UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~March 31,~~September 30, 2020

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from__________ to___________

Commission file number 001-38884

FRANKLIN FINANCIAL SERVICES CORPORATION

(Exact name of registrant as specified in its charter)


Pennsylvania	25-1440803
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)


20 South Main Street, Chambersburg, PA	17201-0819
(Address of principal executive offices)	(Zip Code)

(717) 264-6116

(Registrant's telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

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



Title of class	Symbol	Name of exchange on which registered
Common stock	FRAF	Nasdaq Capital Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company x Emerging growth company ¨

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

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act) Yes ¨ No x

There were ~~4,340,837~~4,372,757 outstanding shares of the Registrant’s common stock as of ~~April 30,~~October 31, 2020.

‎

INDEX


Part I - FINANCIAL INFORMATION

Item 1	Financial Statements
	Consolidated Balance Sheets as of ~~March 31,~~September 30, 2020 and December 31, 2019 (unaudited)	1
	Consolidated Statements of Income for the Three and Nine Months ended ~~March 31,~~September 30, 2020	2
	and 2019 (unaudited)
	Consolidated Statements of Comprehensive Income for the Three and Nine Months ended	3
	~~March 31,~~September 30, 2020 and 2019 (unaudited)
	Consolidated Statements of Changes in Shareholders’ Equity for the Three and Nine Months	3
	ended ~~March 31,~~September 30, 2020 and 2019 (unaudited)
	Consolidated Statements of Cash Flows for the ~~Three~~Nine Months ended ~~March 31,~~September 30, 2020	45
	and 2019 (unaudited)
	Notes to Consolidated Financial Statements (unaudited)	56

Item 2	Management’s Discussion and Analysis ofResults of Operations and Financial Condition	2428
Item 3	Quantitative and Qualitative Disclosures about Market Risk	4151
Item 4	Controls and Procedures	4151

Part II - OTHER INFORMATION

Item 1	Legal Proceedings	4352
Item 1A	Risk Factors	4352
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	4453
Item 3	Defaults Upon Senior Securities	4453
Item 4	Mine Safety Disclosures	4453
Item 5	Other Information	4554
Item 6	Exhibits	4554
SIGNATURE PAGE		4655

Part I FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Balance Sheets



(Dollars in thousands, except share and per share data) (unaudited)	March 31,		December 31,
(Dollars in thousands, except share and per share data)					(unaudited)
					September 30,		December 31,
	2020		2019		2020		2019
Assets
Cash and due from banks	$	12,848	$	15,336	$	16,780	$	15,336
Short-term interest-bearing deposits in other banks		40,502		68,492		54,380		68,492
Total cash and cash equivalents		53,350		83,828		71,160		83,828
Long-term interest-bearing deposits in other banks		10,738		8,746		14,235		8,746
Debt securities available for sale, at fair value		208,040		187,433		346,473		187,433
Equity securities		313		440		301		440
Restricted stock		465		465		468		465
Loans held for sale		2,751		2,040		9,498		2,040
Loans		936,386		934,575		1,022,958		934,575
Allowance for loan losses		(14,730)		(11,966)		(17,151)		(11,966)
Net Loans		921,656		922,609		1,005,807		922,609
Premises and equipment, net		13,717		13,851		13,375		13,851
Right of use asset		5,118		5,126		4,899		5,126
Bank owned life insurance		20,955		23,748		21,177		23,748
Goodwill		9,016		9,016		9,016		9,016
Deferred tax asset, net		3,570		4,003		3,961		4,003
Other assets		12,437		7,852		10,843		7,852
Total assets	$	1,262,126	$	1,269,157	$	1,511,213	$	1,269,157

Liabilities
Deposits
Noninterest-bearing checking	$	198,384	$	192,108	$	270,489	$	192,108
Money management, savings, and interest checking		835,208		843,936		986,943		843,936
Time		83,841		89,348		79,317		89,348
Total deposits		1,117,433		1,125,392		1,336,749		1,125,392
Subordinate notes						19,547		—
Lease liability		5,159		5,161		4,953		5,161
Other liabilities		10,529		11,076		10,390		11,076
Total liabilities		1,133,121		1,141,629		1,371,639		1,141,629

Commitments and contingent liabilities

Shareholders' equity
Common stock, $1 par value per share,15,000,000 shares authorized with
4,710,822 shares issued and 4,337,520 shares outstanding at March 31, 2020 and
4,710,872 shares issued and 4,370,667 shares outstanding at September 30, 2020 and
4,709,849 shares issued and 4,352,753 shares outstanding at December 31, 2019		4,711		4,710		4,711		4,710
Capital stock without par value, 5,000,000 shares authorized with 0
Capital stock 0 par value, 5,000,000 shares authorized with 0
shares issued and outstanding		—		—		—		—
Additional paid-in capital		42,390		42,268		42,505		42,268
Retained earnings		95,359		94,946		99,280		94,946
Accumulated other comprehensive loss		(4,360)		(5,986)
Treasury stock, 373,302 shares at March 31, 2020 and 357,096 shares at
Accumulated other comprehensive income (loss)						1,367		(5,986)
Treasury stock, 340,205 shares at September 30, 2020 and 357,096 shares at
December 31, 2019, at cost		(9,095)		(8,410)		(8,289)		(8,410)
Total shareholders' equity		129,005		127,528		139,574		127,528
Total liabilities and shareholders' equity	$	1,262,126	$	1,269,157	$	1,511,213	$	1,269,157

The accompanying notes are an integral part of these unaudited financial statements.

Consolidated Statements of Income


	For the Three Months Ended				For the Three Months Ended				For the Nine Months Ended
(Dollars in thousands, except per share data) (unaudited)	March 31,				September 30,				September 30,
	2020		2019		2020		2019		2020		2019
Interest income
Loans, including fees	$	10,168	$	11,009	$	9,499	$	11,184	$	29,346	$	33,318
Interest and dividends on investments:
Taxable interest		1,062		540		1,159		695		3,270		1,809
Tax exempt interest		171		338		504		200		1,028		819
Dividend income		6		5		3		5		12		21
Deposits and obligations of other banks		258		97
Interesting-bearing deposits in other banks						72		638		412		1,137
Total interest income		11,665		11,989		11,237		12,722		34,068		37,104
Interest expense
Deposits		1,413		1,624		687		1,887		2,933		5,343
Short-term borrowings		—		36		—		—		—		36
Subordinate notes						167		—		167		—
Total interest expense		1,413		1,660		854		1,887		3,100		5,379
Net interest income		10,252		10,329		10,383		10,835		30,968		31,725
Provision for loan losses		3,000		399
Provision for (recovery of) loan losses						375		(162)		5,350		237
Net interest income after provision for loan losses		7,252		9,930		10,008		10,997		25,618		31,488
Noninterest income
Investment and trust services fees		1,445		1,452		1,433		1,482		4,469		4,582
Loan service charges		285		203		710		238		1,496		670
Deposit service charges and fees		565		545		497		632		1,459		1,781
Other service charges and fees		347		353		382		401		1,065		1,135
Debit card income		418		402		491		469		1,347		1,335
Increase in cash surrender value of life insurance		124		127
Life insurance gain		812		—
Net (losses)/gains on sales of debt securities		(10)		24
Increase in cash surrender value of Bank owned life insurance						110		127		346		383
Bank owned life insurance gain						—		9		812		9
Net (losses) gains on sales of debt securities						(16)		3		(26)		256
Change in fair value of equity securities		(127)		3		(39)		(6)		(139)		10
Other		30		56		35		123		74		181
Total noninterest income		3,889		3,165		3,603		3,478		10,903		10,342
Noninterest Expense
Salaries and employee benefits		5,535		5,442		5,421		5,419		16,337		16,216
Net occupancy		830		856		838		831		2,533		2,545
Marketing and advertising		455		402		384		324		1,303		1,207
Legal and professional		395		430		499		409		1,324		1,310
Data processing		806		705		871		693		2,511		2,135
Pennsylvania bank shares tax		175		243		263		248		701		734
FDIC Insurance		60		65		128		(76)		276		104
ATM/debit card processing		264		258		285		256		828		761
Telecommunications		105		105		110		106		323		318
Other		903		906		850		781		2,685		2,680
Total noninterest expense		9,528		9,412		9,649		8,991		28,821		28,010
Income before federal income taxes		1,613		3,683		3,962		5,484		7,700		13,820
Federal income tax (benefit) expense		(106)		446
Federal income tax expense (benefit)						500		985		(548)		2,100
Net income	$	1,719	$	3,237	$	3,462	$	4,499	$	8,248	$	11,720
Per share
Basic earnings per share	$	0.40	$	0.73	$	0.79	$	1.04	$	1.90	$	2.67
Diluted earnings per share	$	0.39	$	0.73	$	0.79	$	1.03	$	1.89	$	2.66

The accompanying notes are an integral part of these unaudited financial statements.

Consolidated Statements of Comprehensive Income


	For the Three Months Ended					For the Three Months Ended				For the Nine Months Ended
	March 31,					September 30,				September 30,
(Dollars in thousands) (unaudited)	2020		2019			2020		2019		2020		2019
Net Income	$	1,719	$	3,237		$	3,462	$	4,499	$	8,248	$	11,720

Debt Securities:
Unrealized gains arising during the period		2,048		1,414			2,631		589		9,283		3,223
Reclassification adjustment for losses (gains) included in net income (1) (2)		10		(24)			16		(3)		26		(256)
Net unrealized gains		2,058		1,390			2,647		586		9,309		2,967
Tax effect		(432)		(291)			(555)		(123)		(1,956)		(622)
Net of tax amount		1,626		1,099			2,092		463		7,353		2,345

Total other comprehensive income		1,626		1,099			2,092		463		7,353		2,345

Total Comprehensive Income	$	3,345	$	4,336		$	5,554	$	4,962	$	15,601	$	14,065

(1) Reclassified to net gains on sales of debt securities
(2) Net of the reclassification of $(2) and $5 to Federal income tax (benefit) expense
(2) Net of the reclassification of ($3), $1, ($5) and $54 to Federal income tax (benefit) expense					(2) Net of the reclassification of ($3), $1, ($5) and $54 to Federal income tax (benefit) expense

The accompanying notes are an integral part of these unaudited financial statements.

‎

Consolidated Statements of Changes in Shareholders’ Equity

For the three and nine months ended ~~March 31,~~September 30, 2020 and 2019


							Accumulated													Accumulated
			Additional				Other									Additional				Other
	Common		Paid-in		Retained		Comprehensive		Treasury				Number	Common		Paid-in		Retained		Comprehensive		Treasury
(Dollars in thousands, except per share data) (unaudited)	Stock		Capital		Earnings		Loss		Stock		Total		of Shares	Stock		Capital		Earnings		Income (Loss)		Stock		Total
Balance at July 1, 2020													4,352,484	$	4,711	$	42,461	$	97,124	$	(725)	$	(8,731)	$	134,840
Net income															—		—		3,462		—		—		3,462
Other comprehensive income															—		—		—		2,092		—		2,092
Cash dividends declared, $0.30 per share															—		—		(1,306)		—		—		(1,306)
Treasury shares issued under dividend reinvestment plan													17,840		—		(13)		—		—		435		422
Stock Compensation Plans:
Treasury shares issued													293		—		—		—		—		7		7
Common shares issue													50		—		1		—		—		—		1
Compensation expense															—		56		—		—		—		56
Balance at September 30, 2020													4,370,667	$	4,711	$	42,505	$	99,280	$	1,367	$	(8,289)	$	139,574

Balance at January 1, 2020	$	4,710	$	42,268	$	94,946	$	(5,986)	$	(8,410)	$	127,528	4,352,753	$	4,710	$	42,268	$	94,946	$	(5,986)	$	(8,410)	$	127,528
Net income		—		—		1,719		—		—		1,719			—		—		8,248		—		—		8,248
Other comprehensive income		—		—		—		1,626		—		1,626			—		—		—		7,353		—		7,353
Cash dividends declared, $0.30 per share		—		—		(1,306)		—		—		(1,306)
Acquisition of 36,401 shares of treasury stock		—		—		—		—		(1,172)		(1,172)
Treasury shares issued under dividend reinvestment plan, 20,124 shares		—		75		—		—		485		560
Cash dividends declared, $0.90 per share															—		—		(3,914)		—		—		(3,914)
Acquisition of treasury stock													(36,401)		—		—		—		—		(1,172)		(1,172)
Treasury shares issued under dividend reinvestment plan													52,928		—		78		—		—		1,284		1,362
Stock Compensation Plans:
Treasury shares issued (71 shares)		—		1		—		—		2		3
Common shares issued (973 shares)		1		15		—		—		—		16
Treasury shares issued													364		—		1		—		—		9		10
Common shares issued													1,023		1		17		—		—		—		18
Compensation expense		—		31		—		—		—		31			—		141		—		—		—		141
Balance at March 31, 2020	$	4,711	$	42,390	$	95,359	$	(4,360)	$	(9,095)	$	129,005
Balance at September 30, 2020													4,370,667	$	4,711	$	42,505	$	99,280	$	1,367	$	(8,289)	$	139,574

Balance at January 1, 2019
$
4,701
$
41,530
$
83,946
$
(6,380)
$
(5,401)
$
118,396
Net income
—
—
3,237
—
—
3,237
Other comprehensive
—
—
—
1,099
—
1,099
Cash dividends declared, $0.27 per share
—
—
(1,192)
—
—
(1,192)
Acquisition of 15,163 shares of treasury stock
—
—
—
—
(560)
(560)
Treasury shares issued under dividend reinvestment plan, 10,150 shares
—
2
—
—
3
5
Stock Compensation Plans:
Treasury shares issued (10,150 shares)
—
161
—
—
190
351
Common shares issued (6,982 shares)
7
148
—
—
—
155
Balance at March 31, 2019
$
4,708
$
41,841
$
85,991
$
(5,281)
$
(5,768)
$
121,491


Balance at July 1, 2019	4,382,944	$	4,708	$	42,040	$	88,658	$	(4,498)	$	(6,994)	$	123,914
Net income			—		—		4,499		—		—		4,499
Other comprehensive income			—		—		—		463		—		463
Cash dividends declared, $0.30 per share			—		—		(1,302)		—		—		(1,302)
Acquisition of treasury stock	(48,825)		—		—		—		—		(1,816)		(1,816)
Treasury shares issued under dividend reinvestment plan	9,986		—		103		—		—		232		335
Stock Compensation Plans:
Treasury shares issued	10		—		—		—		—		—		—
Common shares issued	200		1		6		—		—		—		7
Balance at September 30, 2019	4,344,315	$	4,709	$	42,149	$	91,855	$	(4,035)	$	(8,578)	$	126,100

Balance at January 1, 2019	4,408,761	$	4,701	$	41,530	$	83,946	$	(6,380)	$	(5,401)	$	118,396
Net income			—		—		11,720		—		—		11,720
Other comprehensive income			—		—		—		2,345		—		2,345
Cash dividends declared, $0.87 per share			—		—		(3,811)		—		—		(3,811)
Acquisition of treasury stock	(103,588)		—		—		—		—		(3,843)		(3,843)
Treasury shares issued under dividend reinvestment plan	29,690		—		438		—		—		619		1,057
Stock Compensation Plans:
Treasury shares issued	2,270		—		27		—		—		47		74
Common shares issued	7,182		8		154		—		—		—		162
Balance at September 30, 2019	4,344,315	$	4,709	$	42,149	$	91,855	$	(4,035)	$	(8,578)	$	126,100

The accompanying notes are an integral part of these unaudited financial statements.

Consolidated Statements of Cash Flows


	Three Months Ended ‎March 31,				Nine Months Ended ‎September 30,
	2020		2019		2020		2019
(Dollars in thousands) (unaudited)
Cash flows from operating activities
Net income	$	1,719	$	3,237	$	8,248	$	11,720
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		331		338		998		1,030
Net amortization of loans and investment securities		340		409		1,620		922
Provision for loan losses		3,000		399		5,350		237
Decrease (increase) in fair value of equity securities		127		(3)		139		(10)
Debt securities losses (gains), net		10		(24)		26		(256)
Loans originated for sale		(9,223)		(6,467)		(66,296)		(32,220)
Proceeds from sale of loans		8,512		6,390		58,838		30,409
Increase in cash surrender value of life insurance		(124)		(127)
Gains from claim on life insurance policy		(812)		—
Write-down of other real estate owned						—		6
Gain on sale of other real estate owned						—		(9)
Increase in cash surrender value of bank owned life insurance						(346)		(383)
Gains from claim on bank owned life insurance policies						(812)		—
Income tax benefit of statutory treatment of net operating loss carryback						(1,112)		—
Stock option compensation		31		—		141		—
Increase in other assets		(1,139)		(50)
(Increase) decrease in other assets						(3,602)		1,538
(Decrease) increase in other liabilities		(281)		118		(817)		1,582
Net cash provided by operating activities		2,491		4,220		2,375		14,566
Cash flows from investing activities
Net increase in long-term interest-bearing deposits in other banks		(1,992)		—		(5,489)		(9,496)
Proceeds from sales and calls of investment securities available for sale		165		3,876		1,390		18,781
Proceeds from maturities and pay-downs of securities available for sale		10,941		6,084		31,450		25,233
Purchase of investment securities available for sale		(29,974)		(5,344)		(183,927)		(57,669)
Net increase in loans		(2,077)		(7,245)
Net increase in restricted stock						(3)		(13)
Net (increase) decrease in loans						(88,838)		35,700
Proceeds from surrender of bank owned life insurance policy						3,623		—
Proceeds from the sale of other real estate owned						—		74
Capital expenditures		(174)		(136)		(451)		(610)
Net cash used in investing activities		(23,111)		(2,765)
Net cash (used in) provided by investing activities						(242,245)		12,000
Cash flows from financing activities
Net decrease in demand deposits, interest-bearing checking, and savings accounts		(2,452)		(33,621)
Net increase in demand deposits, interest-bearing checking, and savings accounts						221,388		49,392
Net (decrease) increase in time deposits		(5,507)		27,483		(10,031)		27,580
Proceeds from subordinated notes, net of issuance costs						19,541		—
Dividends paid		(1,306)		(1,192)		(3,914)		(3,811)
Purchase of Treasury shares		(1,172)		(560)		(1,172)		(3,843)
Cash received from option exercises		19		160		28		236
Treasury shares issued under dividend reinvestment plan		560		351		1,362		1,057
Net cash used in financing activities		(9,858)		(7,379)
Decrease in cash and cash equivalents		(30,478)		(5,924)
Net cash provided by financing activities						227,202		70,611
(Decrease) increase in cash and cash equivalents						(12,668)		97,177
Cash and cash equivalents at the beginning of the period		83,828		52,957		83,828		52,957
Cash and cash equivalents at the end of the period	$	53,350	$	47,033	$	71,160	$	150,134
Supplemental Disclosures of Cash Flow Information
Cash paid during the year for:
Interest on deposits and other borrowed funds	$	1,547	$	1,562	$	3,158	$	5,181
Income taxes					$	1,548	$	80
Noncash Activities
Lease liabilities arising from obtaining right-of-use assets	$	105	$	22	$	105	$	22
Life insurance claim receivable	$	3,613	$	—

The accompanying notes are an integral part of these unaudited financial statements.

FRANKLIN FINANCIAL SERVICES CORPORATION and SUBSIDIARIES

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Basis of Presentation

The consolidated financial statements include the accounts of Franklin Financial Services Corporation (the Corporation), and its wholly owned subsidiaries, Farmers and Merchants Trust Company of Chambersburg (the Bank) and Franklin Future Fund Inc. Farmers and Merchants Trust Company of Chambersburg is a commercial bank that has one wholly owned subsidiary, Franklin Financial Properties Corp. Franklin Financial Properties Corp. holds real estate assets that are leased by the Bank. Franklin Future Fund Inc. is a non-bank investment company. The activities of the non-bank ~~entities are~~subsidiary is not significant to the consolidated totals. All significant intercompany transactions and account balances have been eliminated.

In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the consolidated financial position, results of operations, and cash flows as of ~~March 31,~~September 30, 2020, and for all other periods presented have been made.

Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted. It is suggested that these consolidated financial statements be read in conjunction with the audited consolidated financial statements and notes thereto included in the Corporation’s 2019 Annual Report on Form 10-K. The consolidated results of operations for the three-month and nine-month period ended ~~March 31,~~September 30, 2020 are not necessarily indicative of the operating results for the full year. Management has evaluated subsequent events for potential recognition and/or disclosure through the date these consolidated financial statements were issued.

The consolidated balance sheet at December 31, 2019 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by GAAP for complete consolidated financial statements.

For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, interest-bearing deposits in other banks and cash items with original maturities less than 90 days.

Earnings per share are computed based on the weighted average number of shares outstanding during each period end. A reconciliation of the weighted average shares outstanding used to calculate basic earnings per share and diluted earnings per share follows:


	For the Three Months Ended				For the Three Months Ended				For the Nine Months Ended
	March 31,				September 30,				September 30,
(Dollars and shares in thousands, except per share data)	2020		2019		2020		2019		2020		2019
Weighted average shares outstanding (basic)		4,347		4,412		4,358		4,347		4,350		4,385
Impact of common stock equivalents		14		21		4		18		9		21
Weighted average shares outstanding (diluted)		4,361		4,433		4,362		4,365		4,359		4,406
Anti-dilutive options excluded from calculation		50		—		93		7		74		20
Net income	$	1,719	$	3,237	$	3,462	$	4,499	$	8,248	$	11,720
Basic earnings per share	$	0.40	$	0.73	$	0.79	$	1.04	$	1.90	$	2.67
Diluted earnings per share	$	0.39	$	0.73	$	0.79	$	1.03	$	1.89	$	2.66

‎

Note 2. Recent Accounting Pronouncements


ASU 2017-04, Goodwill (Topic 350)
Description		This guidance, among other things, removes step 2 of the goodwill impairment test thus eliminating the need to determine the fair value of individual assets and liabilities of the reporting unit. Upon adoption of this standard, goodwill impairment will be the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. This may result in more or less impairment being recognized than under the current guidance. Early adoption is permitted for any impairment tests performed after January 1, 2017, applied prospectively.
Effective Date		January 1, 2020
Effect on the Consolidated Financial Statements		The Corporation early adopted the ASU in the fourth quarter of 2018 with the completion of the 2018 impairment analysis. The ASU did not have a material effect on the consolidated financial statements.

ASU 2018-14, Disclosure Framework (Topic 715): Changes to the Disclosure Requirements for Defined Benefit Plans
Description		This ASU makes minor changes to the disclosure requirements for employers that sponsor defined benefit pension and/or other postretirement benefit plans. ASU 2018-14 is effective for fiscal years ending after December 15, 2020; early adoption is permitted.
Effective Date		January 1, 2020
Effect on the Consolidated Financial Statements		The Corporation adopted the provisions of the ASU on January 1, 2020. As the ASU only revised disclosure requirements, it did not have a material effect on the consolidated financial statements.

Recently issued but not yet effective accounting standards

ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
Description		This standard requires credit losses on most financial assets measured at amortized cost and certain other instruments to be measured using an expected credit loss model (referred to as the current expected credit loss (CECL) model). Under this model, entities will estimate credit losses over the entire contractual term of the instrument (considering estimated prepayments, but not expected extensions or modifications unless reasonable expectation of a troubled debt restructuring exists) from the date of initial recognition of that instrument. The ASU replaces the current accounting model for purchased credit impaired loans and debt securities. The allowance for credit losses for purchased financial assets with a more-than insignificant amount of credit deterioration since origination (“PCD assets”), should be determined in a similar manner to other financial assets measured on an amortized cost basis. However, upon initial recognition, the allowance for credit losses is added to the purchase price to determine the initial amortized cost basis. The subsequent accounting for PCD financial assets is the same expected loss model described above.
Effective Date		January 1, 2023
Effect on the Consolidated Financial Statements		We have formed an implementation team led by the Corporation's Risk Management function. The team is reviewing the requirements of the ASU and evaluating methods and models for implementation. The new standard will result in earlier recognition of additions to the allowance for loan losses and possibly a larger allowance for loan loss balance with a corresponding increase in the provision for loan losses in results of operations; however, the Corporation is continuing to evaluate the impact of the pending adoption of the new standard on its consolidated financial statements. A third-party vendor has been selected to assist with the CECL calculations and the implementation process has started. The Corporation expects to be able to run the CECL model in test mode in ~~2020.~~2021.

ASU 2019-05, Financial Instruments - Credit Losses (Topic 326):Targeted Transition Relief
Description		This ASU allows entities to irrevocably elect, upon adoption of ASU 2016-13, the fair value option on financial instruments that (1) were previously recorded at amortized cost and (2) are within the scope of ASC 326-20 if the instruments are eligible for the fair value option under ASC 825-10. The fair value option election does not apply to held-to-maturity debt securities. Entities are required to make this election on an instrument-by-instrument basis. ASU 2019-05 has the same effective date as ASU 2016-13. On October 16,2019, FASB approved its August 2019 proposal to grant certain small public companies a delay in the effective date of ASU 2016-13. For the Corporation, the delay makes the ASU effective January 2023. Since the Corporation currently meets the SEC definition of a small reporting company, the delay will be ~~application~~applied to the Corporation. Early adoption is permitted.
Effective Date		January 1, 2023
Effect on the Consolidated Financial Statements		The Corporation will continue to review the ASU as part of its adoption of ASU 2016-13.

Note 3. Accumulated Other Comprehensive ~~Loss~~Income (Loss)

The components of accumulated other comprehensive ~~losses,~~income (loss), net of income tax effects, included in shareholders' equity are as follows:


		Unrealized					Unrealized Gains
		Gains and Losses on					and Losses on
		Available-for-sale		Defined Benefit			Available-for-sale		Defined Benefit
(Dollars in thousands)		Securities		Pension Items		Total	Securities		Pension Items			Total
March 31, 2020
Nine Months Ended September 30, 2020
Beginning Balance	$	185	$	(6,171)	$	(5,986)	$	185	$	(6,171)	$	(5,986)
Other comprehensive income before reclassification		1,618		—		1,618
Amounts reclassified from accumulated other comprehensive income		8		—		8
Other comprehensive income before reclassification, net of tax								7,333		—		7,333
Amounts reclassified from accumulated other comprehensive income, net of tax								20		—		20
Current period other comprehensive income		1,626		—		1,626		7,353		—		7,353
Ending balance	$	1,811	$	(6,171)	$	(4,360)	$	7,538	$	(6,171)	$	1,367

March 31, 2019
Nine Months Ended September 30, 2019
Beginning Balance	$	(870)	$	(5,510)	$	(6,380)	$	(870)	$	(5,510)	$	(6,380)
Other comprehensive income before reclassification		1,117		—		1,117
Amounts reclassified from accumulated other comprehensive income		(18)		—		(18)
Other comprehensive income before reclassification, net of tax								2,546		—		2,546
Amounts reclassified from accumulated other comprehensive income, net of tax								(201)		—		(201)
Current period other comprehensive income		1,099		—		1,099		2,345		—		2,345
Ending balance	$	229	$	(5,510)	$	(5,281)	$	1,475	$	(5,510)	$	(4,035)

Note 4. Investments

Available for Sale (AFS) Securities

The amortized cost and estimated fair value of AFS securities as of ~~March 31,~~September 30, 2020 and December 31, 2019 are as follows:



(Dollars in thousands)			Gross		Gross						Gross		Gross
	Amortized		unrealized		unrealized		Fair		Amortized		unrealized		unrealized		Fair
March 31, 2020	cost		gains		losses		value
September 30, 2020									cost		gains		losses		value
U.S. Government and Agency securities	$	13,602	$	57	$	(34)	$	13,625	$	11,883	$	29	$	(49)	$	11,863
Municipal securities		94,560		2,892		(242)		97,210		213,206		8,497		(270)		221,433
Trust preferred securities		4,102		—		(556)		3,546
Trust preferred and Corporate securities										10,915		2		(223)		10,694
Agency mortgage-backed securities		68,970		1,638		(461)		70,147		62,438		1,977		(35)		64,380
Private-label mortgage-backed securities		316		11		(4)		323		5,807		22		(19)		5,810
Asset-backed securities		24,197		28		(1,036)		23,189		32,681		59		(447)		32,293
	$	205,747	$	4,626	$	(2,333)	$	208,040	$	336,930	$	10,586	$	(1,043)	$	346,473



(Dollars in thousands)			Gross		Gross						Gross		Gross
	Amortized		unrealized		unrealized		Fair		Amortized		unrealized		unrealized		Fair
December 31, 2019	cost		gains		losses		value		cost		gains		losses		value
U.S. Government and Agency securities	$	8,418	$	30	$	(20)	$	8,428	$	8,418	$	30	$	(20)	$	8,428
Municipal securities		90,865		1,418		(997)		91,286		90,865		1,418		(997)		91,286
Trust preferred securities		4,097		—		(130)		3,967
Trust preferred and Corporate securities										4,097		—		(130)		3,967
Agency mortgage-backed securities		58,503		435		(234)		58,704		58,503		435		(234)		58,704
Private-label mortgage-backed securities		398		31		—		429		398		31		—		429
Asset-backed securities		24,918		6		(305)		24,619		24,918		6		(305)		24,619
	$	187,199	$	1,920	$	(1,686)	$	187,433	$	187,199	$	1,920	$	(1,686)	$	187,433

At ~~March 31,~~September 30, 2020 and December 31, 2019, the fair value of AFS securities pledged to secure public funds and trust deposits totaled ~~$98.0~~$140.5 million and $107.1 million, respectively.

The amortized cost and estimated fair value of debt securities at ~~March 31,~~September 30, 2020, by contractual maturity are shown below. Actual maturities may differ from contractual maturities because of prepayment or call options embedded in the securities. Securities not due at a single maturity date are presented separately.



(Dollars in thousands)	Amortized ‎cost		Fair ‎value		Amortized ‎cost		Fair ‎value
Due in one year or less	$	12,900	$	12,978	$	5,925	$	5,960
Due after one year through five years		31,461		31,369		23,217		23,715
Due after five years through ten years		76,697		77,637		174,099		180,496
Due after ten years		15,403		15,586		32,763		33,819
		136,461		137,570		236,004		243,990
Mortgage-backed securities		69,286		70,470
Mortgage-backed and asset-backed securities						100,926		102,483
	$	205,747	$	208,040	$	336,930	$	346,473

The composition of the net realized gains on AFS securities for the three and nine months ended are as follows:


	For the Three Months Ended				For the Three Months Ended				For the Nine Months Ended
	March 31,				September 30,				September 30,
(Dollars in thousands)	2020		2019		2020		2019		2020		2019
Proceeds	$	165	$	3,876	$	1,225	$	1,826	$	1,390	$	18,781

Gross gains realized		—		33		7		4		7		285
Gross losses realized		(10)		(9)		(23)		(1)		(33)		(29)
Net gains (losses) realized	$	(10)	$	24
Net (losses) gains realized					$	(16)	$	3	$	(26)	$	256

Tax benefit (provision) on net (losses) gains realized	$	2	$	(5)	$	3	$	(1)	$	5	$	(54)

Impairment:

The AFS securities portfolio contained 105 securities with ~~$76.5~~$91 million of temporarily impaired fair value and ~~$2.3~~$1.0 million in unrealized losses at ~~March 31,~~September 30, 2020. The total unrealized loss position has ~~increased $647~~decreased $643 thousand since year-end 2019.

For securities with an unrealized loss, Management applies a systematic methodology in order to perform an assessment of the potential for other-than-temporary impairment. In the case of debt securities, investments considered for other-than-temporary impairment: (1) had a specified maturity or repricing date; (2) were generally expected to be redeemed at ~~par,~~par; and (3) were expected to achieve a recovery in market value within a reasonable period of time. In addition, the Bank considers whether it intends to sell these securities or whether it will be forced to sell these securities before the earlier of amortized cost recovery or maturity. The impairment identified on debt securities and subject to assessment at ~~March 31,~~September 30, 2020, was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted.

The following table reflects temporary impairment in the AFS portfolio, aggregated by investment category, length of time that individual securities have been in a continuous unrealized loss position and the number of securities in each category as of ~~March 31,~~September 30, 2020 and December 31, 2019:



	March 31, 2020															September 30, 2020
	Less than 12 months					12 months or more					Total					Less than 12 months					12 months or more					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized			Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
(Dollars in thousands)	Value		Losses		Count	Value		Losses		Count	Value		Losses		Count	Value		Losses		Count	Value		Losses		Count	Value		Losses		Count

U.S. Government and Agency ‎ securities	$	6,681	$	(27)	8	$	1,284	$	(7)	7	$	7,965	$	(34)	15	$	6,127	$	(32)	7	$	2,372	$	(17)	10	$	8,499	$	(49)	17
Municipal securities		19,666		(235)	21		796		(7)	1		20,462		(242)	22		37,067		(270)	37		—		—	—		37,067		(270)	37
Trust preferred securities		840		(119)	1		2,706		(437)	4		3,546		(556)	5
Trust preferred and Corporate securities																	2,898		(64)	5		2,994		(159)	4		5,892		(223)	9
Agency mortgage-backed securities		22,506		(459)	35		312		(2)	1		22,818		(461)	36		9,011		(29)	8		3,479		(6)	5		12,490		(35)	13
Private-label mortgage-backed securities		123		(4)	1		—		—	—		123		(4)	1		3,473		(19)	1		—		—	—		3,473		(19)	1
Asset-backed securities		15,252		(554)	16		6,300		(482)	10		21,552		(1,036)	26		14,934		(156)	16		8,635		(291)	12		23,569		(447)	28
Total temporarily impaired ‎ securities	$	65,068	$	(1,398)	82	$	11,398	$	(935)	23	$	76,466	$	(2,333)	105	$	73,510	$	(570)	74	$	17,480	$	(473)	31	$	90,990	$	(1,043)	105



	December 31, 2019															December 31, 2019
	Less than 12 months					12 months or more					Total					Less than 12 months					12 months or more					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized			Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
(Dollars in thousands)	Value		Losses		Count	Value		Losses		Count	Value		Losses		Count	Value		Losses		Count	Value		Losses		Count	Value		Losses		Count

U.S. Government and Agency ‎ securities	$	2,559	$	(12)	6	$	1,335	$	(8)	7	$	3,894	$	(20)	13	$	2,559	$	(12)	6	$	1,335	$	(8)	7	$	3,894	$	(20)	13
Municipal securities		38,874		(966)	40		2,655		(31)	4		41,529		(997)	44		38,874		(966)	40		2,655		(31)	4		41,529		(997)	44
Trust preferred securities		—		—	—		3,967		(130)	5		3,967		(130)	5
Trust preferred and Corporate securities																	—		—	—		3,967		(130)	5		3,967		(130)	5
Agency mortgage-backed securities		21,185		(185)	32		6,555		(49)	22		27,740		(234)	54		21,185		(185)	32		6,555		(49)	22		27,740		(234)	54
Asset-backed securities		17,644		(128)	19		5,669		(177)	9		23,313		(305)	28		17,644		(128)	19		5,669		(177)	9		23,313		(305)	28
Total temporarily impaired ‎ securities	$	80,262	$	(1,291)	97	$	20,181	$	(395)	47	$	100,443	$	(1,686)	144	$	80,262	$	(1,291)	97	$	20,181	$	(395)	47	$	100,443	$	(1,686)	144

The following table represents the cumulative credit losses on AFS securities recognized in earnings for:



	Three Months Ended				Nine Months Ended
(Dollars in thousands)	March 31,				September 30,
	2020		2019		2020		2019
Balance of cumulative credit-related OTTI at January 1	$	272	$	272	$	272	$	272
Additions for credit-related OTTI not previously recognized		—		—		—		—
Additional increases for credit-related OTTI previously recognized when there is
no intent to sell and no requirement to sell before recovery of amortized cost basis		—		—		—		—
Decreases for previously recognized credit-related OTTI because there was an intent to sell		—		—		—		—
Reduction for increases in cash flows expected to be collected		—		—		—		—
Balance of credit-related OTTI at March 31	$	272	$	272
Balance of credit-related OTTI at September 30					$	272	$	272

Equity Securities at Fair Value

The Corporation owns 1one equity investment. At ~~March 31,~~September 30, 2020 and December 31, 2019, this investment was reported at fair value of ~~$313~~$301 thousand and $440 thousand, respectively, with changes in value reported through income.

Note 5. Loans

The Bank reports its loan portfolio based on the primary collateral of the loan. It further classifies these loans by the primary purpose, either consumer or commercial. The Bank’s residential real estate loans include long-term loans to individuals and businesses secured by mortgages on the borrower’s real property and include home equity loans. Construction loans are made to finance the purchase of land and the construction of residential and commercial buildings thereon and are secured by mortgages on real estate. Commercial real estate loans include construction, owner and non-owner occupied properties and farm real estate. Commercial loans are made to businesses of various sizes for a variety of purposes including property, plant and equipment, working capital and loans to government municipalities. Commercial lending is concentrated in the Bank’s primary market, but also includes purchased loan participations. Consumer loans are comprised of installment loans and unsecured personal lines of credit.

Each class of loans involves a different kind of risk. However, risk factors such as changes in interest rates, general economic conditions and changes in collateral values are common across all classes. The risk of each loan class is presented below.

Residential Real Estate 1-4 ~~family~~Family

The largest risk in residential real estate loans to retail customers is the borrower’s inability to repay the loan due to the loss of the primary source of income. The Bank attempts to mitigate this risk through prudent underwriting standards including employment history, current financial condition and credit history. These loans are generally owner occupied and serve as the borrower’s primary residence. Commercial purpose loans, secured by residential real estate, are usually dependent upon repayment from the rental income or other business purposes. These loans are generally non-owner occupied. In addition to the real estate collateral, these loans may have personal guarantees or UCC filings on other business assets. If a payment default occurs on a 1-4 family residential real estate loan, the collateral serves as a source of repayment, but may be subject to a change in value due to economic conditions.

910

Residential Real Estate Construction

This class includes loans to individuals for construction of a primary residence and tocontractors and developers to improve real estate and construct residential properties. Construction loans to individuals generally bear the same risk as 1-4 family residential loans. Additional risks may include cost overruns, delays in construction or contractor problems.

Loans to contractors and developers are primarily dependent on the sale of improved lots or finished homes for repayment. Risks associated with these loans include the borrower’s character and capacity to complete a development, the effect of economic conditions on the valuation of lots or homes, cost overruns, delays in construction or contractor problems. In addition to real estate collateral, these loans may have personal guarantees or UCC filings on other business assets, depending on the financial strength and experience of the developer. Real estate construction loans are monitored on a regular basis by either an independent third party or the responsible loan officer, depending on the size and complexity of the project. This monitoring process includes at a minimum, the submission of invoices or ~~AIA~~American Institute of Architects (AIA) documents detailing the cost incurred by the borrower, on-site inspections, and an authorizing signature for disbursement of funds.

Commercial Real Estate

Commercial real estate loans may be secured by various types of commercial property including retail space, office buildings, warehouses, hotels and motel, manufacturing facilities and, agricultural land.

Commercial real estate loans present a higher level of risk than residential real estate loans. Repayment of these loans is normally dependent on cash-flow generated by the operation of a business that utilizes the real estate. The successful operation of the business, and therefore repayment ability, may be affected by general economic conditions outside of the control of the operator. On most commercial real estate loans ongoing monitoring of cash flow and other financial performance indictors is completed annually through financial statement analysis. In addition, the value of the collateral may be negatively affected by economic conditions and may be insufficient to repay the loan in the event of default. In the event of foreclosure, commercial real estate may be more difficult to liquidate than residential real estate.

Commercial

Commercial loans are made for various business purposes to finance equipment, inventory, accounts receivables, and operating liquidity. These loans are generally secured by business assets or equipment, non-real estate collateral and/or personal guarantees.

Commercial loans present a higher level of credit risk than other loans because repayment ability is usually dependent on cash-flow from a business operation that can be affected by general economic conditions. On most Commercial loans ongoing monitoring of cash flow and other financial performance indictors at least annually through financial statement analysis. In the event of a default, collateral for these loans may be more difficult to liquidate, and the valuation of the collateral may decline more quickly than loans secured by other types of collateral.

Loans to governmental municipalities are also included in the Commercial class. These loans generally have less risk than ~~C&I~~Commercial & Industrial (C&I) loans due to the taxing authority of the municipality and its ability to assess fees on services.

Consumer

These loans are made for a variety of reasons to consumers and include term loans and personal lines-of credit. The loans may be secured or unsecured. Repayment is primarily dependent on the income of the borrower and to a lesser extent the sale of collateral. The underwriting of these loans is based on the consumer’s ability and willingness to repay and is determined by the borrower’s employment history, current financial condition and credit background. Collateral for these loans, if any, usually depreciates quickly and therefore, may not be adequate to repay the loan if it is repossessed. Therefore, the overall health of the economy, including unemployment rates and wages, will have an effect on the credit quality in this loan class.

‎

1011

A summary of loans outstanding, by class, at the end of the reporting periods is as follows:



	March 31,		December 31,			September 30,		December 31,
(Dollars in thousands)	2020		2019			2020		2019
Residential Real Estate 1-4 Family
Consumer first liens	$	82,719	$	85,319		$	79,361	$	85,319
Commercial first lien		60,587		57,627			62,235		57,627
Total first liens		143,306		142,946			141,596		142,946

Consumer junior liens and lines of credit		45,269		42,715			53,932		42,715
Commercial junior liens and lines of credit		5,397		4,882			4,844		4,882
Total junior liens and lines of credit		50,666		47,597			58,776		47,597
Total residential real estate 1-4 family		193,972		190,543			200,372		190,543

Residential real estate - construction
Consumer		4,523		4,107			6,323		4,107
Commercial		10,959		9,216			7,891		9,216
Total residential real estate construction		15,482		13,323			14,214		13,323

Commercial real estate		494,143		494,262			505,498		494,262
Commercial		226,128		230,007			296,331		230,007
Total commercial		720,271		724,269			801,829		724,269

Consumer		6,661		6,440			6,543		6,440
		936,386		934,575			1,022,958		934,575
Less: Allowance for loan losses		(14,730)		(11,966)			(17,151)		(11,966)
Net Loans	$	921,656	$	922,609		$	1,005,807	$	922,609

Included in the loan balances are the following:
Net unamortized deferred loan (fees) costs	$	397	$	178		$	(708)	$	178

Paycheck Protection Program (PPP) loans (included in Commercial loans above)					Paycheck Protection Program (PPP) loans (included in Commercial loans above)
Two-year loans						$	62,178	$	—
Five-year loans							1,217		—
Total Paycheck Protection Program loans						$	63,395	$	—

Unamortized deferred PPP loan fees (included in Net unamortized deferred loan fees above)
Two-year loans						$	(1,872)	$	—
Five-year loans							(57)		—
Total unamortized deferred PPP loan fees						$	(1,929)	$	—

Loans pledged as collateral for borrowings and commitments from:
FHLB	$	764,056	$	764,340		$	818,800	$	764,340
Federal Reserve Bank		49,636		32,155			51,293		32,155
	$	813,692	$	796,495		$	870,093	$	796,495

Note 6. Loan Quality and Allowance for Loan Losses

The following table presents, by class, the activity in the Allowance for Loan Losses (ALL) for the periods shown:


	Residential Real Estate 1-4 Family																Residential Real Estate 1-4 Family
	First		Junior Liens &				Commercial										First		Junior Liens &				Commercial
(Dollars in thousands)	Liens		Lines of Credit		Construction		Real Estate		Commercial		Consumer		Unallocated		Total		Liens		Lines of Credit		Construction		Real Estate		Commercial		Consumer		Unallocated		Total

ALL at July 1, 2020																	$	580	$	197	$	242	$	8,837	$	5,845	$	105	$	749	$	16,555
Charge-offs																		—		—		—		—		—		(28)		—		(28)
Recoveries																		—		—		—		—		243		6		—		249
Provision																		(2)		14		17		372		(52)		11		15		375
ALL at September 30, 2020																	$	578	$	211	$	259	$	9,209	$	6,036	$	94	$	764	$	17,151

ALL at December 31, 2019	$	416	$	119	$	184	$	6,022	$	3,815	$	84	$	1,326	$	11,966	$	416	$	119	$	187	$	6,607	$	4,021	$	84	$	532	$	11,966
Charge-offs		—		—		—		—		(220)		(30)		—		(250)		—		—		—		—		(365)		(87)		—		(452)
Recoveries		3		—		—		—		5		6		—		14		4		—		—		—		267		16		—		287
Provision		144		59		82		1,582		886		38		209		3,000		158		92		72		2,602		2,113		81		232		5,350
ALL at March 31, 2020	$	563	$	178	$	266	$	7,604	$	4,486	$	98	$	1,535	$	14,730
ALL at September 30, 2020																	$	578	$	211	$	259	$	9,209	$	6,036	$	94	$	764	$	17,151

ALL at July 1, 2019																	$	437	$	113	$	164	$	6,452	$	4,733	$	95	$	559	$	12,553
Charge-offs																		-		—		(120)		(169)		(17)		(27)		—		(333)
Recoveries																		1		—		—		1		111		11		—		124
Provision																		2		1		139		266		(545)		2		(27)		(162)
ALL at September 30, 2019																	$	440	$	114	$	183	$	6,550	$	4,282	$	81	$	532	$	12,182

ALL at December 31, 2018	$	491	$	133	$	108	$	5,698	$	4,511	$	70	$	1,404	$	12,415	$	491	$	133	$	110	$	6,278	$	4,783	$	70	$	550	$	12,415
Charge-offs		(33)		(1)		(3)		(63)		(61)		(26)		—		(187)		(34)		(1)		(123)		(355)		(92)		(78)		—		(683)
Recoveries		1		—		—		1		42		10		—		54		4		1		—		22		162		24		—		213
Provision		28		—		47		270		70		18		(34)		399		(21)		(19)		196		605		(571)		65		(18)		237
ALL at March 31, 2019	$	487	$	132	$	152	$	5,906	$	4,562	$	72	$	1,370	$	12,681

ALL at September 30, 2019																	$	440	$	114	$	183	$	6,550	$	4,282	$	81	$	532	$	12,182

1113

The following table presents, by class, loans that were evaluated for the ALL under the specific reserve (individually) and those that were evaluated under the general reserve (collectively) and the amount of the ALL established in each class as of ~~March 31,~~September 30, 2020 and December 31, 2019:



	Residential Real Estate 1-4 Family																Residential Real Estate 1-4 Family
	First		Junior Liens &				Commercial										First		Junior Liens &				Commercial
(Dollars in thousands)	Liens		Lines of Credit		Construction		Real Estate		Commercial		Consumer		Unallocated		Total		Liens		Lines of Credit		Construction		Real Estate		Commercial		Consumer		Unallocated		Total

March 31, 2020
September 30, 2020
Loans evaluated for ALL:
Individually	$	653	$	—	$	521	$	10,795	$	—	$	—	$	—	$	11,969	$	643	$	—	$	515	$	16,361	$	—	$	—	$	—	$	17,519
Collectively		142,653		50,666		14,961		483,348		226,128		6,661		—		924,417		140,953		58,776		13,699		489,137		296,331		6,543		—		1,005,439
Total	$	143,306	$	50,666	$	15,482	$	494,143	$	226,128	$	6,661	$	—	$	936,386	$	141,596	$	58,776	$	14,214	$	505,498	$	296,331	$	6,543	$	—	$	1,022,958

ALL established for ‎ loans evaluated:
Individually	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Collectively		563		178		266		7,604		4,486		98		1,535		14,730		578		211		259		9,209		6,036		94		764		17,151
ALL at March 31, 2020	$	563	$	178	$	266	$	7,604	$	4,486	$	98	$	1,535	$	14,730
ALL at September 30, 2020																	$	578	$	211	$	259	$	9,209	$	6,036	$	94	$	764	$	17,151

December 31, 2019
Loans evaluated for ALL:
Individually	$	659	$	—	$	523	$	10,994	$	—	$	—	$	—	$	12,176	$	659	$	—	$	523	$	10,994	$	—	$	—	$	—	$	12,176
Collectively		142,287		47,597		12,800		483,268		230,007		6,440		—		922,399		142,287		47,597		12,800		483,268		230,007		6,440		—		922,399
Total	$	142,946	$	47,597	$	13,323	$	494,262	$	230,007	$	6,440	$	—	$	934,575	$	142,946	$	47,597	$	13,323	$	494,262	$	230,007	$	6,440	$	—	$	934,575

ALL established for ‎ loans evaluated:
Individually	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Collectively		416		119		184		6,022		3,815		84		1,326		11,966		416		119		187		6,607		4,021		84		532		11,966
ALL at December 31, 2019	$	416	$	119	$	184	$	6,022	$	3,815	$	84	$	1,326	$	11,966	$	416	$	119	$	187	$	6,607	$	4,021	$	84	$	532	$	11,966

‎

1214

The following table shows additional information about those loans considered to be impaired at ~~March 31,~~September 30, 2020 and December 31, 2019:


	Impaired Loans										Impaired Loans
	With No Allowance				With Allowance						With No Allowance				With Allowance
(Dollars in thousands)			Unpaid				Unpaid						Unpaid				Unpaid
	Recorded		Principal		Recorded		Principal		Related		Recorded		Principal		Recorded		Principal		Related
March 31, 2020	Investment		Balance		Investment		Balance		Allowance
September 30, 2020											Investment		Balance		Investment		Balance		Allowance
Residential Real Estate 1-4 Family
First liens	$	653	$	653	$	—	$	—	$	—	$	643	$	643	$	—	$	—	$	—
Junior liens and lines of credit		—		—		—		—		—		—		—		—		—		—
Total		653		653		—		—		—		643		643		—		—		—
Residential real estate - construction		521		729		—		—		—		515		729		—		—		—
Commercial real estate		10,795		11,909		—		—		—		16,361		17,511		—		—		—
Commercial		—		—		—		—		—		—		—		—		—		—
Total	$	11,969	$	13,291	$	—	$	—	$	—	$	17,519	$	18,883	$	—	$	—	$	—


December 31, 2019
Residential Real Estate 1-4 Family
First liens	$	659	$	659	$	—	$	—	$	—
Junior liens and lines of credit		—		—		—		—		—
Total		659		659		—		—		—
Residential real estate - construction		523		729		—		—		—
Commercial real estate		10,994		12,096		—		—		—
Commercial		—		—		—		—		—
Total	$	12,176	$	13,484	$	—	$	—	$	—

The following table shows the average of impaired loans and related interest income for the three and nine months ended ~~March 31,~~September 30, 2020 and 2019:


	Three Months Ended				Three Months Ended				Nine Months Ended
	March 31, 2020				September 30, 2020				September 30, 2020
	Average		Interest		Average		Interest		Average		Interest
(Dollars in thousands)	Recorded		Income		Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized		Investment		Recognized
Residential Real Estate 1-4 Family
First liens	$	656	$	10	$	645	$	12	$	651	$	30
Junior liens and lines of credit		—		—		—		—		—		—
Total		656		10		645		12		651		30
Residential real estate - construction		521		—		517		—		519		—
Commercial real estate		10,899		94		16,580		93		13,041		280
Commercial		—		—		—		—		—		—
Total	$	12,076	$	104	$	17,742	$	105	$	14,211	$	310

	Three Months Ended				Three Months Ended				Nine Months Ended
	March 31, 2019				September 30, 2019				September 30, 2019
	Average		Interest		Average		Interest		Average		Interest
(Dollars in thousands)	Recorded		Income		Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized		Investment		Recognized
Residential Real Estate 1-4 Family
First liens	$	893	$	11	$	396	$	6	$	399	$	18
Junior liens and lines of credit		44		—		—		—		—		—
Total		937		11		396		6		399		18
Residential real estate - construction		653		—		646		—		650		—
Commercial real estate		13,494		102		12,461		98		12,933		302
Commercial		129		—		—		—		—		—
Total	$	15,213	$	113	$	13,503	$	104	$	13,982	$	320

‎

1315

The following table presents the aging of payments of the loan portfolio:



(Dollars in thousands)			Loans Past Due and Still Accruing										Total				Loans Past Due and Still Accruing										Total
	Current		30-59 Days		60-89 Days		90 Days+		Total		Non-Accrual		Loans		Current		30-59 Days		60-89 Days		90 Days+		Total		Non-Accrual		Loans
March 31, 2020
September 30, 2020
Residential Real Estate 1-4 Family
First liens	$	142,621	$	588	$	55	$	1	$	644	$	41	$	143,306	$	141,383	$	42	$	130	$	—	$	172	$	41	$	141,596
Junior liens and lines of credit		50,581		40		—		31		71		14		50,666		58,626		99		37		—		136		14		58,776
Total		193,202		628		55		32		715		55		193,972		200,009		141		167		—		308		55		200,372
Residential real estate - construction		14,961		—		—		—		—		521		15,482		13,699		—		—		—		—		515		14,214
Commercial real estate		490,468		110		643		—		753		2,922		494,143		496,472		296		—		443		739		8,287		505,498
Commercial		225,310		288		355		—		643		175		226,128		295,968		158		—		—		158		205		296,331
Consumer		6,625		30		6		—		36		—		6,661		6,493		31		12		7		50		—		6,543
Total	$	930,566	$	1,056	$	1,059	$	32	$	2,147	$	3,673	$	936,386	$	1,012,641	$	626	$	179	$	450	$	1,255	$	9,062	$	1,022,958



December 31, 2019
Residential Real Estate 1-4 Family
First liens	$	141,843	$	646	$	358	$	31	$	1,035	$	68	$	142,946
Junior liens and lines of credit		47,420		70		30		46		146		31		47,597
Total		189,263		716		388		77		1,181		99		190,543
Residential real estate - construction		12,800		—		—		—		—		523		13,323
Commercial real estate		490,114		813		326		—		1,139		3,009		494,262
Commercial		229,659		31		120		—		151		197		230,007
Consumer		6,397		25		18		—		43		—		6,440
Total	$	928,233	$	1,585	$	852	$	77	$	2,514	$	3,828	$	934,575

‎

The following table reports the risk rating for those loans in the portfolio that are assigned an individual risk rating. Consumer purpose loans are assigned a rating of either pass or substandard based on the performance status of the loans. Substandard consumer loans are comprised of loans 90 days or more past due and still accruing, and nonaccrual loans. Commercial purpose loans may be assigned any rating in accordance with the Bank’s internal risk rating system.



	Pass		OAEM		Substandard		Doubtful				Pass		OAEM		Substandard		Doubtful
(Dollars in thousands)	(1-5)		(6)		(7)		(8)		Total		(1-5)		(6)		(7)		(8)		Total

March 31, 2020
September 30, 2020
Residential Real Estate 1-4 Family
First liens	$	143,264	$	—	$	42	$	—	$	143,306	$	141,555	$	—	$	41	$	—	$	141,596
Junior liens and lines of credit		50,621		—		45		—		50,666		58,762		—		14		—		58,776
Total		193,885		—		87		—		193,972		200,317		—		55		—		200,372
Residential real estate - construction		14,961		—		521		—		15,482		13,699		—		515		—		14,214
Commercial real estate		484,031		5,951		4,161		—		494,143		469,953		25,639		9,906		—		505,498
Commercial		225,737		—		391		—		226,128		284,339		11,618		374		—		296,331
Consumer		6,661		—		—		—		6,661		6,537		—		6		—		6,543
Total	$	925,275	$	5,951	$	5,160	$	—	$	936,386	$	974,845	$	37,257	$	10,856	$	—	$	1,022,958



December 31, 2019
Residential Real Estate 1-4 Family
First liens	$	142,847	$	—	$	99	$	—	$	142,946
Junior liens and lines of credit		47,520		—		77		—		47,597
Total		190,367		—		176		—		190,543
Residential real estate - construction		12,800		—		523		—		13,323
Commercial real estate		483,878		5,875		4,509		—		494,262
Commercial		229,465		4		538		—		230,007
Consumer		6,440		—		—		—		6,440
Total	$	922,950	$	5,879	$	5,746	$	—	$	934,575

The following table presents information on the Bank’s Troubled Debt Restructuring (TDR) loans as of:


								Troubled Debt Restructurings										Troubled Debt Restructurings
								Within the Last 12 Months										Within the Last 12 Months
								That Have Defaulted										That Have Defaulted
(Dollars in thousands)	Troubled Debt Restructurings							On Modified Terms			Troubled Debt Restructurings							On Modified Terms
	Number of	Recorded						Number of	Recorded		Number of	Recorded						Number of	Recorded
	Contracts	Investment		Performing*		Nonperforming*		Contracts	Investment		Contracts	Investment		Performing*		Nonperforming*		Contracts	Investment
March 31, 2020
September 30, 2020
Residential real estate - construction	1		443	$	443	$	—	—	$	—	1	$	437	$	437	$	—	—	$	—
Residential real estate	4		652		652		—	—		—	4		643		643		—	—		—
Commercial real estate - owner occupied											4		1,238		795		443	—		—
Commercial real estate - farm land											6		2,235		2,235		—	—		—
Commercial real estate - construction and land development											2		6,221		6,221		—	—		—
Commercial real estate	11		9,220		8,244		976	—		—	2		339		339		—	—		—
Total	16	$	10,315	$	9,339	$	976	—	$	—	19	$	11,113	$	10,670	$	443	—	$	—


December 31, 2019
Residential real estate - construction	1	$	444	$	444	$	—	—	$	—	1	$	444	$	444	$	—	—	$	—
Residential real estate	4		659		659		—	—		—	4		659		659		—	—		—
Commercial real estate - owner occupied											2		846		846		—	—		—
Commercial real estate - farm land											5		1,646		1,646		—	—		—
Commercial real estate - construction and land development											2		6,487		6,487		—	—		—
Commercial real estate	11		9,343		9,343		—	—		—	2		364		364		—	—		—
Total	16	$	10,446	$	10,446	$	—	—	$	—	16	$	10,446	$	10,446	$	—	—	$	—

*The performing status is determined by the loan’s compliance with the modified terms.

‎

The following table reports new TDR loans during 2020, concession granted and the recorded investment as of September 30, 2020:


	New During Period
Nine Months Ended	Number of		Pre-TDR		After-TDR		Recorded
September 30, 2020	Contracts		Modification		Modification		Investment	Concession
Commercial real estate - farm land	1	$	650	$	650	$	650	multiple
Commercial real estate - owner occupied	2		426		426		426	maturity
	3	$	1,076	$	1,076	$	1,076

There were 0 new TDR loans during ~~2020 or~~ 2019. Loans that have been modified on a good-faith basis in response to COVID-19 to borrowers who were classified as current prior to any relief are not TDRs as outlined in the March 22, 2020 Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus.or Section 4013 of the CARES Act. Such short-term modifications (e.g., six months) may include payment deferrals, fee waivers, extension of payment terms or other delays in payment that are insignificant. As of ~~March 31,~~September 30, 2020, the Bank has granted approximately ~~$30~~$83 million loan deferrals or modifications (approximately 3%8% of gross loans).

Note 7. Leases

The Corporation leases various assets in the course of its operations that are subject to recognition on the balance sheet. The Corporation considers all of its leases to be operating leases and it has no finance leases. The leased assets are comprised of equipment, and buildings and land (collectively real estate). The equipment leases are shorter-term than the real estate leases, and generally have a fixed payment over a defined term without renewal options. Certain equipment leases have purchase options and it was determined the option was not reasonably certain to be exercised. The real estate leases are longer-term and may contain renewal options after the initial term, but none of the real estate leases contain a purchase option. The renewal options on real estate leases were reviewed and if it was determined the option was reasonably certain to be renewed, the option term was considered in the determination of the lease liability. There is only one real estate lease with a variable payment based on an index included in the lease liability. None of the leases contain any restrictive covenants and there are no significant leases that have not yet commenced. The discount rate used to determine the lease liability is based on the Bank’s fully secured borrowing rate from the Federal Home Loan Bank for a term similar to the lease term. Operating lease expense is included in net occupancy expense in the consolidated statements of income.

‎

Lease costs:

The components of total lease cost were as follows:


	Three Months Ended		Three Months Ended		Three Months Ended ‎September 30,				Nine Months Ended ‎September 30,
(Dollars in thousands)	March 31, 2020		March 31, 2019		2020		2019		2020		2019
Operating lease cost	$	158	$	188	$	149	$	183	$	466	$	555
Short-term lease cost		2		6		2		7		5		19
Variable lease cost		14		11		11		13		39		36
Total lease cost	$	174	$	205	$	162	$	203	$	510	$	610

‎

Supplemental Lease Information:


	Three Months Ended		Three Months Ended		Nine Months Ended ‎September 30,
(Dollars in thousands)	March 31, 2020		March 31, 2019		2020		2019
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	152		123	$	447	$	375

Weighted-average remaining lease term (years)		12.8		13.7		12.5		12.8
Weighted-average discount rate		3.53%		3.54%		3.54%		3.52%

Lease Obligations:

Future undiscounted lease payments for operating leases with initial terms of one year or more as of ~~March 31,~~September 30, 2020 are as follows:


(Dollars in thousands)

2020	$	577	$	143
2021		556		558
2022		546		546
2023		552		551
2024		508		525
2025 and beyond		3,756		3,876
Undiscounted cash flow		6,495		6,199
Imputed Interest		(1,336)		(1,246)
Total lease liability	$	5,159	$	4,953

Note 8. Other Real Estate Owned

Changes in other real estate owned were as follows:


	Three Months Ended				Three Months Ended				Nine Months Ended
	March 31,				September 30,				September 30,
(Dollars in thousands)	2020		2019		2020		2019		2020		2019
Balance at beginning of the period	$	—	$	2,684	$	—	$	2,684	$	—	$	2,684
Additions		—		—		—		80		—		80
Proceeds from dispositions		—		—		—		(74)		—		(74)
Gains on sales, net		—		—		—		9		—		9
Valuation adjustment		—		—		—		(6)		—		(6)
Balance at the end of the period	$	—	$	2,684	$	—	$	2,693	$	—	$	2,693

Note 9. Derivatives

The Corporation is exposed to certain risks arising from both its business operations and economic conditions. The Corporation principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Corporation manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its assets and liabilities.

The Corporation’s existing credit derivatives result from participations in interest rate swaps provided by external lenders as part of loan participation ~~arrangements, therefore, are not used to manage interest rate risk in the Corporation’s assets or liabilities.~~arrangements. Derivatives not designated as hedges are not speculative and result from a service the Corporation provides to certain lenders which participate in loans.

‎

The table below presents the fair value of the Corporation’s derivative financial instruments as well as their classification on the Balance Sheet.


	Fair Value of Derivative Instruments								Fair Value of Derivative Instruments
	Derivative Liabilities								Derivative Liabilities
(Dollars in thousands)	March 31, 2020				March 31, 2019				September 30, 2020				September 30, 2019
	Notional amount	Balance Sheet Location		Fair Value	Notional amount	Balance Sheet Location		Fair Value	Notional amount	Balance Sheet Location		Fair Value	Notional amount	Balance Sheet Location		Fair Value
Derivatives not designated as hedging instruments
Other Contracts	6,967	Other Liabilities	$	55	—	Other Liabilities	$	—	6,880	Other Liabilities	$	51	—	Other Liabilities	$	—
Total derivatives not designated as hedging instruments			$	55			$	—			$	51			$	—

The table below presents the effect of the Corporation’s derivative financial instruments that are not designated as hedging instruments on the Income Statement.

Effect of Derivatives Not Designated as Hedging Instruments on the Statement of Financial Performance

Derivatives Not Designated as Hedging Instruments under Subtopic 815-20

Location of Gain or (Loss) Recognized in Income on Derivative

Amount of Gain or (Loss) Recognized in Income on Derivatives

(Dollars in thousands)

Three Months Ended

Nine Months Ended

~~March 31,~~September 30, 2020

~~March 31,~~September 30, 2019

September 30, 2020

September 30, 2019

Other Contracts

Other income/(expense)

~~(36)~~-

(33)

As of ~~March 31,~~September 30, 2020, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was ~~$55~~$51 thousand.

Note 10. Pension

The components of pension expense for the periods presented are as follows:


	Three Months Ended				Three Months Ended				Nine Months Ended
	March 31,				September 30,				September 30,
(Dollars in thousands)	2020		2019		2020		2019		2020		2019
Components of net periodic cost:
Service cost	$	83	$	80	$	83	$	82	$	249	$	243
Interest cost		131		158		131		157		394		473
Expected return on plan assets		(269)		(270)		(269)		(272)		(809)		(814)
Recognized net actuarial loss		226		152		226		133		678		419
Total pension expense	$	171	$	120	$	171	$	100	$	512	$	321

~~The Bank expects its pension expense to increase to approximately $680 thousand in 2020 compared to $421 thousand in 2019, due primarily to increases in recognized net actuarial losses.~~ The service cost component of pension expense is in the salaries and employee benefits line on the income statement. All other cost components are in the other expense line on the income statement.

Note 11. Fair Value Measurements and Fair Values of Financial Instruments

Management uses its best judgment in estimating the fair value of the Corporation’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Corporation could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective period-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates maybe different than the amounts reported at each year-end. The Corporation uses the exit price notion to measure the fair value of financial instruments.

FASB ASC Topic 820, “Financial Instruments”, requires disclosure of the fair value of financial assets and liabilities, including those financial assets and liabilities that are not measured and reported at fair value on a recurring and

nonrecurring basis. The Corporation does not report any nonfinancial assets at fair value. FASB ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under FASB ASC Topic 820 are as follows:

Level 1: Valuation is based on unadjusted, quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2: Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. There may be substantial differences in the assumptions used for securities within the same level. For example, prices for U.S. Agency securities have fewer assumptions and are closer to level 1 valuations than the private label mortgage backed securities that require more assumptions and are closer to level 3 valuations.

Level 3: Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Corporation’s assumptions regarding what market participants would assume when pricing a financial instrument.

An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The following information regarding the fair value of the Corporation’s financial instruments should not be interpreted as an estimate of the fair value of the entire Corporation since a fair value calculation is only provided for a limited portion of the Corporation’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Corporation’s disclosures and those of other companies may not be meaningful.

The following methods and assumptions were used to estimate the fair values of the Corporation’s financial instruments measured at fair value on a recurring and nonrecurring basis.

Equity Securities: Equity securities are valued using quoted market prices from nationally recognized markets (Level 1). Equity securities are measured at fair value on a recurring basis.

Investment securities: Fair values of investment securities available-for-sale were primarily measured using information from a third-party pricing service. This service provides pricing information by utilizing evaluated pricing models supported with market data information. Standard inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data from market research publications. Level 2 investment securities are primarily comprised of debt securities issued by states and municipalities, corporations, mortgage-backed securities issued by government agencies, and government-sponsored enterprises. Fair values were estimated primarily by obtaining quoted prices for similar assets in active markets or through the use of pricing models. Investment securities are measured at fair value on a recurring basis.

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals conducted by an independent, licensed appraiser, less cost to sell. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach (Level 2). If the appraiser makes an adjustment to account for differences between the comparable sales and income data available for similar loans, or if management adjusts the appraised value, then the fair value is considered Level 3. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted in accordance with the allowance policy. NaN partial charge-offs on impaired loans were taken in the ~~first~~third quarter of 2020. Impaired loans are measured at fair value on a nonrecurring basis.

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1821

Recurring Fair Value Measurements

For financial assets and liabilities measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at ~~March 31,~~September 30, 2020 and December 31, 2019 are as follows:



(Dollars in thousands)	Fair Value at March 31, 2020								Fair Value at September 30, 2020
Asset Description	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Equity securities, at fair value	$	313	$	—	$	—	$	313	$	301	$	—	$	—	$	301

Available for sale:
U.S. Government and Agency securities		—		13,625		—		13,625		—		11,863		—		11,863
Municipal securities		—		97,210		—		97,210		—		221,433		—		221,433
Trust preferred securities		—		3,546		—		3,546
Trust preferred and Corporate securities										—		10,694		—		10,694
Agency mortgage-backed securities		—		70,147		—		70,147		—		64,380		—		64,380
Private-label mortgage-backed securities		—		323		—		323		—		5,810		—		5,810
Asset-backed securities		—		23,189		—		23,189		—		32,293		—		32,293
Total assets	$	313	$	208,040	$	—	$	208,353	$	301	$	346,473	$	—	$	346,774

The fair value of derivative liabilities measured at fair value at September 30, 2020 is $51 thousand and is considered immaterial.



(Dollars in thousands)	Fair Value at December 31, 2019								Fair Value at December 31, 2019
Asset Description	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Equity securities, at fair value	$	440	$	—	$	—	$	440	$	440	$	—	$	—	$	440

Available for sale:
U.S. Government and Agency securities		—		8,428		—		8,428		—		8,428		—		8,428
Municipal securities		—		91,286		—		91,286		—		91,286		—		91,286
Trust preferred securities		—		3,967		—		3,967
Trust preferred and Corporate securities										—		3,967		—		3,967
Agency mortgage-backed securities		—		58,704		—		58,704		—		58,704		—		58,704
Private-label mortgage-backed securities		—		429		—		429		—		429		—		429
Asset-backed securities		—		24,619		—		24,619		—		24,619		—		24,619
Total assets	$	440	$	187,433	$	—	$	187,873	$	440	$	187,433	$	—	$	187,873

Nonrecurring Fair Value Measurements

There were no assets measured at fair value on a nonrecurring basis as ~~March 31,~~of September 30, 2020 and the following table presents the fair value measurement by level within the fair value hierarchy used at December 31, 2019:



(Dollars in Thousands)	Fair Value at December 31, 2019
Asset Description	Level 1		Level 2		Level 3		Total
Impaired loans (1)	$	—	$	—	$	1,080	$	1,080
Total assets	$	—	$	—	$	1,080	$	1,080

(1)Includes assets directly charged-down to fair value during the year-to-date period.

The Corporation did 0t record any liabilities at fair value for which measurement of the fair value was made on a nonrecurring basis at ~~March 31,~~September 30, 2020. For financial assets and liabilities measured at fair value on a recurring basis, there were 0 transfers of financial assets or liabilities between Level 1 and Level 2 during the period ending ~~March 31,~~September 30, 2020.

There were 0 assets measured at fair value on a nonrecurring basis at ~~March 31,~~September 30, 2020 and the following table presents additional quantitative information about Level 3 assets measured at fair value on a nonrecurring basis at December 31, 2019:



(Dollars in thousands)					Range
December 31, 2019		Fair Value	Valuation Technique	Unobservable Input	Weighted Average
Impaired loans	$	1,080	Appraisal	Appraisal Adjustments	0% - 100% (48%)

(1) Includes assets directly charged-down to fair value during the year-to-date period.

The carrying amounts and estimated fair value of financial instruments not carried at fair value are as follows:



	March 31, 2020										September 30, 2020
	Carrying		Fair								Carrying		Fair
(Dollars in thousands)	Amount		Value		Level 1		Level 2		Level 3		Amount		Value		Level 1		Level 2		Level 3
Financial assets, carried at cost:
Cash and cash equivalents	$	53,350	$	53,350	$	53,350	$	—	$	—	$	71,160	$	71,160	$	71,160	$	—	$	—
Long-term interest-bearing deposits in other banks		10,738		10,738		10,738		—		—		14,235		14,235		14,235		—		—
Loans held for sale		2,751		2,751		—		2,751		—		9,498		9,498		—		9,498		—
Net loans		921,656		921,269		—		—		921,269		1,005,807		1,008,275		—		—		1,008,275
Accrued interest receivable		3,789		3,789		—		—		3,789		6,286		6,286		—		—		6,286

Financial liabilities:
Deposits	$	1,117,433	$	1,118,307	$	—	$	1,118,307	$	—	$	1,336,749	$	1,337,396	$	—	$	1,337,396	$	—
Accrued interest payable		302		302		—		302		—		378		378		—		378		—

	December 31, 2019										December 31, 2019
	Carrying		Fair								Carrying		Fair
(Dollars in thousands)	Amount		Value		Level 1		Level 2		Level 3		Amount		Value		Level 1		Level 2		Level 3
Financial assets, carried at cost:
Cash and cash equivalents	$	83,828	$	83,828	$	83,828	$	—	$	—	$	83,828	$	83,828	$	83,828	$	—	$	—
Long-term interest-bearing deposits in other banks		8,746		8,746		8,746		—		—		8,746		8,746		8,746		—		—
Loans held for sale		2,040		2,040		—		2,040		—		2,040		2,040		—		2,040		—
Net loans		922,609		918,640		—		—		918,640		922,609		918,640		—		—		918,640
Accrued interest receivable		3,845		3,845		—		—		3,845		3,845		3,845		—		—		3,845

Financial liabilities:
Deposits	$	1,125,392	$	1,125,877	$	—	$	1,125,877	$	—	$	1,125,392	$	1,125,877	$	—	$	1,125,877	$	—
Accrued interest payable		436		436		—		436		—		436		436		—		436		—

Note 12. Subordinated Notes

At September 30, 2020, the Corporation had $20 million of unsecured subordinated debt notes payable, $15.0 million which mature on September 1, 2030 and $5.0 million which mature on September 1, 2035. The notes are recorded on the consolidated balance sheet net of remaining debt issuance costs totaling $452.9 thousand at September 30, 2020, which is being amortized on a pro-rata basis over a 5-year and 10-year period, based on the call dates of the notes, on an effective interest method. The subordinated notes totaling $15.0 million have a fixed interest rate of 5.00% through September 1, 2025, then convert to a variable rate of 90-day Secured Overnight Financing Rate (SOFR) plus 4.93% for the applicable interest periods through maturity. The subordinated notes totaling $5.0 million have a fixed interest rate of 5.25% through September 1, 2030, then convert to a variable rate of 90-day SOFR plus 4.92% for the applicable interest periods through maturity. The Corporation may, at its option, redeem the notes, in whole or in part, at any time 5-years prior to the maturity. The notes are structured to qualify as Tier 2 Capital for the Corporation and there are no debt covenants on the notes.

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Note 13. Capital Ratios

Capital adequacy for the Bank is currently defined by regulatory agencies through the use of several minimum required ratios. The capital ratios to be considered “well capitalized” are: (1) Common Equity Tier 1 (CET1) of 6.5%, (2) Tier 1 Leverage of 5%, (3) Tier 1 Risk-Based Capital of 8%, and (4) Total Risk-Based Capital of 10%. In addition, a capital conservation buffer of 2.50% is applicable to all of the capital ratios except for the Tier 1 Leverage ratio. The capital conservation buffer is equal to the lowest value of the three applicable capital ratios less the regulatory minimum for each respective capital measurement. The Bank’s capital conservation buffer at ~~March 31,~~September 30, 2020 was ~~7.78% (total risk-based capital 15.78% less 8.00%)~~7.25% compared to the 2020 regulatory buffer of 2.50%. Compliance with the capital conservation buffer is required in order to avoid limitations to certain capital distributions and is in addition to the minimum required capital requirements. As of ~~March 31,~~September 30, 2020, the Bank was “well capitalized”.

In 2019, the Community Bank Leverage Ratio (CBLR) was approved by federal banking agencies as an optional capital measure available to Qualifying Community Banking Organizations (QCBO). If a bank qualifies as a QCBR and maintains a CBLR of 9% or greater, the bank would be considered “well-capitalized” for regulatory capital purposes and exempt from complying with the risk-based capital rule described above. The CBLR rule took effect January 1, 2020 and banks ~~desiring to~~could opt-in ~~can do so~~ through an election in the first quarter 2020 regulatory filing. The Bank ~~meets~~met the criteria of a QCBR but did not opt-in to the CBLR.

The Bank is participating in the ~~Paycheck Protection Program (PPP)~~PPP and the Paycheck Protection Program Liquidity Facility (PPPLF) to fund PPP Loans. In accordance with regulatory guidance, PPP loans pledged as collateral for PPPLF, and PPPLF advances, are excluded from leverage capital ratios. PPP loans will also carry a 0% risk-weight for risk-based capital rules.

The consolidated asset limit on small bank holding companies is $3 billion and a company with assets under that limit is not subject to the consolidated capital rules but may file reports that include capital amounts and ratios. The Corporation has elected to file those reports.

The following table summarizes the regulatory capital requirements and results as of ~~March 31,~~September 30, 2020 and December 31, 2019 for the Corporation and the Bank:


				Regulatory Ratios					Regulatory Ratios
				Adequately	Well				Adequately	Well
		March 31,	December 31,	Capitalized	Capitalized		September 30,	December 31,	Capitalized	Capitalized
(Dollars in thousands)		2020	2019	Minimum	Minimum		2020	2019	Minimum	Minimum

Common Equity Tier 1 Risk-based Capital Ratio (1)
Franklin Financial Services Corporation		14.73%	14.82%	N/A	N/A		14.21%	14.82%	N/A	N/A
Farmers & Merchants Trust Company		14.52%	14.62%	4.500%	6.50%		13.99%	14.62%	4.50%	6.50%

Tier 1 Risk-based Capital Ratio (2)
Franklin Financial Services Corporation		14.73%	14.82%	N/A	N/A		14.21%	14.82%	N/A	N/A
Farmers & Merchants Trust Company		14.52%	14.62%	6.000%	8.00%		13.99%	14.62%	6.00%	8.00%

Total Risk-based Capital Ratio (3)
Franklin Financial Services Corporation		15.99%	16.08%	N/A	N/A		17.62%	16.08%	N/A	N/A
Farmers & Merchants Trust Company		15.78%	15.87%	8.000%	10.00%		15.25%	15.87%	8.00%	10.00%

Tier 1 Leverage Ratio (4)
Franklin Financial Services Corporation		9.85%	9.72%	N/A	N/A		8.75%	9.72%	N/A	N/A
Farmers & Merchants Trust Company		9.71%	9.59%	4.000%	5.00%		8.61%	9.59%	4.00%	5.00%

(1) Common equity Tier 1 capital/ total risk-weighted assets (2) Tier 1 capital / total risk-weighted assets	(1) Common equity Tier 1 capital/ total risk-weighted assets (2) Tier 1 capital / total risk-weighted assets					(1) Common equity Tier 1 capital/ total risk-weighted assets (2) Tier 1 capital / total risk-weighted assets
(3) Total risk-based capital / total risk-weighted assets, (4) Tier 1 capital / average quarterly assets	(3) Total risk-based capital / total risk-weighted assets, (4) Tier 1 capital / average quarterly assets					(3) Total risk-based capital / total risk-weighted assets, (4) Tier 1 capital / average quarterly assets

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Note ~~13.~~14. Revenue Recognition

All of the Corporation’s revenue from contracts with customers within the scope of ASC 606 is recognized in non-interest income as presented in ~~our~~its consolidated statements of income. Revenue generating activities that fall within the scope of ASC 606 are described as follows:

Investment and Trust Service Fees -– these represent fees from wealth management (assets under management), fees from the management and settlement of estates and commissions from the sale of investment and insurance products.

Asset management fees are generally assessed based on a tiered fee schedule, based on the value of assets under management, and are recognized monthly when the service obligation is completed. Fees recognized were $1.3 million for the ~~first~~third quarter of 2020 and 2019 and $4.2 million year-to-date for 2020, compared to $4.1 million in 2019.

Fees for estate management services are based on the estimated fair value of the estate. These fees are generally recognized monthly over an 18-month period that Management has determined to represent the average time to fulfill the performance obligations of the contract. Management has the discretion to adjust this time period as needed based upon the nature and complexity of an individual estate. Fees recognized were ~~$33~~$45 thousand for the ~~first~~third quarter of 2020, compared to ~~$70~~$105 thousand for the ~~first~~third quarter of 2019 and $118 thousand year-to-date in 2020, compared to $259 thousand year-to-date in 2019.

Commissions from the sale of investment and insurance products are recognized upon the completion of the transaction. Commissions recognized were ~~$74~~$39 thousand for the ~~first~~third quarter of 2020, ~~and $68~~compared to $42 thousand for the third quarter 2019 and $162 thousand year-to-date for 2020, compared to $177 year-to-date in 2019.

Loan Service Charges – these represent fees on loans for services or charges that occur after the loan has been booked, for example, late payment fees. These also include fees for mortgages settled for third-party mortgage companies. All of these fees are transactional in nature and are recognized upon completion of the transaction which represents the performance obligation.

Deposit Service Charges and Fees – these represent fees from deposit customers for transaction based, account maintenance, and overdraft services. Transaction based fees include, but are not limited to, stop payment fees and overdraft fees. These fees are recognized at the time of the transaction when the performance obligation has been fulfilled. Account maintenance fees and account analysis fee are earned over the course of a month, representing the period of the performance obligation, and are recognized monthly.

Debit Card Income – this represents interchange fees from cardholder transactions conducted through the card payment network. Cardholders use the debit card to conduct point-of-sale transactions that produce interchange fees. The

fees are transaction based and the fee is recognized with the processing of the transaction. These fees are reported net of cardholder rewards.

Other Service Charges and Fees – these are comprised primarily of merchant card fees, credit card fees, ATM surcharges and interchange fees and wire transfer fees. Merchant card fees represent fees the Bank earns from a third party for enrolling a customer in the processor’s program. Credit card fees represent a fee earned by the Bank for a successful referral to a card-issuing company. ATM surcharges and interchange fees are the result of Bank customers conducting ATM transactions that generate fee income and are processed through multiple card networks. All of these fees are transaction based and are recognized at the time of the transaction.

Gains/Losses on the Sale of Other Real Estate – these are recognized when control of the property transfers to the buyer.

~~Increases in the cash surrender value of life insurance and security transactions are not within the scope of ASC 606.~~

Contract Balances

A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s noninterest revenue streams are largely based on transactional activity, or standard month-end revenue accruals such as asset management fees based on month-end market values. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into longer-term revenue contracts with customers, and therefore, does not experience significant contract balances.

Contract Acquisition Costs

The Corporation expenses all contract acquisition costs as costs are incurred.

‎

1Note ~~14.~~15. Commitments and Contingencies

In the normal course of business, the Bank is a party to financial instruments that are not reflected in the accompanying financial statements and are commonly referred to as off-balance-sheet instruments. These financial instruments are entered into primarily to meet the financing needs of the Bank’s customers and include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk not recognized in the consolidated balance sheet.

The Corporation’s exposure to credit loss in the event of nonperformance by other parties to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contract or notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as they do for on-balance-sheet instruments.

The Bank had the following outstanding commitments for the periods presented:


	March 31,		December 31,		September 30,		December 31,
(Dollars in thousands)	2020		2019		2020		2019
Financial instruments whose contract amounts represent credit risk
Commercial commitments to extend credit	$	241,341	$	248,251	$	255,637	$	248,251
Consumer commitments to extend credit (secured)		58,712		56,898		66,600		56,898
Consumer commitments to extend credit (unsecured)		5,146		5,088		5,220		5,088
	$	305,199	$	310,237	$	327,457	$	310,237
Standby letters of credit	$	24,199	$	26,382	$	21,367	$	26,382

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses with the exception of home equity lines and personal lines of credit and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank, is based on Management’s credit evaluation of the counterparty. Collateral for most commercial commitments varies but may include accounts receivable, inventory, property, plant, and equipment, and income-producing commercial properties. Collateral for secured consumer commitments consists of liens on residential real estate.

Standby letters of credit are instruments issued by the Bank, which guarantee the beneficiary payment by the Bank in the event of default by the Bank’s customer in the nonperformance of an obligation or service. Most standby letters of credit are extended for one-year periods. Generally, the credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds collateral supporting those commitments for which collateral is deemed necessary primarily in the form of certificates of deposit and liens on real estate. Management believes that the proceeds obtained through a liquidation of such collateral would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees. AsIn the second quarter of ~~June 30,~~ 2018, the Bank established a $2.4 million allowance against letters of credit issued in connection with a commercial borrower that declared bankruptcy. In the first quarter of 2020, the Bank reversed $250 thousand of this reserve as one letter of credit was cancelled. At ~~March 31,~~September 30, 2020 this reserve was $2.1 million. Except for the liability recorded for standby letters of credit, liabilities for credit loss associated with off-balance sheet commitments were not material at ~~March 31,~~September 30, 2020 and December 31, 2019.

Most of the Bank’s business activity is with customers located within its primary market and does not involve any significant concentrations of credit to any one entity or industry.

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Legal Proceedings

The nature of the Corporation’s business generates a certain amount of litigation.

~~We establish~~The Corporation establishes accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probable, and the amount of the loss can be reasonably estimated. When ~~we are~~the Corporation is able to do so, weit also ~~determine~~determines estimates of possible losses, whether in excess of any accrued liability or where there is no accrued liability.

These assessments are based on ~~our~~the analysis of currently available information and are subject to significant judgment and a variety of assumptions and uncertainties. As new information is obtained, wethe Corporation may change ~~our~~its assessments and, as a result, take or adjust the amounts of ~~our~~its accruals and change ~~our~~its estimates of possible losses or ranges of possible losses. Due to the inherent subjectivity of the assessments and the unpredictability of outcomes of legal proceedings, any amounts that may be accrued or included in estimates of possible losses or ranges of possible losses may not represent the actual loss to the Corporation from any legal proceeding. ~~Our~~Its exposure and ultimate losses may be higher, possibly significantly higher, than amounts weit may accrue or amounts weit may estimate.

In management’s opinion, ~~we do~~the Corporation does not anticipate, at the present time, that the ultimate aggregate liability, if any, arising out of all litigation to which the Corporation is a party at this time will have a material adverse effect on ~~our~~its financial position. WeThe Corporation cannot now determine, however, whether or not any claim asserted against usit will have a material adverse effect on ~~our~~its results of operations in any future reporting period, which will depend on, ~~amount~~among other things, the amount of loss resulting from the claim and the amount of income otherwise reported for the reporting period. Thus, at ~~March 31,~~September 30, 2020, ~~we are~~the Corporation is unable to provide an evaluation of the likelihood of an unfavorable outcome or an estimate of the amount or range of potential loss with respect to such other matters and, accordingly, have not yet established any specific accrual for such other matters.

No material proceedings are pending or are known to be threatened or contemplated against usthe Corporation by governmental authorities.

Note ~~15.~~16. Risk Factors

In December 2019, a novel strain of coronavirus surfaced in Wuhan, China, and has spread around the world, with resulting business and social disruption. The coronavirus was declared a Pandemic by the World Health Organization on March 11, 2020. The operations and business results of the Corporation could be materially adversely affected. The ability of our customers to make payments on loans could be adversely impacted, resulting in elevated loan losses and an increase in the Corporation’s allowance for loan losses. Additionally, it is reasonably possible future evaluations of the carrying amount of goodwill could result in a conclusion that goodwill is impaired. The extent to which the coronavirus may impact business activity or investment results will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of the coronavirus and the actions required to contain the coronavirus or treat its impact, among others.

Note ~~16.~~17. Reclassification

Certain prior period amounts may have been reclassified to conform to the current year presentation. Such reclassifications did not affect ~~reported~~prior year net income or shareholders’ equity.

‎

2327

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

Management’s Discussion and Analysis of Results of Operations and Financial Condition

For the Three and Nine Months Ended ~~March 31,~~September 30, 2020 and 2019

Forward Looking Statements

Certain statements appearing herein which are not historical in nature are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements refer to a future period or periods, reflecting management’s current views as to likely future developments, and use words such as “may,” “will,” “expect,” “believe,” “estimate,” “anticipate,” or similar terms. Because forward-looking statements involve certain risks, uncertainties and other factors over which the Corporation has no direct control, actual results could differ materially from those contemplated in such statements. These factors include (but are not limited to) the following: general economic conditions, particularly with regard to the negative impact of severe, wide-ranging and ~~wide-ranging~~continuing disruptions caused by, and resulting from, the spread of the coronavirus COVID-19 pandemic and affects thereof, including governmental responses thereto, changes in interest rates, changes in the Corporation’s cost of funds, changes in government monetary policy, changes in government regulation and taxation of financial institutions, changes in the rate of inflation, changes in technology, the intensification of competition within the Corporation’s market area, and other similar factors. We caution readers not to place undue reliance on these forward-looking statements. They only reflect management’s analysis as of this date. The Corporation does not revise or update these forward-looking statements to reflect events or changed circumstances.

Critical Accounting Policies

Management has identified critical accounting policies for the Corporation. These policies are particularly sensitive, requiring significant judgements, estimates and assumptions to be made by Management. There were no changes to the critical accounting policies disclosed in the 2019 Annual Report on Form 10-K in regards to application or related judgments and estimates used. Please refer to Item 7 of the Corporation’s 2019 Annual Report on Form 10-K for a more detailed disclosure of the critical accounting policies.

Results of Operations

Summary

The Corporation reported net income of ~~$1.7~~$3.5 million ($~~.39~~0.79 per diluted share) for the ~~first~~third quarter of ~~March 31,~~September 30, 2020, ~~compared~~and $8.2 million ($1.89 per diluted share) year-to-date as of September 30, 2020. This compares to ~~$.73~~net income of $4.5 million ($1.03 per ~~share~~diluted share) in the ~~first~~third quarter of 2019 and $11.7 million ($2.66 per diluted share) year-to-date at September 30, 2019.

Net interest income ~~remained unchanged year over year at $10.3 million. However,~~was $10.4 million for the third quarter of 2020, compared to $10.8 million for the third quarter of 2019. The net interest margin was 3.02% for third quarter of 2020, compared to 3.65% for the third quarter of 2019. Year-to-date net interest income was $31.0 million in 2020, compared to $31.7 million in 2019 and the net interest margin fell from ~~3.86%~~3.75% in 2019 to ~~3.53%~~3.25% in 2020.

The year-to-date yield on earning assets fell by 0.79% from 4.36% in 2019 to 3.57% in 2020 as all asset classes had lower yields in 2020 as market rates decreased during the year. The cost of interest-bearing deposits fell from 0.79% in 2019 to 0.39% in 2020 as the Bank reduced deposit rates to offset lower asset yields. The cost of deposits year-to-date fell from 0.64% in 2019 to 0.32% in 2020. For the third quarter of 2020, the net interest margin fell to 3.02% as assets yields continued to decline. The cost of deposits was reduced to 0.21% for the third quarter of 2020.
‎

Earning assets ~~for the first quarter~~year-to-date 2020 averaged ~~$1.2~~$1.3 billion compared to ~~$1.1~~$1.2 billion for the same period in 2019. The average ~~first quarter~~balance of the investment portfolio increased $120.5 million, primarily in the municipal bond portfolio. The year-to-date average balance of the loan portfolio ~~declined~~increased from ~~$978.5~~$971.8 million ~~to $934.5 million from~~in 2019 to $983.2 million in 2020. The average balance of the commercial loan portfolio ~~decreased $44.8~~increased $6.0 million from ~~the comparable quarter in 2019~~ 2019. The increase is primarily due to ~~a decrease in purchased loan participations~~the addition of Paycheck Protection Program (PPP) loans which totaled $63.4 million at September 30, 2020 and ~~slower loan demand that began in the second half of 2019. This decline was more than offset by an increase in~~increased the average balance of the ~~investment~~commercial loan portfolio ~~of $62.7 million.~~$35.6 million year-to-date. The ~~yield on earning assets fell by .45% from 4.45% in the first quarter~~average balance of ~~2019 to 4.00% in 2020. The decrease in the yield was the primary reason for the decline in interest income. Average interest-bearing~~ deposits increased ~~$55.0~~$117.9 million ~~from~~year-to-date over the first quarter of 2019 to the first quarter of 2020. The cost of these deposits fell from .75% in 2019 to .61% in 2020. As a result, interest expense on deposits declined $211 thousand helping to stabilize net interest income quarter to quarter.prior year.
‎

~~For the first quarter of 2020, a~~The provision for loan loss expense for the third quarter of ~~$3.0~~2020 was $375 thousand and $5.4 million ~~was recorded as~~year-to-date. This compares to a recovery of ($162) thousand and expense of $237 thousand for the ~~economic effects~~same respective periods in 2019. The increase in the 2020 year-to-date provision expense is the result of ~~the COVID-19 pandemic caused~~an increase in several qualitative factors in the allowance for loan loss calculation due to ~~increase from moderate risk to very high risk.~~the economic effects and impact of the COVID-19 pandemic. These qualitative factors stabilized in the third quarter; therefore, the third quarter provision expense was less than in the prior quarters of 2020. With this provision expense, the allowance for loan loss ratio was ~~1.57%. The provision expense for~~1.68% of gross loans as of September 30, 2020; compared to 1.28% at December 31, 2019. Excluding the ~~same quarter in 2019 was $399 thousand with an allowance ratio of 1.29%. The provision expense for~~PPP loans, the ~~fourth quarter 2019 was $0 resulting in an~~ allowance for loan loss ratio ~~of 1.28%~~was 1.79% at ~~December 31, 2019. See the Allowance for Loan Loss discussion for more information.~~September 30, 2020.

‎

Noninterest income increased ~~$724~~$125 thousand ~~over~~in the ~~first~~third quarter of 2020 to $3.6 million compared to $3.5 million for the same quarter of 2019. ~~The factor driving this increase~~Year-to-date, noninterest income was $10.9 million, up $561 thousand over 2019. Year-to-date, fee income from the sale of mortgages increased $623 thousand over 2019 and an $812 thousand gain on a bank owned life insurance ~~policy.~~policy was recorded in the first quarter of 2020. These increases were partially offset by decreases in deposit fees, investment and trust fees, and securities gains.

‎

Noninterest expense for the ~~first~~third quarter of 2020 ~~increased $116 thousand over~~was $9.6 million compared to $9.0 million for the same quarter of 2019. ~~There were no significant~~For the first nine months of 2020, noninterest expense was $28.8 million, $811 thousand more than the $28.0 million in the prior year. Year-to-date, the largest expense increases occurred in ~~any~~data processing, marketing, and FDIC insurance. In the second quarter of 2020, the Bank made a $100 thousand contribution to various social service and first responder organizations in the local community.
‎

The Corporation recorded a reversal of $1.1 million to its income tax expense ~~category~~in the second quarter of 2020 due to a benefit available from the passage of the Coronavirus Aid, Relief and Economic Security Act (the CARES Act) in March 2020. The CARES Act allows for net operating losses (NOL) incurred in 2018, 2019 and 2020 to be carried back to offset taxable income earned during the five-year period prior to the year ~~over year.~~in which the NOL was incurred. The Corporation incurred an NOL in 2018 that it is able to carryback to prior periods when the statutory rate for the Corporation was 34% as compared to the current rate of 21%.

Total assets at ~~March 31,~~September 30, 2020 were ~~$1.262~~$1.511 billion compared $1.269 billion at December 31, 2019. Significant balance sheet changes since December 31, 2019 include:

Short-term interest-bearing deposits in other banks decreased ~~$28.0~~$14.1 million since year-end ~~as cash was put into~~while the investment portfolio ~~which~~ increased ~~$20.6~~$159.0 million.

‎

The net loan portfolio increased ~~$1.8~~$83.2 million (9%) during ~~the first quarter of~~ 2020 over the year-end ~~2019. The~~2019 balance. Growth in the portfolio ~~increased~~occurred primarily in ~~residential~~commercial loans from PPP activity, and to a lesser extent, in commercial real estate and ~~construction~~home equity lines of credit. The Bank held $63.4 million of PPP loans ~~but was partially offset~~(6.2% of gross loans) at September 30, 2020. The PPP is administered by ~~a decline~~the Small Business Administration (SBA) and are fully guaranteed by the SBA. These loans have an interest rate of 1%, plus the Bank earned an origination fee ranging from 3% to 5% of the originated loan balance. The Bank is recognizing the PPP fees over the contractual life of the PPP loans (two years or five years). As PPP loans are granted forgiveness by the SBA, fee recognition will accelerate. The Bank has $1.9 million of PPP fees remaining to be recognized at September 30, 2020. The Bank began to receive approval of PPP forgiveness from the SBA in ~~commercial loans.~~October.
‎

At September 30, 2020, the Bank had $82.5 million of loans modified under Section 413 of the CARES Act compared to $196.5 million at June 30, 2020. The current balance is comprised primarily of 24 loans to hotels for $60.8 million, 4 loans in the entertainment sector for $14. 1 million and 2 loans for $4.9 million in rental real estate.
‎

Deposits ~~decreased $8.0~~increased $211.4 million ~~primarily~~from year-end 2019, with all deposit products showing an increase except time deposits. The increases seem to stem from government stimulus payments to consumers and businesses, lower spending as economic activity was limited by the pandemic and the sense of security offered by bank deposits in ~~interest-bearing checking accounts.~~uncertain economic times.
‎

In the third quarter of 2020, the Corporation issued $20.0 million of subordinated notes. At September 30, 2020, the Corporation was well-capitalized with a total risk-based capital ratio of 17.62% and a Tier 1 leverage ratio of 8.75%.

Shareholders’ equity increased ~~$1.5~~$12.0 million, from the end of 2019, due primarily to an increase in accumulated other comprehensive ~~income.~~income from an increase in the value of the investment portfolio. Retained earnings increased ~~only $413 thousand due to~~$4.3 million from the ~~lower quarterly earnings.~~end of 2019. The book value of the Corporation’s common stock increased from ~~$29.40~~$29.30 to ~~$29.74~~$31.93 per share since year-end. The Corporation suspended activity in its stock repurchase plan on March 19, 2020.

Management believes current asset quality is stable with a nonperforming loan ratio of .40% of total gross loans and the allowance for loan loss ratio has been increased to 1.57% higher than at any time during the great recession. As the Corporation faces the unprecedented circumstances of the COVID-19 pandemic, it believes its current balance sheet and capital position will allow it to meet the challenge. As of April 30, 2020, the Bank funded 512 loans for $50.1 million (5.4% of gross loans as of March 31, 2020) through the Paycheck Protection Program administered by the Small Business Administration which started April 3, 2020. The Bank expects to earn approximately $2.0 million of processing fees recognized over the second and third quarter of 2020.The Bank began processing loans for round two of PPP on April 27, 2020. Liquidity has been strengthened by the Paycheck Protection Program Liquidity Facility and the Bank has no borrowings outstanding. The Corporation’s capital position is strong with total risk-based capital ratio of 15.99% and a leverage ratio of 9.85%.

‎

2530

Key performance ratios as of, or for the ~~three~~nine months ended ~~March 31,~~September 30, 2020 and 2019 and the year ended December 31, 2019 are listed below:


	March 31,		December 31,		March 31,		September 30,		December 31,		September 30,
(Dollars in thousands, except per share)	2020		2019		2019		2020		2019		2019

Balance Sheet Highlights
Total assets	$	1,262,126	$	1,269,157	$	1,212,960	$	1,511,213	$	1,269,157	$	1,301,773
Investment and equity securities		208,353		187,873		128,258		346,774		187,873		147,712
Loans, net		921,656		922,609		967,785		1,005,807		922,609		925,033
Deposits		1,117,433		1,125,392		1,076,491		1,336,749		1,125,392		1,159,601
Shareholders' equity		129,005		127,528		121,491		139,574		127,528		126,100

Summary of Operations
Interest income	$	11,665	$	49,235	$	11,989	$	34,068	$	49,235	$	37,104
Interest expense		1,413		7,113		1,660		3,100		7,113		5,379
Net interest income		10,252		42,122		10,329		30,968		42,122		31,725
Provision for loan losses		3,000		237		399		5,350		237		237
Net interest income after provision for loan losses		7,252		41,885		9,930		25,618		41,885		31,488
Noninterest income		3,889		15,424		3,165		10,903		15,424		10,342
Noninterest expense		9,528		38,314		9,412		28,821		38,314		28,010
Income before income taxes		1,613		18,995		3,683		7,700		18,995		13,820
Federal income tax (benefit) expense		(106)		2,880		446		(548)		2,880		2,100
Net income	$	1,719	$	16,115	$	3,237	$	8,248	$	16,115	$	11,720

Performance Measurements
Return on average assets*		0.54%		1.29%		1.08%		0.80%		1.29%		1.26%
Return on average equity*		5.31%		13.17%		10.90%		8.33%		13.17%		12.89%
Return on average tangible equity (1)*		5.70%		14.22%		11.79%		8.94%		14.22%		13.93%
Efficiency ratio (1)		65.36%		65.36%		67.93%		66.93%		65.36%		65.31%
Net interest margin*		3.53%		3.68%		3.86%		3.25%		3.68%		3.75%

Shareholders' Value (per common share)
Diluted earnings per share	$	0.39	$	3.67	$	0.73	$	1.89	$	3.67	$	2.66
Basic earnings per share		0.40		3.68		0.73		1.90		3.68		2.67
Regular cash dividends declared		0.30		1.17		0.27		0.90		1.17		0.87
Book value		29.74		29.30		27.54		31.93		29.30		29.03
Tangible book value (1)		27.66		27.23		25.50		29.87		27.23		26.95
Market value ~~(2)~~		27.45		38.69		36.00		21.38		38.69		35.55
Market value/book value ratio		92.30%		132.05%		130.72%		66.96%		132.05%		122.46%
Market value/tangible book value ratio		99.24%		142.11%		141.18%		71.58%		142.11%		131.90%
Price/earnings multiple*		17.60		10.54		12.33		8.48		10.54		8.63
Current quarter dividend yield		4.37%		3.10%		3.00%		5.61%		3.10%		3.38%
Dividend payout ratio year-to-date		75.97%		31.74%		36.82%		47.45%		31.74%		28.94%

Safety and Soundness
Average equity/average assets		10.24%		9.78%		9.94%		9.62%		9.78%		9.77%
Risk-based capital ratio (Total)		15.99%		16.08%		14.85%		17.62%		16.08%		15.80%
Leverage ratio (Tier 1)		9.85%		9.72%		9.57%		8.75%		9.72%		9.45%
Common equity ratio (Tier 1)		14.73%		14.82%		13.60%		14.21%		14.82%		13.93%
Nonperforming loans/gross loans		0.40%		0.42%		0.60%		0.93%		0.42%		0.53%
Nonperforming assets/total assets		0.29%		0.31%		0.70%		0.63%		0.31%		0.59%
Allowance for loan losses as a % of loans		1.57%		1.28%		1.29%		1.68%		1.28%		1.30%
Net loans charged-off/average loans*		0.10%		0.07%		0.05%		0.02%		0.07%		-0.02%

Assets under Management
Trust assets under management (fair value)	$	674,189	$	790,949	$	753,086	$	775,013	$	790,949	$	763,296
Held at third-party brokers (fair value)		109,145		127,976		127,515		106,238		127,976		121,466

*Year-to-date annualized

(1) See the section titled “GAAP versus Non-GAAP Presentation” that follows.

~~(2) As quoted on the OTCQX for March 31, 2019 and the Nasdaq Capital Market for all other periods.~~

2631

GAAP versus non-GAAP Presentations – The Corporation supplements its traditional GAAP measurements with certain non-GAAP measurements to evaluate its performance and to eliminate the effect of intangible assets. By eliminating intangible assets (Goodwill), the Corporation believes it presents a measurement that is comparable to companies that have no intangible assets or to companies that have eliminated intangible assets in similar calculations. However, not all companies may use the same calculation method for each measurement. The non-GAAP measurements are not intended to be used as a substitute for the related GAAP measurements. Non-GAAP financial measures should be viewed in addition to, and not as an alternative for, our reported results prepared in accordance with GAAP. In the event of such a disclosure or release, the Securities and Exchange Commission’s Regulation G requires: (i) the presentation of the most directly comparable financial measure calculated and presented in accordance with GAAP and (ii) a reconciliation of the differences between the non-GAAP financial measure presented and the most directly comparable financial measure calculated and presented in accordance with GAAP. The following table shows the calculation of the non-GAAP measurements.


(Dollars in thousands, except per share)	Three Months Ended		Twelve Months Ended		Three Months Ended		Nine Months Ended		Twelve Months Ended		Nine Months Ended
	March 31, 2020		December 31, 2019		March 31, 2019		September 30, 2020		December 31, 2019		September 30, 2019
Return on Tangible Equity (non-GAAP)
Net income	$	1,719	$	16,115	$	3,237	$	8,248	$	16,115	$	11,720

Average shareholders' equity		129,613		122,377		118,793		132,095		122,377		121,193
Less average intangible assets		(9,016)		(9,016)		(9,016)		(9,016)		(9,016)		(9,016)
Average tangible equity (non-GAAP)		120,597		113,361		109,777		123,079		113,361		112,177

Return on average tangible equity (non-GAAP)*		5.70%		14.22%		11.79%		8.94%		14.22%		13.93%

Tangible Book Value (per share) (non-GAAP)
Shareholders' equity	$	129,005	$	127,528	$	121,491	$	139,574	$	127,528	$	126,100
Less intangible assets		(9,016)		(9,016)		(9,016)		(9,016)		(9,016)		(9,016)
Tangible book value (non-GAAP)		119,989		118,512		112,475		130,558		118,512		117,084

Shares outstanding (in thousands)		4,338		4,353		4,411		4,371		4,353		4,344

Tangible book value per share (non-GAAP)		27.66		27.23		25.50		29.87		27.23		26.95

Efficiency Ratio
Noninterest expense	$	9,528	$	38,314	$	9,412	$	28,821	$	38,314	$	28,010

Net interest income		10,252		42,122		10,329		30,968		42,122		31,725
Plus tax equivalent adjustment to net interest income		300		1,393		388		1,028		1,393		1,084
Plus noninterest income, net of securities transactions		4,026		15,102		3,138		11,068		15,102		10,076
Total revenue		14,578		58,617		13,855		43,064		58,617		42,885

Efficiency ratio (Noninterest expense/total revenue)		65.36%		65.36%		67.93%		66.93%		65.36%		65.31%

* Year-to-date annualized

Net Interest Income

The largest source of the Corporation’s earnings is net interest income, which is defined as the difference between income on interest-earning assets and the expense of interest-bearing liabilities supporting those assets. Principal categories of interest-earning assets are loans and securities, while deposits, short-term borrowings and long-term debt are the principal categories of interest-bearing liabilities. Demand deposits enhance net interest income because they are noninterest-bearing deposits. For the purpose of this discussion, balance sheet items refer to the average balance for the year and net interest income is adjusted to a fully taxable-equivalent basis. This tax-equivalent adjustment facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Corporation’s 21% Federal statutory rate.

2732

Comparison of the three months ended March 31,September 30, 2020 to the three months ended March 31,September 30, 2019:

Tax equivalent net interest income decreased ~~$165~~$391 thousand to ~~$10.6~~$10.8 million in the ~~first~~third quarter of 2020 compared to ~~$10.7~~$11.2 million for the same period in 2019. Balance sheet volume contributed ~~$77 thousand~~$1.3 million to tax equivalent net interest but was more than offset by a ~~$242 thousand~~$1.7 million reduction due to rates.

The following table presents average balances, tax-equivalent (T/E) interest income, and yields earned or rates paid on the assets or liabilities. Nonaccrual loans are included in the average loan balance used to calculate the yield. All nontaxable interest income has been adjusted to a tax-equivalent basis using a tax rate of 21%.


	For the Three Months Ended March 31,										For the Three Months Ended September 30,
	2020					2019					2020					2019

	Average		Income or		Average	Average		Income or		Average	Average		Income or		Average	Average		Income or		Average
(Dollars in thousands)	balance		expense		yield/rate	balance		expense		yield/rate	balance		expense		yield/rate	balance		expense		yield/rate

Interest-earning assets:
Interest-bearing obligations of other
banks and federal funds sold	$	68,975	$	258	1.50%	$	15,112	$	97	2.60%
Interest-bearing obligations in other banks											$	75,686	$	72	0.38%	$	118,880	$	638	2.13%
Investment securities:
Taxable		172,319		1,068	2.49%		82,297		545	2.69%		231,803		1,162	1.99%		106,747		700	2.60%
Tax Exempt		23,861		216	3.62%		51,167		425	3.33%		84,740		635	3.00%		28,581		251	3.52%
Investments		196,180		1,284	2.63%		133,464		970	2.95%		316,543		1,797	2.25%		135,328		951	2.79%
Loans:
Commercial, industrial and agricultural		793,085		8,890	4.45%		837,906		9,644	4.60%		871,753		8,460	3.82%		819,426		9,773	4.70%
Residential mortgage		68,346		728	4.27%		69,466		752	4.32%		73,497		641	3.64%		70,306		768	4.38%
Home equity loans and lines		66,599		724	4.36%		65,981		832	5.11%		72,655		614	3.35%		64,084		827	5.12%
Consumer		6,509		81	4.99%		5,124		82	6.49%		6,707		42	2.48%		6,160		93	5.99%
Loans		934,539		10,423	4.43%		978,477		11,310	4.63%		1,024,612		9,757	3.75%		959,976		11,461	4.71%
Total interest-earning assets		1,199,694	$	11,965	4.00%		1,127,053	$	12,377	4.45%		1,416,841	$	11,626	3.26%		1,214,184	$	13,050	4.26%
Other assets		65,814					67,718					62,990					70,172
Total assets	$	1,265,508				$	1,194,771				$	1,479,831				$	1,284,356

Interest-bearing liabilities:
Deposits:
Interest-bearing checking	$	325,300	$	274	0.34%	$	295,786	$	263	0.36%	$	401,668	$	165	0.16%	$	345,040	$	367	0.42%
Money Management		432,270		740	0.69%		424,969		1,046	1.00%		468,782		264	0.22%		419,678		1,083	1.02%
Savings		84,059		58	0.28%		81,156		107	0.54%		96,919		15	0.06%		84,183		93	0.44%
Time		87,774		341	1.56%		72,481		208	1.16%		80,693		243	1.19%		87,906		344	1.55%
Total interest-bearing deposits		929,403		1,413	0.61%		874,392		1,624	0.75%		1,048,062		687	0.26%		936,807		1,887	0.80%

Other borrowings		—		—	—		5,386		36	2.61%
Subordinated Notes												12,364		167	5.36%		—		—	—
Total interest-bearing liabilities		929,403		1,413	0.61%		879,778		1,660	0.77%		1,060,426		854	0.32%		936,807		1,887	0.80%
Noninterest-bearing deposits		188,735					183,809					267,404					208,054
Other liabilities		17,757					12,391					15,402					16,209
Shareholders' equity		129,613					118,793					136,599					123,286
Total liabilities and shareholders' equity	$	1,265,508				$	1,194,771				$	1,479,831				$	1,284,356
T/E net interest income/Net interest margin				10,552	3.53%				10,717	3.86%				10,772	3.02%				11,163	3.65%
Tax equivalent adjustment				(300)					(388)					(389)					(328)
Net interest income			$	10,252				$	10,329				$	10,383				$	10,835

Net Interest Spread					3.39%					3.68%					2.94%					3.46%
Cost of Funds					0.51%					0.63%					0.26%					0.65%
Cost of Deposits															0.21%					0.65%

Provision for Loan Losses

~~Following its first quarter assessment and analysis, the~~The Bank ~~expensed $3.0 million~~recorded $375 thousand of ~~its~~ provision for loan loss expense for the ~~first~~third quarter, ~~as the economic effects~~compared to a recovery of ~~the COVID-19 pandemic caused several qualitative factors in the allowance for loan loss calculation to increase from moderate risk to very high risk. The provision expense was $399~~$162 thousand in the ~~first~~third quarter of 2019. For more information refer to the Loan Quality and Allowance for Loan Losses discussion in the Financial Condition section.

‎

Noninterest Income

For the third quarter of 2020, noninterest income increased $125 thousand from the same period in 2019. Loan service charges increased as mortgage production was higher in 2020, totaling $504 thousand for the quarter compared to $94 thousand for the same period in 2019. Deposit fees and service charges decreased primarily in transaction-based fees due to the change in business operations due to COVID-19 and governmental responses thereto. Other income was higher in 2019 due to an insurance recovery.

The following table presents a comparison of noninterest income for the three months ended September 30, 2020 and 2019:


	For the Three Months Ended
	September 30,				Change
(Dollars in thousands)	2020		2019		Amount		%
Noninterest Income
Investment and trust services fees	$	1,433	$	1,482	$	(49)	(3.3)
Loan service charges		710		238		472	198.3
Deposit service charges and fees		497		632		(135)	(21.4)
Other service charges and fees		382		401		(19)	(4.7)
Debit card income		491		469		22	4.7
Increase in cash surrender value of life insurance		110		127		(17)	(13.4)
Bank owned life insurance gain		—		9		(9)	N/A
Net (losses)/gains on sales of debt securities		(16)		3		(19)	(633.3)
Change in fair value of equity securities		(39)		(6)		(33)	(550.0)
Other		35		123		(88)	(71.5)
Total noninterest income	$	3,603	$	3,478	$	125	3.6

Noninterest Expense

Noninterest expense for the third quarter of 2020 increased $658 thousand compared to the same period in 2019. Due to the pandemic there was very little change in all categories of noninterest expense. The pandemic held many expense items in check, such as business travel, education and community activities. Data processing increased due to increased mobile banking offerings and software purchased to improve processes and create efficiencies. FDIC insurance expense increased primarily due to a $150 thousand credit from the usage of Small Bank Assessment Credits in September 2019.

The following table presents a comparison of noninterest expense for the three months ended September 30, 2020 and 2019:


	For the Three Months Ended
(Dollars in thousands)	September 30,				Change
Noninterest Expense	2020		2019		Amount		%
Salaries and benefits	$	5,421	$	5,419	$	2	0.0
Net occupancy		838		831		7	0.8
Marketing and advertising		384		324		60	18.5
Legal and professional		499		409		90	22.0
Data processing		871		693		178	25.7
Pennsylvania bank shares tax		263		248		15	6.0
FDIC insurance		128		(76)		204	268.4
ATM/debit card processing		285		256		29	11.3
Telecommunications		110		106		4	3.8
Other		850		781		69	8.8
Total noninterest expense	$	9,649	$	8,991	$	658	7.3

Provision for Income Taxes

For the third quarter of 2020, the Corporation recorded a Federal income tax expense of $500 thousand compared to a tax expense of $985 thousand for the same quarter in 2019. The effective tax rate for the third quarter of 2020 was 12.6%, compared to 18.0% for the same quarter in 2019. The decrease in the effective tax rate was due to an increase in tax-exempt income and lower pre-tax income in 2020. The federal statutory tax rate is 21% for 2020 and 2019.

Comparison of the nine months ended September 30, 2020 to the nine months ended September 30, 2019:

Tax equivalent net interest income decreased $813 thousand to $32.0 million in the first nine months of 2020 compared to $32.8 million for the same period in 2019. Balance sheet volume contributed $2.3 million to tax equivalent net interest but was offset by a $3.1 million reduction due to rates.


	For the Nine Months Ended September 30,
	2020					2019

	Average		Income or		Average	Average		Income or		Average
(Dollars in thousands)	balance		expense		yield/rate	balance		expense		yield/rate

Interest-earning assets:
Interest-bearing obligations in other banks	$	74,043	$	412	0.74%	$	67,133	$	1,137	2.26%
Investment securities:
Taxable		198,661		3,282	2.20%		91,713		1,830	2.67%
Tax Exempt		53,983		1,293	3.20%		40,471		1,031	3.39%
Investments		252,644		4,575	2.41%		132,184		2,861	2.89%
Loans:
Commercial, industrial and agricultural		837,301		25,909	4.08%		831,293		29,170	4.64%
Residential mortgage		70,265		2,067	4.01%		69,862		2,260	4.32%
Home equity loans and lines		69,075		1,946	3.75%		64,950		2,498	5.14%
Consumer		6,579		187	3.79%		5,689		262	6.16%
Loans		983,220		30,109	4.05%		971,794		34,190	4.66%
Total interest-earning assets		1,309,907	$	35,096	3.57%		1,171,111	$	38,188	4.36%
Other assets		63,925					69,937
Total assets	$	1,373,832				$	1,241,048

Interest-bearing liabilities:
Deposits:
Interest-bearing checking	$	366,575	$	637	0.23%	$	319,927	$	931	0.39%
Money Management		449,777		1,347	0.40%		419,845		3,195	1.02%
Savings		90,945		90	0.13%		82,783		306	0.49%
Time		83,226		859	1.37%		84,828		911	1.44%
Total interest-bearing deposits		990,523		2,933	0.39%		907,383		5,343	0.79%

Other borrowings		—		—			1,776		36	2.61%
Subordinated Notes		4,152		167	5.36%		—		—
Total interest-bearing liabilities		994,675		3,100	0.42%		909,159		5,379	0.79%
Noninterest-bearing deposits		230,911					196,162
Other liabilities		16,151					14,534
Shareholders' equity		132,095					121,193
Total liabilities and shareholders' equity	$	1,373,832				$	1,241,048
T/E net interest income/Net interest margin				31,996	3.25%				32,809	3.75%
Tax equivalent adjustment				(1,028)					(1,084)
Net interest income			$	30,968				$	31,725

Net Interest Spread					3.15%					3.57%
Cost of Funds					0.34%					0.65%
Cost of Deposits					0.32%					0.64%

Provision for Loan Losses

Year-to-date, the Bank expensed $5.4 million for provision for loan loss expense from the assessment and analysis of the Bank’s allowance for loan losses as the economic effects of the COVID-19 pandemic caused several qualitative factors in the calculation to increase from moderate risk to very high risk. The provision expense was $237 thousand for the first nine months of 2019. For more information refer to the Loan Quality and Allowance for Loan Losses discussion in the Financial Condition section.

‎

Noninterest Income

For the first ~~quarter~~nine months of 2020, noninterest income increased ~~$724~~$561 thousand from the same period in 2019. Loan service charges increased as mortgage production was higher in 2020 due to ~~increased mortgage originator staff. Debit card income was higher~~the interest rate environment, with fees totaling $876 thousand in 2020 compared to $253 thousand for the same period in 2019. Deposit fees and service charges decreased primarily in transaction-based fees due to ~~an increase~~the change in ~~transaction volume on commercial accounts.~~business operations due to COVID-19. The life insurance gain was from a

claim on bank-owned life insurance ~~policy.~~policies. There were two debt security calls and one sale in 2020 for a net loss of $26 thousand, compared to multiple sales in the same period in 2019 which generated a net gain of $256 thousand. The change in the fair value of equity investments recorded through income was a loss of ~~$127~~$139 thousand compared to a gain of $3$10 thousand in the same period in 2019.

The following table presents a comparison of noninterest income for the ~~three~~nine months ended ~~March 31,~~September 30, 2020 and 2019:


	For the Three Months Ended							For the Nine Months Ended
	March 31,				Change			September 30,				Change
(Dollars in thousands)	2020		2019		Amount		%	2020		2019		Amount		%
Noninterest Income
Investment and trust services fees	$	1,445	$	1,452	$	(7)	(0.5)	$	4,469	$	4,582	$	(113)	(2.5)
Loan service charges		285		203		82	40.4		1,496		670		826	123.3
Deposit service charges and fees		565		545		20	3.7		1,459		1,781		(322)	(18.1)
Other service charges and fees		347		353		(6)	(1.7)		1,065		1,135		(70)	(6.2)
Debit card income		418		402		16	4.0		1,347		1,335		12	0.9
Increase in cash surrender value of life insurance		124		127		(3)	(2.4)		346		383		(37)	(9.7)
Life insurance gain		812		—		812	NA
Bank owned life insurance gain									812		9		803	8,922.2
Net (losses)/gains on sales of debt securities		(10)		24		(34)	(141.7)		(26)		256		(282)	(110.2)
Change in fair value of equity securities		(127)		3		(130)	(4,333.3)		(139)		10		(149)	(1,490.0)
Other		30		56		(26)	(46.4)		74		181		(107)	(59.1)
Total noninterest income	$	3,889	$	3,165	$	724	22.9	$	10,903	$	10,342	$	561	5.4

Noninterest Expense

Noninterest expense for the first ~~quarter~~nine months of 2020 increased ~~$116~~$811 thousand compared to the same period in 2019. The increase in salaries and benefits was primarily due to an increase in salary expense ~~($355 thousand)~~ from merit increases and commissions expense from mortgage originations, net of a decrease in health insurance ~~($210 thousand),~~and education and training expense compared to the same period in 2019. ~~Pennsylvania shares tax decreased~~Data processing expenses increased due to more customers utilizing mobile banking during the pandemic closure and as the Bank ~~received certain tax credits associated with~~added functionality to its mobile banking platform. FDIC insurance expense increased primarily due to a ~~portion~~$150 thousand credit from the usage of Small Bank Assessment Credits in September 2019. Overall, the ~~increase~~pandemic held many expense items in ~~charitable donations (in other expenses)~~check, such as business travel, education and community activities. The Bank estimates it has spent approximately $54 thousand in additional expenses for COVID-19 related ~~to Pennsylvania’s Educational Improvement Tax Credit program, which allowed~~mitigation efforts. In addition, the Bank contributed $100 thousand to ~~reduce its expense.~~various social service and first responder organizations in our community.

The following table presents a comparison of noninterest expense for the nine months ended September 30, 2020 and 2019:
	For the Nine Months Ended
(Dollars in thousands)	September 30,				Change
Noninterest Expense	2020		2019		Amount		%
Salaries and employee benefits	$	16,337	$	16,216	$	121	0.7
Net occupancy		2,533		2,545		(12)	(0.5)
Marketing and advertising		1,303		1,207		96	8.0
Legal and professional		1,324		1,310		14	1.1
Data processing		2,511		2,135		376	17.6
Pennsylvania bank shares tax		701		734		(33)	(4.5)
FDIC insurance		276		104		172	165.4
ATM/debit card processing		828		761		67	8.8
Telecommunications		323		318		5	1.6
Other		2,685		2,680		5	0.2
Total noninterest expense	$	28,821	$	28,010	$	811	2.9

~~The following table presents a comparison of noninterest expense for the three months ended March 31, 2020 and 2019:~~
‎

For the Three Months Ended
(Dollars in thousands)
March 31,
Change
Noninterest Expense
2020
2019
Amount
%
Salaries and benefits
$
5,535
$
5,442
$
93
1.7
Net occupancy
830
856
(26)
(3.0)
Marketing and advertising
455
402
53
13.2
Legal and professional
395
430
(35)
(8.1)
Data processing
806
705
101
14.3
Pennsylvania bank shares tax
175
243
(68)
(28.0)
FDIC insurance
60
65
(5)
(7.7)
ATM/debit card processing
264
258
6
2.3
Telecommunications
105
105
—
—
Other
903
906
(3)
(0.3)
Total noninterest expense
$
9,528
$
9,412
$
116
1.2

Provision for Income Taxes

For the first quarter,nine months of 2020, the Corporation recorded a Federal income tax benefit of $106$548 thousand compared to a tax expense of $446 thousand$2.1 million for the same quarterperiod in 2019. The Corporation recorded an income tax benefit of $1.1 million in the second quarter of 2020. This benefit was available due to the passage of the Coronavirus Aid, Relief and Economic Security Act (the CARES Act) in March 2020. The CARES Act allows for net operating losses (NOL) incurred in 2018, 2019 and 2020 to be carried back to offset taxable income earned during the five-year period prior to the year in which the NOL was incurred. The Corporation incurred an NOL in 2018 that it was able to carryback to prior periods when the statutory rate for the Corporation was 34% as compared to the current rate of 21%. The effective tax rate for the first quarternine months of 2020 was (6.5)%7.3% (excluding the NOL benefit), compared to 12.1%15.2% for the same quarterperiod in 2019. The decrease in the effective tax rate was due to lower pre-tax income offset by tax-free income. The federal statutory tax rate is 21% for 2020 and 2019.

‎

Financial Condition

Cash and Cash Equivalents:

Cash and cash equivalents totaled ~~$53.4~~$71.2 million at ~~March 31,~~September 30, 2020, a decrease of ~~$30.5~~$12.7 million from the prior year-end balance of $83.8 million. The decrease was mainly due to lower interest-bearing balances at the Federal Reserve ~~from~~due to purchases in the investment portfolio. Interest-bearing deposits are held primarily at the Federal Reserve ($~~36.9 million) and in short-term bank-owned certificates of deposit ($3.5~~53.7 million).

Investment Securities:

AFS Securities: The AFS securities portfolio has increased ~~$18.5~~$149.7 million on a cost basis, since year-end ~~2019. The composition~~2019 with the majority of the increase occurring in the municipal bond portfolio. The portfolio ~~has remained consistent with~~is comprised primarily municipal securities and U.S. Agency mortgage-backed securities ~~comprising the greatest portion of the portfolio~~ at approximately ~~47%~~64% and ~~34%~~19% of the portfolio fair value, respectively. The average life of the portfolio was ~~5.9~~7.36 years.

The AFS securities portfolio had a net unrealized gain of ~~$2.3~~$9.5 million at ~~March 31,~~September 30, 2020 compared to a net unrealized gain of $234 thousand at the prior year-end. The portfolio averaged ~~$196.2~~$252.6 million with a yield of ~~2.63%~~2.41% for the first ~~three~~nine months of 2020. This compares to an average of ~~$133.5~~$132.2 million and a yield of ~~2.95%~~2.89% for the same period in 2019.

The municipal bond portfolio is well diversified geographically ~~(108~~(208 issuers) and is comprised primarily of general obligation bonds ~~(61%~~(62%). Many municipal bonds have credit enhancements in the form of private bond insurance or other credit support. The largest geographic municipal bond exposure is in the states of Texas (13%), California ~~(13%~~(12%), and ~~Michigan (6%~~Pennsylvania (9%). The average rating of the municipal portfolio from Moody’s is AA. No municipal bonds are rated below investment grade.

The unrealized loss in the municipal bond portfolio decreased to ~~$242~~$270 thousand from $997 thousand at December 31, 2019. There are ~~twenty-two~~thirty-seven securities in this portfolio with an unrealized loss and the loss in this portfolio is deemed to be non-credit related and no other-than-temporary impairment charges have been recorded.

The trust ~~preferred~~preferred/corporate portfolio ~~contains five~~is comprised of 5 variable rate bank issued trust preferred securities with a fair value of ~~$3.5~~$3.9 million and 15 fixed rate bank issued subordinated notes with a fair value of $6.8 million. This portfolio has an unrealized loss of ~~$556 thousand.~~$223 thousand on nine securities with a fair value of $5.9 million. The trust-preferred securities held by the Bank are single entity issues, not pooled trust preferred securities. Therefore, the impairment review of these securities is based only on the issuer and the security cannot be impaired by the performance of other issuers as if it was a pooled trust-preferred bond. ~~All of the Bank’s trust preferred securities are single issue, variable rate notes with long maturities (2027–2028).~~ None of these issuers have suspended or missed a dividend or interest payment. At ~~March 31,~~September 30, 2020, the Bank believes it will be able to collect all interest and principal due on these bonds and no other-than-temporary-impairment charges were recorded.

The unrealized loss in the ~~Asset-backed~~asset-backed securities portfolio increased ~~$731~~$142 thousand from December 31, 2019. This sector had the largest unrealized loss of ~~$1.0 million, 44.4%~~$447 thousand, 42.9% of the total unrealized losses ($~~2.3~~1 million). FFELP (Federal Family Education Loan Program) bonds make up the majority of this sector and have a 97% guarantee from the US Department of Education. The FFELP bonds are all rated AAA. Management fully expects to be paid back at par and no other-than-temporary impairment charges have been recorded.

~~Equity securities at Fair Value:~~
‎ The Corporation owns one equity investment. At March 31, 2020 and December 31, 2019, this investment was reported at fair value of $313 thousand and $440 thousand, respectively, with changes in value reported through income.

Restricted Stock at Cost: The Bank held ~~$465~~$468 thousand of restricted stock at ~~March 31,~~September 30, 2020. Except for $30 thousand, this investment represents stock in FHLB Pittsburgh. The Bank is required to hold this stock to be a member of FHLB and it is carried at cost of $100 per share. The level of FHLB stock held is determined by FHLB and is comprised of a minimum membership amount plus a variable activity amount. FHLB stock is evaluated for impairment primarily based on an assessment of the ultimate recoverability of its cost. As a government sponsored entity, FHLB has the ability to raise funding through the U.S. Treasury that can be used to support its operations. There is not a public market for FHLB stock and the benefits of FHLB membership (e.g., liquidity and low-cost funding) add value to the stock beyond purely financial measures. Management intends to remain a member of the FHLB and believes that it will be able to fully recover the cost basis of this investment.

See Note 4 of the accompanying financial statements for additional information on Investment Securities.

Loans:

Residential real estate: This category is comprised of consumer purpose loans secured by residential real estate and to a lesser extent, commercial purpose loans secured by residential real estate. The consumer purpose category represents traditional residential mortgage loans and home equity products (primarily junior liens and lines of credit). Commercial purpose loans in this category represent loans made for various business needs but are secured with residential real estate. In addition to the real estate collateral, it is possible that additional security is provided by personal guarantees or UCC filings. These loans are underwritten as commercial loans and are not originated to be sold.

Total residential real estate loans increased ~~$3.4~~$9.8 million over year-end 2019, as the Bank ~~retained~~originated a higher ~~percentage~~volume of ~~its originations.~~junior liens and lines of credit. For the first ~~three~~nine months of 2020, the Bank originated ~~$9.2~~$66.3 million and sold ~~$8.5~~$58.8 million in mortgages for a fee through third party brokerage agreements. The Bank does not originate or hold any loans that would be considered sub-prime or Alt-A and does not generally originate mortgages outside of its primary market area.

Residential real estate construction: This category contains loans for the vertical construction of 1-4 family residential properties. The largest component of this category represents loans to residential real estate developers ($~~11.0~~7.9 million), while loans for individuals to construct personal residences totaled ~~$4.5~~$6.3 million at ~~March 31,~~September 30, 2020. The Bank’s exposure to residential construction loans is concentrated primarily in south central Pennsylvania. Real estate construction loans, including residential real estate and land development loans, occasionally provide an interest reserve in order to assist the developer during the development stage when minimal cash flow is generated. All real estate construction loans are underwritten in the same manner, regardless of the use of an interest reserve.

Commercial real estate (CRE): This category includes commercial, industrial, farm and agricultural loans and land development loans, where real estate serves as the primary collateral for the loans. Total commercial real estate loans increased to $505.5 million from $494.3 million at the end of 2019, as originations largely kept pace with pay-downs. The largest sectors (by collateral) in the commercial real estate category are: hotels and motels ($72.3 million), land development ($60.6 million), office buildings ($54.6 million), manufacturing facility ($35.3 million) and shopping centers ($35.2 million). The majority of the Bank’s hotel exposure is located along the Interstate 81 (I-81) corridor through south-central Pennsylvania. The portfolio is comprised of properties operating under 17 flagged brands and 3 independent operators.

Also included in CRE are real estate construction loans totaling $92.3 million. At ~~March 31,~~September 30, 2020, the Bank had ~~$17.1~~$24.4 million in real estate construction loans funded with an interest reserve and capitalized ~~$222~~$673 thousand of interest in 2020 from these reserves on active projects for commercial construction. Real estate construction loans are monitored on a regular basis by either an independent third-party inspector or the assigned loan officer depending on loan amount or complexity of the project. This monitoring process includes at a minimum, the submission of invoices and AIA documents (depending on the complexity of the project) detailing costs incurred by the borrower, on-site inspections, and a signature by the assigned loan officer for disbursement of funds.

~~Commercial real estate (CRE):~~ This category includes commercial, industrial, farm and agricultural loans and land development loans, where real estate serves as the primary collateral for the loans. Total commercial real estate loans remained flat at $494.1 million from $494.2 million at the end of 2019, as originations kept pace with pay-downs. The largest sectors (by collateral) in the commercial real estate category are: hotels and motels ($69.1 million), land development ($65.3 million), office buildings ($55.2 million), warehouse facilities ($31.9 million) and manufacturing facility ($31.7 million). The majority of the Bank’s hotel exposure is located along the Interstate 81 (I-81) corridor through south-central Pennsylvania. The portfolio is comprised of properties operating under 16 flagged brands, representing 10 hotel chains. Independent hotels represent only 4% of the hotel portfolio.

Commercial: This category includes commercial, industrial, farm, agricultural, and municipal loans. Commercial loans ~~decreased $3.9~~increased $66.3 million to ~~$226.1~~$296.3 million at ~~March 31,~~September 30, 2020, compared to $230.0 million at the end of 2019, primarily due to ~~paydowns.~~PPP originations. At ~~March 31,~~September 30, 2020, the Bank had approximately ~~$138~~$150 million in tax-free loans in the commercial portfolio. The largest sectors (by industry) in the commercial category are: public administration ($~~69.9~~59.9 million), utilities ($~~33.5~~54.6 million), educational services ($~~22.8~~22.1 million), real estate rental and leasing ($~~13.0~~12.1 million) and ~~finance and insurance~~manufacturing ($~~12.2~~10.9 million). ~~The Bank expects~~This category also includes $63.4 million of PPP loans that ~~commercial lending will continue to be~~are 100% guaranteed by the ~~primary area of loan growth in the future via in-market lending.~~SBA.

‎

Participations: The Bank may supplement its own commercial loan production by purchasing loan participations. These participations are primarily located in south-central Pennsylvania. At ~~March 31,~~September 30, 2020, the outstanding commercial participations accounted for ~~6.4%~~6.8%, or ~~$60.3~~$69.1 million, of total gross loans compared to 9.4% and $67.7 million at December 31, 2019. The Bank’s total exposure (including outstanding balances and unfunded commitments) to purchased participations is ~~$75.7~~$84.6 million, compared to $84.0 million at December 31, 2019. The commercial loan participations are comprised of ~~$14.9~~$14.8 million of Commercial loans and ~~$45.4~~$54.4 million of CRE loans, reported in the respective loan class.

Consumer loans: This category increased by ~~$221~~$103 thousand to ~~$6.7~~$6.5 million at ~~March 31,~~September 30, 2020, compared to ~~$6.5~~$6.4 million at prior year-end and is mainly comprised of unsecured personal lines of credit.

‎

The following table presents a summary of loans outstanding, by class as of:



	March 31,		December 31,			Change		September 30,		December 31,			Change
(Dollars in thousands)	2020		2019			Amount	%	2020		2019			Amount	%
Residential Real Estate 1-4 Family
Consumer first liens	$	82,719	$	85,319	$	(2,600)	(3.0)	$	79,361	$	85,319	$	(5,958)	(7.0)
Commercial first lien		60,587		57,627		2,960	5.1		62,235		57,627		4,608	8.0
Total first liens		143,306		142,946		360	0.3		141,596		142,946		(1,350)	(0.9)

Consumer junior liens and lines of credit		45,269		42,715		2,554	6.0		53,932		42,715		11,217	26.3
Commercial junior liens and lines of credit		5,397		4,882		515	10.5		4,844		4,882		(38)	(0.8)
Total junior liens and lines of credit		50,666		47,597		3,069	6.4		58,776		47,597		11,179	23.5
Total residential real estate 1-4 family		193,972		190,543		3,429	1.8		200,372		190,543		9,829	5.2

Residential real estate - construction
Consumer		4,523		4,107		416	10.1		6,323		4,107		2,216	54.0
Commercial		10,959		9,216		1,743	18.9		7,891		9,216		(1,325)	(14.4)
Total residential real estate construction		15,482		13,323		2,159	16.2		14,214		13,323		891	6.7

Commercial real estate		494,143		494,262		(119)	(0.0)		505,498		494,262		11,236	2.3
Commercial		226,128		230,007		(3,879)	(1.7)		296,331		230,007		66,324	28.8
Total commercial		720,271		724,269		(3,998)	(0.6)		801,829		724,269		77,560	10.7

Consumer		6,661		6,440		221	3.4		6,543		6,440		103	1.6
		936,386		934,575		1,811	0.2		1,022,958		934,575		88,383	9.5
Less: Allowance for loan losses		(14,730)		(11,966)		(2,764)	23.1		(17,151)		(11,966)		(5,185)	43.3
Net Loans	$	921,656	$	922,609	$	(953)	(0.1)	$	1,005,807	$	922,609	$	83,198	9.0


Paycheck Protection Program (PPP) loans (included in Commercial loans above)
Two-year loans	$	62,178	$	—
Five-year loans		1,217		—
Total Paycheck Protection Program loans	$	63,395	$	—	$	63,395	N/A

Loan Quality:

Management utilizes a risk rating scale ranging from 1-Prime to 9-Loss to evaluate loan quality. This risk rating scale is used primarily for commercial purpose loans. Consumer purpose loans are identified as either a pass or substandard rating based on the performance status of the loans. Substandard consumer loans are loans that are 90 days or more past due and still accruing. Loans rated 1 – 4 are considered pass credits. Loans rated 5 are pass credits but have been identified as credits that are likely to warrant additional attention and monitoring. Loans rated 6-Other Asset Especially Mentioned (OAEM) or worse begin to receive enhanced monitoring and reporting by the Bank. Loans rated 7-Substandard or 8-Doubtful exhibit the greatest financial weakness and present the greatest possible risk of loss to the Bank. Nonaccrual loans are rated no better than 7-Substandard. The following factors represent some of the factors used in determining the risk rating of a borrower: cash flow, debt coverage, liquidity, management, and collateral. Risk ratings, for pass credits, are generally reviewed annually for term debt and at renewal for revolving or renewing debt. The Bank monitors loan quality by reviewing three primary measurements: (1) loans rated 6-OAEM or worse (collectively “watch list”), (2) delinquent loans, and (3) net-charge-offs.,

Watch list loans exhibit financial weaknesses that increase the potential risk of default or loss to the Bank. However, inclusion on the watch list, does not by itself, mean a loss is certain. The watch list totaled ~~$11.1~~$48.1 million at quarter end compared to $11.5 million at June 30, 2020 and $11.6 million at December 31, 2019. The increase in the watch list is the result of a $31.3 million increase in 6-rated loans and a $5.3 million increase in 7-rated loans. The increase in 6-rated loans is due primarily to $24.3 million in hotel loans being downgraded to a 6-rating. A $5.7 million hotel loan was placed on nonaccrual status in September and accounted for the increase in 7-rated loans, having been rated a 6 the prior quarter. This loan is listed as Credit 2 in the Significant Nonaccrual table presented in this section. The watch list includes both performing and nonperforming loans. Included in the substandard total are ~~$3.7~~$9.1 million of nonaccrual loans. The credit composition of the watch list (loans rated 6, 7, or 8), by primary collateral is shown in Note 6 of the accompanying financial statements.

Delinquent loans are a result of borrowers’ cash flow and/or alternative sources of cash being insufficient to repay loans. The Bank’s likelihood of collateral liquidation to repay the loans becomes more probable the further behind a borrower falls, particularly when loans reach 90 days or more past due. Management monitors the performance status of loans by the use of an aging report. The aging report can provide an early indicator of loans that may become severely delinquent and possibly result in a loss to the Bank. See Note 6 in the accompanying financial statements for a table that presents the aging of payments in the loan portfolio.

Nonaccruing loans generally represent Management’s determination that the borrower will be unable to repay the loan in accordance with its contractual terms and that collateral liquidation may or may not fully repay both interest and principal. It is the Bank’s policy to evaluate the probable collectability of principal and interest due under terms of loan contracts for all loans 90-days or more past due, nonaccrual loans, or impaired loans. Further, it is the Bank’s policy to discontinue accruing interest on loans that are not adequately secured and in the process of collection. Upon determination of nonaccrual status, the Bank subtracts any current year accrued and unpaid interest from its income, and any prior year

accrued and unpaid interest from the allowance for loan losses. Management continually monitors the status of nonperforming loans, the value of any collateral and potential of risk of loss. Nonaccrual loans are rated no better than 7-Substandard.

The Bank’s Loan Management Committee reviews these loans and risk ratings on a quarterly basis in order to proactively identify and manage problem loans. In addition, a committee meets monthly to discuss possible workout strategies for ~~and~~ all credits rated 7-Substandard or worse. Management also tracks other commercial loan risk measurements including high loan to value loans, concentrations, participations and policy exceptions and reports these to the Credit Risk Oversight Committee of the Board of Directors. The Bank also uses a third-party consultant to assist with internal loan review with a goal of reviewing ~~60%~~80% of commercial loans each year. The FDIC defines certain supervisory loan-to-value lending limits. The Bank’s internal loan–to-value limits are all equal to or have a lower loan-to-value limit than the supervisory limits. However, in certain instances, the Bank may make a loan that exceeds the supervisory loan-to-value limit. At ~~March 31,~~September 30, 2020, the Bank had loans of ~~$22~~$22.6 million ~~(2.4%~~(2.1% of gross loans) that exceeded the supervisory limit, compared to ~~2.69%~~2.6% at year-end 2019.

Loan quality, ~~overall,~~as measured by nonperforming loans has ~~remained stable~~declined during the ~~first~~third quarter of ~~2020. Both~~2020 due to a $5.2 million increase in nonaccrual loans since year-end 2019 due to the addition of the new nonaccrual hotel loan previously discussed. Consequently, the non-performing loan ratio increased to 0.93% at September 30, 2020, from 0.42% at December 31, 2019.

Loans that have been modified on a good-faith basis in response to COVID-19 to borrowers who were classified as current prior to any relief as outlined in the March 22, 2020 Interagency Statement on Loan Modifications and ~~loans~~Reporting for Financial Institutions Working with Customers Affected by the Coronavirus or Section 4013 of the CARES Act do not need to be reported as past due ~~90 days or more~~during the period of the qualifying modification for short-term loan modifications (e.g. six months). Consequently, loan delinquencies and ~~still accruing have declined slightly since year-end 2019.~~nonaccrual loans could continue to increase during the remainder of 2020 if modified loans are not able to return to a performing status. Potential problem loans, defined as watch list loans less loans on nonaccrual or past due more than 90 days ~~declined to $6.3~~totaled $38.6 million at ~~March 31,~~quarter end compare to $7.4 million at June 30, 2020 ~~compared to~~and $7.7 million at December 31, ~~2019 as a result of the commercial real estate loan moving to nonaccrual.~~2019. The following table presents a summary of nonperforming assets as of:


	March 31,		December 31,		September 30,		December 31,
(Dollars in thousands)	2020		2019		2020		2019

Nonaccrual loans
Residential Real Estate 1-4 Family
First liens	$	41	$	68	$	41	$	68
Junior liens and lines of credit		14		31		14		31
Total		55		99		55		99
Residential real estate - construction		521		523		515		523
Commercial real estate		2,922		3,009		8,287		3,009
Commercial		175		197		205		197
Total nonaccrual loans		3,673		3,828		9,062		3,828

Loans past due 90 days or more and still accruing
Residential Real Estate 1-4 Family
First liens		1		31		—		31
Junior liens and lines of credit		31		46		—		46
Total		32		77		—		77
Commercial real estate						443		—
Consumer						7		—
Total loans past due 90 days or more and still accruing		32		77		450		77

Total nonperforming loans		3,705		3,905		9,512		3,905

Other real estate owned		—		—		—		—
Total nonperforming assets	$	3,705	$	3,905	$	9,512	$	3,905

Nonperforming loans to total gross loans		0.40%		0.42%		0.93%		0.42%
Nonperforming assets to total assets		0.29%		0.31%		0.63%		0.31%
Allowance for loan losses to nonperforming loans		397.57%		306.43%		180.31%		306.43%

‎

3341

The following table identifies the most significant loans in nonaccrual status. These two nonaccrual loans account for ~~63%~~77% of the total nonaccrual balance. Credit 2 is a hotel under renovation and is currently not open. The Bank is working with the borrower in an effort to reopen the property in the fourth quarter of 2020.

(Dollars in thousands)

ALL

Nonaccrual

TDR

Collateral

ALL

Nonaccrual

TDR

Collateral

Balance

Reserve

Date

Status

Collateral

Location

Value (1)

Balance

Reserve

Date

Status

Collateral

Location

Value (1)

Credit 1

1,319

—

Mar-12

1st and 2nd liens on commercial real estate, residential real estate and business assets

3,064

1,277

—

Mar-12

1st and 2nd liens on commercial real estate, residential real estate and business assets

2,820

Credit 2

1,004

—

Mar-19

land for residential development, residential and commercial real estate

1,517

5,702

—

Sep-20

1st and 2nd liens on commercial real estate (hotel) and all related business assets

5,888

2,323

—

6,979

—

(1) Includes any estimated discount on appraised value and cost to sell.

In addition to monitoring nonaccrual loans, the Bank also closely monitors impaired loans and troubled debt restructurings (TDR). A loan is considered to be impaired when, based on current information and events, it is probable that the Bank will be unable to collect all interest and principal payments due according to the originally contracted terms of the loan agreement. Nonaccrual loans (excluding consumer purpose loans) and TDR loans are considered impaired.

A loan is considered a troubled debt restructuring if the creditor (the Bank), for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. These concessions may include lowering the rate, extending the maturity, re-amortization of the payment, or a combination of multiple concessions. The Bank reviews all loans rated 6-OAEM or worse when it is providing a loan restructure, modification or new credit facility to determine if the action is a TDR. If a TDR loan is placed on nonaccrual status, it remains on nonaccrual status for at least six months to ensure performance. Loans that have been modified on a good-faith basis in response to COVID-19 to borrowers who were classified as current prior to any relief are not TDRs as outlined in the March 22, 2020 Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus orSection 4013 of the CARES Act. Loans may be modified under Section 4013 until the earlier of December 31, 2020 or the 60^th day after the end of the COVID-19 national emergency declared by the President.

In accordance with financial accounting standards, TDR loans are always considered impaired until they are paid off or in certain circumstances, refinanced. However, an impaired TDR loan can be a performing loan. Impaired loans ~~decreased~~totaled $17.5 million compared to ~~$12.0~~$12.3 million ~~at quarter-end compared~~the prior quarter and to $12.2 million at year-end 2019. The previously mentioned $5.7 million nonaccrual hotel loan is included in the impaired loan total.

Pandemic Effect on Loan ~~Quality~~Quality: The ~~credit quality of the Bank’s loan portfolio as of March 31, 2020 is stable. The ratio of nonperforming loans to total gross loans is .40%. However, the~~ pandemic, ~~outbreak~~and governmental responses thereto, has the potential to affect the credit quality of the loan portfolio in future periods. The pandemic has resulted in certain federal, state and local governmental authorities taking action to stop the spread of the ~~pandemic.~~pandemic or mitigate its impact. These actions have included stay-at-home orders, restrictions on business activity, and proclamations and/or directives aimed at minimizing the spread of the pandemic by restricting the movement of people, products and services in the economy. As a result of these actions, the economic activity of the Bank’s market area has been curtailed, businesses have been shut down and unemployment has dramatically increased. Many of these restrictions, to some level, remained in place at September 30, 2020. The repayment of every loan is dependent, in some way, on an efficiently functioning economy. Any action that has the effect of restricting economic activity has the potential to reduce cash flow available to repay loans. At this time, the length of this economic downturn is uncertain, as is the effect on the Bank’s loan portfolio.

~~As addressed below in~~ See the Allowance for Loan Losses (ALL) section that follows for the effect of the pandemic on the ALL ~~was increased by $3.0 million in the first quarter of 2020 based on higher risk factors in the qualitative allowance. In evaluating the~~and provision for loan ~~portfolio, the most significant things considered were; loan deferrals or modifications, the Paycheck Protection Program, and composition of the portfolio by industry segments.~~loss expense.

Loan Deferrals. As the economy quickly contracted in March and April of 2020 as the result of the pandemic, the Bank began to receive requests for payment modifications. Unlike past economic downturns, bank regulators provided favorable guidance for banks allowing them wide latitude to make modifications. ~~This~~Under guidance ~~allowed~~provided by the CARES Act and a joint regulatory agency statement issued by banking agencies, banks could, under certain circumstances, ~~banks to~~ avoid reporting loan modifications as delinquent, nonperforming or as a trouble debt restructuring. As of ~~April~~September 30, 2020, the Bank has granted approximately ~~$154~~$83 million loan deferrals or modifications (approximately ~~16%~~8% of gross loans). down from $196 million (19% of gross loans) as of the prior quarter-end. These modifications include the deferral of principal and interest payments, deferral of interest payments for interest only lines of credit or providing for an interest only payment. Any interest that is deferred is due and payable at the end of the deferral period. Principal that is deferred will be added to the end of the loan as an extension of the maturity date or as a balloon payment, depending on the loan structure. The Bank will continue to accrue interest during the deferral period. The majority of deferrals were for an initial period of 3 ~~months.~~

‎months with the potential for second 3-month deferral after review. If a borrower requested a second deferral, the Bank required a review of updated financial reports and forecast prior to granting an additional deferral.

3442

The following ~~tables show~~table shows the loan deferrals made as of ~~April~~September 30, 2020 by North American Industry Classification System (NAICS) code and type of collateral.

(Dollars in thousands)
Percent of
Collateral
Industry Description
Balance
Gross Loans
Real Estate
Non Real Estate
Accommodation and Food Services
$
68,796
7%
$
68,668
$
128
Retail Trade
36,826
4%
36,115
711
Real Estate and Rental and Leasing
26,433
3%
26,382
51
Health Care and Social Assistance
6,133
1%
4,531
1,602
Construction
4,613
< 1%
2,514
2,099
Arts, Entertainment, and Recreation
3,408
< 1%
3,077
331
Other Services (except Public Administration)
3,260
< 1%
2,963
297
Agriculture, Forestry, Fishing and Hunting
1,798
< 1%
1,715
83
Transportation and Warehousing
1,280
< 1%
439
841
Administrative/Support & Waste Mgt Services
496
< 1%
238
258
Public Administration
396
< 1%
396
—
Manufacturing
321
< 1%
120
201
Professional, Scientific, and Technical Services
170
< 1%
—
170
Total
$
153,930
16%
$
147,158
$
6,772


					Percent of	Collateral
(Dollars in thousands)	Number of			Percent of	Risk-based	Real Estate		Non-Real Estate
Industry Description	Loans		Balance	Gross Loans	Capital (1)	secured		secured
Hotels	24	$	60,827	6%	44%	$	60,820	$	7
Arts, Entertainment, and Recreation	4		14,093	1%	10%		14,075		18
Real Estate, Rental & Leasing	2		4,911	< 1%	< 1%		4,911		—
Food Service	2		931	< 1%	< 1%		931		—
Agriculture	3		891	< 1%	< 1%		891		—
Public Administration	3		290	< 1%	< 1%		114		176
Retail Trade	1		117	< 1%	< 1%		117		—
Other Services (except Public Administration)	2		76	< 1%	< 1%		—		76
Residential and Consumer loans	3		353	< 1%	< 1%		351		2
Total	44	$	82,489	8%	59%	$	82,210	$	279
(1) Based on Bank's Risk-based Capital

The following tables show the type of modifications by industry as of September 30, 2020, and the same sectors one quarter earlier at June 30, 2020.


September 30, 2020	Type of Modification
(Dollars in thousands)	Principal Deferred		Interest Only Loans		Principal & Interest
Industry Description	Interest Only Payments		Payments Deferred		Payments Deferred			Total
Hotels	$	18,026	$	—	$	42,801	$	60,827
Arts, Entertainment & Recreation		—		—		14,093		14,093
Real Estate, Rental & Leasing		4,718		—		193		4,911
Food Service		883		—		48		931
Agriculture		—		74		817		891
Public Administration		—		140		150		290
Retail Trade		117		—		—		117
Other Services		—		—		76		76
Residential and Consumer loans		—		—		353		353
Total	$	23,744	$	214	$	58,531	$	82,489


June 30, 2020	Type of Modification
(Dollars in thousands)	Principal Deferred		Interest Only Loans		Principal & Interest
Industry Description	Interest Only Payments		Payments Deferred		Payments Deferred			Total
Hotels	$	—	$	285	$	66,387	$	66,672
Arts, Entertainment & Recreation		1,117		39		2,686		3,842
Real Estate, Rental & Leasing		15,474		130		56,786		72,390
Food Service		1,206		—		2,918		4,124
Agriculture		—		—		2,705		2,705
Public Administration		396		—		—		396
Retail Trade		14,055		236		9,907		24,198
Other Services		—		—		1,801		1,801
Residential and Consumer loans		552		428		4,218		5,198
Total	$	32,800	$	1,118	$	147,408	$	181,326

The performance of these loans as they come out of the deferral period will be critical in predicting the credit quality of the loans in the future. ~~The Bank expects the balance of modifications and deferrals to increase during the second quarter.~~

Paycheck Protection Program. The Bank participated in the Paycheck Protection Program (PPP) administered by the Small Business Administration (SBA). The PPP is a small business loan program designed to assist in allowing small businesses to keep workers on the payroll during the COVID-19 pandemic. When workers are kept on the payroll for the qualifying period, the loan could be forgiven if the small business incurs eligible expenses. The PPP loans, are 100 percent guaranteed by the SBA, have a maturity of two-years and ~~have~~five-years with a fixed interest rate of 1% for the life of the loan. Borrowers of PPP loans do not have to make payments on the loan for the first six months, ~~then it is~~and the loans will fully ~~amortizing~~amortize for the remainder of the ~~two-year term.~~two- or five-year terms. The SBA pays originating banks a processing fee ranging from 3% to 5% of the loan, depending on the loan ~~balance. The~~balance and the Bank ~~focused its efforts for~~will recognize these fees in interest income over the ~~first round~~contractual life (two or five years) of the loan. As PPP ~~on its current customers and funded 90% of all approved applications it received for approximately $50.1 million. The~~loans are granted forgiveness by the SBA, fee recognition will accelerate. At September 30, 2020 the Bank ~~expects to receive fee income of approximately $2~~held $63.4 million of ~~processing fees from~~ PPP loans ~~recognized over the second~~ and ~~third quarter~~$1.9 million of ~~2020.~~ PPP fees remaining to be recognized. The PPP loans are 100% guaranteed by the SBA, thereby presenting no credit risk to the Bank once the SBA guarantee is fulfilled, if necessary. However, the PPP loan is only designed to cover short-term operating needs of the borrower. If the economy does not recover quickly from the pandemic and the borrower experiences long-term operational problems beyond the PPP funding, the performance of other loans to these customers could begin to deteriorate. The Bank began to receive approval of PPP forgiveness from the SBA in October.

Industry Exposure. With the pandemic shut down of non-essential businesses and stay at home orders, nearly every business and industry has been affected. Certain businesses have had a complete stoppage of operations, while many others have seen their business significantly reduced. Some businesses have requested loan modifications and others have taken PPPThe Bank believes its greatest risk exposure to modified loans ~~to continue operations.~~

~~To better understand the risk~~is in the ~~portfolio from the pandemic, the Bank has segregated its portfolio by industry and the perceived exposure to be economically affected by the pandemic.~~

hotel sector. The following table ~~shows~~presents additional information on the ~~loan portfolio by perceived pandemic risk at March 31, 2020.~~modified hotel loans.

(Dollars in thousands)
Low
$
448,945
Medium
359,362
High
128,079
Total
$
936,386

‎

~~The following tables show the medium and high perceived pandemic risk by industry and collateral at March 31, 2020.~~

(Dollars in thousands)
Percent of
Medium Risk
Gross Loans
Real Estate Secured
Non-Real Estate Secured
Retail - Consumer Loans - Non Real Estate
$
5,744
1%
$
—
$
5,744
Construction
71,260
8%
61,228
10,031
Real Estate and Rental and Leasing
282,358
30%
265,772
16,587
Total
$
359,362
38%
$
327,000
$
32,362
High Risk
Arts, Entertainment, and Recreation
$
15,393
2%
$
14,903
$
490
Retail Trade - Non Operating Sectors
34,447
4%
32,006
2,442
Accommodation and Food Services
78,239
8%
76,697
1,543
Total
$
128,079
14%
$
123,606
$
4,475


September 30, 2020
(Dollars in thousands, except average daily rate)
Modified Balance	$	60,827
Number of Loans Modified		24
Average Balance	$	2,534
Average Loan-to-Value		62%
Risk Rated - 5	$	33,396
Risk Rated - 6	$	21,729
Risk Rated - 7	$	5,702
September 2020 Daily Occupancy*		44%
September 2019 Daily Occupancy*		57%
September 2020 Average Daily Rate*	$	87
September 2019 Average Daily Rate*	$	100
Hotel Flags		17

*Daily occupancy and average daily rate represent data reported for the primary markets in which the hotels operate and may or may not represent the experience of any specific property in the portfolio.

Allowance for Loan Losses:

Management monitors loan performance on a monthly basis and performs a quarterly evaluation of the adequacy of the allowance for loan ~~losses (ALL).~~losses. The ALL is determined by segmenting the loan portfolio based on the loan’s collateral. When calculating the ALL, consideration is given to a variety of factors in establishing this estimate including, but not limited to, current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, historical charge-offs, the adequacy of the underlying collateral (if collateral dependent) and other relevant factors. The Bank begins enhanced monitoring of all loans rated 6-OAEM, or worse, and obtains a new appraisal or asset valuation for any placed on nonaccrual and rated 7-Substandard or worse. Management, at its discretion, may determine that additional adjustments to the appraisal or valuation are required. Valuation adjustments will be made as necessary based on factors, including, but not limited to; the economy, deferred maintenance, industry, type of property/equipment, age of the appraisal, etc. and the knowledge Management has about a particular situation. In addition, the cost to sell or liquidate the collateral is also estimated and deducted from the valuation in order to determine the net realizable value to the Bank. When determining the allowance for loan losses, certain factors involved in the evaluation are inherently subjective and require material estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans. Management monitors the adequacy of the allowance for loan losses on an ongoing basis and reports its adequacy quarterly to the Credit Risk Oversight Committee of the Board of Directors. Management believes that the allowance for loan losses at ~~March 31,~~September 30, 2020 is adequate.

‎

The analysis for determining the ALL is consistent with guidance set forth in generally accepted accounting principles (GAAP) and the Interagency Policy Statement on the Allowance for Loan and Lease Losses. The analysis has three components; specific, general and unallocated. The specific component addresses specific reserves established for impaired loans. A loan is considered to be impaired when, based on current information and events, it is probable that the Bank will be unable to collect all interest and principal payments due according to the originally contracted terms of the loan agreement. Collateral values discounted for market conditions and selling costs are used to establish specific allocations for impaired loans. However, it is possible that as a result of the credit analysis, a specific reserve is not required for an impaired loan. Commercial loans with a balance less than $250 thousand, and all consumer purpose loans are not included in the specific reserve analysis as impaired loans but are added to the general allocation pool. These loans totaled ~~$412~~$411 thousand at ~~March 31,~~September 30, 2020 and are comprised primarily of loans secured by residential real estate. Management does not believe that excluding these loans from the specific reserve analysis presents any additional risk. There was no specific reserve established for any of the ~~impaired loans. Note 6 of the accompanying financial statements provides additional information about the ALL established for~~ impaired loans.

The general allocation component addresses the reserves established for pools of homogenous loans. The general component includes a quantitative and qualitative analysis. When calculating the general allocation, the Bank segregates its loan portfolio into the following segments based primarily on the type of supporting collateral: residential real estate, commercial, industrial or agricultural real estate; commercial and industrial (C&I non-real estate), and consumer. Each segment may be further segregated by type of collateral, lien position, or owner/nonowner occupied properties. The quantitative analysis uses the Bank’s twenty quarter rolling historical loan loss experience as determined for each loan segment to determine a loss factor applicable to each loan segment. PPP loans, because of the SBA guarantee, were excluded from the quantitative analysis. The allowance established as a result of the quantitative analysis was $3.8 million compared to $3.6 million at June 30, 2020 and $2.9 million at ~~March 31, 2020, unchanged from~~ year-end 2019.

The qualitative analysis utilizes a risk matrix that incorporates four primary risk factors: economic conditions, delinquency, classified loans, and level of risk, and assigns a risk score (as measured in basis points) to each factor. The

economic condition factor is primarily based on unemployment rates. The delinquency factor considers the level of past due loans and charge-offs. The classified loan factor considers the internal credit risk score of the portfolio. The level of risk factor considers operational factors such as: loan volume, management, loan review process, credit concentrations, competition, and legal and regulatory issues. The risk score (as measured in basis points) for each of the four risk factors is minimal, low, moderate, high and very high and is determined independently for commercial loans, residential mortgage loans and consumer loans. At ~~March 31,~~June 30, the Bank increased the ~~risk score for economic conditions and level of risk from a moderate range~~basis point adjustment connected to athe very high range for ~~all loan portfolios~~the economic conditions risk factor to reflect increased risk presented by the ~~pandemic. The risk score for delinquency~~pandemic and ~~classified loan~~these factors remained unchanged ~~but could~~at September 30, 2020. The classified loan risk factor for the commercial loan portfolio increased slightly during the third quarter due to an increase ~~depending~~in classified loans. In addition, the Bank carved out the portfolio of modified loans for a qualitative assessment separate from the overall commercial loan ~~performance in~~portfolio. This allowed for assignment of a higher qualitative risk score on this portfolio. PPP loans, because of the ~~future. These~~SBA guarantee, were excluded from the qualitative analysis. Year-to-date, these changes resulted in a ~~$2.6~~$4.9 million increase in the qualitative component of the ALL to ~~$10.3~~$12.6 million ~~March~~as of September 30, 2020 compared to $7.7 million at December 31, ~~2020.~~2019.

The unallocated component is maintained to cover uncertainties that could affect Management’s estimate of probable loss. The unallocated component of the ALL reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

The following table shows, by loan segment, the activity in the ALL, the amount of allowance established in each category and the loans that were evaluated for the ALL under a specific reserve (individually) and those that were evaluated under a general reserve (collectively) as of ~~March 31,~~September 30, 2020.

‎

Residential Real Estate 1-4 Family
First
Junior Liens &
Commercial
(Dollars in thousands)
Liens
Lines of Credit
Construction
Real Estate
Commercial
Consumer
Unallocated
Total
ALL at December 31, 2019
$
416
$
119
$
184
$
6,022
$
3,815
$
84
$
1,326
$
11,966
Charge-offs
—
—
—
—
(220)
(30)
—
(250)
Recoveries
3
—
—
—
5
6
—
14
Provision
144
59
82
1,582
886
38
209
3,000
ALL at March 31, 2020
$
563
$
178
$
266
$
7,604
$
4,486
$
98
$
1,535
$
14,730

Residential Real Estate 1-4 Family
First
Junior Liens &
Commercial
(Dollars in thousands)
Liens
Lines of Credit
Construction
Real Estate
Commercial
Consumer
Unallocated
Total
March 31, 2020
Loans evaluated for ALL:
Individually
$
653
$
—
$
521
$
10,795
$
—
$
—
$
—
$
11,969
Collectively
142,653
50,666
14,961
483,348
226,128
6,661
—
924,417
Total
$
143,306
$
50,666
$
15,482
$
494,143
$
226,128
$
6,661
$
—
$
936,386
ALL established for
‎ loans evaluated:
Individually
$
—
$
—
$
—
$
—
$
—
$
—
$
—
$
—
Collectively
563
178
266
7,604
4,486
98
1,535
14,730
ALL at March 31, 2020
$
563
$
178
$
266
$
7,604
$
4,486
$
98
$
1,535
$
14,730


	Residential Real Estate 1-4 Family
	First		Junior Liens &				Commercial
(Dollars in thousands)	Liens		Lines of Credit		Construction		Real Estate		Commercial		Consumer		Unallocated		Total


ALL at June 30, 2020	$	580	$	197	$	242	$	8,837	$	5,845	$	105	$	749	$	16,555
Charge-offs		—		—		—		—		—		(28)		—		(28)
Recoveries		—		—		—		—		243		6		—		249
Provision		(2)		14		17		372		(52)		11		15		375
ALL at September 30, 2020	$	578	$	211	$	259	$	9,209	$	6,036	$	94	$	764	$	17,151

ALL at December 31, 2019	$	416	$	119	$	187	$	6,607	$	4,021	$	84	$	532	$	11,966
Charge-offs		—		—		—		—		(365)		(87)		—		(452)
Recoveries		4		—		—		—		267		16		—		287
Provision		158		92		72		2,602		2,113		81		232		5,350
ALL at September 30, 2020	$	578	$	211	$	259	$	9,209	$	6,036	$	94	$	764	$	17,151

ALL at June 30, 2019	$	437	$	113	$	164	$	6,452	$	4,733	$	95	$	559	$	12,553
Charge-offs		-		—		(120)		(169)		(17)		(27)		—		(333)
Recoveries		1		—		—		1		111		11		—		124
Provision		2		1		139		266		(545)		2		(27)		(162)
ALL at September 30, 2019	$	440	$	114	$	183	$	6,550	$	4,282	$	81	$	532	$	12,182

ALL at December 31, 2018	$	491	$	133	$	110	$	6,278	$	4,783	$	70	$	550	$	12,415
Charge-offs		(34)		(1)		(123)		(355)		(92)		(78)		—		(683)
Recoveries		4		1		—		22		162		24		—		213
Provision		(21)		(19)		196		605		(571)		65		(18)		237
ALL at September 30, 2019	$	440	$	114	$	183	$	6,550	$	4,282	$	81	$	532	$	12,182


	Residential Real Estate 1-4 Family
	First		Junior Liens &				Commercial
(Dollars in thousands)	Liens		Lines of Credit		Construction		Real Estate		Commercial		Consumer		Unallocated		Total

September 30, 2020
Loans evaluated for ALL:
Individually	$	643	$	—	$	515	$	16,361	$	—	$	—	$	—	$	17,519
Collectively		140,953		58,776		13,699		489,137		296,331		6,543		—		1,005,439
Total	$	141,596	$	58,776	$	14,214	$	505,498	$	296,331	$	6,543	$	—	$	1,022,958

ALL established for ‎ loans evaluated:
Individually	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Collectively		578		211		259		9,209		6,036		94		764		17,151
ALL at September 30, 2020	$	578	$	211	$	259	$	9,209	$	6,036	$	94	$	764	$	17,151

December 31, 2019
Loans evaluated for ALL:
Individually	$	659	$	—	$	523	$	10,994	$	—	$	—	$	—	$	12,176
Collectively		142,287		47,597		12,800		483,268		230,007		6,440		—		922,399
Total	$	142,946	$	47,597	$	13,323	$	494,262	$	230,007	$	6,440	$	—	$	934,575

ALL established for ‎ loans evaluated:
Individually	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Collectively		416		119		187		6,607		4,021		84		532		11,966
ALL at December 31, 2019	$	416	$	119	$	187	$	6,607	$	4,021	$	84	$	532	$	11,966

Real estate appraisals and collateral valuations are an important part of the Bank’s process for determining potential loss on collateral dependent loans and thereby have a direct effect on the determination of loan reserves, charge-offs and the calculation of the allowance for loan losses. As long as the loan remains a performing loan, no further updates to appraisals are required. If a loan or relationship migrates to nonaccrual and a risk rating of 7-Substandard or worse, an evaluation for impairment status is made based on the current information available at the time of downgrade and a new appraisal or collateral valuation is obtained. We believe this practice complies with the regulatory guidance.

In determining the allowance for loan losses, Management, at its discretion, may determine that additional adjustments to the fair value obtained from an appraisal or collateral valuation are required. Adjustments will be made as necessary based on factors, including, but not limited to the economy, deferred maintenance, industry, type of property or equipment etc., and the knowledge Management has about a particular situation. In addition, the cost to sell or liquidate the collateral is also estimated and deducted from the valuation in order to determine the net realizable value to the Bank. If an appraisal is not available, Management may make its best estimate of the real value of the collateral or use last

known market value and apply appropriate discounts. If an adjustment is made to the collateral valuation, this will be documented with appropriate support and reported to the Loan Management Committee.

The allocation of the allowance for loan losses is based on estimates and is not intended to imply limitations on the usage of the allowance. The entire allowance is available to absorb any losses without regard to the category in which the loan is classified.

The following table shows the ALL and charge-off ratios for the periods ended:


	Three Months Ended		Year ended			Three Months Ended		Nine Months Ended		Year Ended			Nine Months Ended
	March 31, 2020			December 31, 2019		March 31, 2019		September 30, 2020			December 31, 2019		September 30, 2019
Net charge-offs (recoveries)/average loans*		0.10%			0.07%		0.05%		0.02%			0.07%		0.06%
Net loan charge-offs (recoveries) as a percentage of the provision for loan losses		7.87%			289.54%		33.33%		3.08%			289.54%		198.31%
Allowance for loan losses as a % of loans		1.57%			1.28%		1.29%		1.68%			1.28%		1.30%
Net charge-offs (recoveries)	$	236		$	686	$	133	$	165		$	686	$	470
* Annualized

Deposits:

Total deposits ~~decreased $8.0~~increased $211.4 million during the first ~~three~~nine months of 2020 to ~~$1.117~~$1.337 billion. Of this increase, approximately $36.0 million are remaining PPP loan proceeds. Noninterest-bearing deposits increased ~~$6.3~~$78.4 million (primarily in small business and commercial checking deposits) and interest-bearing checking and savings deposits ~~decreased $8.7~~increased $143.0 million, while time deposits decreased ~~$5.5~~$10.0 million. Interest-bearing checking ~~decreased~~increased by ~~$12.0~~$72.5 million ~~primarily~~ in ~~commercial~~retail and ~~municipal~~commercial deposits, while the Bank’s Money Management ~~and remained flat~~increased $54.7 million and Savings products increased ~~$2.3~~$15.9 million compared to year-end ~~2019. Time~~2019, as customers deposited stimulus checks and did not spend the funds. The decrease in time deposits ~~also decreased since year-end and~~is primarily in retail accounts.

As of ~~March 31,~~September 30, 2020, the Bank had ~~$158.1~~$209.1 million placed in the ICS reciprocal deposit program ($~~106.3~~163.6 million in ~~interesting-bearing~~interest-bearing checking and ~~$48.5~~$45.5 million in money management) and ~~$3.2~~$5.0 million in reciprocal time deposits in the CDARS program included in time deposits. These programs allow the Bank to offer full FDIC coverage to large depositors, but with the convenience to the customer of only having to deal with one bank. The Bank solicits these deposits from within its market and it believes they present no greater risk than any other local deposit. Only reciprocal deposits that exceed 20% of liabilities are considered brokered deposits. At ~~March 31,~~September 30, 2020, the Bank’s reciprocal deposits were ~~14.7%~~15.5% of total liabilities compared to 14.2% at year-end 2019.

The following table presents a summary of deposits for the periods ended:


	March 31,		December 31,			Change		September 30,		December 31,			Change
(Dollars in thousands)	2020		2019			Amount	%	2020		2019			Amount	%
Noninterest-bearing checking	$	198,384	$	192,108	$	6,276	3.3	$	270,489	$	192,108	$	78,381	40.8

Interest-bearing checking		319,928		331,886		(11,958)	(3.6)		404,367		331,886		72,481	21.8
Money management		430,138		429,199		939	0.2		483,868		429,199		54,669	12.7
Savings		85,142		82,851		2,291	2.8		98,708		82,851		15,857	19.1
Total interest-bearing checking and savings		835,208		843,936		(8,728)	(1.0)		986,943		843,936		143,007	16.9

Time deposits		83,841		89,348		(5,507)	(6.2)		79,317		89,348		(10,031)	(11.2)

Total deposits	$	1,117,433	$	1,125,392	$	(7,959)	(0.7)	$	1,336,749	$	1,125,392	$	211,357	18.8

Overdrawn deposit accounts reclassified as loans	$	227	$	153				$	124	$	153

‎

Borrowings:

On August 4, 2020 the Corporation completed the sale of a subordinated debt note offering. The Corporation sold $15.0 million of subordinated debt notes with a maturity date of September 1, 2030. These notes are noncallable for 5 years and carry a fixed interest rate of 5% per year for 5 years and then convert to floating rate of SOFR plus 4.93% per year for the remainder of the term. The notes can be redeemed at par beginning 5 years prior to maturity. The Corporation also sold $5.0 million of subordinated debt notes with a maturity date of September 1, 2035. These notes are noncallable for 10 years and carry a fixed interest rate of 5.25% per year for 10 years and then convert to floating rate of SOFR plus 4.92% per year for the remainder of the term. The notes can be redeemed at par beginning 5 years prior to maturity. The notes are structured to qualify as Tier 2 capital for the Corporation and any funds it invests in the Bank qualify as Tier 1 capital at the Bank. The Corporation paid an issuance fee of 2% of the total issue that will be amortized to the call date of each issue on a pro-rata basis. The proceeds are intended to be used for general corporate purposes. The Corporation had no borrowings at ~~March 31, 2020 and~~ December 31, 2019.

Shareholders’ Equity:

Total shareholders’ equity increased ~~$1.5~~$12.0 million to ~~$129.0~~$139.6 million at ~~March 31,~~September 30, 2020, from $127.5 million at the end of 2019. The Corporation’s net earnings of ~~$1.7~~$8.2 million were partially offset by the cash dividend of ~~$1.3~~$3.9 million. The Corporation’s Dividend Reinvestment Plan (DRIP) added ~~$349~~$718 thousand in new capital from optional cash contributions and ~~$211~~$644 thousand from the reinvestment of quarterly dividends. The Corporation’s dividend payout ratio was ~~75.97%~~47.45% for the first ~~three~~nine months of 2020.

As part of its quarterly dividend decision, the Corporation considers current and future income projections, dividend yield, payout ratio, and current and future capital ratios. For the ~~first~~third quarter of 2020, the Corporation paid a $0.30 per share dividend, compared to ~~$0.27~~$0.30 paid in the ~~first~~third quarter of 2019. On ~~April 16,~~October 8, 2020 the Board of Directors declared a $0.30 per share regular quarterly dividend for the ~~second~~fourth quarter of 2020, which will be paid on ~~May 27,~~November 25, 2020.

On September 12, 2019, the Board of Directors authorized the 2019 Repurchase Plan for the repurchase of up to 150,000 shares of the Corporation’s $1.00 par value common stock at market prices in open market or privately

negotiated transactions beginning September 13, 2019 and ~~continuing through~~expired on September 12, 2020. During the first quarter of 2020, 36,401 shares were repurchased, under the 2019 plan. The Corporation suspended activity in the stock repurchase plan on March 19, 2020.

The Bank is participating in the Paycheck Protection Program (PPP) and the Paycheck Protection Program Liquidity Facility (PPPLF) to fund PPP Loans. In accordance with regulatory guidance, PPP loans pledged as collateral for PPPLF, and PPPLF advances, are excluded from leverage capital ratios. PPP loans will also carry a 0% risk-weight for risk-based capital rules.

The following table summarizes the regulatory capital requirements and results as of ~~March 31,~~September 30, 2020 and December 31, 2019 for the Corporation and the Bank:


				Regulatory Ratios					Regulatory Ratios
				Adequately	Well				Adequately	Well
		March 31,	December 31,	Capitalized	Capitalized		September 30,	December 31,	Capitalized	Capitalized
(Dollars in thousands)		2020	2019	Minimum	Minimum		2020	2019	Minimum	Minimum

Common Equity Tier 1 Risk-based Capital Ratio (1)
Franklin Financial Services Corporation		14.73%	14.82%	N/A	N/A		14.21%	14.82%	N/A	N/A
Farmers & Merchants Trust Company		14.52%	14.62%	4.500%	6.50%		13.99%	14.62%	4.50%	6.50%

Tier 1 Risk-based Capital Ratio (2)
Franklin Financial Services Corporation		14.73%	14.82%	N/A	N/A		14.21%	14.82%	N/A	N/A
Farmers & Merchants Trust Company		14.52%	14.62%	6.000%	8.00%		13.99%	14.62%	6.00%	8.00%

Total Risk-based Capital Ratio (3)
Franklin Financial Services Corporation		15.99%	16.08%	N/A	N/A		17.62%	16.08%	N/A	N/A
Farmers & Merchants Trust Company		15.78%	15.87%	8.000%	10.00%		15.25%	15.87%	8.00%	10.00%

Tier 1 Leverage Ratio (4)
Franklin Financial Services Corporation		9.85%	9.72%	N/A	N/A		8.75%	9.72%	N/A	N/A
Farmers & Merchants Trust Company		9.71%	9.59%	4.000%	5.00%		8.61%	9.59%	4.00%	5.00%

(1) Common equity Tier 1 capital/ total risk-weighted assets (2) Tier 1 capital / total risk-weighted assets	(1) Common equity Tier 1 capital/ total risk-weighted assets (2) Tier 1 capital / total risk-weighted assets					(1) Common equity Tier 1 capital/ total risk-weighted assets (2) Tier 1 capital / total risk-weighted assets
(3) Total risk-based capital / total risk-weighted assets, (4) Tier 1 capital / average quarterly assets	(3) Total risk-based capital / total risk-weighted assets, (4) Tier 1 capital / average quarterly assets					(3) Total risk-based capital / total risk-weighted assets, (4) Tier 1 capital / average quarterly assets

Economy

The Corporation’s primary market area includes Franklin, Fulton, Cumberland and Huntingdon Counties, Pennsylvania. This area is diverse in demographic and economic makeup. County populations range from a low of approximately 15,000 in Fulton County to over 249,000 in Cumberland County. Unemployment in the Bank’s market area ~~has remained virtually unchanged over the past year and ranges~~ranged from ~~a low of 3.5%~~9.9% in Cumberland County to ~~5.3%~~15.1% in

~~Huntingdon County.~~ Fulton County, as of the end of August. The market area has a diverse economic base and local industries include warehousing, truck & rail shipping centers, light and heavy manufacturers, ~~health-care,~~healthcare, higher education institutions, farming and agriculture, and a varied service sector. The Corporation’s primary market area is located in South Central PA and provides easy access to the major metropolitan markets on the east coast via trucking and rail transportation. Because of this, warehousing and distribution companies continue to find the area attractive. The local economy is not overly dependent on any one industry or business and Management believes that the Bank’s primary market area continues to be well suited for growth.

In early March 2020, the economic outlook changed dramatically driven primarily by the COVID-19 pandemic. The effects of the pandemic stretched into the second quarter of 2020 and are expected to last throughout the remainder of the year. The pandemic has resulted in certain federal, state and local governmental authorities taking action to stop the spread of the ~~pandemic.~~virus. These actions have included stay-at-home orders, restrictions on business activity, and proclamations and/or directives aimed at minimizing the spread of the pandemic by restricting the movement of people, products and services in the economy. As a result of these actions, the economic activity of the Bank’s market area has been curtailed, businesses have been shut down and unemployment has dramatically increased. The repayment of every loan is dependent, in some way, on an efficiently functioning economy. Any action that has the effect of restricting economic activity has the potential to reduce cash flow available to repay loans. At this time, the length of this economic downturn and its effect on the Corporation is uncertain.

Impact of Inflation

The impact of inflation upon financial institutions such as the Corporation differs from its effect upon other commercial enterprises. Unlike many companies, the assets and liabilities of the Corporation are financial in nature. As such, interest rates and changes in interest rates may have a more significant effect on the Corporation’s financial results than on other types of industries. Because of this, the Corporation watches the actions of the Federal Reserve Open Market Committee (FOMC) as it makes decisions about interest rate changes and how such changes affect market rates and the Corporation. Although inflation (and inflation expectations) may affect the interest rate environment, it is not possible to measure with any precision the ~~affect~~effect of inflation on the Corporation.

Liquidity

The Corporation must meet the financial needs of the customers that it serves, while providing a satisfactory return on the shareholders’ investment. In order to accomplish this, the Corporation must maintain sufficient liquidity in order to respond quickly to the changing level of funds required for both loan and deposit activity. The goal of liquidity management is to meet the ongoing cash flow requirements of depositors who want to withdraw funds and of borrowers who request loan disbursements. The Bank regularly reviews it liquidity position by measuring its projected net cash flows (in and out) at a 30 and 90-day interval. The Bank stresses the measurements by assuming a level of deposit out-flows that have not historically been realized. In addition to this forecast, other funding sources are reviewed as a method to provide emergency funding if necessary. The objective of this measurement is to identify the amount of cash that could be raised quickly without the need to liquidate assets. The Bank also stresses its liquidity position utilizing different longer-term scenarios. The varying degrees of stress create pressure on deposit flows in its local market, reduce access to wholesale funding and limit access of funds available through brokered deposit channels. In addition to stressing cash flow, specific liquidity risk indicators are monitored to help identify risk areas. This analysis helps identify and quantify the potential cash surplus/deficit over a variety of time horizons to ensure the Bank has adequate funding resources. Assumptions used for liquidity stress testing are subjective. Should an evolving liquidity situation or business cycle present new data, potential assumption changes will be considered. The Bank believes it can meet all anticipated liquidity demands.

Historically, the Corporation has satisfied its liquidity needs from earnings, repayment of loans and amortizing investment securities, maturing investment securities, loan` sales, deposit growth and its ability to access existing lines of credit. All investment securities are classified as available for sale; therefore, securities that are unencumbered (approximately ~~$125.7~~$227.2 million fair value) as collateral for borrowings are an additional source of readily available liquidity, either by selling the security or, more preferably, to provide collateral for additional borrowing. The Bank also has access to other wholesale funding via the brokered CD market.

The FHLB system has always been a major funding source for the Bank. There are no current indicators that lead the Bank to believe the FHLB would discontinue its lending function or restrict the Bank’s ability to borrow. If either of these events would occur, it would have a negative effect on the Bank, and it is unlikely that the Bank could replace the level of FHLB funding in a short time. The Bank has established credit at the Federal Reserve Discount Window and at correspondent banks.

‎

The following table shows the Bank’s available liquidity at ~~March 31,~~September 30, 2020.


(Dollars in thousands)

Liquidity Source		Capacity		Outstanding		Available		Capacity		Outstanding		Available
Federal Home Loan Bank	$	377,600	$	—	$	377,600	$	387,935	$	—	$	387,935
Federal Reserve Bank Discount Window		21,000		—		21,000		24,786		—		24,786
Correspondent Banks		21,000		—		21,000		21,000		—		21,000
Paycheck Protection Program Liquidity Facility								63,395		—		63,395
Total	$	419,600	$	—	$	419,600	$	497,116	$	—	$	497,116

Pandemic Effect on ~~Liquidity -~~Liquidity: The Bank is closely monitoring itits liquidity needs as loans are modified and delinquencies are expected to increase. The Bank expects to see a reduction in monthly cash flow from loan deferrals, as discussed in the Loan Quality section. The Bank expects to be able to absorb this reduction through its current liquidity resources. To support its liquidity position, the Bank is participating in the Paycheck Protection Program Liquidity Facility (PPPLF) established by the Federal Reserve to fund loans made through the Paycheck Protection Program sponsored by the Small Business Administration. The PPPLF is a term financing facility with a fixed interest rate of ~~.35%~~0.35% and a maturity equal to the maturity date of ~~no more than 2~~the PPP loans (2 years ~~for each loan.~~or 5 years). Loans made through the PPP are used as collateral for PPPLF funding. The PPPLF will allow the Bank to fully fund its PPP loans at a low fixed rate without having to access its normal liquidity sources described above. The Bank also expects to see a temporary increase in funding as the stimulus checks provided by the Coronavirus Aid, Relief and Economic Security Act (CARES Act) are issued and deposited to the bank. However, the Bank expects these funds to be quickly withdrawn. The Bank believes it can meet all anticipated liquidity demands of the pandemic through its current liquidity sources and the government sponsored programs.

The CARES Act also granted the FDIC authority to reinstitute the liquidity guarantee program to offer unlimited FDIC insurance on noninterest bearing deposit. If this is approved by the FDIC, it would provide less incentive for customers to withdraw deposits and possibly strain bank liquidity
‎

Off Balance Sheet Commitments

The Corporation’s financial statements do not reflect various commitments that are made in the normal course of business, which may involve some liquidity risk. These commitments consist mainly of unfunded loans and letters of credit made under the same standards as on-balance sheet instruments. Because these instruments have fixed maturity dates, and because many of them will expire without being drawn upon, they do not generally present any significant liquidity risk to the Corporation. Unused commitments and standby letters of credit totaled ~~$329.4~~$348.8 million and $336.6 million, respectively, at ~~March 31,~~September 30, 2020 and December 31, 2019. AsIn the second quarter of ~~June 30,~~ 2018, the Bank established a $2.4 million allowance against letters of credit issued in connection with a commercial borrower that declared bankruptcy. In the first quarter of 2020, the Bank reversed $250 thousand of this reserve as one letter of credit was cancelled. At ~~March 31,~~September 30, 2020, this reserve was $2.1 million.

The Corporation has entered into various contractual obligations to make future payments. These obligations include time deposits, long-term debt, operating leases, deferred compensation and pension payments. These amounts have not changed materially from those reported in the Corporation’s 2019 Annual Report on Form 10-K.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

There were no material changes in the Corporation’s exposure to market risk during the ~~three~~nine months ended ~~March 31,~~September 30, 2020. For more information on market risk refer to the Corporation’s 2019 Annual Report on Form 10-K.

Item 4. Controls and Procedures

Evaluation of Controls and Procedures

The Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon the evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer concluded that as of ~~March 31,~~September 30, 2020, the Corporation’s disclosure controls and procedures are effective. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in the Corporation’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. There were no changes in the Corporation’s internal control

over financial reporting during the quarterly period ended ~~March 31,~~September 30, 2020, that have materially affected, or are reasonably likely to materially affect, the internal control over financial reporting.

The management of the Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. The Corporation’s internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

‎

4251

Part II – OTHER INFORMATION

Item 1. Legal Proceedings

The nature of the Corporation’s business generates a certain amount of litigation.

We establish accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probable, and the amount of the loss can be reasonably estimated. When we are able to do so, we also determine estimates of possible losses, whether in excess of any accrued liability or where there is no accrued liability.

These assessments are based on our analysis of currently available information and are subject to significant judgment and a variety of assumptions and uncertainties. As new information is obtained, we may change our assessments and, as a result, take or adjust the amounts of our accruals and change our estimates of possible losses or ranges of possible losses. Due to the inherent subjectivity of the assessments and the unpredictability of outcomes of legal proceedings, any amounts that may be accrued or included in estimates of possible losses or ranges of possible losses may not represent the actual loss to the Corporation from any legal proceeding. Our exposure and ultimate losses may be higher, possibly significantly higher, than amounts we may accrue or amounts we may estimate.

In management’s opinion, we do not anticipate, at the present time, that the ultimate aggregate liability, if any, arising out of all litigation to which the Corporation is a party will have a material adverse effect on our financial position. We cannot now determine, however, whether or not any claim asserted against us will have a material adverse effect on our results of operations in any future reporting period, which will depend on, amount other things, the amount of loss resulting from the claim and the amount of income otherwise reported for the reporting period. Thus, at ~~March 31,~~September 30, 2020, we are unable to provide an evaluation of the likelihood of an unfavorable outcome or an estimate of the amount or range of potential loss with respect to such other matters and, accordingly, have not yet established any specific accrual for such other matters.

No material proceedings are pending or are known to be threatened or contemplated against us by governmental authorities.

In management’s opinion, there are no other proceedings pending to which the Corporation is a party or to which its property is subject which, if determined adversely to the Corporation, would be material. No material proceedings are pending or are known to be threatened or contemplated against us by any governmental authorities.

Item 1A. Risk Factors

During the ~~three~~nine months ended ~~March 31,~~September 30, 2020 the Corporation has determined the following risk associated with its business, financial condition, results of operations and common stock. This risk factor supplements the risk factors described in the Corporation’s 2019 Annual Report on Form 10-K.

Public health crisis such as epidemics or pandemics could materially and adversely impact our business.

The COVID-19 pandemic has negatively impacted the global, national and local economies, disrupted global and national supply chains, lowered equity market valuations, created significant volatility and disruption in financial markets, and increased unemployment levels. In addition, the pandemic ~~has~~ resulted in temporary closures of many businesses and the institution of social distancing and sheltering in place requirements in many states and ~~communities.~~communities and may result in the same or similar restrictions in the future. As a result, the demand for our products and services have been and may continue to be significantly impacted, which could adversely affect our revenue and results of operations. Furthermore, the pandemic could continue to result in the recognition of credit losses in our loan portfolios and increase in our allowance for credit losses, particularly if businesses remain ~~closed,~~restricted or are required to close again, the impact on the global, national and local economies worsen, or more customers draw on their lines of credit or seek additional loans to help finance their businesses. Similarly, because of changing economic and market conditions affecting issuers, we may be required to recognize further impairments on the securities we hold as well as reductions in other comprehensive income. Our business operations may also be disrupted if significant portions of our workforce are unable to work effectively, including because of illness, quarantines, government actions, or other restrictions in connection with the pandemic. The extent to which the COVID-19 pandemic impacts our business, results of operations, and financial conditions, as well as our regulatory capital and liquidity ratios, will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities and other third parties in response to the pandemic.

‎

We continue to closely monitor the COVID-19 pandemic and related risks as they evolve. The magnitude, duration and likelihood of the current outbreak of COVID-19, further outbreaks of COVID-19, future actions taken by governmental authorities and/or other third parties in response to the COVID-19 pandemic, and its future direct and

indirect effects on the global, national and local economy and our business and results of operation are highly uncertain. The COVID-19 pandemic may cause prolonged global or national recessionary economic conditions or longer lasting effects on economic conditions than currently exist, which could have a material adverse effect on our business, results of operations and financial condition.

Due to the Corporation’s participation in the U.S. Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”), the Corporation is subject to additional risks of litigation from its clients or other parties regarding the processing of loans for the PPP and risks that the SBA may not fund some or all of PPP loan guaranties.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted, which included a $349 billion loan program administered through the SBA referred to as the PPP. Under the PPP, small businesses and other entities and individuals could apply for loans from existing SBA lenders and other approved regulated lenders. The Corporation participated as a lender in the PPP. Because of the short timeframe between the passing of the CARES Act and the opening of the PPP, there was some ambiguity in the laws, rules and guidance regarding the operation of the PPP along with the continually evolving nature of SBA the rules, interpretations and guidelines concerning this program, which exposes us to risks relating to the noncompliance with the PPP. Since the launch of the PPP, several large banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP. As such, we may be exposed to the risk of litigation, from both clients and non-clients that approached the Corporation regarding PPP loans, regarding its process and procedures used in processing applications for the PPP. If any such litigation is filed against us and is not resolved in a manner favorable to us, it may result in significant financial liability or adversely affect our reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP related litigation could have a material adverse impact on our business, financial condition and results of operations.

The Corporation also has credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, underwritten, certified by the borrower, funded, or serviced by the Corporation, such as an issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules and guidance regarding the operation of the PPP. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, certified by the borrower, funded, or serviced by the FNBPA, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from us.

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

(Dollars in thousands, except per share)
Period
Number of
‎Shares Purchased as Part of Publicly Announced Program
Weighted
‎Average
‎Price Paid
‎per Share
Dollar Amount of
‎Shares Purchased
‎as Part of Publicly
‎Announced Program

‎Shares Yet
‎To Be Purchased
‎Under Program
March 2020
36,401
32.19
1,172
113,499
36,401
$
1,172

On December 20, 2018, the Board of Directors authorized the 2018 Repurchase Plan for the repurchase of up to 100,000 shares of the Corporation’s $1.00 par value common stock at market prices in open market or privately negotiated transactions beginning December 21, 2018 and continuing through December 21, 2019. The 2018 Repurchase plan was completed in the third quarter of 2019. On September 12, 2019, the Board of Directors authorized the 2019 Repurchase Plan for the repurchase of up to 150,000 shares of the Corporation’s $1.00 par value common stock at market prices in open market or privately negotiated transactions beginning September 13, 2019 and ~~continuing through~~expired on September ~~13,~~12, 2020. The Corporation suspended activity in the stock repurchase plan on March 19, 2020. There were no share purchases made during the third quarter of 2020.

Item 3. Defaults by the Company on its Senior Securities

None

Item 4. Mine Safety Disclosures

Not Applicable

‎

4453

Item 5. Other Information

None

Item 6. Exhibits

Exhibits


3.1	Amended and Restated Articles of Incorporation of the ~~Corporation.~~Corporation (Filed as Exhibit 3.1 to ~~Annual~~Quarterly Report on Form ~~10-K~~10-Q for the ~~year~~quarter ended ~~December 31, 2014~~June 30, 2020 and incorporated herein by ~~reference.)~~reference).

3.2	Bylaws of the Corporation. (Filed as Exhibit 3.2 to Current Report on Form 8-K, as filed with the commission on December 21, 2018 and incorporated herein by reference.)

31.1	Rule 13a – 14(a)/15d-14(a) Certifications – Principal Executive Officer

31.2	Rule 13a – 14(a)/15d-14(a) Certifications – Principal Financial Officer

32.1	Section 1350 Certifications – Principal Executive Officer

32.2	Section 1350 Certifications – Principal Financial Officer

101	Interactive Data File (XBRL)

104	Cover Page Interactive Data File (the cover page XBRL tags are imbedded in the XBRL document)

‎

4554

FRANKLIN FINANCIAL SERVICES CORPORATION

and SUBSIDIARIES

SIGNATURES

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

Franklin Financial Services Corporation



~~May 11,~~November 9, 2020		/s/ Timothy G. Henry
		Timothy G. Henry
		Chief Executive Office and President
		(Principal Executive Officer)

~~May 11,~~November 9, 2020		/s/ Mark R. Hollar
		Mark R. Hollar
		Treasurer and Chief Financial Officer
		(Principal Financial and Accounting Officer)

4655


(Dollars in thousands)

Low	$	448,945
Medium		359,362
High		128,079
Total	$	936,386


(Dollars in thousands)
			Percent of
Medium Risk			Gross Loans	Real Estate Secured		Non-Real Estate Secured
Retail - Consumer Loans - Non Real Estate	$	5,744	1%	$	—	$	5,744
Construction		71,260	8%		61,228		10,031
Real Estate and Rental and Leasing		282,358	30%		265,772		16,587
Total	$	359,362	38%	$	327,000	$	32,362


High Risk
Arts, Entertainment, and Recreation	$	15,393	2%	$	14,903	$	490
Retail Trade - Non Operating Sectors		34,447	4%		32,006		2,442
Accommodation and Food Services		78,239	8%		76,697		1,543
Total	$	128,079	14%	$	123,606	$	4,475


(Dollars in thousands, except per share)
Period	Number of ‎Shares Purchased as Part of Publicly Announced Program	Weighted ‎Average ‎Price Paid ‎per Share		Dollar Amount of ‎Shares Purchased ‎as Part of Publicly ‎Announced Program	‎Shares Yet ‎To Be Purchased ‎Under Program
March 2020	36,401	32.19		1,172	113,499
	36,401		$	1,172