Kish Bancorp, Inc.
Annual Report 2011

Plain-text annual report

2 0 1 1 A n n u Al R e p oRt Making a Difference, One custOMer at a tiMe Chairman’s Letter to the Shareholders Several years ago, the theme for our annual report to shareholders was titled “The Test of Time.” I couldn’t help but be reminded of that theme recently when the Comptroller of the Currency presented Kish Bank with a large embossed certificate on the occasion of the 100th anniversary of the Bank’s national charter. Kish’s charter was originally granted to the Farmers National Bank of Belleville in 1912. Over the years, it is a charter that has stood the test of challenging economic periods and difficult regulatory conditions, perhaps never more so than the past few years. Today, we can say with pride that this milepost, like all those before it, was made possible by a sustained focus on the fundamentals of our business and a tradition of delivering on our promises to our customers and communities. So that now, as we review the results for Kish Bancorp in 2011, we can do so with a deep sense of pride in the tradition of performance that has brought Kish to this point in our history; a tradition of “Making a Difference, One Customer at a Time.” A discussion of Kish Bancorp’s performance in 2011 begins with an acknowledgement of the political, economic and regulatory climate that provided the backdrop for the year. A famous politician once said, “All politics is local.” That statement is true for banking as well. Sooner or later, the forces at work on the national stage, from which we often feel removed, come home to impact us locally. That was the case for Kish in 2011. The Dodd-Frank Act, which had passed in 2010 with the stated intent of addressing the excesses that caused the financial crisis, had already rewritten the rules under which banks operate. Bank bashing remained in vogue in Washington, despite the fact that few banks, and certainly few community banks, had contributed to the crisis. The economic recovery that many were predicting and hoping for failed to gain much traction; therefore, headwinds facing many of our small business borrowers continued. The challenging regulatory climate and heightened scrutiny of community banks, previously focused on other regions of the country, began to impact Pennsylvania’s community banks as well. In February of 2011, Kish Bank voluntarily entered into an agreement with its primary regulator to address certain concerns arising from a 2009 examination regarding criticized loans and IT infrastructure. Despite this unexpected development, we maintained our focus on serving our customers and communities while moving swiftly to address these regulatory issues. Although the resources dedicated to addressing this situation were significant, Kish Bank remained profitable, well capitalized and growing. We continued to add new customers and new members to the team. We also remained supportive of our existing borrowers, most of whom had been customers for years and had never stopped performing or paying as agreed. Today we can point with pride to the metrics of loan quality and financial performance that were sustained at high levels throughout 2011. We can also report that the actions necessary to address the agreement are essentially completed, except for the period of time required to validate our capacity to sustain this performance. As you review our results for 2011, I would also ask you to bear in mind that the financial and internal resources committed to responding to the environment, while considerable, in reality represent the commitment of resources necessary to build the platform for the future. Our 2011 performance continued to advance Kish’s strategic vision of “Building to a Billion” William P. Hayes, Chairman, President, and Chief Executive Officer contents Chairman’s Letter to the Shareholders Financial Highlights 1-4 5-7 Making a Difference, One Customer at a Time 8-10 Report of Independent Auditors 11 Financial Statements 12-15 Notes to Consolidated Financial Statements 16-47 The People of Kish Bancorp, Inc. 48-49 www.KishBank.com in assets. The balance sheet was strengthened. We invested in internal processes, systems, and infrastructure. Kish Bank expanded its market share in the region and our capacity to manage growth was fortified by a number of key additions to the Kish team. We are better positioned to pursue the growth opportunities that we are confident await us as the economic recovery begins to take hold. It is this solid foundation, built on the discipline of performance and team commitment, that permits us to proudly present this Annual Report. Net income for 2011 grew to $3.631 million, an increase of 2.1 percent over 2010. Earnings per share, at $6.74, also exceeded 2010 performance. Return on average shareholder’s equity remained strong at 9.82 percent, significantly exceeding the current industry average. It was this critical measure of shareholder performance that ranked Kish Bancorp among the top 200 Community Banks in the U.S. in 2011 for the third consecutive year, based on a ranking by U.S. Banker magazine. The key driver of the growth in net income was a stable net interest margin coupled with growth in earning assets. Most importantly, the core banking business remained strong. Kish achieved a 1.5 percent increase in net interest income compared to 2010, despite weak market demand for commercial loans that contributed to a nominal decline of 1 percent in the loan portfolio. Net interest income during 2011 was $17.243 million, an increase of $255 thousand compared to 2010. Earnings were also aided during 2011 by strengthening loan quality metrics. There was a $1.05 million decrease in the contribution to the reserve for loan losses, as $800 thousand was set aside in 2011 compared to $1.850 million in 2010. Because of a significant decline in actual losses, the reserve for loan losses, the Bank’s buffer against possible future loan charge-offs, increased 12.8 percent to $7.043 million at December 31, 2011 from $6.245 million at December 31, 2010. While the Corporation’s provision expenses declined, the reserve ratio increased substantially to 1.91 percent of total loans as of December 31, 2011 from 1.67 percent at December 31, 2010. As noted above, loan quality indicators began the year on positive footing and grew stronger as 2011 progressed. The increased stability of our loan portfolio reflected continued efforts to work with our borrowers to resolve loan problems. Most notably, net loan losses were near zero during 2011, loan delinquencies were near historic lows, and criticized assets had begun to decrease substantially. When compared to our national peer group of banks between $300 million and $1 billion in assets at year end, Kish Bank’s ratio of loan losses to total loans ranked in the top 3 percent of those banks; our earnings coverage of net losses ranked in the top 1 percent, and loans on non-accrual as a percentage of loans ranked in the top 60 percent. Over the past five years, and in stark contrast to our national peer group, the sustained quality of these metrics have been important contributors to Kish Bancorp’s overall performance. They also reflect our capacity to support local borrowers who have endured this very difficult economic period. Noninterest income increased $1.574 million, or 24.6 percent, to $7.982 million for 2011 from $6.408 million in 2010. This includes full- year business property income from a foreclosed business loan on the property, which was sold during the fourth quarter. Offsetting this $1.9 million increase in noninterest revenues was a decline in investment securities gains, as well as lower gains on sales of residential mortgage loans originated for the secondary market. Noninterest expense was $20.355 million during 2011, an increase of $2.835 million, or 16.2 percent, over the same period in 2010. This was driven in large part by the costs related to operating the business property discussed above. Excluding the impact of these expenses, core noninterest expenses grew by $1.288 million, or 7.5 percent, in 2011 due to increases in FDIC insurance premiums, consulting fees, and salaries and benefits. Although a number of these expenses were nonrecurring, the rising cost of regulatory compliance in this environment must be a concern and underscores the need for prudent and profitable growth if we are to continue to achieve historical performance thresholds. 2 In addition to our sustained earnings performance, 2011 also witnessed the improvement of other key indicators of financial strength and durability. Capital ratios were continuously bolstered during the past year through retained earnings and a private offering of common stock of just over $3 million. These activities served to augment Kish Bancorp’s already strong capital base and equip the Corporation for the next period of expansion. Capital ratios at the holding company for December 31, 2011 versus the previous year were as follows: Tier 1 Leverage – 8.26 percent up from 7.24 percent; and Total Risk Based Capital – 13.85 percent up from 11.67 percent. We were pleased with the ready acceptance given to the private offering during what is still a difficult environment for banks in the capital markets. We were also gratified that the issuance had little impact on the market value of Kish Bancorp stock. As was true with previous forms of government provided capital (TARP), Kish did not raise capital through the U.S. Treasury’s Small Business Lending Fund. During 2011, the Bank implemented further enhancements to information security protocols, technology infrastructure, and information management systems that, along with other actions, have improved external and internal service capabilities across the organization. We will continue to place a high priority on investing in systems that protect information and deliver the most efficient service possible to our customers. To further strengthen our Build to a Billion initiatives and sharpen our focus on service to our customers, Kish also realigned the executive management team and made a number of strategic hires and appointments that are worthy of note in this report. In that process, we have strengthened our overall management focus, our sales focus and our sales teams. In recognition of his leadership and strong performance since joining the Kish organization in 2009, Brad Scovill was promoted to the position of Senior Executive Vice President and Chief Operating Officer. In that capacity, he assumed full day-to- day operating responsibility for the Bank. He previously served in the dual role as Chief Operating Officer and CFO. Brad is also continuing his responsibilities as Chief Risk Officer for the Corporation. There were also important additions to the Kish team this past year. • John Arrington joined Kish early in 2011 as Regional Market Manager, Centre County, and was subsequently promoted to Executive Vice President for Sales and Retail Banking. John is passionate about community banking and customer service and, in addition to directing the sales efforts across all regions, is leading the Bank’s efforts in product and service improvement. 3 • Carol Herrmann, a noted State College business leader, joined Kish as Vice President for Administration to provide executive-level direction, support and administrative oversight of such key functions as strategic planning, corporate communications, investor relations and marketing. She also facilitates the governance activities of the Bank and Corporation Boards of Directors and Regional Boards. • Sangeeta Kishore, a seasoned bank financial executive, joined Kish Bank as Executive Vice President and Chief Financial Officer. She brought an extensive background and expertise in reporting requirements for banks above the $1 billion asset threshold that will be invaluable as Kish continues to grow. • Other key additions and appointments include Matt Raptosh, who joined the Bank as Assistant Vice President, Commercial Relationship Manager in Centre County, and John Keeler, as a Commercial Relationship Manager in Mifflin County. Several seasoned Kish bankers were promoted to new roles. In Mifflin County, John Cunningham was promoted to Regional Market Manager, Mifflin County and Allana Hartung was promoted to VP, Commercial Relationship Manager. Marsha Kuhns was appointed as VP of Branch Administration, In reviewing the Corporation’s achievements for 2011, we gratefully acknowledge the continued support and encouragement of you, our shareholders. You have supported Kish’s special mission in the marketplace and its ambitious goals for the future. The Corporation has been fortunate to welcome a strong and local group of new investors this year. We extend to you a warm welcome to the Kish organization, one uniquely committed to making a difference in our community— one customer at a time. As always, we encourage your inquiries regarding the Corporation’s performance noted herein and throughout the coming year. Sincerely, William P. Hayes Chairman, President, and Chief Executive Officer and Kayelene Sunderland was promoted to AVP and Trust Manager. These enhancements to the team, among others, were part of an overall reorganization that aligned executive efforts in a number of key areas including sales, retail and business banking, finance, operations, and enterprise risk management. An important component of Kish’s Build to a Billion strategy is to develop the professional governance capabilities necessary to represent the interests of our shareholders, oversee and direct our activities, and set the strategic direction of the Company. Board members of Kish Bank and Kish Bancorp are charged with understanding the banking and diverse financial needs of our businesses and customers and possessing the technical and financial acumen important to the governance of the Bank and its various business units. They are also accountable for Kish’s adherence to the regulatory structure under which we operate. Together, our Board members further strengthen the capacity of the Corporation to achieve its long-term goals and objectives. We are grateful for their extraordinary commitment to Kish and our mission of driving sustained shareholder value through an unwavering focus on service to our customers and communities. In that regard, we were pleased to welcome Mr. Delmont R. Sunderland of Huntingdon to the Kish Bancorp Board in 2011. Recently, we were also pleased to announce the appointment of William S. Lake to the Kish Bank and Kish Bancorp Boards of Directors. Mr. Lake is a long-time resident of Mifflin County and is the owner of the Lake Automobile Dealerships in Lewistown. He is respected for his community support and business acumen and brings an in-depth knowledge of the markets in which we operate. He will stand for election by the shareholders at the upcoming annual meeting in May. We also want to acknowledge with gratitude the departure of a valued member of our Boards following the upcoming shareholders meeting in May. Alison B. Kurtz of State College has decided to conclude her service as a director of Kish Bank and Kish Bancorp at the end of her term. The demands imposed on our directors have increased dramatically in recent years and we are grateful to Alison for her contributions, commitment, and dedication during a challenging and demanding time. In summary, Kish’s sustained positive financial performance, strengthened balance sheet, loan quality, realignment of the management structure, additions to our governance teams, and focus on building a winning team, in combination with strategic investments in our technology infrastructure, focus on risk management, improvement in our internal processes, and refinements to our product development and support processes, reinforce Kish’s ability to continue to advance the Corporation’s long-term goals in the years ahead. Financial Highlights Five Year Summary for the year Net Income 2011 $3,631,298 2010 $3,556,124 2009 $3,216,423 2008 $3,937,791 2007 $3,933,582 Net Income Before Taxes 4,070,114 4,026,669 3,586,370 4,817,481 4,826,174 Total Dividends Declared 1,760,493 1,739,714 1,721,575 1,713,474 1,629,120 at year end (in 000’s) Total Assets Total Loans (Net) Total Deposits Stockholders’ Equity Loan Loss Reserve Net Loan Losses (Recoveries) ratio analysis Return on Average Assets Return on Average Equity Dividend Declared/Net Income Loan/Deposits Primary Capital/Total Assets Total Capital/Risk Weighted Assets Loan Loss Reserve/Loans Net Loan Losses to Total Loans (Net) per share data Basic Earnings Fully Diluted Earnings Dividends Paid Equity (Book Value) Equity Plus Loan Loss Reserve $560,069 $556,623 $527,396 $476,263 $454,092 362,163 454,660 43,517 7,043 3 0.65% 9.82% 48.48% 79.66% 9.03% 13.85% 1.91% 0.00% $6.74 6.72 3.24 72.95 84.75 367,306 446,002 35,729 6,245 1,001 0.65% 10.31% 48.92% 82.36% 7.54% 11.67% 1.67% 0.27% $6.72 6.68 3.24 66.54 78.17 367,824 407,721 34,062 5,397 252 0.64% 9.73% 53.57% 90.21% 7.48% 11.26% 1.44% 0.07% $6.08 6.07 3.24 63.61 73.69 333,434 352,729 31,302 3,305 (5) 0.84% 12.75% 43.51% 94.53% 7.27% 10.40% 0.98% 0.00% $7.47 7.47 3.24 59.04 65.27 305,729 331,688 30,323 3,001 140 0.92% 13.32% 41.42% 92.17% 7.34% 10.41% 0.97% 0.05% $7.37 7.35 3.03 57.50 63.19 Average Shares Outstanding (#) 538,735 529,343 528,125 527,044 534,916 4 5 Financial Highlights Net Income (in millions) Basic Earnings Per Share Total Assets (in millions) Total Capital/ Risk Weighted Assets Return on Average Equity Dividends Per Share Loan Loss Reserve/Loans Net Loan Losses to Total Loans (Net) * Source – SNL Financial, median values * Source – SNL Financial, median values 6 7 Making a Difference – one Customer at a time Ed Bridgens Owner, Eastgate Feed & Grain Kish Banking, Insurance, and Travel Customer Suzy Glenn Owner, Best Event Rental Kish Bank Customer Mark Mazur and Christina Calkins-Mazur Owners, Calkins Automotive Kish Bank Customers Art DeCamp Kish Insurance Customer Paula Seguin Owner, Boxer’s Café Kish Bank Customer At Kish Bancorp, we never get confused about our Most importantly of course, by touching so many With the long retail hours and financial complexities, seemed a lot more interested in passing his questions reason for being in business. We’re here to serve our aspects of our customers’ lives with an expanding range running a successful car dealership doesn’t allow for along to assistants, instead of working with him directly. customers by meeting their needs and helping them of products and services, we make a difference in our much down time. So it’s important for Mark Mazur That’s why Art has found that his experience with accomplish their goals, realize their dreams, and build community by helping to fuel business innovation and and Christina Calkins-Mazur to be able to ensure the Kish Insurance makes such a difference. It has been brighter futures. To the extent we are successful in expansion, capital formation, and wealth generation. achievement of their personal financial goals without a like a breath of fresh air to have an insurance partner achieving that objective, then we can also focus on our goal of delivering long term performance and value to our shareholders and our communities. All of this makes an investment in Kish a winning proposition on multiple levels. It’s an investment not only in an organization committed to achieving Of course, the critical element of delivering value outstanding financial results, but also dedicated to is strong financial performance. But it extends having a positive impact on the quality of life in our beyond that. By producing consistently strong community. An investment in Kish is an investment that financial performance, we not only achieve results makes a difference. for shareholders, we are also able to invest in our franchise, our employees and the organizations that serve our communities. As we reinvest in the infrastructure of the company, we strengthen our capacity to perform and compete. The same is true for our workforce. Investing in our people is the only means to elevate the professional capacity of our people and deliver great service. Solid profitability also enhances our ability to provide financial support to the organizations that help the most vulnerable and needy in our communities. So, one of the best ways to see how Kish makes a difference is to look first-hand at the experiences of our customers. Behind every Kish customer relationship is an individual story. As a community-based institution built on personal relationships, Kish has a unique opportunity to see our customers’ stories unfold on a direct and personal level. The stories you will see in these pages provide just a few of many examples of how Kish makes a difference—one customer at a time. lot of hands-on administrative involvement. That’s why who takes the time to truly understand his needs and they choose Kish Bank for their personal banking needs personally attend to the smallest details. as well as their business banking. The peace of mind that comes with knowing that Kish is navigating their personal financial ship in the right direction makes a difference in their lives; plus it gives them more opportunities to enjoy life with their growing young family, including leisure time at the shore. Ed Bridgens has experienced all facets of financial services delivery through his relationship with Kish: his business banking needs as a small business owner, personal banking, as well as his personal and business insurance and investment management needs have all been provided at levels that have helped him meet Art DeCamp has a variety of specialized relationships his financial goals; all while maintaining a quality of with the financial services team at Kish. From life in the local community that makes his hard work banking, to investment management to insurance, worthwhile. So when it comes to leisure time, Ed turns his experience is that Kish delivers customized and to a trusted source for managing his vacation trips as highly personalized solutions. He likes to discuss his well. There are many options, online and offline, for insurance needs—some of which he wasn’t even fully planning a vacation. Finding competitive prices on aware of before he met his Kish Insurance agent— fares and lodging can be time consuming and often as an example of how Kish differentiates itself. challenging. It’s even more daunting to try to make Previously, he had repeatedly experienced the sure you don’t run into the unexpected hassles and frustration of working with insurance agents who unpleasant surprises that can make a pleasure trip 8 9 “ Kish caters to me.” – John Pannizzo Owner, Downtown OIP and Grille Kish Financial Solutions Customer much less pleasurable. If you lead the busy lifestyle of more—giving him more time to lace up the sneakers a business owner like Ed Bridgens, finding the time it and make tracks. takes to plan a vacation on your own can be difficult. That’s why Ed trusts the experts at Kish Travel, who make a difference in his leisure life by devoting the time and personal attention it takes to take care of the details and ensure that every trip, from a weekend getaway to a long, leisurely vacation package, is an exceptional and memorable experience. We think these customer stories speak volumes. Since our management team and associates share our communities with our customers and shareholders, we can see the positive difference that our performance, products and services make in our neighbors’ lives: from helping their personal and business finances thrive… to helping them provide The restaurant business is fast-paced—that’s a given. for their children’s education and attaining financial But that doesn’t bother John Pannizzo, who you’re security for retirement; from providing peace of mind likely to see out for a run if he’s not at his restaurant with insurance products to protecting what matters multi-tasking to make sure everything, from the kitchen most to them… to enhancing their ability to enjoy to the dining room to the restrooms, is running in a way downtime with unique travel and leisure experiences. that ensures his customers an experience that meets his high standards. John also has high standards when it comes to choosing a financial services partner. With a life outside of work that’s often just as fast-paced as his business, he doesn’t want to spend a lot of time managing the details of keeping his long-term financial goals on track. So it makes a big difference for John that he can trust Kish Financial Solutions to manage the details of retirement, children’s college funding, and The Kish Experience is a story about our customers’ success. It is a sum of the stories of all of our customers. It is what makes our alignment with our customers so strong and our shareholders’ investment so important to the health and well-being of our communities. Report of Independent Auditors Kish Bancorp, Inc. Consolidated Audited Financial Statements December 31, 2011 Report of Independent Auditors Board of Directors and Stockholders, Kish Bancorp, Inc. Page Number We have audited the accompanying consolidated Report of Independent Auditors ............................11 Financial Statements Consolidated Balance Sheet ...............................12 balance sheet of Kish Bancorp, Inc. and subsidiaries as of December 31, 2011 and 2010, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for the years then Consolidated Statement of Income ...................13 ended. These financial statements are the responsibility Consolidated Statement of Changes in Stockholders’ Equity .........................................14 of the Company’s management. Our responsibility is to express an opinion on these financial statements based Consolidated Statement of Cash Flows ............15 on our audits. Notes to Consolidated Financial Statements ..16–47 Market and Dividend Information for 2011 During 2011, Kish Bancorp, Inc. paid four quarterly dividends totaling $3.24. $0.81 per share was paid on January 31, April 30, July 31 and October 31. These dividends were paid to shareholders of record as of January 1, April 1, July 1 and October 1. Stock in Kish Bancorp, Inc. is not actively traded on a national securities exchange. During 2011, trades occurred in the over the counter (OTC) market. To management’s knowledge, sale prices ranged from $63.00 to $56.00 per share. At year-end, an average bid price of $58.00 was posted. On December 31, 2011, there were 438 shareholders of record. The following firms are market makers in the Corporation’s stock: Boenning & Scattergood, Inc. 4 Tower Bridge, 200 Barr Harbor Drive, Suite 300 West Conshohocken, PA 19428 (610) 862-5368 Raymond James and Associates, Inc. 222 South Riverside Plaza, 7th Floor Chicago, IL 60606 (312) 655-2975 Registrar and Transfer Company serves as the Corporation’s transfer agent and record keeper. Founded in 1899, Registrar and Transfer Company is the nation’s oldest, most widely respected specialist in the stock transfer business. Thousands of banks and public companies, trading on all U.S. exchanges, utilize R&T to provide efficient and comprehensive shareholder services. Their contact information is as follows: Registrar and Transfer Company 10 Commerce Drive Cranford, NJ 07016 (800) 368-5948 info@rtco.com We conducted our audits in accordance with U.S. generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Kish Bancorp, Inc. and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. Wexford, Pennsylvania March 14, 2012 10 11 Consolidated Balance Sheet KISH BANCORP, INC. CONSOLIDATED BALANCE SHEET KISH BANCORP, INC. CONSOLIDATED STATEMENT OF INCOME Consolidated Statement of Income ASSETS Cash and due from banks Interest-bearing deposits with other institutions Cash and cash equivalents Certificates of deposit in other financial institutions Investment securities available for sale Loans held for sale Loans Less allowance for loan losses Net loans Premises and equipment Goodwill Regulatory stock Bank-owned life insurance Accrued interest and other assets TOTAL ASSETS LIABILITIES Deposits: Noninterest-bearing Interest-bearing demand Savings Money market Time Total deposits Short-term borrowings Other borrowings Accrued interest and other liabilities TOTAL LIABILITIES STOCKHOLDERS' EQUITY December 31, 2011 2010 $ $ 9,592,946 31,588,825 41,181,771 9,338,767 10,544,564 19,883,331 1,619,833 114,170,492 2,734,094 120,862,285 1,401,376 918,342 369,205,842 7,042,911 362,162,931 14,211,627 1,668,699 4,042,400 12,097,673 7,512,072 373,551,450 6,245,441 367,306,009 13,633,292 1,668,699 4,161,800 11,684,697 13,770,102 $ 560,068,874 $ 556,622,651 $ $ 54,985,004 8,021,861 40,358,678 177,667,176 173,627,594 454,660,313 5,696,162 52,049,918 4,145,495 516,551,888 45,225,548 8,233,339 36,303,525 177,084,834 179,154,740 446,001,986 7,608,645 62,871,140 4,411,628 520,893,399 Preferred stock, $.50 par value; 500,000 shares authorized, no shares issued and outstanding Common stock, $.50 par value; 2,000,000 shares authorized, 663,791 and 610,000 shares issued Additional paid-in capital Retained earnings Accumulated other comprehensive income Treasury stock, at cost (67,237 and 73,046 shares) TOTAL STOCKHOLDERS' EQUITY - - 331,896 2,979,269 43,654,117 2,466,659 (5,914,955) 43,516,986 305,000 114,999 41,783,312 24,409 (6,498,468) 35,729,252 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 560,068,874 $ 556,622,651 See accompanying notes to consolidated financial statements. 2 12 Year Ended December 31, 2011 2010 $ 19,773,794 1,030,427 $ 20,716,935 1,087,627 1,832,161 1,336,001 83,224 63,870 24,119,477 4,266,998 203,640 2,406,192 6,876,830 1,891,681 1,322,196 108,819 88,104 25,215,362 4,861,254 121,890 3,244,235 8,227,379 17,242,647 800,000 16,987,983 1,850,000 16,442,647 15,137,983 1,483,286 840,576 (8,728) 797,914 416,069 886,733 236,580 2,059,377 1,270,226 7,982,033 9,969,960 2,847,007 1,574,312 356,458 436,651 1,074,877 - 353,018 3,742,283 20,354,566 4,070,114 438,816 1,423,464 1,050,999 (28,167) 1,045,435 399,688 852,732 230,688 168,008 1,265,390 6,408,237 8,751,543 2,207,718 1,537,774 254,195 377,299 646,016 548,896 - 3,196,110 17,519,551 4,026,669 470,545 $ $ 3,631,298 $ 3,556,124 6.74 6.72 $ 6.72 6.68 INTEREST AND DIVIDEND INCOME Interest and fees on loans: Taxable Exempt from federal income tax Interest and dividends on investment securities: Taxable Exempt from federal income tax Interest-bearing deposits with other institutions Other dividend income Total interest and dividend income INTEREST EXPENSE Deposits Short-term borrowings Other borrowings Total interest expense NET INTEREST INCOME Provision for loan losses NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES NONINTEREST INCOME Service fees on deposit accounts Investment securities gains, net Investment securities impairment loss Gain on sale of loans, net Earnings on bank-owned life insurance Insurance commissions Travel agency commissions Business property income Other Total noninterest income NONINTEREST EXPENSE Salaries and employee benefits Occupancy and equipment Data processing Professional fees Advertising Federal deposit insurance Prepayment penalty on extinguishment of debt Loss on sale of other assets Other Total noninterest expense Income before income taxes Income taxes NET INCOME EARNINGS PER SHARE Basic Diluted See accompanying notes to the consolidated financial statements. 3 13 Consolidated Statement of Changes In Stockholders’ Equity KISH BANCORP, INC. CONSOLIDATED STATEMENT OF CASH FLOWS Consolidated Statement of Cash Flows e v i s n e h e r p m o C ) s s o L ( e m o c n I ' s r e d l o h k c o t S y t i u q E y r u s a e r T k c o t S l a t o T d e t a l u m u c c A r e h t O e v i s n e h e r p m o C ) s s o L ( e m o c n I d e n i a t e R s g n i n r a E l a n o i t i d d A n i - d i a P l a t i p a C n o m m o C k c o t S . C N I , P R O C N A B H S I K Y T I U Q E ' S R E D L O H K C O T S N I S E G N A H C F O T N E M E T A T S D E T A D I L O S N O C 4 2 1 , 6 5 5 , 3 $ 4 2 1 , 6 5 5 , 3 4 2 1 , 6 5 5 3 , ) 3 7 1 , 2 2 2 ( 1 5 9 , 3 3 3 , 3 $ ) 3 7 1 , 2 2 2 ( , ) 3 7 1 2 2 2 ( - - 6 7 6 , 9 2 6 8 8 , 5 8 6 9 8 , 4 5 1 ) 0 5 1 , 7 9 1 ( ) 4 1 7 , 9 3 7 , 1 ( ) 8 2 3 , 7 1 ( 0 2 1 , 0 2 3 ) 0 5 1 , 7 9 1 ( 9 7 3 , 6 2 1 ) 4 1 7 , 9 3 7 1 ( , . ) 3 9 4 , 0 4 ( 6 7 6 , 9 2 ) 0 2 1 , 0 2 3 ( 8 2 3 , 7 1 6 9 8 4 5 1 , 3 5 4 , 4 1 1 $ f o t i f e n e b x a t f o t e n , t n e m t s u j d a ) s e r a h s 3 7 9 , 2 ( k c o t s y r u s a e r t f o e s a h c r u P ) s e r a h s 1 4 3 , 1 ( k c o t s y r u s a e r t f o e l a S s e r a h s P S R d e n r a e n u f o n o i t a z i t r o m A ) e r a h s r e p 4 2 . 3 $ ( s d n e d i v i d h s a C e s n e p x e n o i t a s n e p m o c n o i t p o k c o t S e m o c n i e v i s n e h e r p m o C P S R y b s e r a h s f o e r u t i e f r o F P S R y b s e r a h s f o e s a h c r u P n o i t a c i f i s s a l c e r f o t e n , s e i t i r u c e s e l a s - r o f - e l b a l i a v a n o s s o l d e z i l a e r n U : s s o l e v i s n e h e r p m o c r e h t O e m o c n i t e N 2 5 2 , 9 2 7 , 5 3 ) 8 6 4 , 8 9 4 , 6 ( 9 0 4 4 2 , 2 1 3 , 3 8 7 , 1 4 9 9 9 , 4 1 1 0 0 0 5 0 3 , 0 1 0 2 , 1 3 r e b m e c e D , e c n a l a B 7 0 7 , 1 6 0 , 4 3 $ ) 9 8 4 , 0 3 7 , 6 ( $ 2 8 5 6 4 2 , $ 2 0 9 , 6 6 9 , 9 3 $ 2 1 7 , 3 7 2 $ 0 0 0 5 0 3 , $ 9 0 0 2 , 1 3 r e b m e c e D , e c n a l a B 0 5 2 , 2 4 4 , 2 8 4 5 , 3 7 0 , 6 $ 0 5 2 , 2 4 4 , 2 0 5 2 , 2 4 4 2 , 8 9 2 , 1 3 6 , 3 $ 8 9 2 , 1 3 6 , 3 8 9 2 , 1 3 6 3 , - - 0 0 1 , 2 4 ) 7 2 2 , 3 2 ( 0 9 5 , 5 8 9 1 3 , 3 9 1 ) 3 9 4 , 0 6 7 , 1 ( 7 9 8 , 6 7 1 , 3 ) 5 0 4 , 7 2 ( 1 1 9 , 8 9 4 ) 7 2 2 , 3 2 ( 4 3 2 , 5 3 1 ) 3 9 4 , 0 6 7 1 ( , 0 0 1 , 2 4 ) 1 1 9 , 8 9 4 ( 5 0 4 , 7 2 9 1 3 3 9 1 , 6 0 7 , 0 7 2 , 1 $ f o s e x a t f o t e n , t n e m t s u j d a e s n e p x e n o i t a s n e p m o c n o i t p o k c o t S e m o c n i e v i s n e h e r p m o C n o i t a c i f i s s a l c e r f o t e n , s e i t i r u c e s e l a s - r o f - e l b a l i a v a n o n i a g d e z i l a e r n U : e m o c n i e v i s n e h e r p m o c r e h t O s e r a h s P S R d e n r a e n u f o n o i t a z i t r o m A ) e r a h s r e p 4 2 . 3 $ ( s d n e d i v i d h s a C P S R y b s e r a h s f o e r u t i e f r o F P S R y b s e r a h s f o e s a h c r u P e m o c n i t e N 14 6 8 9 , 6 1 5 , 3 4 $ ) 5 5 9 , 4 1 9 , 5 ( $ 9 5 6 , 6 6 4 , 2 $ 7 1 1 4 5 6 , , 3 4 $ 9 6 2 9 7 9 , , 2 $ 6 9 8 , 1 3 3 $ 1 1 0 2 , 1 3 r e b m e c e D , e c n a l a B 0 1 0 2 1 1 0 2 6 9 8 , 2 5 4 $ 0 7 2 , 1 9 9 , 2 $ 0 9 5 , 8 1 0 6 7 , 5 ) 9 5 6 , 3 9 6 ( ) 0 8 7 , 4 5 5 ( ) 3 7 1 , 2 2 2 ( $ 0 5 2 , 2 4 4 , 2 $ t i f e n e b x a t f o t e n , e m o c n i t e n n i d e d u l c n i s e s s o l t n e m r i a p m I 7 7 5 , 9 $ d n a 8 6 9 , 2 $ f o : ) s s o l ( e m o c n i e v i s n e h e r p m o c r e h t o f o s t n e n o p m o C , e m o c n i t e n n i d e d u l c n i s n i a g d e z i l a e R 0 4 3 , 7 5 3 $ d n a 6 9 7 , 5 8 2 $ f o x a t f o t e n e l a s r o f e l b a l i a v a s t n e m t s e v n i n o n i a g d e z i l a e r n u t e n n i e g n a h C . s t n e m e t a t s l a i c n a n i f d e t a d i l o s n o c o t s e t o n g n i y n a p m o c c a e e S l a t o T OPERATING ACTIVITIES Net income Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses Investment securities gains, net Investment securities impairment loss Proceeds from sale of loans held for sale Origination of loans held for sale Gain on sales of loans, net Depreciation, amortization and accretion Deferred income taxes Increase (decrease) in accrued interest receivable Decrease in accrued interest payable Earnings on bank-owned life insurance Decrease in prepaid federal deposit insurance Loss on sale of other assets Other, net Net cash provided by operating activities INVESTING ACTIVITIES Maturities of certificates of deposit Purchase of certificates of deposit Investment securities available for sale: Proceeds from sale of investments Proceeds from repayments and maturities Purchases Decrease (increase) in loans, net Purchase of regulatory stock Redemption of regulatory stock Purchase of premises and equipment Proceeds from sale of premises and equipment Purchase of bank-owned life insurance ("BOLI") Proceeds from sale of other real estate owned Proceeds from sale of other assets Net cash provided by (used for) investing activities FINANCING ACTIVITIES Increase in deposits, net Increase (decrease) in short-term borrowings, net Proceeds from other borrowings Repayments of other borrowings Proceeds from sale of common stock Purchases of treasury stock Proceeds from sale of treasury stock Cash dividends Net cash provided by (used for) financing activities Increase (decrease) in cash and cash equivalents CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR CASH AND CASH EQUIVALENTS AT END OF YEAR SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the year for: Interest on deposits and borrowings Income taxes SUPPLEMENTAL DISCLOSURE OF NON-CASH CASH FLOW INFORMATION Real estate acquired in settlement of loans See accompanying notes to consolidated financial statements. 5 15 Year Ended December 31, 2010 2011 $ 3,631,298 $ 3,556,124 800,000 (840,576) 8,728 24,715,642 (24,400,762) (797,914) 1,557,325 (104,051) 167,919 (101,444) (416,069) 1,035,498 353,018 143,275 5,751,887 1,850,000 (1,050,999) 28,167 36,312,273 (35,611,190) (1,045,435) 2,696,173 (428,312) (163,160) (118,311) (399,688) 597,013 - (180,986) 6,041,669 1,114,261 - 2,642,275 (1,818,165) 53,533,950 21,467,880 (64,388,175) 7,038,702 (213,000) 332,400 (1,516,320) - (16,000) 43,127 746,339 18,143,164 8,658,327 (1,912,483) 2,712,000 (13,533,222) 3,176,897 (23,227) 85,590 (1,760,493) (2,596,611) 21,298,440 19,883,331 45,120,669 16,851,299 (105,916,061) (5,070,085) (17,500) - (1,144,384) 67,966 - 570,135 - (48,713,851) 38,280,949 2,980,743 10,050,000 (24,102,662) - (197,150) 85,886 (1,739,714) 25,358,052 (17,314,130) 37,197,461 $ $ $ 41,181,771 $ 19,883,331 6,978,272 482,000 $ 8,345,690 1,050,000 54,841 $ 3,737,599 1 0 0 , 0 5 1 3 , 6 9 8 , 6 2 ) s e r a h s 1 9 7 , 3 5 ( k c o t s n o m m o c e u s s i w e n f o e l a S ) 4 4 6 , 9 4 ( ) s e r a h s 3 8 3 ( k c o t s y r u s a e r t f o e s a h c r u P ) s e r a h s 1 1 4 , 1 ( k c o t s y r u s a e r t f o e l a S Notes to Consolidated Financial Statements KISH BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) A summary of the significant accounting and reporting policies applied in the presentation of the accompanying consolidated financial statements follows: Investment Securities (Continued) Nature of Operations and Basis of Presentation Kish Bancorp, Inc. (the “Company”) is a diversified financial services organization whose principal activity is the ownership and management of its subsidiaries, Kishacoquillas Valley National Bank (the “Bank”), Kish Travel Services, Inc., and the Bank’s subsidiaries, Kish Agency, Inc. and Tri Valley Properties, LLC. The Company generates commercial and agricultural, commercial mortgage, residential real estate, and consumer loans and deposit services to its customers located primarily in central Pennsylvania and the surrounding areas. The Bank operates under a national bank charter and provides full banking services. Deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”) to the extent provided by law. Kish Agency, Inc. provides insurance products and services. Kish Travel Services, Inc. is a Pennsylvania business established to provide travel services to its customers. Tri Valley properties, LLC is a limited liability company established to hold and manage real estate and other property acquired through debts previously contracted. The consolidated financial statements include the accounts of Kish Bancorp, Inc., and its subsidiaries, Kishacoquillas Valley National Bank and Kish Travel Services, Inc., after elimination of all intercompany transactions. The accounting principles followed by the Company and the methods of applying these principles conform to U.S. generally accepted accounting principles (“GAAP”) and to general practice within the banking industry. Management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the Consolidated Balance Sheet date and revenues and expenses for that period. Actual results could differ from those estimates. Investment Securities Investment securities are classified at the time of purchase, based on management’s intention and ability, as securities held to maturity, available for sale, or trading. Debt securities acquired with the intent and ability to hold to maturity are stated at cost, adjusted for amortization of premium and accretion of discount, which are computed using the interest method and recognized as adjustments of interest income. Debt securities which are held principally as a source of liquidity are classified as available for sale. Unrealized holding gains and losses for available-for-sale securities are reported as a separate component of stockholders’ equity, net of tax, until realized. Realized security gains and losses are computed using the specific identification method for debt securities and the average cost method for marketable equity securities. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in current earnings. Realized securities gains and losses are computed using the specific identification method. The Company does not have trading securities or securities held to maturity as of December 31, 2011 and 2010. Interest and dividends on investment securities are recognized as income when earned. Securities are evaluated on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether a decline in their value is other than temporary. For debt securities, management considers whether the present value of cash flows expected to be collected are less than the security’s amortized cost basis (the difference defined as the credit loss), the magnitude and duration of the decline, the reasons underlying the decline and the Company’s intent to sell the security or whether it is more likely than not that the Company would be required to sell the security before its anticipated recovery in market value, to determine whether the loss in value is other than temporary. Once a decline in value is determined to be other than temporary, if the investor does not intend to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of the security’s amortized cost basis, the charge to earnings is limited to the amount of credit loss. Any remaining difference between fair value and amortized cost (the difference 6 16 defined as the non-credit portion) is recognized in other comprehensive income, net of applicable taxes. Otherwise, the entire difference between fair value and amortized cost is charged to earnings. Common stock of the Federal Home Loan Bank (“FHLB”) of Pittsburgh and Federal Reserve Bank represents ownership in institutions that are wholly owned by other financial institutions. These equity securities are accounted for at cost and are shown separately on the Consolidated Balance Sheet. The Bank is a member of the FHLB and, as such, is required to maintain a minimum investment in stock of the FHLB that varies with the level of advances outstanding with the FHLB. The stock is bought from and sold to the FHLB based upon its $100 par value. The stock does not have a readily determinable fair value and, as such, is classified as restricted stock, carried at cost and evaluated by management. The stock’s value is determined by the ultimate recoverability of the par value rather than by recognizing temporary declines. The determination of whether the par value will ultimately be recovered is influenced by criteria such as the following: (a) the significance of the decline in net assets of the FHLB as compared with the capital stock amount and the length of time this situation has persisted; (b) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance; (c) the impact of legislative and regulatory changes on the customer base of the FHLB; and (d) the liquidity position of the FHLB. The FHLB had incurred losses in 2009 and for parts of 2010 due primarily to other-than-temporary impairment credit losses on its private-label mortgage-backed securities portfolio. These securities were the most effected by the extreme economic conditions in place during the previous several years. As a result, the FHLB had suspended the payment of dividends and limited the amount of excess capital stock repurchases. The FHLB has reported net income for both the fourth quarter and the year ended December 31, 2011, and has declared a .10 percent annualized dividend to its shareholders effective February 23, 2012. While the FHLB has not committed to regular dividend payments or future limited repurchases of excess capital stock, it will continue to monitor the overall financial performance of the FHLB in order to determine the status of limited repurchases of excess capital stock or dividends in the future. Management evaluated the stock and concluded that the stock was not impaired for the periods presented herein. More consideration was given to the long-term prospects for the FHLB as opposed to the recent stress caused by the extreme economic conditions the world is facing. Management also considered that the FHLB maintains regulatory capital ratios in excess of all regulatory capital requirements, liquidity appears adequate, new shares of FHLB stock continue to change hands at the $100 par value, and the resumption of dividends. Loans Loans are reported at their principal amount net of the allowance for loan losses and deferred origination fees or costs. Interest on loans is recognized as income when earned on the accrual method. Generally, the policy has been to stop accruing interest on loans when it is determined that a reasonable doubt exists as to the collectibility of additional interest. Interest previously accrued but deemed uncollectible is deducted from current interest income. Payments received on nonaccrual loans are recorded as income or applied against principal according to management’s judgment as to the collectibility of such principal. Nonaccrual loans will generally be put back on accrual status after demonstrating six consecutive months of nondelinquency. The allowance for loan losses is established through provisions for loan losses charged against income. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. Loan origination fees and certain direct loan origination costs are being deferred and the net amount amortized is accounted for as an adjustment of the related loan’s yield. Management is amortizing these amounts over the contractual life of the related loans. In general, fixed rate, permanent residential mortgage loans originated by the Bank are held for sale and are carried in the aggregate at the lower of cost or market. The Bank sells these loans to various other financial institutions. Currently, the Bank retains the servicing of those loans sold to the FHLB and releases the servicing of loans sold to all other institutions. 7 17 Notes to Consolidated Financial Statements 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Allowance for Loan Losses Goodwill The allowance for loan losses represents the amount that management estimates is adequate to provide for probable losses inherent in its loan portfolio as of the Consolidated Balance Sheet date. The allowance method is used in providing for loan losses. Accordingly, all loan losses are charged to the allowance, and all recoveries are credited to it. The allowance for loan losses is established through a provision for loan losses charged to operations. The provision for loan losses is based on management’s periodic evaluation of individual loans, economic factors, past loan loss experience, changes in the composition and volume of the portfolio, and other relevant factors. The estimates used in determining the adequacy of the allowance for loan losses, including the amounts and timing of future cash flows expected on impaired loans, are particularly susceptible to change in the near term. Impaired loans are commercial and industrial, agricultural, state and political subdivisions, and commercial real estate loans for which it is probable the Company will not be able to collect all amounts due according to the contractual terms of the loan agreement. The Company individually evaluates such loans for impairment and does not aggregate loans by major risk classifications. The definition of “impaired loans” is not the same as the definition of “nonaccrual loans,” although the two categories overlap. The Company may choose to place a loan on nonaccrual status due to payment delinquency or uncertain collectibility while not classifying the loan as impaired, provided the loan is not a commercial or commercial real estate classification. Factors considered by management in determining impairment include payment status and collateral value. The amount of impairment for these types of loans is determined by the difference between the present value of the expected cash flows related to the loan using the original interest rate and its recorded value, or as a practical expedient in the case of collateralized loans, the difference between the fair value of the collateral and the recorded amount of the loans. When foreclosure is probable, impairment is measured based on the fair value of the collateral. Mortgage loans secured by one-to-four family properties and all consumer loans are large groups of smaller- balance homogenous loans and are measured for impairment collectively. Loans that experience insignificant payment delays, which are defined as 90 days or less, generally are not classified as impaired. Management determines the significance of payment delays on a case-by-case basis taking into consideration all circumstances concerning the loan, the creditworthiness and payment history of the borrower, the length of the payment delay, and the amount of shortfall in relation to the principal and interest owed. In addition to the allowance for loan losses, the Company also estimates probable losses related to unfunded lending commitments, such as letters of credit, financial guarantees and unfunded loan commitments. Unfunded lending commitments are subject to individual reviews and are analyzed and segregated by risk according to the Company’s internal risk rating scale. These risk classifications, in conjunction with an analysis of historical loss experience, current economic conditions, performance trends within specific portfolio segments and any other pertinent information, result in the estimation of the reserve for unfunded lending commitments. Provision for credit losses related to the loan portfolio and unfunded lending commitments are reported in the Consolidated Statement of Income. Premises and Equipment Land is carried at cost. Premises and equipment are stated at cost, less accumulated depreciation. Depreciation is principally computed on the straight-line method over the estimated useful lives of the related assets, which range from 3 to 7 years for furniture, fixtures, and equipment, and 31 to 39½ years for building premises and leasehold improvements. Expenditures for maintenance and repairs are charged against income as incurred. Costs of major additions and improvements are capitalized. The Company accounts for goodwill using a two-step process for testing the impairment of goodwill on at least an annual basis. This approach could cause more volatility in the Company’s reported net income because impairment losses, if any, could occur irregularly and in varying amounts. Bank-Owned Life Insurance (“BOLI”) The Company purchased life insurance policies on certain key employees. BOLI is recorded at its cash surrender value, or the amount that can be realized. Real Estate Owned Real estate acquired by foreclosure is included with other assets on the Consolidated Balance Sheet at the lower of the recorded investment in the property or its fair value less estimated costs of sale. Prior to foreclosure, the value of the underlying collateral is written down by a charge to the allowance for loan losses if necessary. Any subsequent write-downs are charged against operating expenses. Operating expenses of such properties, net of related income and losses on their disposition, are included in other expense. Treasury Stock Treasury stock is carried at cost. Sales are determined by the first-in, first-out method. Advertising Costs Advertising costs are expensed as the costs are incurred. Advertising expense amounted to $436,651 and $377,299 for 2011 and 2010, respectively. Income Taxes The Company and its subsidiaries file a consolidated federal income tax return. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Earnings Per Share The Company provides dual presentation of basic and diluted earnings per share. Basic earnings per share are calculated utilizing net income as reported in the numerator and average shares outstanding in the denominator. The computation of diluted earnings per share differs in that the dilutive effects of any stock options, warrants, and convertible securities are adjusted in the denominator. Stock Options As of December 31, 2011 and 2010, the Company recorded compensation expense of $42,100 and $29,676 related to share-based compensation awards. At December 31, 2011, there was approximately $49,018 in unrecognized compensation cost related to unvested share-based compensation awards granted. That cost is expected to be recognized over the next two years. 18 8 19 9 Notes to Consolidated Financial Statements 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 2. EARNINGS PER SHARE Stock Options (Continued) For purposes of computing stock compensation expense, the Company estimated the fair values of stock options using the Black-Scholes option-pricing model. The model requires the use of subjective assumptions that can materially affect fair value estimates. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the option and each vesting date. The fair value of each stock option granted was estimated using the following weighted-average assumptions: Grant Year 2011 2010 2009 Expected Dividend Yield 5.79 4.75 6.20 % % % Risk-Free Interest Rate 3.27 3.89 2.31 % % % Expected Volatility % 17.71 12.73 % 15.53 % Expected Life (in Years) 10.00 10.00 6.30 The weighted-average fair value of each stock option granted for 2011 and 2010 was $5.01 and $5.28, respectively. There were no stock options exercised during the years ended December 31, 2011 and 2010. Mortgage Servicing Rights (“MSRs”) The Company has agreements for the express purpose of selling loans in the secondary market. The Company retains servicing rights for certain loans. Originated MSRs are recorded by allocating total costs incurred between the loan and servicing rights based on their relative fair values. MSRs are amortized in proportion to the estimated servicing income over the estimated life of the servicing portfolio. The Company performs an impairment review of the MSRs and recognizes impairment through a valuation account. MSRs are a component of accrued interest and other assets on the Consolidated Balance Sheet. Gains and losses on sales of loans are recognized at settlement dates and are determined by the difference between the sales proceeds and the carrying value of the loans. All sales are made with limited recourse. For the years ended December 31, 2011 and 2010, the Company recorded gross servicing rights of $319,725 and $324,141 with a reserve for impairment of $150,322 and $135,055, respectively. Transfer of Assets Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when: (1) the assets have been isolated from the Company; (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets; and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Cash Flow Information The Company has defined cash and cash equivalents as those amounts included in the balance sheet captions “Cash and due from banks” and “Interest-bearing deposits with other institutions” that have original maturities of less than 90 days. Reclassification of Comparative Amounts Certain items previously reported have been reclassified to conform to the current year’s format. Such reclassifications did not affect net income or stockholders’ equity. There are no convertible securities that would affect the numerator in calculating basic and diluted earnings per share; therefore, net income as presented on the Consolidated Statement of Income will be used as the numerator. The following table sets forth the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings per share computation. Weighted-average common shares outstanding Average treasury stock shares Average unearned nonvested RSP shares Weighted-average common shares and common stock equivalents used to calculate basic earnings per share Additional common stock equivalents (nonvested stock) used to calculate diluted earnings per share Additional common stock equivalents (stock options) used to calculate diluted earnings per share Weighted-average common shares and common stock equivalents used to calculate diluted earnings per share 2011 2010 616,925 (69,675) (8,515) 610,000 (73,233) (7,424) 538,735 529,343 710 398 1,291 2,231 540,736 531,972 Options to purchase 48,620 and 65,760 shares of common stock at a price of $68.25 to $96.75, as of December 31, 2011 and 2010, and 4,956 and 5,293 shares of restricted stock ranging in price from $59.50 to $93.00, respectively, were not included in the computation of diluted earnings per share. To include these shares would have been antidilutive. 3. INVESTMENT SECURITIES AVAILABLE FOR SALE The amortized cost and fair value of investment securities available for sale are as follows: Amortized Cost 2011 Gross Unrealized Gains Gross Unrealized Losses Fair Value U.S. government agency securities Obligations of states and political subdivisions Corporate securities Mortgage-backed securities in government-sponsored entities Total debt securities Equity securities in financial institutions $ 23,682,923 $ 688,742 $ (50) $ 24,371,615 51,204,454 3,365,045 3,054,779 - (36,077) (463,700) 54,223,156 2,901,345 31,861,904 110,114,326 451,776 4,195,297 (3,093) (502,920) 32,310,587 113,806,703 318,800 56,725 (11,736) 363,789 Total $ 110,433,126 $ 4,252,022 $ (514,656) $ 114,170,492 20 10 21 11 Notes to Consolidated Financial Statements 3. INVESTMENT SECURITIES AVAILABLE FOR SALE (Continued) 3. INVESTMENT SECURITIES AVAILABLE FOR SALE (Continued) Amortized Cost 2010 Gross Unrealized Gains Gross Unrealized Losses Fair Value $ 12,773,866 $ 127,833 $ - $ 12,901,699 37,053,379 182,459 (493,846) 36,741,992 57,664,105 4,043,027 912,020 91,564 (634,554) (374,811) 57,941,571 3,759,780 8,839,595 120,373,972 202,110 1,515,986 (37,592) (1,540,803) 9,004,113 120,349,155 460,298 73,124 (20,292) 513,130 U.S. treasury securities U.S. government agency securities Obligations of states and political subdivisions Corporate securities Mortgage-backed securities in government-sponsored entities Total debt securities Equity securities in financial institutions Less than Twelve Months 2010 Twelve Months or Greater Total Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses $ 22,169,080 $ (493,846) $ - $ - $ 22,169,080 $ (493,846) 24,938,008 1,803,861 (604,970) (21,666) 443,059 114,355 (29,584) (353,145) 25,381,067 1,918,216 (634,554) (374,811) 4,762,831 53,673,780 (37,592) (1,158,074) - 557,414 - (382,729) 4,762,831 54,231,194 (37,592) (1,540,803) - - 79,590 (20,292) 79,590 (20,292) U.S. government agency securities Obligations of states and political subdivisions Corporate securities Mortgage-backed securities in government-sponsored entities Total debt securities Equity securities in financial institutions Total $ 120,834,270 $ 1,589,110 $ (1,561,095) $ 120,862,285 Total $ 53,673,780 $ (1,158,074) $ 637,004 $ (403,021) $ 54,310,784 $ (1,561,095) The following tables show the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at December 31, 2011 and 2010. Less than Twelve Months 2011 Twelve Months or Greater Total Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses $ 999,950 $ (50) $ - $ - $ 999,950 $ (50) 321,942 2,315,813 (82) (81,732) 436,796 585,532 (35,995) (381,968) 758,738 2,901,345 (36,077) (463,700) 6,745,746 10,383,451 (3,093) (84,957) - 1,022,328 - (417,963) 6,745,746 11,405,779 (3,093) (502,920) 167,456 (11,736) - - 167,456 (11,736) U.S. government agency securities Obligations of states and political subdivisions Corporate securities Mortgage-backed securities in government-sponsored entities Total debt securities Equity securities in financial institutions Total $ 10,550,907 $ (96,693) $ 1,022,328 $ (417,963) $ 11,573,235 $ (514,656) U.S. Government agency securities. The unrealized loss on one investment in U.S. government obligations and direct obligations of U.S. government agencies was caused by interest rate increases. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2011. Obligations of states and political subdivisions. The Company’s unrealized losses on two municipal bonds relates to investments within the governmental service sector. The unrealized losses are primarily caused by recent decreases in profitability and profit forecasts, in general, by industry analysts. The contractual terms of these investments do not permit the issuer to settle the security at a price less than the par value of the investment. The Company currently does not believe it is probable that it will be unable to collect all amounts due according to the contractual terms of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their par value, which may be maturity, it does not consider these investments to be other-than-temporarily impaired at December 31, 2011. Corporate securities. The Company had unrealized losses on investments in seven different debt securities with an aggregate fair value of $2,901,345 at December 31, 2011. The unrealized losses on these debt securities amounted to $463,700 at December 31, 2011. Due to dislocations in the credit markets broadly, and the lack of trading and new issuances, market price indications generally reflect the lack of liquidity in the market. Prices on debt securities were calculated by a third-party valuation company. The valuation methodology is based on the premise that the fair value of the security’s collateral should approximate the fair value of its liabilities. Based on cash flow forecasts for the securities, the Company expects to recover the remaining amortized cost of these securities. Furthermore, the Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell these securities before recovery of their cost basis, which may be maturity. Therefore, it does not consider these investments to be other-than-temporarily impaired at December 31, 2011. 22 12 23 13 Notes to Consolidated Financial Statements 3. INVESTMENT SECURITIES AVAILABLE FOR SALE (Continued) 4. LOANS Mortgage-backed securities in government-sponsored entities. The unrealized losses on the Company’s investment in three mortgage-backed securities were caused by interest rate increases. The Company purchased those investments at a premium relative to their face amount, and the contractual cash flows of those investments are guaranteed by an agency of the U.S. government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost basis of the Company’s investments. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2011. Equity securities. The Company’s investments in four marketable equity securities consist primarily of common stock of entities in the financial services industry. As of December 31, 2011, the Company recognized in earnings impairment charges of $8,728 on one investment in common stock of a community bank, resulting from the duration and extent to which the market value has been less than the cost and the performance of the financial institution over the past two years. Based on the Company’s analysis, and because the Company has the ability and intent to hold the investments until recovery of its cost basis, except for the investment mentioned above, the Company does not consider the remaining assets to be other-than-temporarily impaired at December 31, 2011. The amortized cost and fair value of debt securities at December 31, 2011, by contractual maturity, are shown below. Expected maturities of mortgage-backed securities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Due in one year or less Due after one year through five years Due after five years through ten years Due after ten years Total $ Available for Sale Amortized Cost 2,004,333 26,197,163 29,546,850 52,365,980 $ Fair Value 2,016,193 27,189,504 30,997,445 53,603,561 $ 110,114,326 $ 113,806,703 Investment securities with a carrying value of $79,829,596 and $90,418,896 at December 31, 2011 and 2010, respectively, were pledged to secure deposits and other purposes as required by law. The following is a summary of proceeds received, gross gains, and gross losses realized on the sale of investment securities available for sale for the years ended December 31: Proceeds from sales Gross gains Gross losses Other-than-temporary impairment loss $ $ 2011 53,533,950 939,368 98,792 8,728 2010 45,120,669 1,706,450 655,451 28,167 Major classifications of loans are summarized as follows: Commercial real estate Commercial and industrial Agricultural State and political subdivisions Consumer Residential real estate Less allowance for loan losses Net loans $ 2011 2010 $ 120,270,997 79,754,672 19,294,360 25,125,149 45,026,255 79,734,409 369,205,842 7,042,911 126,325,616 88,126,648 19,126,593 23,936,034 44,439,561 71,596,998 373,551,450 6,245,441 $ 362,162,931 $ 367,306,009 Mortgage loans serviced by the Company for others amounted to $54,190,608 and $54,939,124 at December 31, 2011 and 2010, respectively. The Company grants residential, commercial, and consumer loans to customers throughout its trade area, which is concentrated in central Pennsylvania. Such loans are subject to, at origination, credit risk assessment by management following the Company’s lending policy. Although the Company has a diversified loan portfolio at December 31, 2011 and 2010, a substantial portion of its debtors’ ability to honor their loan agreements is dependent upon the economic stability of its immediate trade area. In the normal course of business, loans are extended to directors, executive officers, and their associates. A summary of loan activity for those directors, executive officers, and their associates with loan balances in excess of $60,000 for the year ended December 31, 2011 is as follows: 2010 Additions Amounts Collected Change in Executive Officer Status 2011 $ 7,576,927 $ 4,944,438 $ 5,622,172 $ (565,773) $ 6,333,420 5. ALLOWANCE FOR LOAN LOSSES Changes in the allowance for loan losses for the years ended December 31 are as follows: Balance, January 1 Add: Provisions charged to operations Recoveries Less loans charged off 2011 2010 $ 6,245,441 $ 5,396,553 800,000 14,419 (16,949) 1,850,000 10,424 (1,011,536) Balance, December 31 $ 7,042,911 $ 6,245,441 24 14 25 15 Notes to Consolidated Financial Statements 5. ALLOWANCE FOR LOAN LOSSES (Continued) 5. ALLOWANCE FOR LOAN LOSSES (Continued) Management has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. For purposes of determining the allowance for loan losses, the Company has segmented certain loans in the portfolio by product type. Loans are segmented into the following pools: commercial real estate loans, commercial and industrial loans, agricultural loans, state and political subdivision loans, consumer loans, and residential real estate loans. Historical loss percentages for each risk category are calculated and used as the basis for calculating allowance allocations. These historical loss percentages are calculated over a two-year period for all portfolio segments. Certain qualitative factors are then added to the historical loss percentages to get the adjusted factor to be applied to nonclassified loans. The following qualitative factors are analyzed to determine allocations for nonclassified loans for each portfolio segment: • Changes in lending policies and procedures • Changes in economic and business conditions • Changes in nature and volume of the loan portfolio • Changes in lending staff experience and ability • Changes in past-due loans, nonaccrual loans, and classified loans • Changes in loan review • Changes in underlying value of collateral-dependent loans • Levels of credit concentrations • Effects of external factors, such as legal and regulatory requirements These qualitative factors are reviewed each quarter and adjusted based upon relevant changes within the Bank’s operating environment. During 2011, the qualitative factors percentages for commercial real estate loans, commercial and industrial loans, state and political subdivision loans, and consumer loans all increased, while the qualitative factors for agricultural loans and residential real estate loans remained approximately the same. Changes in lending staff experience and ability, changes in the loan review process, and the effect of external factors all contributed to the increase in factor percentages for both commercial real estate loans and commercial and industrial loans. Changes in the underlying value of collateral-dependent loans also contributed to the factor percentage increase for commercial real estate loans. The increase in factor percentage for consumer loans was attributable to changes in economic and business conditions, along with changes in the loan review process and changes in external factors, while the increase in factor percentage for state and political subdivision loans was attributable solely to changes in the lending staff’s experience and ability. The change in lending staff experience and ability factor percentage increased because of the retirement of some key lending personnel in 2011 combined with the addition of some new, less experienced lending personnel during the same time period. The changes in the loan review process factor percentage increased because of ongoing changes in the credit risk management process, while the effect of external factors’ percentage increased due to a number of reasons, including the enactment of the Dodd-Frank Act. The changes in the underlying value of collateral-dependent loans increase in the commercial real estate category are attributable to the ongoing decline in market value of commercial real estate within the Bank’s primary market area, while the changes in economic and business conditions’ increase in the consumer loan category are attributable to the continued stagnant unemployment numbers in the Bank’s market area. We consider commercial real estate loans, commercial and industrial loans, agricultural loans and consumer loans to be riskier than one-to-four family residential mortgage loans. Commercial real estate loans entail significant additional credit risks compared to one-to-four family residential mortgage loans, as they involve large loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties typically depends on the successful operation of the related real estate project and/or business operation of the borrower who is also the primary occupant, and thus may be subject to a greater extent to adverse conditions in the real estate market and in the general economy. Commercial and industrial loans, along with agricultural loans, involve a higher risk of default than residential mortgage loans of like duration since their repayment is generally dependent on the successful operation of the borrower’s business and the sufficiency of collateral, if any. The repayment of agricultural loans can also be impacted by commodity prices going up and down. Although a customer’s ability to repay for both one-to-four family residential mortgage loans and consumer loans is highly dependent on the local economy, especially employment levels, consumer loans as a group generally present a higher degree of risk because of the nature of collateral, if any. State and political subdivision loans carry approximately the same risk as residential real estate loans as most state and 16 26 political subdivision loans are either backed by the full taxing authority of a municipality or the revenue of a municipal authority. The following tables present, by portfolio segment, the changes in the allowance for loan losses and the recorded investment in loans as of and for the years ended December 31: Commercial Real Estate Commercial and Industrial Agricultural 2011 State and Political Subdivisions Consumer Residential Real Estate Unallocated Total Allowance for loan losses: Beginning balance Charge-offs Recoveries Provision Ending balance Ending balance individually evaluated for impairment Ending balance collectively evaluated for impairment Loans: Individually evaluated for impairment Collectively evaluated for impairment $ $ $ $ $ $ $ $ 3,023,441 - - 587,464 3,610,905 $ 1,854,554 (6,258) 9,738 224,651 2,082,685 255,190 - 1,402 (54,072) 202,520 105,893 - - (4,342) 101,551 403,463 (10,691) 3,279 (84,848) 311,203 455,083 - - (93,476) 361,607 147,817 - - 224,623 372,440 $ $ $ $ $ $ $ 6,245,441 (16,949) 14,419 800,000 7,042,911 $ 495,725 $ 272,299 $ - $ - $ 29,000 $ 59,840 $ - $ 856,864 $ 3,115,180 $ 1,810,386 $ 202,520 $ 101,551 $ 282,203 $ 301,767 $ 372,440 $ 6,186,047 $ 4,476,570 $ 1,252,246 $ 90,993 $ - $ 104,289 $ 269,806 $ - $ 6,193,904 115,794,427 78,502,426 19,203,367 25,125,149 44,921,966 79,464,603 - 363,011,938 Ending balance $ 120,270,997 $ 79,754,672 $ 19,294,360 $ 25,125,149 $ 45,026,255 $ 79,734,409 $ - $ 369,205,842 Commercial Real Estate Commercial and Industrial Agricultural Consumer Residential Real Estate Unallocated Total $ $ $ $ $ $ $ 2,837,773 (676,862) - 862,530 3,023,441 1,242,249 (272,903) 4,729 880,479 1,854,554 240,231 - 1,955 13,004 255,190 478,002 (33,857) 3,740 (44,422) 403,463 342,768 - - 112,315 455,083 255,531 - - (107,714) 147,817 5,396,554 (1,011,537) 10,424 1,850,000 6,245,441 $ $ $ $ $ $ $ 2010 State and Political Subdivisions $ - (27,915) - 133,808 105,893 $ $ 97,347 $ - $ - $ - $ - $ - $ - $ 97,347 $ 2,926,094 $ 1,854,554 $ 255,190 $ 105,893 $ 403,463 $ 455,083 $ 147,817 $ 6,148,094 $ 2,626,582 $ 1,422,441 $ - $ - $ - $ - $ - $ 4,049,023 123,699,034 86,704,207 19,126,593 23,936,034 44,439,561 71,596,998 - 369,502,427 Allowance for loan losses: Beginning balance Charge-offs Recoveries Provision Ending balance Ending balance individually evaluated for impairment Ending balance collectively evaluated for impairment Loans: Individually evaluated for impairment Collectively evaluated for impairment Ending balance $ 126,325,616 $ 88,126,648 $ 19,126,593 $ 23,936,034 $ 44,439,561 $ 71,596,998 $ - $ 373,551,450 17 27 Notes to Consolidated Financial Statements 5. ALLOWANCE FOR LOAN LOSSES (Continued) 5. ALLOWANCE FOR LOAN LOSSES (Continued) Credit Quality Information Credit Quality Information (Continued) The following tables represent the commercial credit exposures by internally-assigned grades for the years ended December 31, 2011 and 2010, respectively. The grading analysis estimates the capability of the borrower to repay the contractual obligations under the loan agreements as scheduled or at all. The Company’s internal credit risk grading system is based on experiences with similarly graded loans. The Company’s internally-assigned grades are as follows: Pass loans are loans which are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral. Special Mention loans are loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected. Substandard loans are loans that have a well-defined weakness based on objective evidence and are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Doubtful loans have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, based on existing circumstances. Finally, loans classified as Loss are considered uncollectible, or of such value that continuance as an asset is not warranted. Commercial Real Estate $ 90,581,881 9,447,786 17,856,862 2,384,468 - Commercial and Industrial $ 63,974,717 5,523,313 9,731,488 525,154 - 2011 Agricultural $ 17,650,944 598,908 1,044,508 - - State and Political Subdivisions $ 24,912,457 212,692 - - - Total $ 197,119,999 15,782,699 28,632,858 2,909,622 - $ 120,270,997 $ 79,754,672 $ 19,294,360 $ 25,125,149 $ 244,445,178 Commercial Real Estate $ 93,555,529 15,409,637 14,733,868 2,626,582 - Commercial and Industrial $ 69,502,061 7,870,482 10,709,323 44,782 - 2010 Agricultural $ 16,828,267 1,054,163 1,244,163 - - State and Political Subdivisions $ 23,936,034 - - - - Total $ 203,821,891 24,334,282 26,687,354 2,671,364 - $ 126,325,616 $ 88,126,648 $ 19,126,593 $ 23,936,034 $ 257,514,891 Pass Special Mention Substandard Doubtful Loss Total Pass Special Mention Substandard Doubtful Loss Total For consumer loans, the Company evaluates credit quality based on whether the loan is considered performing or nonperforming. The following table presents the balances of consumer loans by classes of loan portfolio based on payment performance as of December 31: Performing Nonperforming Total Performing Nonperforming Total Consumer $ $ 44,872,546 153,709 45,026,255 Consumer $ $ 44,268,145 171,416 44,439,561 2011 Residential Real Estate $ $ 79,066,061 668,348 79,734,409 2010 Residential Real Estate $ $ 71,289,516 307,482 71,596,998 Total $ $ 123,938,607 822,057 124,760,664 Total $ $ 115,557,661 478,898 116,036,559 Age Analysis of Past-Due Loans by Class The following are tables which show the aging analysis of past-due loans as of December 31: 2011 30-59 Days 60-89 Days Past Due Past Due 90 Days or Greater Past Due Total Past Due Current Total Loans Commercial real estate Commercial and industrial Agricultural State and political subdivisions Consumer Residential real estate Total $ 954,872 480,256 257,928 118,908 189,895 138,046 2,139,905 $ $ 1,194,157 - - - 45,219 - 2,783,066 729,903 90,993 - 153,709 668,348 4,426,019 4,932,095 1,210,159 348,921 118,908 388,823 806,394 7,805,300 115,338,902 78,544,513 18,945,439 25,006,241 44,637,432 78,928,015 361,400,542 $ 120,270,997 79,754,672 19,294,360 25,125,149 45,026,255 79,734,409 369,205,842 $ $ 1,239,376 $ $ $ $ $ $ Commercial real estate Commercial and industrial Agricultural State and political subdivisions Consumer Residential real estate Total 30-59 Days 60-89 Days Past Due Past Due $ - 631,679 - - 113,404 392,191 1,137,274 $ $ - 96,955 - - 64,365 28,206 189,526 $ 2010 90 Days or Greater Past Due Total Past Due Current Total Loans $ $ $ 650,042 20,503 - - 171,416 279,276 1,121,237 650,042 749,137 - - 349,185 699,673 2,448,037 125,675,574 87,377,511 19,126,593 23,936,034 44,090,376 70,897,325 371,103,413 $ 126,325,616 88,126,648 19,126,593 23,936,034 44,439,561 71,596,998 373,551,450 $ $ $ $ Recorded Investment 90 Days and Accruing - $ - - - 49,420 398,542 447,962 $ Recorded Investment 90 Days and Accruing $ - - - - 171,416 279,276 450,692 $ 28 18 29 19 Notes to Consolidated Financial Statements 5. ALLOWANCE FOR LOAN LOSSES (Continued) Impaired Loans 5. ALLOWANCE FOR LOAN LOSSES (Continued) Impaired Loans (Continued) Management considers commercial real estate loans, commercial and industrial loans, agricultural loans, and state and political subdivision loans which are 90 days or more past due to be impaired. After becoming 90 days or more past due, these categories of loans are measured for impairment. These loans are analyzed to determine if it is probable that all amounts will not be collected according to the contractual terms of the loan agreement. If management determines that the fair value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs, and unamortized premium or discount), impairment is recognized through a provision or through a charge to the allowance for loan losses. The following tables include the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount as of December 31: With no related allowance recorded: Commercial real estate Commercial and industrial Agricultural State and political subdivisions Consumer Residential real estate With an allowance recorded: Commercial real estate Commercial and industrial Agricultural State and political subdivisions Consumer Residential real estate Total: Commercial real estate Commercial and industrial Agricultural State and political subdivisions Consumer Residential real estate Total Recorded Investment Unpaid Principal Balance 2011 Related Allowance $ $ 2,561,616 287,539 90,993 - 57,083 231,066 3,228,297 1,914,954 964,707 - - 47,206 38,740 2,965,607 4,476,570 1,252,246 90,993 - 104,289 269,806 6,193,904 $ $ 2,561,616 287,539 90,993 - 57,083 231,066 3,228,297 1,914,954 964,707 - - 47,206 38,740 2,965,607 4,476,570 1,252,246 90,993 - 104,289 269,806 6,193,904 $ $ - - - - - - - 495,725 272,299 - - 29,000 59,840 856,864 495,725 272,299 - - 29,000 59,840 856,864 $ $ Average Recorded Investment Interest Income Recognized $ 2,318,776 1,236,654 173,373 - 94,985 224,562 4,048,350 129,281 59,394 3,893 - 8,351 4,112 205,031 483,530 147,859 - - 11,801 22,598 665,788 - - - - - - - 2,802,306 1,384,513 173,373 - 106,786 247,160 4,714,138 $ 129,281 59,394 3,893 - 8,351 4,112 205,031 With no related allowance recorded: Commercial real estate Commercial and industrial Agricultural State and political subdivisions Consumer Residential real estate With an allowance recorded: Commercial real estate Commercial and industrial Agricultural State and political subdivisions Consumer Residential real estate Total: Commercial real estate Commercial and industrial Agricultural State and political subdivisions Consumer Residential real estate Recorded Investment Unpaid Principal Balance 2010 Related Allowance Average Recorded Investment Interest Income Recognized $ 2,158,115 $ 1,422,441 2,158,115 $ 1,422,441 - - - - - - - - 3,580,556 3,580,556 $ - - - - - - - 2,186,997 $ 739,670 271,564 - - - 3,198,231 145,898 16,817 21,016 - - - 183,731 468,467 - - - - - 468,467 468,467 - - - - - 468,467 2,626,582 1,422,441 2,626,582 1,422,441 - - - - - - - - 97,347 - - - - - 97,347 97,347 - - - - - 4,261,352 142,320 - - - - 4,403,672 6,448,349 881,990 271,564 - - - - - - - - - - 145,898 16,817 21,016 - - - 183,731 Total $ 4,049,023 $ 4,049,023 $ 97,347 $ 7,601,903 $ Nonaccrual Loans Loans are considered nonaccrual upon reaching 90 days of delinquency even though the Company may be receiving partial payments of interest and partial repayments of principal on such loans. When a loan is placed on nonaccrual status, previously accrued but unpaid interest is deducted from interest income. On the following table are the loan balances on nonaccrual status as of December 31: Commercial real estate Commercial and industrial Agricultural State and political subdivisions Consumer Residential real estate Total 2011 2010 $ 4,476,571 1,102,246 90,993 - 104,289 269,806 $ 2,626,582 1,422,441 - - - 28,206 $ 6,043,905 $ 4,077,229 30 20 31 21 Notes to Consolidated Financial Statements 5. ALLOWANCE FOR LOAN LOSSES (Continued) Troubled Debt Restructuring The Company’s loan portfolio also includes certain loans that have been modified in a troubled debt restructuring (“TDR”), where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. At December 31, 2011, the Company had four commercial real estate loans totaling $2,134,564 that are TDRs and are classified as nonperforming and one commercial and industrial loan totaling $48,802 that is a TDR that is classified nonperforming. At December 31, 2010, the Company did not have any TDRs. When the Company modifies a loan, management evaluates any possible impairment based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, except when the sole remaining source of repayment for the loan is the operation or liquidation of the collateral. In these cases, management uses the current fair value of the collateral, less selling costs, instead of discounted cash flows. If management determines that the value of the modified loan is less than the recorded investment in the loan, impairment is recognized by segment of class of loan, as applicable, through a charge-off to the allowance. Segment and class status is determined by the loan’s classification at origination. As of December 31, 2011 no specific reserves have been established against the TDRs. Also, as of December 31, 2011 no charge-offs for the TDRs were required. 6. PREMISES AND EQUIPMENT Major classifications of premises and equipment are summarized as follows: Land and land improvements Building and leasehold improvements Furniture, fixtures, and equipment Less accumulated depreciation Total 2011 2010 $ $ 793,458 15,535,165 5,538,570 21,867,193 7,655,566 793,458 14,955,760 4,636,864 20,386,082 6,752,790 $ 14,211,627 $ 13,633,292 Depreciation and amortization charged to operations was $937,985 in 2011 and $850,118 in 2010. 7. GOODWILL As of each of the years ended December 31, 2011 and 2010, goodwill had a carrying amount of $1,668,699. The gross carrying amount of goodwill was tested for impairment in the third quarter, after the annual forecasting process. There was no impairment for the years ended December 31, 2011 and 2010. Loan modifications that are considered “TDRs” completed during the year ending December 31, 2011 were as follows: 8. DEPOSITS The scheduled maturities of time deposits approximate the following: 2011 Pre-Modification Post-Modification Number of Outstanding Recorded Outstanding Recorded Contracts Investment Investment Troubled debt restructurings: Commercial real estate loans Commercial and industrial Agricultural State and political subdivision Consumer Residential real estate Total 4 1 - - - - 5 $ 2,148,060 50,299 - - - - $ 2,148,060 50,299 - - - - $ 2,198,359 $ 2,198,359 As of December 31, 2011, none of the loan modifications classified as TDRs subsequently defaulted within one year of modification. Year Ending December 31, 2012 2013 2014 2015 2016 Thereafter Amount 89,285,908 30,400,711 19,237,752 10,855,847 4,314,089 19,533,287 173,627,594 $ $ The aggregate of all time deposit accounts of $100,000 or more amounted to $62,843,237 and $65,447,156 at December 31, 2011 and 2010, respectively. 9. SHORT-TERM BORROWINGS Short-term borrowings include overnight repurchase agreements through the FHLB, Federal Funds Purchased, and repurchase agreements with customers. Short-term borrowings also include a $5,000,000 unsecured line of credit with a commercial bank for the years ended December 31, 2011 and 2010, respectively. The line of credit agreement contains various covenants requiring the Company to maintain certain levels of financial performance. At December 31, 2011 and 2010, the Company was in compliance with all of its covenants. The outstanding balances and related information for short-term borrowings are summarized as follows: Balance at year-end Average balance outstanding Maximum month-end balance Weighted-average rate at year-end Weighted-average rate during the year $ 2011 2010 $ 5,696,162 10,577,428 16,028,082 1.56% 1.93% 7,608,645 8,699,070 14,254,009 2.66% 1.40% 32 34 33 23 Notes to Consolidated Financial Statements 10. OTHER BORROWINGS 10. OTHER BORROWINGS (Continued) The following table sets forth information concerning other borrowings: Description Convertible Fixed rate Fixed rate amortizing Mid-term repos Subordinated capital notes Note payable Maturity Range From To 08/22/12 01/03/12 07/17/13 07/08/13 03/23/19 03/17/35 08/22/12 11/14/17 06/26/18 07/08/13 12/28/20 11/23/35 Weighted- Average Interest Rate Stated Interest Rate Range From To 4.44 3.58 3.43 1.53 7.83 4.33 % 4.44 % 4.44 % $ 1.32 1.95 1.53 3.88 2.56 4.96 6.53 1.53 8.50 6.11 At December 31, 2011 2010 $ 5,000,000 28,484,805 4,629,113 3,000,000 4,750,000 6,186,000 10,000,000 30,192,205 6,442,935 6,000,000 4,050,000 6,186,000 The Company issued $3,000,000 of fixed rate subordinated debt securities with stated maturities of March 23, 2019 through June 26, 2019. These securities bear a fixed annual rate of 8.5 percent. The Company may redeem them, in whole or in part, at face value on or after March 23, 2014. These borrowings are included in the liabilities section of the Company’s Consolidated Balance Sheet. The Company issued $1,700,000 of fixed rate subordinated debt securities with stated maturities of November 12, 2020 through February 10, 2021 and $50,000 of adjustable rate subordinated debt securities with a stated maturity of March 2, 2021. The fixed securities bear an annual rate of 6.75 percent and the adjustable rate securities bear a rate of three-month LIBOR plus 3.50 percent and adjust quarterly. The Company may redeem them, in whole or in part, at face value on or after November 12, 2015. These borrowings are included in the liabilities section of the Company’s Consolidated Balance Sheet. Maturities of other borrowings at December 31, 2011 are summarized as follows: The provision for federal income taxes consists of: $ 52,049,918 $ 62,871,140 11. INCOME TAXES Year Ending December 31, 2012 2013 2014 2015 2016 2017 and after $ Amount 11,329,200 16,107,445 4,217,600 4,224,486 2,012,000 14,159,187 $ 52,049,918 Weighted- Average Rate 4.41 % 3.37 3.19 2.77 1.34 5.39 4.01 % The terms of the convertible borrowings allow the FHLB to convert the interest rate to an adjustable rate based on the three-month London Interbank Offered Rate (“LIBOR”) after two years from the original date of the advance. The fixed rate amortizing borrowings require monthly payments of principal and interest. Borrowing capacity consists of credit arrangements with the FHLB. FHLB borrowings are subject to annual renewal, incur no service charges, and are secured by a blanket security agreement on certain investment and mortgage-backed securities, outstanding residential mortgages, and the Bank’s investment in FHLB stock. As of December 31, 2011, the Bank’s maximum borrowing capacity with the FHLB was approximately $146 million. The Company formed a special purpose entity (“Entity”) to issue $3,093,000 of fixed/floating rate subordinated debt securities with a stated maturity of March 17, 2035. The rate on these securities is determined quarterly and floats based on three-month LIBOR plus 2.00 percent. The Entity may redeem them, in whole or in part, at face value on or after March 17, 2010. The Company borrowed the proceeds from the Entity in the form of a $3,093,000 note payable, which is included in the liabilities section of the Company’s Consolidated Balance Sheet. The Company formed an additional special purpose entity to issue $3,093,000 of fixed/floating rate subordinated debt securities with a stated maturity of November 23, 2035. These securities bear a fixed rate of 6.11 percent until November 23, 2015, at which time the rate is determined quarterly and floats based on three-month LIBOR plus 1.50 percent. The Entity may redeem them, in whole or in part, at face value on or after November 23, 2010. The Company borrowed the proceeds from the Entity in the form of a $3,093,000 note payable, which is included in the liabilities section of the Company’s Consolidated Balance Sheet. The Company’s minority interests in these entities were recorded at the initial investment amount and is included in the accrued interest and other assets on the Consolidated Balance Sheet. These entities are not consolidated as part of the Company’s consolidated financial statements. Current Deferred Total provision 2011 2010 $ $ 542,867 (104,051) $ 898,857 (428,312) 438,816 $ 470,545 The tax effects of deductible and taxable temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows: Deferred tax assets: Allowance for loan losses Deferred compensation Core deposit intangible assets Alternative minimum tax carryforward Asset valuation allowances Employee compensation accruals Nonaccrual interest receivable Capital loss carryforward Deferred tax assets Deferred tax liabilities: Premises and equipment Goodwill Deferred loan fees Partnerships Other Unrealized gain on available-for-sale securities Deferred tax liabilities Net deferred tax assets 2011 2010 $ $ 2,394,590 235,036 32,759 479,512 313,102 266,212 84,741 228,767 4,034,719 1,052,800 506,450 141,356 168,844 5,417 1,270,707 3,145,574 889,145 $ $ 2,123,450 245,923 41,861 474,550 326,381 187,438 58,126 157,627 3,615,356 829,422 455,805 138,219 130,692 5,417 9,525 1,569,080 2,046,276 No valuation allowance was established at December 31, 2011 and 2010 in view of the Company’s ability to carryback taxes paid in previous years and certain tax strategies, coupled with the anticipated future taxable income as evidenced by the Company’s earnings potential. 34 24 35 25 Notes to Consolidated Financial Statements 11. INCOME TAXES (Continued) The reconciliation between the federal statutory rate and the Company’s effective consolidated income tax rate is as follows: 12. EMPLOYEE BENEFITS (Continued) Restricted Stock Plan Provision at statutory rate Tax-exempt interest Life insurance income Other Actual tax expense and effective rate 2011 2010 Amount 1,385,395 (804,586) (99,776) (42,217) % of Pretax Income % $ 34.0 (19.7) (2.5) (1.0) Amount 1,369,067 (819,340) (87,822) 8,640 % of Pretax Income % 34.0 (20.3) (2.2) 0.2 438,816 10.8 % $ 470,545 11.7 % $ $ The Company prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Benefits from tax positions should be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. There is currently no liability for uncertain tax positions and no known unrecognized tax benefits. The Company recognizes, when applicable, interest and penalties related to unrecognized tax benefits in the provision for income taxes in the Consolidated Statement of Income. The Company’s federal and state income tax returns for taxable years through 2007 have been closed for purposes of examination by the Internal Revenue Service and the Pennsylvania Department of Revenue. 12. EMPLOYEE BENEFITS Savings Plan The Bank maintains a qualified 401(k) salary reduction and profit sharing plan that covers substantially all employees. Under the plan, employees make voluntary, pretax contributions to their accounts, and the Bank contributions to the plan are at the discretion of the Board of Directors. Contributions by the Bank charged to operations were $214,295 and $204,465 for the years ended December 31, 2011 and 2010, respectively. The fair value of plan assets includes $627,270 and $604,632 pertaining to the value of the Company’s common stock that is held by the plans as of December 31, 2011 and 2010, respectively. Deferred Compensation Plan The Company has a nonqualified deferred compensation plan that allows directors to defer fees. Outstanding balances under this arrangement for 2011 and 2010 were $691,282 and $723,302, respectively, and are reported as “Other liabilities” on the Consolidated Balance Sheet. Expenses related to this plan were $1,616 and $40,534 for December 31, 2011 and 2010, respectively. The Company maintains a Restricted Stock Plan (the “Plan”). Employees and non-employee corporate directors are eligible to receive awards of restricted stock based upon performance-related requirements. Awards granted under the Plan are in the form of the Company’s common stock and are subject to certain vesting requirements including continuous employment or service with the Company. The Company has authorized 12,000 shares of the Company’s common stock. The Plan assists the Company in attracting, retaining and motivating employees and non-employee directors to make substantial contributions to the success of the Company and to increase the emphasis on the use of equity as a key component of compensation. Compensation expense recognized related to the vesting of shares was $193,319 and $158,649 for the years ended December 31, 2011 and 2010, respectively. The following is a summary of the status of the Company’s restricted stock as of December 31, 2011, and changes therein during the year then ended: Nonvested at January 1, 2011 Granted Vested Forfeited Number of Shares of Restricted Stock 7,310 5,208 (2,714) (282) Weighted- Average Grant Date Fair Value $ 66.15 59.47 65.08 63.13 Nonvested at December 31, 2011 9,522 $ 62.89 Stock Option Plan The Company has a fixed director and employee stock-based compensation plan. The plan has total options available to grant of 190,000 shares of common stock. The exercise price for the purchase of shares subject to a stock option may not be less than 100 percent of the fair market value of the shares covered by the option on the date of the grant. The term of stock options will not exceed ten years from the date of grant. Options granted are primarily vested evenly over a three-year period from the grant date. The following table presents share data related to the outstanding options: Outstanding, January 1, 2011 Granted Exercised Forfeited Outstanding, December 31, 2011 Exercisable at year-end Number of Options $ 71,983 13,000 - (6,746) 78,237 55,141 $ $ Weighted- Average Exercise Price 80.21 59.52 - 77.18 77.04 83.74 36 26 37 27 Notes to Consolidated Financial Statements 12. EMPLOYEE BENEFITS (Continued) Stock Option Plan (Continued) The following table summarizes the characteristics of stock options at December 31, 2011: Grant Date 01/24/02 02/21/02 02/27/03 09/02/03 12/29/03 03/16/04 05/26/04 06/30/04 01/05/05 02/03/05 02/09/05 02/10/05 02/24/05 03/29/05 04/26/05 07/08/05 12/08/05 12/10/05 12/16/05 12/22/05 01/25/07 02/23/07 01/31/08 03/26/09 10/27/09 04/01/10 04/28/11 10/11/11 12/22/11 $ Exercise Price 90.00 91.00 90.00 90.00 91.25 91.25 94.00 96.75 93.00 93.00 93.00 95.00 96.00 96.00 96.00 96.00 95.00 95.25 95.00 95.00 88.00 90.00 76.35 51.00 70.00 68.25 59.50 62.00 56.00 Outstanding Contractual Average Life Average Exercise Price 0.06 $ 0.14 0.15 0.67 2.00 2.20 2.40 2.49 3.01 3.09 3.11 3.11 3.15 3.24 3.32 3.52 3.93 3.94 3.96 3.97 5.07 5.15 5.08 7.23 7.82 8.25 9.24 9.77 9.98 90.00 91.00 90.00 90.00 91.25 91.25 94.00 96.75 93.00 93.00 93.00 95.00 96.00 96.00 96.00 96.00 95.00 95.25 95.00 95.00 88.00 90.00 76.35 51.00 70.00 68.25 59.50 62.00 56.00 Shares 5,012 8 4,059 2,222 3,168 3,450 734 2,618 8,127 380 26 100 42 3 441 333 1,401 3 150 4,440 545 525 6,750 9,800 1,000 10,300 11,800 500 300 78,237 Exercisable Average Exercise Price 90.00 91.00 90.00 90.00 91.25 91.25 94.00 96.75 93.00 93.00 93.00 95.00 96.00 96.00 96.00 96.00 95.00 95.25 95.00 95.00 88.00 90.00 76.35 51.00 70.00 68.25 59.50 62.00 56.00 $ Shares 5,012 8 4,059 2,222 3,168 3,450 734 2,618 8,127 380 26 100 42 3 441 333 1,401 3 150 4,440 545 525 6,750 6,521 666 3,417 - - - 55,141 13. COMMITMENTS In the normal course of business, there are outstanding commitments and contingent liabilities such as commitments to extend credit, financial guarantees, and letters of credit that are not reflected in the accompanying consolidated financial statements. The Company does not anticipate any losses as a result of these transactions. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Balance Sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in the particular classes of financial instruments that consisted of the following: Commitments to extend credit Standby letters of credit Total 2011 2010 $ $ 94,033,585 5,091,765 $ 93,380,149 6,370,718 99,125,350 $ 99,750,867 28 38 13. COMMITMENTS (Continued) 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 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. Standby letters of credit represent conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These instruments are issued primarily to support bid or performance-related contracts. The coverage period for these instruments is typically a one-year period with an annual renewal option subject to prior approval by management. Fees earned from the issuance of these letters are recognized upon expiration of the commitment period. For secured letters of credit, the collateral is typically Bank deposit instruments or real estate. The Bank has committed to various operating leases for their branch and office facilities. Some of these leases include renewal options as well as specific provisions relating to rent increases. The minimum annual rental commitments under these leases outstanding at December 31, 2011 are as follows: 2012 2013 2014 2015 2016 Thereafter Total Minimum Lease Payment 274,972 272,992 269,032 269,032 235,363 3,833,643 5,155,034 $ $ Rent expense under leases for each of the years ended December 31, 2011 and 2010 was $285,923 and $277,449, respectively. Contingent Liabilities The Company from time to time may be a party in various legal actions from the normal course of business activities. Management believes the liability, if any, arising from such actions will not have a material adverse effect on the Company’s financial position. 14. REGULATORY RESTRICTIONS Restriction on Cash and Due From Banks The Bank is required to maintain reserve funds in cash or on deposit with the Federal Reserve Bank. The required reserve at December 31, 2011 and 2010, was $1,513,000 and $1,188,000, respectively. Loans Federal law prevents the Company from borrowing from the Bank unless the loans are secured by specific obligations. Further, such secured loans are limited in amount to 10 percent of the Bank’s common stock and capital surplus. Dividends The approval of the Comptroller of the Currency is required before a national bank can pay any dividends up to the Company if the total of all dividends declared in any calendar year would exceed net profits, as defined for that year, combined with its retained net profits for the two preceding calendar years less any required transfers to surplus. Under this formula, the amount available for payment of dividends in 2012, without prior approval of the Comptroller, is approximately $8.7 million plus net profits retained in 2012 up to the date of the dividend declaration. 29 39 Notes to Consolidated Financial Statements 14. REGULATORY RESTRICTIONS (Continued) Dividends (Continued) In order to manage capital and support safety and soundness of the Company and the Bank, management has decided to provide the banking regulators with written notice of any intention to pay dividends or make any capital distributions. 15. REGULATORY CAPITAL Federal regulations require the Company and the Bank to maintain minimum amounts of capital. Specifically, each is required to maintain certain minimum dollar amounts and ratios of Total and Tier I capital to risk-weighted assets and of Tier I capital to average total assets. In addition to the capital requirements, the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”) established five capital categories ranging from “well capitalized” to “critically undercapitalized.” Should any institution fail to meet the requirements to be considered “adequately capitalized,” it would become subject to a series of increasingly restrictive regulatory actions. As of December 31, 2011 and 2010, the FDIC categorized the Company and the Bank as well capitalized under the regulatory framework for prompt corrective action. To be classified as a well capitalized financial institution, Total risk-based, Tier I risk-based, and Tier I leverage capital ratios must be at least 10 percent, 6 percent, and 5 percent, respectively. The Company’s actual capital ratios are presented in the following table that shows the Company met all regulatory capital requirements: Total Capital (to Risk-Weighted Assets) Actual For Capital Adequacy Purposes To Be Well Capitalized Tier I Capital (to Risk-Weighted Assets) Actual For Capital Adequacy Purposes To Be Well Capitalized Tier I Capital (to Average Assets) Actual For Capital Adequacy Purposes To Be Well Capitalized 2011 2010 Amount Ratio Amount Ratio 55,927,625 32,307,719 40,384,648 % $ 13.85 8.00 10.00 50,167,757 34,386,299 1,004,609 % 11.67 8.00 10.00 45,912,913 16,153,859 24,230,789 % $ 11.37 4.00 6.00 40,560,601 17,193,150 25,789,724 45,912,913 22,229,663 27,787,078 % $ 8.26 4.00 5.00 40,560,601 43,516,985 28,016,617 % 9.44 4.00 6.00 % 7.24 4.00 5.00 $ $ $ 15. REGULATORY CAPITAL (Continued) The Bank’s actual capital ratios are presented in the following table which shows the Bank met all regulatory capital requirements: 2011 2010 Amount Ratio Amount Ratio Total Capital (to Risk-Weighted Assets) Actual For Capital Adequacy Purposes To Be Well Capitalized Tier I Capital (to Risk-Weighted Assets) Actual For Capital Adequacy Purposes To Be Well Capitalized Tier I Capital (to Average Assets) Actual For Capital Adequacy Purposes To Be Well Capitalized 16. FAIR VALUE MEASUREMENTS $ $ $ 54,533,683 32,179,644 40,224,655 % $ 13.56 8.00 10.00 50,457,841 34,169,840 42,712,300 49,313,930 16,089,862 24,134,793 % $ 12.26 4.00 6.00 44,953,926 17,084,920 25,627,380 49,313,930 22,135,707 27,669,634 % $ 8.91 4.00 5.00 44,953,926 22,312,505 27,890,631 % 11.81 8.00 10.00 % 10.52 4.00 6.00 % 8.06 4.00 5.00 The following disclosures show the hierarchal disclosure framework associated with the level of pricing observations utilized in measuring assets and liabilities at fair value. The three broad levels of pricing observations are as follows: Level I: Quoted prices are available in active markets for identical assets or liabilities as of the reported date. Level II: Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are fair-valued using other financial instruments, the parameters of which can be directly observed. Level III: Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable. This hierarchy requires the use of observable market data when available. 40 30 41 31 Notes to Consolidated Financial Statements 16. FAIR VALUE MEASUREMENTS (Continued) 16. FAIR VALUE MEASUREMENTS (Continued) The following tables present the assets reported on the Consolidated Balance Sheet at their fair value as of December 31, 2011 and 2010, by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Assets: U.S. government agency securities Obligations of states and political subdivisions Corporate securities Mortgage-backed securities in government-sponsored entities Total debt securities Equity securities Total Assets: U.S. treasury securities U.S. government agency securities Obligations of states and political subdivisions Corporate securities Mortgage-backed securities in government-sponsored entities Total debt securities Equity securities December 31, 2011 Level I Level II Level III Total $ $ $ - - - $ 24,371,615 $ - $ 24,371,615 54,223,156 2,801,028 - 100,317 54,223,156 2,901,345 - - 363,789 32,310,587 113,706,386 - - 100,317 - 32,310,587 113,806,703 363,789 363,789 $ 113,706,386 $ 100,317 $ 114,170,492 December 31, 2010 Level I Level II Level III Total - - - - $ 12,901,699 $ 36,741,992 57,941,571 2,305,629 - - - 1,454,151 $ 12,901,699 36,741,992 57,941,571 3,759,780 - - 513,130 9,004,113 118,895,004 - - 1,454,151 - 9,004,113 120,349,155 513,130 Total $ 513,130 $ 118,895,004 $ 1,454,151 $ 120,862,285 Financial instruments are considered Level III when their values are determined using pricing models, discounted cash flow methodologies or similar techniques, and at least one significant model assumption or input is unobservable. In addition to these unobservable inputs, the valuation models for Level III financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly. Level III financial instruments also include those for which the determination of fair value requires significant management judgment or estimation. The following table presents the changes in the Level III fair-value category for the years ended December 31, 2011 and 2010. Balance, January 1, 2010 Transfers to Level III Net change on unrealized gain on investment securities available for sale Balance, January 1, 2011 Sales Net change on unrealized gain on investment securities available for sale Balance, December 31, 2011 Corporate Securities $ 1,198,313 267,165 (11,327) 1,454,151 (1,339,795) (14,039) $ 100,317 The following tables present the assets measured on a nonrecurring basis on the Consolidated Balance Sheet at their fair value as of December 31, 2011 and 2010, by level within the fair value hierarchy. Impaired loans that are collateral dependent are written down to fair value through the establishment of specific reserves. Techniques used to value the collateral that secure the impaired loans include: quoted market prices for identical assets classified as Level I inputs and observable inputs employed by certified appraisers for similar assets classified as Level II inputs. In cases where valuation techniques included inputs that are unobservable and are based on estimates and assumptions developed by management based on the best information available under each circumstance, the asset valuation is classified as Level III input. Other real estate owned is measured at fair value, less cost to sell at the date of foreclosure. Valuations are periodically performed by management and the assets are carried at the lower of carrying amount, or fair value less cost to sell. The fair value for mortgage servicing rights is estimated by discounting contractual cashflows and adjusting for prepayment estimates. Discount rates are based upon rates generally charged for such loans with similar characteristics. Assets: Impaired loans Other real estate owned Mortgage servicing rights Assets: Impaired loans Other real estate owned Mortgage servicing rights $ $ Level I - - - Level I - - - $ $ December 31, 2011 Level II Level III - 370,173 319,725 $ 5,337,040 $ - - December 31, 2010 Level II Level III - 396,024 324,141 $ 3,951,676 $ - - Total 5,337,040 370,173 319,725 Total 3,951,676 396,024 324,141 42 32 43 33 Notes to Consolidated Financial Statements 17. FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS 17. FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS (Continued) The estimated fair values of the Company’s financial instruments at December 31 are as follows: Investment Securities Available for Sale 2011 Carrying Value Fair Value 2010 Carrying Value Fair Value The fair value of investment securities is equal to the available quoted market price. If no quoted market price is available, fair value is estimated using the quoted market price for similar securities. Fair values for certain corporate bonds were determined utilizing discounted cash flow models, due to the absence of a current market to provide reliable market quotes for the instruments. $ 41,181,771 1,619,833 $ 41,181,771 1,619,833 $ 19,883,331 2,734,094 $ 19,883,331 2,734,094 Loans 120,862,285 918,342 372,213,168 4,161,800 11,684,697 2,257,625 324,141 449,310,136 7,608,645 64,412,272 1,050,045 Financial assets: Cash and cash equivalents Certificates of deposit Investment securities available for sale Loans held for sale Net loans Regulatory stock Bank-owned life insurance Accrued interest receivable Mortgage servicing rights Financial liabilities: 114,170,492 1,401,376 362,162,931 4,042,400 12,097,673 2,089,706 319,725 114,170,492 1,401,376 367,556,756 4,042,400 12,097,673 2,089,706 319,725 120,862,285 918,342 367,306,009 4,161,800 11,684,697 2,257,625 324,141 Deposits Short-term borrowings Other borrowings Accrued interest payable $ $ 454,660,313 5,696,162 52,049,918 948,603 $ 460,020,954 5,696,162 53,352,801 948,603 $ 446,001,986 7,608,645 62,871,140 1,050,045 Financial instruments are defined as cash, evidence of ownership interest in an entity, or a contract which creates an obligation or right to receive or deliver cash or another financial instrument from/to a second entity on potentially favorable or unfavorable terms. Fair value is defined as the amount at which a financial instrument could be exchanged in a current transaction between willing parties other than in a forced liquidation sale. If a quoted market price is available for a financial instrument, the estimated fair value would be calculated based upon the market price per trading unit of the instrument. If no readily available market exists, the fair value estimates for financial instruments should be based upon management’s judgment regarding current economic conditions, interest rate risk, expected cash flows, future estimated losses, and other factors as determined through various option pricing formulas or simulation modeling. As many of these assumptions result from judgments made by management based upon estimates, which are inherently uncertain, the resulting estimated fair values may not be indicative of the amount realizable in the sale of a particular financial instrument. In addition, changes in assumptions on which the estimated fair values are based may have a significant impact on the resulting estimated fair values. As certain assets such as deferred tax assets and premises and equipment are not considered financial instruments, the estimated fair value of financial instruments would not represent the full value of the Company. The fair value is estimated by discounting future cash flows using current market inputs at which loans with similar terms and qualities would be made to borrowers of similar credit quality. Where quoted market prices were available, primarily for certain residential mortgage loans, such market rates were utilized as estimates for fair value. Bank-Owned Life Insurance The fair value is equal to the cash surrender value of the life insurance policies. Mortgage Servicing Rights The fair value for mortgage servicing rights is estimated by discounting contractual cash flows and adjusting for prepayment estimates. Discount rates are based upon rates generally charged for such loans with similar characteristics. Deposits The fair values of certificates of deposit are based on the discounted value of contractual cash flows. The discount rates are estimated using rates currently offered for similar instruments with similar remaining maturities. Demand, savings, and money market deposit accounts are valued at the amount payable on demand as of year-end. Other Borrowings Fair values for other borrowings are estimated using a discounted cash flow calculation that applies contractual costs currently being offered for similar borrowings. Commitments to Extend Credit These financial instruments are generally not subject to sale, and estimated fair values are not readily available. The carrying value, represented by the net deferred fee arising from the unrecognized commitment or letter of credit, and the fair value, determined by discounting the remaining contractual fee over the term of the commitment using fees currently charged to enter into similar agreements with similar credit risk, are not considered material for disclosure. The contractual amounts of unfunded commitments and letters of credit are presented in Note 13. The Company employed simulation modeling in determining the estimated fair value of financial instruments for which quoted market prices were not available based upon the following assumptions: 18. SUBSEQUENT EVENTS Cash and Cash Equivalents, Certificates of Deposit, Loans Held for Sale, Regulatory Stock, Accrued Interest Receivable, Accrued Interest Payable, and Short-Term Borrowings The fair value is equal to the current carrying value. Management has reviewed events occurring through March 14, 2012, the date the financial statements were issued, and no subsequent events occurred requiring accrual or disclosure. 44 34 45 35 Notes to Consolidated Financial Statements 19. PARENT COMPANY Following are condensed financial statements for the Company: CONDENSED BALANCE SHEET ASSETS Cash and due from banks Investment securities Investment in subsidiaries Other assets TOTAL ASSETS LIABILITIES Borrowings Other liabilities TOTAL LIABILITIES STOCKHOLDERS' EQUITY $ $ $ December 31, 2011 2010 $ 1,004,609 363,789 53,317,012 1,651,431 1,489,049 433,540 46,537,422 1,918,170 56,336,841 $ 50,378,181 12,686,000 133,855 $ 14,236,000 412,929 12,819,855 14,648,929 43,516,986 35,729,252 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 56,336,841 $ 50,378,181 CONDENSED STATEMENT OF INCOME INCOME Interest and dividend income Investment securities gains (losses), net Other income Total income EXPENSES Interest expense Other expenses Total expenses Loss before tax benefit and equity in undistributed net income of subsidiaries Income tax benefit Equity in undistributed net income of subsidiaries Year ended December 31, 2011 2010 $ $ 21,462 10,517 52,715 84,694 49,219 (352,493) 52,863 (250,411) 818,873 274,540 1,093,413 661,489 250,153 911,642 (1,008,719) (341,246) (1,162,053) (402,194) 4,298,771 4,315,983 NET INCOME $ 3,631,298 $ 3,556,124 19. PARENT COMPANY (Continued) CONDENSED STATEMENT OF CASH FLOWS OPERATING ACTIVITIES Net income Adjustments to reconcile net income to net cash used for operating activities: Equity in undistributed net income of subsidiaries Investment securities losses (gains), net Other Net cash used for operating activities INVESTING ACTIVITIES Investment securities: Proceeds from sales Advance to subsidiaries Net cash provided by investing activities FINANCING ACTIVITIES Increase (decrease) in short-term borrowings Proceeds from other borrowings Repayments of other borrowings Proceeds from sale of common stock Purchases of treasury stock Proceeds from sale of treasury stock Cash dividends Net cash provided by (used for) financing activities Year ended December 31, 2010 2011 $ 3,631,298 $ 3,556,124 (4,298,771) (10,517) 232,650 (445,340) (4,315,983) 352,493 72,359 (335,007) 52,133 (20,000) 32,133 1,363,441 - 1,363,441 (2,250,000) 700,000 - 3,176,897 (23,227) 85,590 (1,760,493) (71,233) 1,000,000 1,300,000 (120,464) - (197,150) 85,886 (1,739,714) 328,558 Increase (decrease) in cash and due from banks (484,440) 1,356,992 CASH AND DUE FROM BANKS AT BEGINNING OF YEAR 1,489,049 132,057 CASH AND DUE FROM BANKS AT END OF YEAR $ 1,004,609 $ 1,489,049 46 36 47 37 The People of Kish Bank BoARD oF DIRECToRS oF KISH BANCoRP, INC. Phyllis L. Palm, Member John Pannizzo, Member William P. Hayes, Chairman James J. Lakso, Vice Chairman William L. Dancy, Secretary Richard L. Kalin, Member Alison B. Kurtz, Member Phyllis L. Palm, Member Alan J. Metzler, Member Delmont R. Sunderland, Member BoARD oF DIRECToRS oF KISH BANK William P. Hayes, Chairman James J. Lakso, Vice Chairman William L. Dancy, Secretary Richard L. Kalin, Member Alison B. Kurtz, Member Phyllis L. Palm, Member Alan J. Metzler, Member CENTRE CoUNTY REGIoNAL BoARD Randall A. Bachman, Member Thomas F. Brown, Member Kristine S. Clark, Member Spyros A. Degleris, Member David Horner, Member Richard L. Kalin, Member Michael J. Krentzman, Member Alison B. Kurtz, Member Karen P. Shute, Member Brandon M. Zlupko, Member HUNTINGDoN CoUNTY REGIoNAL BoARD Arthur J. DeCamp, Member Wayne A. Hearn, Member Steven Huston, Member James J. Lakso, Member Robert L. orr, Member Pamela Prosser, Member Burgess A. Smith, Member Delmont R. Sunderland, Member MIFFLIN CoUNTY REGIoNAL BoARD Michael A. Buffington, Member Christina Calkins-Mazur, Member Ronald M. Cowan, Member William L. Dancy, Member Eric K. Fowler, Member Nichola A. Hidlay, Member William S. Lake, Member Harvard K. McCardle, Member Alan J. Metzler, Member Gary L. oden, Member ExECUTIVE oFFICERS William P. Hayes, President, Chief Executive Officer J. Bradley Scovill, Senior Executive Vice President and Chief Operating Officer Michael F. Allen, Executive Vice President, Chief Credit Officer John E. Arrington, Executive Vice President, Sales & Retail Banking Manager Sangeeta Kishore, Executive Vice President, Chief Financial Officer Robert S. McMinn, Executive Vice President, Financial Services and General Counsel James L. Shilling, Jr., Executive Vice President, Senior Lending Officer SENIoR oFFICERS Amy M. Muchler, Senior Vice President, Operations and Branch Support Manager Gerhard Royer, Senior Vice President, Commercial Lender Ronald B. Beyer, CFA®, Vice President, Profitability & Investment Portfolio Manager Kathleen M. Boop, Vice President, Personal Lines Insurance Manager Larry E. Burger, Vice President, Commercial Relationship Manager David A. Coble, Vice President, Branch Service Manager John P. Cunningham, II, Vice President, Regional Market Manager Wade E. Curry, LUTCF, Vice President, Investment Services Ann K. Guss, Vice President, Consumer Lender Allana L. Hartung, Vice President, Commercial Relationship Manager Gregory T. Hayes, Vice President, Business Banker and Branch Service Manager Carol M. Herrmann, Vice President for Administration Christopher P. Kelly, Vice President, Information Technology Manager Marsha K. Kuhns, Vice President, Branch Administration John Q. Massie, Regional Vice President, Agricultural Manager Scott R. Reigle, Vice President, Accounting and Controls Manager Melissa K. Royer, Vice President, Operations Manager & Security Officer Cheryl E. Shope, Vice President, Consumer Lender Lana M. Walker, Vice President, Commercial Relationship Manager Debra K. Weikel, Vice President, Mortgage Underwriter Suzanne M. White, Vice President, Human Resource Manager Jeffrey D. Wilson, Vice President, CEO, Kish Agency William W. Yaudes, Vice President, Regional Market Manager oFFICERS Stanley N. Ayers, Assistant Vice President, Credit Administration Manager Kimberly A. Bubb, Assistant Vice President, Product Development & Business Service Support Manager Terra L. Decker, BSA/Fraud Manager Lucinda K. Dell, Assistant Vice President, Assistant Mortgage Underwriter Paul J. Fochler, Assistant Vice President, Risk Analyst Carol K. Kennedy, Consumer Lending Officer Jeremy G. Mattern, Assistant Vice President, Senior Credit Analyst Peter K. ort, Branch Manager Matthew Q. Raptosh, Assistant Vice President, Commercial Loan Officer Stephanie L. Strickler, CFMP, Assistant Vice President, Marketing Manager N. Robert Sunday, III, Assistant Vice President, Compliance and Loan Review Officer Kayelene Sunderland, Assistant Vice President, Wealth Management/Trust Administrator D. Michael Whalen, General Manager, Travel Agency Penny L. Zesiger, Assistant Vice President, Consumer Lender KISH BANK EMPLoYEES Natalie B. Allison, Business Banking Specialist Tammy S. Anna, Customer Service Teller Christina L. Bagrosky, Customer Service Teller Barry L. Bargo, Courier/Mail Clerk Katherine A. Bates, Personal Banker Douglas C. Baxter, Accounting Specialist Melissa D. Beale, Customer Service Teller Sara M. Bean, Marketing and Communications Specialist Stacy A. Boozel, Loan Operations Specialist Brittany A. Byler, Customer Service Teller Ruth H. Carper, Mortgage Administration Specialist Stephanie L. Chilcote, Customer Service Teller Ashley A. Clark, Personal Banker Brenda Collins, Mortgage Administration Specialist Alisha D. Cooper, Regional Personal Banker Mary A. Cowher, Branch Manager Richard D. Crider, ALCO & Reporting Manager Jason M. Cunningham, Branch Manager Maxi E. Curry, Administrative Assistant Kati E. Deans, Credit Administration Specialist Peggy J. Dearing, Credit Administration Specialist oksana F. DeArment, Executive Assistant to the CEO Jannifer N. Diehl, Senior Credit Administration Specialist Mary S. Dietz, Collections Manager Megan D. Dietz, Investment Services Assistant Angela D. Drake, Personal Banker Brandi M. Dufford, Customer Service Teller Amanda S. Dutrow, Administrative Assistant Kathy D. Fisher, Branch Service Support Specialist Keatyn M. Fletcher, Credit Administration Specialist Alexis E. Fox, Regional Customer Service Teller Troy J. Frank, Network Administrator Jodie M. Gibboney, Personal Banker Karen S. Gilbert, Business Banking Specialist Gina K. Perrin, Personal Lines Insurance Specialist Tracy S. Powell, Personal Lines CSR Cindy J. Robinson, Commercial Lines CSR J. Anthony Willard, Commercial Lines Insurance Specialist KISH TRAVEL EMPLoYEES Sandra K. Berardis, Travel Officer Jolene Byler, Assistant Manager, Travel Consultant Donna R. Feicke, Travel Office Assistant Sandra L. Hunley, Lead Travel Agent Beth N. Metz Gilmore, Human Resources Assistant Janice Y. Glick, Personal Banking Specialist Candee A. Gutshall, Branch Operations Specialist Sharon A. Hall, Personal Banker Lisa J. Hamler, Customer Service Teller Jeffrey T. Hayes, Financial Advisor Ashley L. Henry, Profitability Specialist R. Michael Henry, Technical Support Specialst Sallie M. Hicks, Branch Operations Specialist Donald F. Hindman, Courier/ Mail Clerk Christina A. Hinkle, Business Banking Specialist Evan S. Hodes, Customer Service Courier Lara A. Hoffman, Regional Assistant Branch Manager Sandra D. Hummel, Mortgage Administrative Assistant Lauren M. Jeranka, Loan Documentation Review Manager Karen M. Johnson, Trust Operations Specialist Paula J. Kauffman, Senior Credit Administration Specialist Michael S. Kearns, Data Analyst John J. Keeler, Commercial Relationship Manager Lisa A. Kennedy, Training & Development Manager Brittany E. Kern, Business Service Support Specialist Darla S. King, Branch Service Support Specialist Abbey N. Knepp, Branch Service Support Specialist Chelcee L. Kyle, Customer Service Teller Carolyn M. Leacy, Customer Service Teller Lori A. Legradi, Customer Service Teller Michael J. Leidy, Personal Banker Heidi C. Leonard, Consumer Lender Carmella J. Long, Personal Banker Tina K. McCurdy, Branch Operations Specialist Kathryn A. McKnight, Collections Assistant Kristie R. McKnight, Business Banker Trainee Shelley V. Merrell, Customer Service Teller Mary A. Miller, Executive Assistant Joanna M. Minium, Credit Administration Specialist Jennifer A. Mitchell, Mortgage Administration Specialist Tina L. Nace, Senior Credit Administration Specialist Antonietta M. Naimo, Personal Banker Seth J. Napikoski, Credit Analyst Stephanie J. Neff, Branch Service Support Specialist Carol A. Noland, BSA Specialist Melissa A. Paladino, Application Support Specialist Constance F. Palm, Branch Manager Anne E. Parks, Customer Service Teller Susan K. Peachey, Branch Operations Specialist Danielle A. Peck, Credit Administration Specialist Christine M. Petroski, Branch Support Servive Specialist Susan C. Rainey, Customer Service Teller Haley L. Ralston, Regional Personal Banker Jesse L. Reed, Branch Operations Specialist Amber N. Resto, Personal Banker Denise M. Rothrock, Branch Operations Specialist Billie A. Rupert, Investment Services Assistant Krista M. Rupert, Customer Service Teller Elise C. Santarelli, Credit Analyst Leslie J. Sauer, Accounting Specialist Clayton B. Scovill, Business Banking Representative Melissa A. Sellers, Business Banking Specialist April L. Shawver, Customer Service Teller Glenn E. Snyder, Jr., Facilities Manager Paula A. Stimeling, Mortgage Administration Specialist Wendy S. Strohecker, Branch Service Support Manager Crystal M. Sunderland, Business Service Support Specialist Lisa M. Sunderland, Branch Service Support Specialist Angela E. Swartzentruber, Personal Banker Christopher E. Sweeney, Financial Planner Cynthia G. Swineford, Customer Service Teller Quinn L. Swineford, Branch Service Support Specialist Patricia A. Trinclisti, Customer Service Teller Donald L. Varner, Courier/ Maintenance Supervisor Jeanne L. Wagner, Customer Service Teller Roy A. Wagner, Courier/ Mail Clerk Rebecca M. Watt, Senior Mortgage Administration Specialist Elaine S. Weller, Branch Manager Debra J. Wert, Business Banking Specialist Rick W. Wert, Information Security Administrator Crystal D. Yoder, Customer Service Teller Delores K. Yoder, Business Banking Specialist Judy A. Yoder, Customer Service Teller Roland G. Yoder, Courier/ Mail Clerk Nancy A. Zimmerman, Personal Banker Scott G. Zimmerman, Branch Operations Specialist KISH INSURANCE EMPLoYEES Jennifer R. Beachel, Systems and Operations Manager Arlene M. Byler, Customer Service Rep/Support Assistant Duane J. Coy, Commercial Lines Insurance Specialist Megan S. Diemert, Personal Lines Insurance Specialist Marlene K. Johnson, Personal Lines CSR Amber E. oborski, Personal Lines CSR 48 49 

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