 
1,057,166

 
42,686

 
4.04
%
 
975,574

 
39,705

 
4.07
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Taxable securities
 
84,079

 
2,689

 
3.20
%
 
94,887

 
3,072

 
3.24
%
 
127,052

 
4,183

 
3.29
%
Tax-exempt securities
 
50,169

 
1,845

 
3.68
%
 
53,638

 
2,270

 
4.23
%
 
83,293

 
4,235

 
5.08
%
Total securities
 
134,248

 
4,534

 
3.38
%
 
148,525

 
5,342

 
3.60
%
 
210,345

 
8,418

 
4.00
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
 
22,461

 
237

 
1.06
%
 
36,592

 
187

 
0.51
%
 
4,238

 
12

 
0.28
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total interest-earning assets
 
1,306,156

 
51,258

 
3.92
%
 
1,242,283

 
48,215

 
3.88
%
 
1,190,157

 
48,135

 
4.04
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other assets
 
100,481

 
 

 
 

 
99,500

 
 

 
 

 
97,103

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
1,406,637

 
 

 
 

 
$
1,341,783

 
 

 
 

 
$
1,287,260

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and shareholders’ equity:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Savings
 
$
157,851

 
62

 
0.04
%
 
$
151,397

 
58

 
0.04
%
 
$
143,055

 
56

 
0.04
%
Super Now deposits
 
200,436

 
528

 
0.26
%
 
187,106

 
458

 
0.24
%
 
187,396

 
491

 
0.26
%
Money market deposits
 
274,546

 
949

 
0.35
%
 
238,175

 
648

 
0.27
%
 
207,252

 
554

 
0.27
%
Time deposits
 
210,608

 
2,544

 
1.21
%
 
221,498

 
2,383

 
1.08
%
 
220,360

 
2,028

 
0.92
%
Total interest-bearing deposits
 
843,441

 
4,083

 
0.48
%
 
798,176

 
3,547

 
0.44
%
 
758,063

 
3,129

 
0.41
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Short-term borrowings
 
25,984

 
234

 
0.89
%
 
18,518

 
46

 
0.25
%
 
38,909

 
116

 
0.30
%
Long-term borrowings
 
78,745

 
1,580

 
1.98
%
 
90,554

 
1,974

 
2.14
%
 
84,721

 
1,974

 
2.30
%
Total borrowings
 
104,729

 
1,814

 
1.71
%
 
109,072

 
2,020

 
1.82
%
 
123,630

 
2,090

 
1.67
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total interest-bearing liabilities
 
948,170

 
5,897

 
0.62
%
 
907,248

 
5,567

 
0.61
%
 
881,693

 
5,219

 
0.59
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
 
302,651

 
 

 
 

 
279,130

 
 

 
 

 
251,029

 
 

 
 

Other liabilities
 
14,398

 
 

 
 

 
16,152

 
 

 
 

 
17,047

 
 

 
 

Shareholders’ equity
 
141,418

 
 

 
 

 
139,253

 
 

 
 

 
137,491

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total liabilities and shareholders’ equity
 
$
1,406,637

 
 

 
 

 
$
1,341,783

 
 

 
 

 
$
1,287,260

 
 

 
 

Interest rate spread
 
 

 
 

 
3.30
%
 
 

 
 

 
3.27
%
 
 

 
 

 
3.45
%
Net interest income/margin
 
 

 
$
45,361

 
3.47
%
 
 

 
$
42,648

 
3.44
%
 
 

 
$
42,916

 
3.61
%
 
·                  Fees on loans are included with interest on loans as follows: 2017 - $1,159,000; 2016 - $873,000; 2015 - $422,000.
·                  Information in this table has been calculated using average daily balance sheets to obtain average balances.
·                  Nonaccrual loans have been included with loans for the purpose of analyzing net interest earnings.
·                  Income and rates on a fully taxable equivalent basis include an adjustment for the difference between annual income from tax-exempt obligations and the taxable equivalent of such income at the standard 34% tax rate.
 

19


Reconciliation of Taxable Equivalent Net Interest Income
 
(In Thousands)
 
2017
 
2016
 
2015
Total interest income
 
$
49,977

 
$
46,813

 
$
46,124

Total interest expense
 
5,897

 
5,567

 
5,219

Net interest income
 
44,080

 
41,246

 
40,905

Tax equivalent adjustment
 
1,281

 
1,402

 
2,011

Net interest income (fully taxable equivalent)
 
$
45,361

 
$
42,648

 
$
42,916


Rate/Volume Analysis
 
The table below sets forth certain information regarding changes in our interest income and interest expense for the periods indicated. For interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (changes in average volume multiplied by old rate) and (ii) changes in rates (changes in rate multiplied by old average volume). Increases and decreases due to both interest rate and volume, which cannot be separated, have been allocated proportionally to the change due to volume and the change due to interest rate.  Income and interest rates are on a taxable equivalent basis.
 
 
 
Year Ended December 31,
 
 
2017 vs. 2016
 
2016 vs. 2015
 
 
Increase (Decrease) Due To
 
Increase (Decrease) Due To
(In Thousands)
 
Volume
 
Rate
 
Net
 
Volume
 
Rate
 
Net
Interest income:
 
 

 
 

 
 

 
 

 
 

 
 

Loans, tax-exempt
 
$
73

 
$
(1
)
 
$
72

 
$
173

 
$

 
$
173

Loans
 
3,729

 

 
3,729

 
3,093

 
(285
)
 
2,808

Taxable investment securities
 
(345
)
 
(38
)
 
(383
)
 
(1,048
)
 
(63
)
 
(1,111
)
Tax-exempt investment securities
 
(142
)
 
(283
)
 
(425
)
 
(1,338
)
 
(627
)
 
(1,965
)
Interest-bearing deposits
 
(36
)
 
86

 
50

 
91

 
84

 
175

Total interest-earning assets
 
3,279

 
(236
)
 
3,043

 
971

 
(891
)
 
80

 
 
 
 
 
 
 
 
 
 
 
 
 
Interest expense:
 
 

 
 

 
 

 
 

 
 

 
 

Savings deposits
 
4

 

 
4

 
4

 
(2
)
 
2

Super Now deposits
 
29

 
41

 
70

 
(1
)
 
(32
)
 
(33
)
Money market deposits
 
107

 
194

 
301

 
90

 
4

 
94

Time deposits
 
(35
)
 
196

 
161

 
11

 
344

 
355

Short-term borrowings
 
25

 
163

 
188

 
(52
)
 
(18
)
 
(70
)
Long-term borrowings
 
(250
)
 
(144
)
 
(394
)
 
133

 
(133
)
 

Total interest-bearing liabilities
 
(120
)
 
450

 
330

 
185

 
163

 
348

Change in net interest income
 
$
3,399

 
$
(686
)
 
$
2,713

 
$
786

 
$
(1,054
)
 
$
(268
)
 
PROVISION FOR LOAN LOSSES
 
2017 vs. 2016
 
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 Company.  Management remains committed to an aggressive program of problem loan identification and resolution.

The allowance is calculated 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 nonperforming loans and its knowledge and experience with specific lending segments.

20


 
Although management believes that it uses the best information available to make such determinations and that the allowance for loan losses is adequate at December 31, 2017, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making the initial determinations.  A downturn in the local economy or employment and delays in receiving financial information from borrowers could result in increased levels of nonperforming assets and charge-offs, increased loan loss provisions and reductions in interest income.  Additionally, as an integral part of the examination process, bank regulatory agencies periodically review the Banks' loan loss allowance. The banking regulators could require additions to the loan loss allowance based on their judgment of information available to them at the time of their examination.

While 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 declined slightly from $12,896,000 at December 31, 2016 to $12,858,000 at December 31, 2017.  At December 31, 2017, the allowance for loan losses was 1.03% of total loans compared to 1.18% of total loans at December 31, 2016.

The provision for loan losses totaled $730,000 for the year ended December 31, 2017 compared to $1,196,000 for the year ended December 31, 2016.  The decrease in the provision was appropriate when considering the gross loan growth and low level of net charge-offs during 2017.  Net charge-offs of $768,000 represented 0.07% of average loans for the year ended December 31, 2017 compared to net charge-offs of $344,000 or 0.03% of average loans for the year ended December 31, 2016.  The growth in the loan portfolio was driven by home equity product growth which historically is a lower risk product than commercial loans and requires a lower allowance for loan losses. In addition, growth occurred in the indirect auto loan portfolio that has experienced minimal charge-offs. Nonperforming loans decreased $4,358,000 as a large nonperforming loan was paid-off during the third quarter of 2017. The majority of the nonperforming loans are centered on several loans that are either in a secured position and have sureties with a strong underlying financial position and/or a specific allowance within the allowance for loan losses.  Internal loan review and analysis, coupled with the ratios and decreased level of nonperforming loans noted previously, dictated a decrease in the provision for loan losses.  Utilizing both internal and external resources, as noted, senior management has concluded that the allowance for loan losses remains at a level adequate to provide for probable losses inherent in the loan portfolio.
 
2016 vs. 2015

The allowance for loan losses increased from $12,044,000 at December 31, 2015 to $12,896,000 at December 31, 2016.  At December 31, 2016, the allowance for loan losses was 1.18% of total loans compared to 1.15% of total loans at December 31, 2015.

The provision for loan losses totaled $1,196,000 for the year ended December 31, 2016 compared to $2,300,000 for the year ended December 31, 2015.  The decrease in the provision was appropriate when considering the gross loan growth and low level of net charge-offs during 2016.  Net charge-offs of $344,000 represented 0.03% of average loans for the year ended December 31, 2016 compared to net charge-offs of $835,000 or 0.09% of average loans for the year ended December 31, 2015.  The growth in the loan portfolio was driven by home equity product growth which historically is a lower risk product than commercial loans and requires a lower allowance for loan losses. While nonperforming loans increased, the majority of the nonperforming loans are centered on several loans that are either in a secured position and have sureties with a strong underlying financial position and/or a specific allowance within the allowance for loan losses.  Internal loan review and analysis, coupled with the ratios noted previously, dictated a decrease in the provision for loan losses.  Utilizing both internal and external resources, as noted, senior management has concluded that the allowance for loan losses remains at a level adequate to provide for probable losses inherent in the loan portfolio.

NON-INTEREST INCOME

2017 vs. 2016

Total non-interest income decreased $1,369,000 from the year ended December 31, 2016 to December 31, 2017.  Excluding net security gains, non-interest income decreased $292,000 year over year.  Service charges decreased due to decreased level of overdraft income. Bank owned life insurance income decreased due to a decrease in the earnings rate. Insurance commissions decreased while brokerage commissions increased due to a shift in product mix.  Gain on sale of loans decreased due to reduced volume. Debit card income increased to $1,960,000 for 2017 an increase of $64,000 or 3.38% from 2016.
 

21


 
 
2017
 
2016
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Service charges
 
$
2,222

 
20.68
 %
 
$
2,249

 
18.57
%
 
$
(27
)
 
(1.20
)%
Net securities gains, available for sale
 
600

 
5.58

 
1,611

 
13.30

 
(1,011
)
 
(62.76
)
Net securities (losses) gains, trading
 
(8
)
 
(0.07
)
 
58

 
0.48

 
(66
)
 
113.79

Bank owned life insurance
 
666

 
6.20

 
684

 
5.65

 
(18
)
 
(2.63
)
Gain on sale of loans
 
1,674

 
15.58

 
2,102

 
17.35

 
(428
)
 
(20.36
)
Insurance commissions
 
496

 
4.62

 
795

 
6.56

 
(299
)
 
(37.61
)
Brokerage commissions
 
1,378

 
12.83

 
1,098

 
9.06

 
280

 
25.50

Debit card income
 
1,960

 
18.24

 
1,896

 
15.65

 
64

 
3.38

Other
 
1,756

 
16.34

 
1,620

 
13.38

 
136

 
8.40

Total non-interest income
 
$
10,744

 
100.00
 %
 
$
12,113

 
100.00
%
 
$
(1,369
)
 
(11.30
)%
 
2016 vs. 2015

Total non-interest income decreased $652,000 from the year ended December 31, 2015 to December 31, 2016. Excluding net security gains, non-interest income increased $249,000 year over year.  Service charges decreased due to a decreased level of overdraft income. Bank owned life insurance income decreased due to a decrease in the earnings rate. Insurance commissions and brokerage commissions increased in part due to the book of business that was purchased in 2016.  Gain on sale of loans increased due to a shift product mix that began in the latter part of 2015 and the addition of mortgage loan originators. Debit card income increased to 1,896,000 for 2016 an increase of $204,000 or 12.06% from 2015.

 
 
2016
 
2015
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Service charges
 
$
2,249

 
18.57
%
 
$
2,383

 
18.67
 %
 
$
(134
)
 
(5.62
)%
Net securities gains, available for sale
 
1,611

 
13.30

 
2,592

 
20.31

 
(981
)
 
(37.85
)
Net securities gains (losses), trading
 
58

 
0.48

 
(22
)
 
(0.17
)
 
80

 
363.64

Bank owned life insurance
 
684

 
5.65

 
720

 
5.64

 
(36
)
 
(5.00
)
Gain on sale of loans
 
2,102

 
17.35

 
1,743

 
13.65

 
359

 
20.60

Insurance commissions
 
795

 
6.56

 
781

 
6.12

 
14

 
1.79

Brokerage commissions
 
1,098

 
9.06

 
1,064

 
8.34

 
34

 
3.20

Debit card income
 
1,896

 
15.65

 
1,692

 
13.25

 
204

 
12.06

Other
 
1,620

 
13.38

 
1,812

 
14.19

 
(192
)
 
(10.60
)
Total non-interest income
 
$
12,113

 
100.00
%
 
$
12,765

 
100.00
 %
 
$
(652
)
 
(5.11
)%
 
NON-INTEREST EXPENSE
 
2017 vs. 2016
 
Total non-interest expenses increased $1,771,000 from the year ended December 31, 2016 to December 31, 2017.  The increase in salaries and employee benefits was attributable to increased health insurance expense and annual wage increases. Occupancy expense increased primarily due to the opening of a new location that houses executive offices and select operations units. Furniture and equipment expenses increased due to the continued enhancement of systems. The increase in marketing expense was primarily related to the home equity and time deposit campaigns. Professional fees increased to $2,353,000 for 2017, an increase of $257,000 or 12.26% from 2016.
  

22


 
 
2017
 
2016
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Salaries and employee benefits
 
$
18,999

 
51.54
%
 
$
17,813

 
50.76
%
 
$
1,186

 
6.66
 %
Occupancy
 
2,447

 
6.64

 
2,223

 
6.33

 
224

 
10.08

Furniture and equipment
 
2,915

 
7.91

 
2,793

 
7.96

 
122

 
4.37

Software Amortization
 
974

 
2.64

 
1,256

 
3.58

 
(282
)
 
(22.45
)
Pennsylvania shares tax
 
925

 
2.51

 
873

 
2.49

 
52

 
5.96

Professional fees
 
2,353

 
6.38

 
2,096

 
5.97

 
257

 
12.26

Federal Deposit Insurance Corporation deposit insurance
 
669

 
1.81

 
767

 
2.19

 
(98
)
 
(12.78
)
Debit card expenses
 
602

 
1.63

 
604

 
1.72

 
(2
)
 
(0.33
)
Marketing
 
958

 
2.60

 
740

 
2.11

 
218

 
29.46

Intangible amortization
 
337

 
0.91

 
366

 
1.04

 
(29
)
 
(7.92
)
Other
 
5,683

 
15.43

 
5,560

 
15.85

 
123

 
2.21

Total non-interest expense
 
$
36,862

 
100.00
%
 
$
35,091

 
100.00
%
 
$
1,771

 
5.05
 %
 
2016 vs. 2015  

Total non-interest expenses increased $1,355,000 from the year ended December 31, 2015 to December 31, 2016.  The increase in salaries and employee benefits was attributable to increased health insurance expense and annual wage increases. Furniture and equipment expenses increased due to the continued enhancement of systems. Amortization of investment in limited partnerships decreased as two investments were fully amortized during 2016. The increase in marketing expense was primarily related to the home equity and time deposit campaigns conducted during 2016. Other expenses were impacted by a mass replacement of debit cards to implement EMV card technology to better protect the security of our customers. In addition, expenses increased due to a data breach at a national restaurant chain that impacted our customer base. Professional fees increased to $2,096,000 for 2016, an increase of $177,000 or 9.22% from 2015.

 
 
2016
 
2015
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Salaries and employee benefits
 
$
17,813

 
50.76
%
 
$
17,023

 
50.46
%
 
$
790

 
4.64
 %
Occupancy
 
2,223

 
6.33

 
2,248

 
6.66

 
(25
)
 
(1.11
)
Furniture and equipment
 
2,793

 
7.96

 
2,622

 
7.77

 
171

 
6.52

Software Amortization
 
1,256

 
3.58

 
1,140

 
3.38

 
116

 
10.18

Pennsylvania shares tax
 
873

 
2.49

 
954

 
2.83

 
(81
)
 
(8.49
)
Professional fees
 
2,096

 
5.97

 
1,919

 
5.69

 
177

 
9.22

Federal Deposit Insurance Corporation deposit insurance
 
767

 
2.19

 
867

 
2.57

 
(100
)
 
(11.53
)
Debit card expenses
 
604

 
1.72

 
576

 
1.71

 
28

 
4.86

Marketing
 
740

 
2.11

 
612

 
1.81

 
128

 
20.92

Intangible amortization
 
366

 
1.04

 
311

 
0.92

 
55

 
17.68

Other
 
5,560

 
15.85

 
5,464

 
16.20

 
96

 
1.76

Total non-interest expense
 
$
35,091

 
100.00
%
 
$
33,736

 
100.00
%
 
$
1,355

 
4.02
 %
 
INCOME TAXES
 
2017 vs. 2016
 
The provision for income taxes for the year ended December 31, 2017 increased $2,862,000 and resulted in an effective income tax rate of 43.29% compared to 26.93% for 2016.  The increase was driven by a revaluation of the Company's net deferred tax assets that resulted in a recognition of a provisional net income tax expense in the amount of $2,724,000 for the year ended December 31,m 2017 due to the December 2017 passage of the Tax Cuts and Jobs Act.

23



The Tax Cuts and Jobs Act, among other things, reduces the corporate income tax rate to 21%, effective January 1, 2018. The law is complex and has extensive implications for the Company’s federal and state current and deferred taxes and income tax expense.

Under ASC 740, Income Taxes, the effect of income tax law changes on deferred taxes should be recognized as a component of income tax expense related to continuing operations in the period in which the law is enacted. This requirement applies not only to items initially recognized in continuing operations, but also to items initially recognized in other comprehensive income. Accordingly, the Company has conducted a revaluation of our net deferred tax assets and recorded the effects to reflect the changes associated with the law’s provisions in its 2017 fourth quarter.

As a result of the reduction in the U.S. federal statutory income tax rate, we recognized a provisional net income tax expense totaling $2,724,000, determined as follows:

(In Thousands)
 
Amount recognized in tax expense
 
 
 
Deferred taxes related to items recognized in continuing operations
 
$
1,906

 
 
 
Deferred taxes related to items recognized in other comprehensive income:
 
 
Deferred taxes on net actuarial loss on defined benefit post- retirement benefit plan
 
809

Deferred taxes on net unrealized loss on securities available for sale
 
9

Net adjustment to deferred taxes
 
$
2,724


The Tax Cuts and Jobs Act also:

eliminates the corporate alternative minimum tax and allows the use of any net operating loss carryforward to offset regular tax liability for any taxable year;
limits the deduction for net interest expense incurred by U.S. corporations;
allows businesses to immediately expense, for tax purposes, the cost of new investments in certain qualified depreciable assets;
eliminates or reduces certain deductions related to meals and entertainment expenses; and
modifies the corporate dividends received deductions.

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 carryforward period and therefore does not require a valuation allowance.
 
The foregoing description of the impact of the Tax Cuts and Jobs Act on us should be read in conjunction with Note 12 - "Income Taxes" and Note 2 - "Accumulated Other Comprehensive Income (Loss)" of the "Notes to Consolidated Financial Statements" included in Item 8 of this Annual Report on Form 10-K.

2016 vs. 2015
 
The provision for income taxes for the year ended December 31, 2017 resulted in an effective income tax rate of 26.93% compared to 21.19% for 2016.  This increase is primarily the result of decreased tax-exempt investment income and bank-owned life insurance income which has resulted in a greater percentage of the pre-tax income being taxable.

FINANCIAL CONDITION
 
INVESTMENTS
 
2017
 
The fair value of the investment portfolio decreased $8,885,000 from December 31, 2016 to December 31, 2017.  The decrease in value is the result of the investment portfolio being actively managed in order to reduce interest rate and market risk. This is being undertaken primarily through the sale of long-term municipal bonds that have a maturity date greater than ten years and securities with a call date within the next five years. In addition, the decrease in corporate bond holdings is being undertaken to reduce risk and also in response to the changes in bank regulatory capital calculations per Basel III. The proceeds of the bond sales are primarily being deployed into loans. The strategy to sell a portion of the long-term bond portfolio does negatively impact

24


current earnings, but this action plays a key role in our long-term asset/liability management strategy as the balance sheet is shortened to better prepare for a rising rate environment. The unrealized losses within the debt securities portfolio are the result of market activity, not credit issues/ratings, as approximately 83% of the debt securities portfolio on an amortized cost basis is currently rated A or higher by either S&P or Moody’s.
 
2016
 
The fair value of the investment portfolio decreased $42,680,000 from December 31, 2015 to December 31, 2016.  The decrease in value is the result of the investment portfolio being actively managed in order to reduce interest rate and market risk. This process began in 2014 and is being undertaken primarily through the sale of long-term municipal bonds that have a maturity date greater than ten years and securities with a call date within the next five years. In addition, the decrease in corporate bond holdings is being undertaken to reduce risk and also in response to the changes in bank regulatory capital calculations per Basel III. The proceeds of the bond sales are primarily being deployed into loans. The strategy to sell a portion of the long-term bond portfolio does negatively impact current earnings, but this action plays a key role in our long-term asset/liability manage