Kish Bancorp, Inc.
Annual Report 2012

Plain-text annual report

Building on Shared Values 2012 annual report Chairman’s letter to the Shareholders William P. Hayes, Chairman, President, and Chief Executive Officer In January 2013, a research report was released on the banking industry, prepared in collaboration with Harris Interactive, entitled “State of the Bank.” Aiming to take some “vital signs” of the industry based on a variety of indicators that are primarily qualitative and centered on the customer experience, the report sums up its findings as demonstrating a state of “disconnect between the banking industry and its customers.” Reading that assessment of our industry brought home for me once again the beauty of Kish Bank as an institution that, after more than 100 successful years, continues to operate independently, maintaining as our primary source of strength an unwavering focus on customer and community, built on a solid base of shareholder loyalty. At Kish, we’re far from being in a state of disconnect with our customers. Connection, rather, is what our culture is—and always has been—about. Our connection with our customer and community is what allows us to be a positive force for local economic change and development, and for the continued growth and prosperity of our region. It puts us in a position of strength as we look ahead toward our planned efforts to pursue new horizons of opportunity—all while remaining unwaveringly focused on our core, community-centered values. Just as with the preceding three years, Kish Bancorp began 2012 with a principal focus on risk assessment and risk reduction. The Great Recession, which began in late 2007 and lasted until 2009, and the stubbornly slow recovery that ensued, had created significant and sustained headwinds for the economy and for banking. Regulators had responded to the difficult environment by intensifying their focus on bank oversight and requiring more formal actions where there were areas of concern. Risk management was the watchword that guided the actions of our industry as well as the Corporation. At the outset of 2012, Kish Bank was intently concentrating on several remaining risk factors that were critical to addressing the issues set forth in a regulatory agreement entered into in February 2011. The central focus of this effort was on problem loan management and the level of classified loans. By mid-year 2012, management had documented substantial completion of these as well as all other matters under the agreement. While final validation of that completion would await a regulatory examination in September and final review in December, we were pleased 3 “ connection... is what our culture is – and always has been – about.” – William P. Hayes contents Chairman’s Letter to the Shareholders 3-5 A Year of Unwavering Focus 6-8 Financial Highlights 9-11 Independent Auditor’s Report 12 Financial Statements 13-17 Notes to Consolidated Financial Statements The People of Kish 18-49 50-51 www.KishBank.com 20 12during the latter half of the year to return our full attention and Contributing positively to the change in net income was a reduction in resources to serving our customers and growing our business. We the provision for potential loan losses. In 2012, $270 thousand was set Walter Kay, Senior Vice President and Senior Information Officer, brings to our team more than 20 It is an honor to have Coach Washington on board, and we look forward to seeing the impact that her high visibility, leadership and could do so with the confidence that our team had faced this period aside from earnings through the loan loss provision, as compared to years of experience in senior-level leadership of enterprise representation will have on deepening the appreciation of the value of adversity and responded to the challenge with a dedication and $800 thousand in 2011. As the level of classified loans declined, other information technology operations in a variety of industries, that Kish brings to our region. professionalism that demonstrated its readiness to perform at the next loan quality metrics remained positive. At year end, the allowance for including banking. level. It was a stronger, more capable team that was ready to continue loan losses was $6.867 million, or 1.92 percent of total loans its campaign of “Building to a Billion.” We had also demonstrated our outstanding. The Bank’s reserves continue to reflect a strengthened continuing commitment to our customers and communities. balance sheet that protects Kish from unforeseen negative In this context, we are pleased to report that profitable operations continued in 2012, with net income of $3.630 million, earnings per share of $6.10, and return on average shareholders’ equity of 8.01 percent. While net income was equal to the prior year, the additional developments in the economy that may impact the Bank’s loan portfolio. Actual charge-offs for the year remained modest, and the Bank’s delinquent loans have been sustained at exceptionally low levels. common stock raised in late 2011 and early 2012 of $3.8 million We are also pleased to note that, as we enter 2013, demand for served to depress both EPS and ROE by approximately 10 percent. new credit by businesses has begun to accelerate, a trend that is Higher capital levels were necessary and prudent during the period of expected to continue with further economic recovery and improving elevated risk. As the Corporation’s risk parameters improve, strategies business confidence. William Hoyne, Executive Vice President and Chief Credit Officer, is an industry veteran with more As we conclude this review of another successful year for Kish Bank and look ahead to a promising future, we gratefully acknowledge the continued support and encouragement of you, our shareholders. than 45 years in banking. He brings to Kish a distinguished As investors, you contribute in so many ways to the vitality of our track record of successfully managing the integrity and community. It is your loyalty and confidence that has helped to define profitability of lending portfolios, both in strong economies the unique culture and values of Kish Bank and will continue to do and challenging times. Last but certainly not least, we are also pleased to welcome to our “extended team” one of the most noted leaders of the Central Pennsylvania community. Coquese Washington, Head Coach of the Penn State Lady Lion basketball team, is a uniquely qualified advocate for “the Kish way of doing business.” In her early interactions with so as we work together to achieve our goals and advance toward the exciting new horizons that await us. Sincerely, to either employ the additional capital or return it to shareholders are under active evaluation. We believe ROE and EPS growth will continue to be the key performance measures that drive long-term shareholder performance. Our goal is to live up to a reputation for financial performance that has merited, for a sixth consecutive year, a position among the top 200 Community Banks in the U.S. Dividends per share were sustained at $3.24 per share for the year, although, based on the increase in outstanding shares, total dividends paid grew by 11.3 percent to $1.96 million from $1.76 million in 2011. The dividend per share rate has been sustained throughout the recession. Net interest income after provision for loan losses during 2012 was $16.546 million, an increase of $104 thousand, or 0.6 percent, compared to 2011. This modest expansion reflected the slow growth in earning assets and a contraction in the net interest margin as new and existing borrowers moved to refinance existing debt at Noninterest income declined $1.0 million, or 12.57 percent, to $7.0 Kish, Coach Washington developed an appreciation of the core values million for 2012 from $8.0 million in 2011. 2011 results were skewed that she shares with us, including a commitment to excellent William P. Hayes by the addition of $2.1 million of business property income related to a performance and to the importance of serving as a leader and mentor Chairman, President, and Chief Executive Officer business loan workout with ongoing operations. Excluding this revenue in the community. This appreciation not only motivated her to choose from 2011 noninterest income, as well as investment securities gains, Kish as her bank, but also to agree to serve as a “Kish ambassador.” core noninterest income increased by $1.0 million, or 20.1 percent, driven primarily by excellent strength in residential mortgage origination activities, sustained growth in retail deposit service fees and stronger revenues from our wealth management unit. Noninterest expense was $19.4 million during 2012, a decrease of $1.0 million, or 4.9 percent, from $20.4 million in 2011. The primary driver of the decrease in 2012 expenses was the elimination of the cost of managing the business property described in the previous paragraph, as well as a reduction in the cost of federal deposit insurance. significantly lower rates. The yield on the securities portfolio declined In addition to capital investments to prepare for the future that are as new investments also reflected the low yields created by the Fed’s reflected in these financial results, 2012 also witnessed several key sustained easing of monetary policy. As reported in the quarterly additions to the Kish team that will further enhance our customer- statements, net interest income in the fourth quarter of 2012 was focused culture and accelerate progress toward Kish’s long-term $4.213 million, an increase of $45 thousand, or 1.1 percent, corporate goals: compared to $4.168 million for the fourth quarter of 2011. Bill Hayes and Coquese Washington Introducing our new Kish ambassador 4 5 A Year of Unwavering Focus Left: Oksana DeArment Kish associate, teaching children to save Right: Sandy Berardis, Greg Hayes, John Arrington Kish associates building a home for Habitat for Humanity A Focus on our community At Kish, community focus is a strategic objective. From top to bottom, we’re a team that takes pride in putting our time and resources to work to build better communities. A major part of this unwavering focus is realized in our direct role as an institution that works closely with the individuals, entrepreneurs, and business leaders that make our communities so vibrant, meeting their financial needs at a highly personalized level. But it doesn’t stop there. In 2012, we also moved our longstanding community service commitment to the next level by forming regional groups that integrate community involvement into our official operations: the Kish Community Action Teams (CATs). Activities under the CAT umbrella are broad and far-reaching. They encompass, for example, our sponsorship and engagement in causes like fighting breast cancer through our Power of Pink program in partnership with the Pennsylvania Pink Zone and the Penn State Lady Lion Basketball Team; an initiative to send bankers into classrooms to help young students get a head start on a lifetime of good financial habits through the Teach Children to Save Program; and participation in a range of other community activities, including Habitat for Humanity and United Way. Our CAT program also supports the efforts of Kish associates to pursue their passions to serve individually, applying their talents, interests, energies, and drive to community involvement as EMTs, musicians, coaches, pet rescuers, and more. After just one year, the CATs already have become a driving force clients to protect what matters most to them… to the deep, first-hand expertise of Kish Travel Specialists that enables them to help clients enjoy more memorable travel experiences. To further enhance our service across the organization, we strengthened our team with several key hires. Natalie Xanthopoulous, Insurance Specialist, focuses on delivering exemplary service to insurance clients as our insurance presence continues to grow, especially in the Centre County area. Walter Kay, Senior Vice President and Senior Information Officer, applies his comprehensive information technology expertise to ensure that Kish will always meet the highest standards of security and privacy of clients’ personal and financial information. Walter also leads the company’s initiative to grow the customer base through the application of data and information systems. In keeping with our unwavering focus on fulfilling client needs, we engaged the services of our marketing consultant to help us reenergize Kish Travel with more innovative approaches to service and elevate further the travel experience we provide our clients. Carol Herrmann, who joined Kish in 2011, will lead this change in her new role as Kish in making our service commitment more visible and in shaping our Travel CEO. internal culture and external impact. A Focus on our clients One of the factors that makes Kish such a rewarding institution to be involved with is our ability to serve clients in ways that make an important difference in their lives—from the breadth and depth of products and services from Kish Bank and Kish Financial Solutions that allow us to help clients as they work toward their goals and dreams… to the comprehensive coverages available to Kish Insurance Specialists as they work with Enhancing our facilities was another priority in 2012. Kish Bank has been well received in McVeytown, having first opened its doors there more than 15 years ago. Since then, our McVeytown business has grown along with our clients’ needs for the full range of financial and related services Kish provides. In February 2012, we broke ground on a beautiful new branch facility to better serve these growing needs. Ten months later, the doors of the new McVeytown branch opened, offering the added conveniences of off-street parking, ATM service, and a two-lane drive-thru. This updated facility creates yet another opportunity to further enhance service to existing clients, to introduce more individuals and organizations to the full breadth of Kish services, and to strengthen our signature “expect more” culture and approach to doing business. Bruce, Kym & Ryan Burke Owners, One on One Fitness 6 The new McVeytown Branch 7 20 12Left: Kish Travel’s Disney Night The Tone Rangers serenade guests with Disney tunes Below: Coquese Washington Head Coach, Penn State Lady Lion Basketball Team Financial Highlights Five Year Summary For the YeAr Net Income Net Income Before Taxes Total Dividends Declared 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 2012 $3,629,794 4,168,872 1,960,051 2011 $3,631,298 4,070,114 1,760,493 2010 $3,556,124 4,026,669 1,739,714 2009 $3,213,423 3,586,370 1,721,575 2008 $3,937,791 4,817,481 1,713,474 $557,575 351,040 460,450 46,252 6,867 445 0.65% 8.61% 54.00% 76.24% 9.53% 14.05% 1.92% 0.12% $6.10 6.09 3.24 76.20 87.51 $560,069 362,163 454,660 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 $556,623 367,306 446,002 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 $527,396 367,824 407,721 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 $476,263 333,434 352,729 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 Average Shares Outstanding (#) 594,611 538,735 529,343 528,125 527,044 * Due to fluctuations in the mark to market valuation for investment securities, we do not include them in our total for average assets and average equity. A Focus on communicating the Unique Value of Kish As a shareholder, you already know that Kish is much more than just another bank. We’re a distinctively diversified financial institution that meets not only the deposit and credit needs of our clients, but also provides a suite of complementary services in travel, wealth management, insurance, and more. Add to that mix our unwavering commitment to our clients and our communities, and you have a highly effective client-centric organization. To continue to strengthen the community’s understanding of our mission and all Kish does to fulfill it, we proudly brought on board our new Kish ambassador, Coquese Washington, Head Coach of the Penn State Lady Lion Basketball Team and a client who chose Kish Bank based on values she shares with us. We look forward to engaging her in a full range of internal and external activities throughout the coming years. 2012, a year in which we celebrated the 100th anniversary of our charter, has given us the opportunity to reflect on how our community bank has enjoyed the privilege of helping the individuals, businesses, and organizations in our markets survive, thrive, and maintain stability while navigating through a century of changing financial tides. Today, our community impact is stronger than ever. Working together with the great people and organizations we serve toward full realization of the values we share remains our primary reason for being. This is reflected not only in the value of the financial services we provide, but also in our continued community support and involvement. 8 9 Financial Highlights Financial Highlights Financial Highlights $5.0 $4.0 $3.0 $2.0 $1.0 $0.0 $50.0 $40.0 $30.0 $20.0 $10.0 $0.0 Net Income (in millions) Earnings and Dividends per Share Basic Earnings per Share Dividends per Share Loan Loss Reserve/Loans Loan Loss Reserve/Loans PA Bank Operating Companies with $500mm to $1B in Assets* PA Bank Operating Companies with $500mm to $1B in Assets* Kish Bancorp Kish Bancorp Total Noninterest Income and Total Noninterest Income and Components (in millions) Components (in millions) Bank Svc Fees* Bank Svc Fees* Sec Gains Sec Gains Insurance Insurance KFS KFS Travel Travel $8.00 $6.00 $4.00 $2.00 $0.00 2008 2009 2010 2011 2012 2008 2009 2010 2011 2012 Net Interest Income After Provision (in millions) Stockholders' Equity (in millions) and ROE Stockholders' Equity ROE 15.00% 12.00% 9.00% 6.00% 3.00% 0.00% $18.0 $15.0 $12.0 $9.0 $6.0 $3.0 $0.0 2008 2009 2010 2011 2012 2008 2009 2010 2011 2012 2.00% 2.00% 1.50% 1.50% 1.00% 1.00% 0.50% 0.50% 0.00% 0.00% $600 $600 $500 $500 $400 $400 $300 $300 $200 $200 $100 $100 $0 $0 $8.0 $8.0 $6.0 $6.0 $4.0 $4.0 $2.0 $2.0 $0.0 $0.0 2012 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 * Source - SNL Financial, median values * Source - SNL Financial, median values * Excluding unrelated business income * Excluding unrelated business income Balance Sheet (in millions) Balance Sheet (in millions) Assets Assets Loans Loans Deposits Deposits Stock Valuation (per share) Stock Valuation (per share) Book Value Book Value Market Value Market Value 2008 2009 2010 2011 2012 2008 2009 2010 2011 2012 $100.00 $100.00 $80.00 $80.00 $60.00 $60.00 $40.00 $40.00 $20.00 $20.00 $0.00 $0.00 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 10 11 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 Independent auditor’s report Independent Auditor’s Report Board of Directors and Stockholders, Kish Bancorp, Inc. We have audited the accompanying consolidated financial statements Opinion of Kish Bancorp, Inc. and subsidiaries which comprise the consolidated In our opinion, the consolidated financial statements referred to above balance sheet as of December 31, 2012 and 2011; the related consolidated present fairly, in all material respects, the financial position of Kish statements of income, comprehensive income, changes in stockholders’ Bancorp, Inc. and subsidiaries as of December 31, 2012 and 2011, and equity, and cash flows for the years then ended; and the related notes to the results of their operations and their cash flows for the years then ended the financial statements. in accordance with accounting principles generally accepted in the United Management’s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor’s Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements States of America. Wexford, Pennsylvania March 20, 2013 Kish Bancorp, Inc. Consolidated Audited Financial Statements December 31, 2012 Independent Auditor’s Report ..............................................................12 Page Number are free of material misstatement. Financial Statements An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. Consolidated Balance Sheet ...........................................................13 Consolidated Statement of Income .................................................14 The procedures selected depend on the auditor’s judgment, including Consolidated Statement of Comprehensive Income .......................15 Consolidated Statement of Changes in Stockholders’ Equity ..........16 Consolidated Statement of Cash Flows ..........................................17 Notes to Consolidated Financial Statements ................................ 18–49 the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. 12 KISH BANCORP, INC. CONSOLIDATED BALANCE SHEET Consolidated Balance Sheet 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 December 31, 2012 2011 $ $ 8,944,401 14,848,221 23,792,622 9,592,946 31,588,825 41,181,771 2,374,375 136,214,232 1,619,833 114,170,492 584,380 1,401,376 357,907,840 6,867,370 351,040,470 15,078,798 1,668,699 4,794,900 12,517,831 9,508,580 369,205,842 7,042,911 362,162,931 14,211,627 1,668,699 4,042,400 12,097,673 7,512,072 TOTAL ASSETS $ 557,574,887 $ 560,068,874 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 $ $ 55,046,956 9,658,721 47,336,921 189,715,682 158,691,542 460,449,822 4,157,290 42,121,094 4,594,956 511,323,162 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 Preferred stock, $.50 par value; 500,000 shares authorized, no shares issued and outstanding Common stock, $.50 par value; 2,000,000 shares authorized, 674,374 and 663,791 shares issued Additional paid-in capital Retained earnings Accumulated other comprehensive income Treasury stock, at cost (67,380 and 67,237) TOTAL STOCKHOLDERS' EQUITY - - 337,187 3,376,514 45,323,860 2,907,315 (5,693,151) 46,251,725 331,896 2,979,269 43,654,117 2,466,659 (5,914,955) 43,516,986 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 557,574,887 $ 560,068,874 See accompanying notes to consolidated financial statements. 3 13 Consolidated Statement of Income KISH BANCORP, INC. CONSOLIDATED STATEMENT OF INCOME KISH BANCORP, INC. CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME Consolidated Statement of Comprehensive Income 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 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. 4 14 Year Ended December 31, 2012 2011 $ 17,767,995 956,766 $ 19,773,794 1,030,427 2,077,035 1,180,783 128,265 102,529 22,213,373 3,412,997 94,657 1,889,289 5,396,943 1,832,161 1,336,001 83,224 63,870 24,119,477 4,266,998 203,640 2,406,192 6,876,830 16,816,430 270,000 17,242,647 800,000 16,546,430 16,442,647 1,573,098 797,324 - 1,901,882 416,414 888,876 194,174 - 1,207,008 6,978,776 10,449,906 2,435,665 1,683,149 392,961 414,113 743,008 - 3,237,532 19,356,334 4,168,872 539,078 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 $ $ 3,629,794 $ 3,631,298 6.10 $ 6.09 6.74 6.72 Net income Other comprehensive income: Securities available for sale: Unrealized holding gains on available-for-sale securities Tax effect Reclassification adjustment for net gains realized in net income Tax effect Impairment losses included in net income Tax effect Total other comprehensive income Year Ended December 31, 2012 2011 $ 3,629,794 $ 3,631,298 1,464,984 (498,095) 4,532,228 (1,540,957) (797,324) 271,091 (840,576) 285,795 - - 8,728 (2,968) 440,656 2,442,250 Total comprehensive income $ 4,070,450 $ 6,073,548 See accompanying notes to the consolidated financial statements. 5 15 Consolidated Statement of Changes in Stockholders’ equity KISH BANCORP, INC. CONSOLIDATED STATEMENT OF CASH FLOWS Consolidated Statement of Cash Flows l a t o T ' 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 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 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 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 - - 0 0 1 , 2 4 8 9 2 , 1 3 6 , 3 0 5 2 , 2 4 4 , 2 ) 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 0 5 2 , 2 4 4 , 2 8 9 2 , 1 3 6 , 3 ) 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 s e r a h s n a l p k c o t s d e t c i r t s e 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 n a l p k c o t s d e t c i r t s e r y b s e r a h s f o e s a h c r u P n a l p k c o t s d e t c i r t s e r y b s e r a h s f o e r u t i e f r o F x a t f o t e n , e m o c n i e v i s n e h e r p m o c r e h t O 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 t e N 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 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 - - 3 6 8 , 6 4 6 5 6 , 0 4 4 4 9 7 , 9 2 6 , 3 7 5 8 , 3 0 2 ) 1 5 0 , 0 6 9 , 1 ( 7 5 0 , 5 2 6 ) 5 4 2 , 9 6 2 ( 8 0 8 , 7 1 ) 2 0 0 , 5 4 ( 5 4 0 , 2 7 2 ) 5 4 2 , 9 6 2 ( 6 0 0 , 4 6 2 6 5 6 , 0 4 4 4 9 7 , 9 2 6 , 3 ) 1 5 0 , 0 6 9 , 1 ( 3 6 8 , 6 4 ) 5 4 0 , 2 7 2 ( 2 0 0 , 5 4 7 5 8 , 3 0 2 s e r a h s n a l p k c o t s d e t c i r t s e 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 n a l p k c o t s d e t c i r t s e r y b s e r a h s f o e s a h c r u P n a l p k c o t s d e t c i r t s e r y b s e r a h s f o e r u t i e f r o F x a t f o t e n , e m o c n i e v i s n e h e r p m o c r e h t O 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 t e N 16 6 6 7 , 9 1 6 1 9 2 , 5 ) s e r a h s 3 8 5 , 0 1 ( 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 ) 8 9 1 , 6 4 2 ( ) s e r a h s 9 1 4 4 ( , 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 9 1 7 , 2 ( k c o t s y r u s a e r t f o e l a S 5 2 7 , 1 5 2 , 6 4 $ ) 1 5 1 , 3 9 6 , 5 ( $ 5 1 3 , 7 0 9 , 2 $ 0 6 8 , 3 2 3 , 5 4 $ 4 1 5 , 6 7 3 , 3 $ 7 8 1 , 7 3 3 $ 2 1 0 2 , 1 3 r e b m e c e D , e c n a l a B . 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 e h t o t s e t o n g n i y n a p m o c c a e e S 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 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 in loans, net Purchase of regulatory stock Redemption of regulatory stock Purchase of premises and equipment Purchase of bank-owned life insurance ("BOLI") Proceeds from sale of other real estate owned Net cash provided by (used for) investing activities FINANCING ACTIVITIES Increase in deposits, net 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 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 Investment sales not settled See accompanying notes to consolidated financial statements. 7 17 Year Ended December 31, 2011 2012 $ 3,629,794 $ 3,631,298 270,000 (797,324) - 47,056,498 (44,337,620) (1,901,882) 1,112,213 31,885 282,921 (182,013) (416,414) 709,737 - (364,059) 5,093,736 800,000 (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 5,751,887 250,000 (1,004,542) 1,114,261 - 21,211,034 28,756,606 (72,690,346) 10,025,751 (962,436) 206,000 (1,901,683) - 894,098 (15,215,518) 5,786,760 (1,538,872) 2,000,000 (11,928,824) 625,057 (269,245) 17,808 (1,960,051) (7,267,367) (17,389,149) 41,181,771 53,533,950 21,467,880 (64,388,175) 7,038,702 (213,000) 332,400 (1,516,320) (16,000) 789,466 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 $ $ $ 23,792,622 $ 41,181,771 5,578,956 685,000 826,710 2,066,250 $ $ 6,978,272 482,000 54,841 - notes to Consolidated Financial Statements KISH BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES notes to Consolidated Financial Statements 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Investment Securities (Continued) A summary of the significant accounting and reporting policies applied in the presentation of the accompanying consolidated financial statements follows: 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. 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 industrial, 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, 2012 and 2011. 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 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. Management evaluated the stock and concluded that the stock was not impaired for the periods presented herein. 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 collectability 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 collectability of such principal. Nonaccrual loans will generally be put back on accrual status after demonstrating six consecutive months of no delinquency. 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. 8 18 9 19 notes to Consolidated Financial Statements 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 those 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 evaluates commercial and industrial, agricultural, state and political subdivisions, commercial real estate, and all troubled debt restructuring loans for possible impairment. Consumer and residential real estate loans are also evaluated if part of a commercial lending relationship. 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 collectability 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. 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 noninterest 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 $414,113 and $436,651 for 2012 and 2011, 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. Premises and Equipment Stock Options 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. As of December 31, 2012 and 2011, the Company recorded compensation expense of $46,863 and $42,100 related to share-based compensation awards. At December 31, 2012, there was approximately $18,029 in unrecognized compensation cost related to unvested share-based compensation awards granted. That cost is expected to be recognized over the next two years. 10 20 11 21 notes to Consolidated Financial Statements 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 2012 2011 Expected Dividend Yield Risk-Free Interest Rate Expected Volatility Expected Life (in Years) 5.31 5.79 % % 2.23 3.27 % % 12.25 17.71 % % 10.00 10.00 The weighted-average fair value of each stock option granted for 2012 and 2011 was $1.90 and $5.01, respectively. There were no stock options exercised during the years ended December 31, 2012 and 2011. 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, 2012 and 2011, the Company recorded gross servicing rights of $671,967 and $470,047 with a reserve for impairment of $315,477 and $150,322, 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 restricted share plan 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 2012 2011 672,382 (67,303) 616,925 (69,675) (10,468) (8,515) 594,611 538,735 272 923 710 1,291 595,806 540,736 Options to purchase 68,626 and 48,620 shares of common stock at a price of $51.50 to $96.75, as of December 31, 2012 and 2011, and 8,801 and 4,956 shares of restricted stock ranging in price from $51.00 to $76.35, 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: 2012 Gross Unrealized Gains Gross Unrealized Losses Fair Value Amortized Cost $ 4,992,428 44,667,778 $ 114,029 680,635 $ $ (27,397) (74,593) 5,079,060 45,273,820 48,039,353 4,015,236 29,931,421 131,646,216 162,990 3,241,734 9,806 872,420 4,918,624 55,254 (50,758) (408,537) (7,567) (568,852) - 51,230,329 3,616,505 30,796,274 135,995,988 218,244 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 Total $ 131,809,206 $ 4,973,878 $ (568,852) $ 136,214,232 12 22 13 23 notes to Consolidated Financial Statements notes to Consolidated Financial Statements 3. INVESTMENT SECURITIES AVAILABLE FOR SALE (Continued) 3. INVESTMENT SECURITIES AVAILABLE FOR SALE (Continued) 2011 Gross Unrealized Gains Gross Unrealized Losses Fair Value Amortized Cost $ 23,682,923 $ 688,742 $ (50) $ 24,371,615 51,204,454 3,365,045 31,861,904 110,114,326 318,800 3,054,779 - 451,776 4,195,297 56,725 (36,077) (463,700) (3,093) (502,920) (11,736) 54,223,156 2,901,345 32,310,587 113,806,703 363,789 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 $ 110,433,126 $ 4,252,022 $ (514,656) $ 114,170,492 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, 2012 and 2011. Less than Twelve Months Gross Unrealized Losses Fair Value 2012 Twelve Months or Greater Fair Value Gross Unrealized Losses Total Fair Value Gross Unrealized Losses $ 3,010,780 $ (27,397) $ 12,999,055 (74,593) 3,206,412 877,282 (50,758) (8,571) - - - 1,567,534 $ - - $ 3,010,780 $ (27,397) 12,999,055 (74,593) - (399,966) 3,206,412 2,444,816 (50,758) (408,537) 1,079,860 21,173,389 $ (7,567) (168,886) $ - $ 1,567,534 $ - (399,966) $ 1,079,860 22,740,923 $ (7,567) (568,852) U.S. treasury securities U.S. government agency securities Obligations of states and political subdivisions Corporate securities Mortgage-backed securities in govern- ment-sponsored entities Total Less than Twelve Months Gross Unrealized Losses Fair Value 2011 Twelve Months or Greater Fair Value Gross Unrealized Losses Total 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 govern- ment-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. treasury securities. The unrealized loss on two investments in U.S. treasury notes 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, 2012. U.S. government agency securities. The unrealized loss on ten investments 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, 2012. Obligations of states and political subdivisions. The Company’s unrealized losses on seven 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, 2012. Corporate securities. The Company had unrealized losses on investments in six different debt securities with an aggregate fair value of $2,444,816 at December 31, 2012. The unrealized losses on these debt securities amounted to $408,537 at December 31, 2012. 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. 14 24 15 25 notes to Consolidated Financial Statements notes to Consolidated Financial Statements 3. INVESTMENT SECURITIES AVAILABLE FOR SALE (Continued) 4. LOANS 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, 2012. Mortgage-backed securities in government-sponsored entities. The unrealized losses on the Company’s investment in one mortgage-backed securities were caused by interest rate increases. The Company purchased this investment at a premium relative to its face amount, and the contractual cash flows of the investment are guaranteed by an agency of the U.S. government. Accordingly, it is expected that the security would not be settled at a price less than the amortized cost basis of the Company’s investment. 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 investment and it is not more likely than not that the Company will be required to sell the investment before recovery of its amortized cost basis, which may be maturity, the Company does not consider this investment to be other-than-temporarily impaired at December 31, 2012. Equity securities. The Company’s investments in three 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. In 2012, the Company sold this security for a gain of $26,743. As of December 31, 2012, the Company had no equity securities at an unrealized loss position. The amortized cost and fair value of debt securities at December 31, 2012, 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 $ 2,263,153 18,172,632 46,546,919 64,663,512 Fair Value 2,299,637 18,720,045 48,547,217 66,429,089 $ $ 131,646,216 $ 135,995,988 Investment securities with a carrying value of $75,688,114 and $79,829,596 at December 31, 2012 and 2011, 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 2012 2011 $ $ 21,211,034 814,552 17,228 - 53,533,950 939,368 98,792 8,728 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 $ 2012 2011 $ 113,748,488 77,537,911 19,442,003 24,657,876 45,091,647 77,429,915 357,907,840 6,867,370 120,270,997 79,754,672 19,294,360 25,125,149 45,026,255 79,734,409 369,205,842 7,042,911 $ 351,040,470 $ 362,162,931 Mortgage loans serviced by the Company for others amounted to $69,900,031 and $54,190,608 at December 31, 2012 and 2011, 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, 2012 and 2011, 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, 2012 is as follows: 2011 Additions Amounts Collected 2012 $ 6,333,420 $ 19,605,007 $ 16,948,965 $ 8,989,462 5. ALLOWANCE FOR LOAN LOSSES 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 three-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. 16 26 17 27 notes to Consolidated Financial Statements notes to Consolidated Financial Statements 5. ALLOWANCE FOR LOAN LOSSES (Continued) 5. ALLOWANCE FOR LOAN LOSSES (Continued) 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 2012, management elevated the qualitative factors reserve percentage for all pools of loans, although the increase was higher for commercial real estate loans and commercial and industrial loans. Changes in lending staff experience and ability, changes in the nature and volume of the loan portfolio, changes in the loan review process, and the effect of external factors all contributed to the increase in factor percentages for various loan pools. 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 percentages for consumer loans and loans to state and political subdivisions was attributable to changes in economic and business conditions, as well as changes in the lending staff. The change in credit staff experience and ability factor percentage was increased because of the resignation of the Chief Credit Officer and the addition of some new, less experienced lending personnel. Though a new Chief Credit Officer has been hired with over 40 years of experience in the banking industry, potential risk levels remain elevated as his time with the Bank has been nominal and requires validation. The effect of external factors’ percentage increased due to a number of reasons, including the enactment of the Dodd-Frank Act and continued lack of economic growth. The changes in the underlying value of collateral- dependent loans in the commercial real estate category are attributable to ongoing modest declines 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 stubbornly high 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 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 2012 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 $ $ 3,610,905 (270,731) 3,208 (697,305) 2,646,077 2,082,685 (23,732) 2,148 (41,449) 2,019,652 $ $ 202,520 (23,376) - 41,041 220,185 $ $ 101,551 - - 30,463 132,014 $ $ $ $ $ 311,203 (108,292) 3,439 141,136 347,486 361,607 (28,205) - 137,336 470,738 372,440 - - 658,778 1,031,218 $ $ 7,042,911 (454,336) 8,795 270,000 6,867,370 $ $ $ $ 309,060 $ 645,765 $ - $ - $ - $ 22,240 $ - $ 977,065 $ 2,337,017 $ 1,373,887 $ 220,185 $ 132,014 $ 347,486 $ 448,498 $ 1,031,218 $ 5,890,305 $ 4,361,721 $ 1,579,920 $ 407,170 $ - $ 161,774 $ 593,021 $ - $ 7,103,606 109,386,767 75,957,991 19,034,833 24,657,876 44,929,873 76,836,894 - 350,804,234 Ending balance $ 113,748,488 $ 77,537,911 $ 19,442,003 $ 24,657,876 $ 45,091,647 $ 77,429,915 $ - $ 357,907,840 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 18 28 19 29 notes to Consolidated Financial Statements notes to Consolidated Financial Statements 5. ALLOWANCE FOR LOAN LOSSES (Continued) 5. ALLOWANCE FOR LOAN LOSSES (Continued) Reserve requirement for commercial real estate loans decreased by $697,304 from 2011 to 2012, while those for commercial and industrial loans decreased by $41,449 during the same period. This was a direct result of decreases during 2012 of criticized and classified assets which at $27.8 million at December 31, 2012, indicates a 42.41 percent or $20.5 million decrease from December 31, 2011. While the reduced balances in criticized and classified assets signify better management of the portfolio and reduced risk to the Bank, management has chosen to adopt a more conservative approach and evaluate sustained performance of these loans. Credit Quality Information (Continued) For consumer and residential real estate loans, the Company evaluates credit quality based on whether the loan is considered performing or nonperforming. Nonperforming loans are those loans past due 90 days or more and loans on nonaccrual. The following tables present the balances of consumer and residential real estate loans by classes of loan portfolio based on payment performance as of December 31: Credit Quality Information The following tables represent the commercial credit exposures by internally-assigned grades for the years ended December 31, 2012 and 2011, 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 and 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 Commercial and Industrial $ $ 102,453,018 4,970,737 6,285,096 39,637 - $ 69,619,198 5,320,354 2,362,688 235,671 - 2012 Agricultural 18,013,206 784,330 563,974 80,493 - State and Political Subdivisions $ 24,657,876 $ - - - - Total 214,743,298 11,075,421 9,211,758 355,801 - $ 113,748,488 $ 77,537,911 $ 19,442,003 $ 24,657,876 $ 235,386,278 Commercial Real Estate Commercial and Industrial $ $ 90,581,881 9,447,786 17,856,862 2,384,468 - $ 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 Pass Special Mention Substandard Doubtful Loss Total Pass Special Mention Substandard Doubtful Loss Total Performing Nonperforming Total Performing Nonperforming Total Consumer 45,030,460 61,187 45,091,647 Consumer 44,872,546 153,709 45,026,255 $ $ $ $ 2012 Residential Real Estate 77,028,748 401,167 77,429,915 2011 Residential Real Estate 79,066,061 668,348 79,734,409 $ $ $ $ $ $ $ $ Total 122,059,208 462,354 122,521,562 Total 123,938,607 822,057 124,760,664 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: 2012 30-59 Days Past Due 60-89 Days Past Due 90 Days or Greater Past Due Total Past Due Current Total Loans Commercial real estate Commercial and industrial Agricultural State and political subdivision Consumer Residential real estate Total $ - 237,590 - 112,696 139,288 418,377 907,951 $ $ $ $ $ $ 27,099 81,851 3,675 - 43,201 - 155,826 3,517,492 80,560 323,002 - 61,187 401,167 4,383,408 3,544,591 400,001 326,677 112,696 243,676 819,544 5,447,185 110,203,897 77,137,910 19,115,326 24,545,180 44,847,971 76,610,371 352,460,655 113,748,488 77,537,911 19,442,003 24,657,876 45,091,647 77,429,915 357,907,840 $ $ $ $ $ 2011 30-59 Days Past Due 60-89 Days Past Due 90 Days or Greater Past Due Total Past Due Current Total Loans $ $ $ $ $ Commercial real estate Commercial and industrial Agricultural State and political subdivision 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 - $ 1,239,376 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 $ $ $ $ $ Recorded Investment 90 Days and Accruing - $ - - - 3,676 - 3,676 $ Recorded Investment 90 Days and Accruing - $ - - - 49,420 398,542 447,962 $ 20 30 21 31 notes to Consolidated Financial Statements notes to Consolidated Financial Statements 5. ALLOWANCE FOR LOAN LOSSES (Continued) 5. ALLOWANCE FOR LOAN LOSSES (Continued) Impaired Loans 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. Any consumer and residential real estate loans related to these delinquent loans are also considered to be impaired. Troubled debt restructurings are measured for impairment at the time of restructuring. 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: Recorded Investment Unpaid Principal Balance 2012 Related Allowance Average Recorded Investment Interest Income Recognized With no related allowance recorded: Commercial real estate Commercial and industrial Agricultural State and political subdivision Consumer Residential real estate $ With an allowance recorded: Commercial real estate Commercial and industrial Agricultural State and political subdivision Consumer Residential real estate Total: Commercial real estate Commercial and industrial Agricultural State and political subdivision Consumer Residential real estate $ 3,413,066 436,829 407,170 - 161,774 372,194 $ 3,413,066 436,829 407,170 - 161,774 372,194 4,791,033 4,791,033 $ - - - - - - - 948,655 1,143,091 - - - 220,827 948,655 1,143,091 - - - 220,827 2,312,573 2,312,573 4,361,721 1,579,920 407,170 - 161,774 593,021 4,361,721 1,579,920 407,170 - 161,774 593,021 309,060 645,765 - - - 22,240 977,065 309,060 645,765 - - - 22,240 $ 3,589,772 642,595 252,420 - 113,093 387,838 4,985,718 1,746,439 1,165,633 6,251 - 35,377 188,666 3,142,366 5,336,211 1,808,228 258,671 - 148,470 576,504 Total $ 7,103,606 $ 7,103,606 $ 977,065 $ 8,128,084 $ 32,786 10,993 - - - 753 44,532 2,955 - - - - - 2,955 35,741 10,993 - - - 753 47,487 With no related allowance recorded: Commercial real estate Commercial and industrial Agricultural State and political subdivision Consumer Residential real estate $ With an allowance recorded: Commercial real estate Commercial and industrial Agricultural State and political subdivision Consumer Residential real estate Total: Commercial real estate Commercial and industrial Agricultural State and political subdivision Consumer Residential real estate Recorded Investment Unpaid Principal Balance 2011 Related Allowance Average Recorded Investment Interest Income Recognized $ 2,561,616 287,539 90,993 - 57,083 231,066 $ 2,561,616 287,539 90,993 - 57,083 231,066 3,228,297 3,228,297 - - - - - - - $ $ 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 1,914,954 964,707 - - 47,206 38,740 1,914,954 964,707 - - 47,206 38,740 2,965,607 2,965,607 4,476,570 1,252,246 90,993 - 104,289 269,806 4,476,570 1,252,246 90,993 - 104,289 269,806 495,725 272,299 - - 29,000 59,840 856,864 495,725 272,299 - - 29,000 59,840 483,530 147,859 - - 11,801 22,598 665,788 2,802,306 1,384,513 173,373 - 106,786 247,160 - - - - - - - 129,281 59,394 3,893 - 8,351 4,112 205,031 Total $ 6,193,904 $ 6,193,904 $ 856,864 $ 4,714,138 $ 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 subdivision Consumer Residential real estate Total 2012 $ 4,361,721 1,579,920 407,170 - 161,774 593,021 $ 2011 4,476,570 1,252,246 90,993 - 104,289 269,806 $ 7,103,606 $ 6,193,904 22 32 23 33 notes to Consolidated Financial Statements notes to Consolidated Financial Statements 5. ALLOWANCE FOR LOAN LOSSES (Continued) 6. PREMISES AND EQUIPMENT Troubled Debt Restructuring Major classifications of premises and equipment are summarized as follows: The Company’s loan portfolio also includes certain loans that have been modified in a troubled debt restructuring, 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. 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, 2012 no specific reserves have been established against the troubled debt restructurings. Also, as of December 31, 2012 no charge-offs for the troubled debt restructurings were required. Loan modifications that are considered troubled debt restructurings completed during the years ended December 31 were as follows: 2012 Pre-Modification Post-Modification Number of Outstanding Recorded Outstanding Recorded Contracts Investment Investment Land and land improvements Building and leasehold improvements Furniture, fixtures, and equipment Less accumulated depreciation Total 2012 2011 $ $ 793,458 16,623,584 5,530,468 22,947,510 7,868,712 793,458 15,535,165 5,538,570 21,867,193 7,655,566 $ 15,078,798 $ 14,211,627 Depreciation and amortization charged to operations was $1,034,512 in 2012 and $937,985 in 2011. 7. GOODWILL As of each of the years ended December 31, 2012 and 2011, 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, 2012 and 2011. 8. DEPOSITS The scheduled maturities of time deposits approximate the following: Troubled debt restructurings: Commercial real estate Commercial and industrial Agricultural Residential real estate Total 2 2 1 3 8 $ 121,576 668,167 85,993 323,287 $ 121,576 668,167 85,993 323,287 $ 1,199,023 $ 1,199,023 2011 Pre-Modification Post-Modification Year Ending December 31, 2013 2014 2015 2016 2017 Thereafter Number of Outstanding Recorded Outstanding Recorded Contracts Investment Investment Troubled debt restructurings: Commercial real estate Commercial and industrial Total 4 1 5 $ 2,148,060 50,299 $ 2,148,060 50,299 $ 2,198,359 $ 2,198,359 $ Amount 78,690,900 29,957,826 17,120,175 5,561,284 6,765,087 20,596,270 $ 158,691,542 The aggregate of all time deposit accounts of $100,000 or more amounted to $54,466,112 and $62,843,237 at December 31, 2012 and 2011, 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, 2012 and 2011, respectively. The line of credit agreement contains various covenants requiring the Company to maintain certain levels of financial performance. 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 $ 2012 2011 $ 4,157,290 6,354,923 11,001,139 2.50% 1.43% 5,696,162 10,577,428 16,028,082 1.56% 1.93% 24 34 25 35 notes to Consolidated Financial Statements 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 n/a 01/07/13 07/17/13 07/08/13 03/23/19 03/17/35 n/a 11/14/17 06/26/18 07/08/13 03/02/21 11/23/35 Weighted- Average Interest Rate Stated Interest Rate Range From To At December 31, 2012 2011 n/a 3.09 3.36 1.53 7.82 4.21 % n/a % n/a % $ - $ 1.09 1.95 1.53 3.86 2.31 4.96 6.53 1.53 8.50 6.11 25,014,605 3,170,489 3,000,000 4,750,000 6,186,000 5,000,000 28,484,805 4,629,113 3,000,000 4,750,000 6,186,000 $ 42,121,094 $ 52,049,918 Maturities of other borrowings at December 31, 2012 are summarized as follows: Year Ending December 31, 2013 2014 2015 2016 2017 2018 and after $ Amount 15,262,119 4,217,600 4,026,822 2,012,000 5,457,229 11,145,324 $ 42,121,094 Weighted- Average Rate 3.34 % 3.19 2.81 1.34 2.35 5.79 3.70 % 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, 2012, the Bank’s maximum borrowing capacity with the FHLB was approximately $165 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 are 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. The Bank may request a Federal Reserve Advance secured by acceptable collateral. The Bank’s maximum borrowing capacity with the Federal Reserve Bank as of December 31, 2012, is approximately $11.7 million. 26 36 The Bank also maintains a $5.0 million and $4.0 million federal funds line of credit with two other financial institutions. The Bank did not have outstanding borrowings related to these lines of credit at December 31, 2012. 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. 11. INCOME TAXES The provision for federal income taxes consists of: Current Deferred Total provision 2012 2011 $ $ 507,193 31,885 $ 542,867 (104,051) 539,078 $ 438,816 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 Other 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 $ 2012 2011 $ 2,334,906 213,444 24,382 519,020 348,672 275,083 166,997 232,403 2,940 4,117,847 1,088,401 550,359 116,088 229,620 5,417 1,451,711 3,441,596 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 Net deferred tax assets $ 676,251 $ 889,145 No valuation allowance was established at December 31, 2012 and 2011 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. 27 37 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: Provision at statutory rate Tax-exempt interest Life insurance income Other Actual tax expense and effective rate 2012 2011 % of Pretax Income % $ 34.0 (17.4) (2.3) (1.3) Amount 1,385,395 (804,586) (99,776) (42,217) % of Pretax Income % 34.0 (19.7) (2.5) (1.0) Amount 1,417,418 (726,767) (96,343) (55,230) 539,078 13.0 % $ 438,816 10.8 % $ $ 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 2008 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 $251,048 and $214,295 for the years ended December 31, 2012 and 2011, respectively. The fair value of plan assets includes $705,376 and $627,270 pertaining to the value of the Company’s common stock that is held by the plan as of December 31, 2012 and 2011, respectively. Deferred Compensation Plan The Company has a nonqualified deferred compensation plan that allows directors to defer fees. Outstanding balances under this arrangement for 2012 and 2011 were $627,775 and $691,282, respectively, and are reported as “Other liabilities” on the Consolidated Balance Sheet. Expenses related to this plan were $50,398 and $1,616 for December 31, 2012 and 2011, respectively. notes to Consolidated Financial Statements 12. EMPLOYEE BENEFITS (Continued) Restricted Stock Plan 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 $203,857 and $193,319 for the years ended December 31, 2012 and 2011, respectively. The following is a summary of the status of the Company’s restricted stock as of December 31, 2012, and changes therein during the year then ended: Nonvested at January 1, 2012 Granted Vested Forfeited Number of Shares of Restricted Stock 9,522 4,748 (3,394) (733) Weighted- Average Grant Date Fair Value $ 62.89 61.17 63.98 61.39 Nonvested at December 31, 2012 10,143 $ 61.54 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, 2012 Granted Exercised Forfeited Outstanding, December 31, 2012 Exercisable at year-end Number of Options 78,237 12,200 - (11,301) 79,136 54,993 Weighted- Average Exercise Price 77.04 60.00 - 90.00 75.23 77.63 $ $ $ 28 38 29 39 notes to Consolidated Financial Statements 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, 2012: Grant Date 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 04/02/12 $ Exercise Price 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 60.00 Outstanding Contractual Average Life Average Exercise Price 1.00 $ 1.20 1.40 1.49 2.01 2.09 2.11 0.21 2.15 2.24 2.32 2.52 2.93 2.94 2.96 2.97 4.07 4.15 4.08 6.23 6.82 7.25 8.24 8.77 8.98 9.24 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 60.00 Shares 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 12,200 79,136 Exercisable Average Exercise Price 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 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 6,798 3,894 165 100 - 54,993 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. 13. COMMITMENTS (Continued) 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 2012 2011 $ $ 106,638,654 5,424,804 $ 94,033,585 5,091,765 112,063,458 $ 99,125,350 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, 2012 are as follows: 2013 2014 2015 2016 2017 Thereafter Total Minimum Lease Payment 272,992 269,032 269,032 235,363 235,363 3,598,280 4,880,062 $ $ Rent expense under leases for each of the years ended December 31, 2012 and 2011 was $364,896 and $285,923, 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. 30 40 31 41 notes to Consolidated Financial Statements notes to Consolidated Financial Statements 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, 2012 and 2011, was $1,503,000 and $1,513,000, 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 2013, without prior approval of the Comptroller, is approximately $8.1 million plus net profits retained in 2013 up to the date of the dividend declaration. 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, 2012 and 2011, 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. 15. REGULATORY CAPITAL (Continued) The Company’s actual capital ratios are presented in the following table that shows the Company met all regulatory capital requirements: 2012 2011 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 $ $ $ 58,458,296 33,288,986 41,611,233 % $ 14.05 8.00 10.00 55,927,625 32,307,719 40,384,648 48,203,132 16,644,493 24,966,740 % $ 11.58 4.00 6.00 45,912,913 16,153,859 24,230,789 48,203,132 22,334,023 27,917,528 % $ 8.63 4.00 5.00 45,912,913 22,229,663 27,787,078 % 13.85 8.00 10.00 % 11.37 4.00 6.00 % 8.26 4.00 5.00 The Bank’s actual capital ratios are presented in the following table which shows the Bank 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 2012 2011 Amount Ratio Amount Ratio $ $ $ 58,557,150 33,124,360 41,405,450 % $ 14.14 8.00 10.00 54,533,683 32,179,644 40,224,655 53,100,024 16,562,180 24,843,270 % $ 12.82 4.00 6.00 49,313,930 16,089,862 24,134,793 53,100,024 22,247,473 27,809,341 % $ 9.55 4.00 5.00 49,313,930 22,135,707 27,669,634 % 13.56 8.00 10.00 % 12.26 4.00 6.00 % 8.91 4.00 5.00 32 42 33 43 notes to Consolidated Financial Statements notes to Consolidated Financial Statements 16. FAIR VALUE MEASUREMENTS 16. FAIR VALUE MEASUREMENTS (Continued) 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. The following tables present the assets reported on the Consolidated Balance Sheet at their fair value as of December 31, 2012 and 2011, 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. 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, 2012 Level I Level II Level III Total $ - - - - $ 5,079,060 $ 45,273,820 51,230,329 3,495,781 - - $ 5,079,060 45,273,820 - 120,724 51,230,329 3,616,505 - - 218,244 30,796,274 135,875,264 - - 120,724 - 30,796,274 135,995,988 218,244 Total $ 218,244 $ 135,875,264 $ 120,724 $ 136,214,232 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 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 Total $ 363,789 $ 113,706,386 $ 100,317 $ 114,170,492 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, 2012 and 2011. Balance, January 1, 2011 Sales Net change on unrealized gain on investment securities available for sale Balance, January 1, 2012 Sales Net change on unrealized gain on investment securities available for sale Balance, December 31, 2012 Corporate Securities $ 1,454,151 (1,339,795) (14,039) 100,317 - 20,407 $ 120,724 The following tables present the assets measured on a nonrecurring basis on the Consolidated Balance Sheet at their fair value as of December 31, 2012 and 2011, 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 34 44 35 45 notes to Consolidated Financial Statements notes to Consolidated Financial Statements 16. FAIR VALUE MEASUREMENTS (Continued) 17. FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS 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 II Level III Total December 31, 2012 $ $ $ $ - - - Level I - - - $ - - - 6,126,540 $ 287,385 356,490 6,126,540 287,385 356,490 December 31, 2011 Level II Level III Total $ - - - $ 5,337,040 370,173 319,725 5,337,040 370,173 319,725 The following table provides a listing of significant unobservable inputs used in the fair value measurement process for items valued utilizing Level III techniques as of December 31, 2012. Corporate securities Fair Value $ 120,724 Impaired loans $ 6,126,541 Other real estate owned $ 287,385 Mortage servicing rights $ 356,490 Valuation Technique Discounted cash flows Property appraisals Property appraisals Discounted cash flows Unobservable Input Range Projected defaults 0 projected defaults Discount rate 17.76% discount rate Management discount for property type and recent market volatality Management discount for property type and recent market volatality 0% - 15% discount 0% - 15% discount Discount rate 2.11 - 2.75% discount Prepayment speeds 2.49 - 4.29 prepaymnet factor 135,875,264 - - - - - - - - - - 120,724 - 361,572,848 - - - 356,490 $ 164,018,944 - 42,741,294 - The estimated fair values of the Company’s financial instruments at December 31 are as follows: Carrying Value Fair Value 2012 Level I Level II Level III $ 23,792,622 2,374,375 $ 23,792,622 2,374,375 $ 23,792,622 2,374,375 $ $ - - - - 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: 136,214,232 584,380 351,040,470 4,794,900 12,517,831 1,806,098 356,490 136,214,232 584,380 361,572,848 4,794,900 12,517,831 1,806,098 356,490 218,244 584,380 - 4,794,900 12,517,831 1,806,098 - Deposits Short-term borrowings Other borrowings Accrued interest payable $ $ 460,447,071 4,157,290 42,121,094 766,587 465,777,223 4,157,290 42,741,294 766,587 $ 301,758,279 4,157,290 $ - 766,587 2011 Carrying Value Fair Value $ 41,181,771 1,619,833 $ 41,181,771 1,619,833 114,170,492 1,401,376 362,162,931 4,602,584 12,097,673 2,089,706 319,725 114,170,492 1,401,376 367,556,756 4,602,584 12,097,673 2,089,706 319,725 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: 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 36 46 37 47 notes to Consolidated Financial Statements notes to Consolidated Financial Statements 17. FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS (Continued) 17. FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS (Continued) 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. 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 Management has reviewed events occurring through March 20, 2013, the date the financial statements were issued, and no subsequent events occurred requiring accrual or disclosure. The fair value is equal to the current carrying value. Investment Securities Available for Sale 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. Loans 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. 38 48 39 49 the people of Kish Bank BOARD OF DIRECTORS OF KISH BANCORP, INC. William P. Hayes, Chairman James J. Lakso, Vice Chairman William L. Dancy, Secretary Spyros A. Degleris, Member William S. Lake, Member Alan J. Metzler, Member Phyllis L. Palm, Member Delmont R. Sunderland, Member BOARD OF DIRECTORS OF KISH BANK William P. Hayes, Chairman James J. Lakso, Vice Chairman William L. Dancy, Secretary Spyros A. Degleris, Member William S. Lake, Member Alan J. Metzler, Member Phyllis L. Palm, Member CENTRE COUNTy REGIONAl BOARD Randall A. Bachman, Member Thomas F. Brown, Member Spyros A. Degleris, Member David Horner, Member Michael J. Krentzman, 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 Phyllis L. Palm, Member John Pannizzo, Member ExECUTIVE OFFICERS William P. Hayes, President, Chief Executive Officer J. Bradley Scovill, Senior Executive Vice President, Chief Operating Officer John E. Arrington, Executive Vice President, Sales & Retail Banking Manager William J. Hoyne, Vice President, Chief Credit Officer 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 Walter J. Kay, Senior Vice President, Senior Information Officer Amy M. Muchler, Senior Vice President, Deposit Operations and Branch Administration Director Gerhard Royer, Senior Vice President, Commercial Lender Stanley N. Ayers, Vice President, Special Assets Manager 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 Manager John P. Cunningham, II, Vice President, Regional Market Manager Wade E. Curry, LUTCF, Vice President, Investment Services Ann K. Guss, Vice President, Residential Lender Allana L. Hartung, Vice President, Commercial Relationship Manager Gregory T. Hayes, Vice President, Loan Services Manager Carol M. Herrmann, Vice President, Administration and Communications Director/CEO, Kish Travel Marsha K. Kuhns, Vice President, Branch Manager John Q. Massie, Vice President, Commercial Relationship Manager Scott R. Reigle, Vice President, Accounting and Controls Manager/ BSA Officer Melissa K. Royer, Vice President, Service Support Manager & Security Officer Cheryl E. Shope, Vice President, Residential Lender Lana M. Walker, Vice President, Commercial Relationship Manager Debra K. Weikel, Vice President, Loan Operations Director Suzanne M. White, Vice President, Human Resource Director Jeffrey D. Wilson, Vice President, CEO, Kish Agency William W. Yaudes, Vice President, Regional Market Manager OFFICERS Kimberly A. Bubb, Assistant Vice President, Services and Systems Manager Oksana F. DeArment, Assistant Vice President, Administrative Services Manager Terra L. Decker, Assistant BSA Officer/Fraud Manager Lucinda K. Dell, Assistant Vice President, Mortgage Underwriting Manager Paul J. Fochler, Assistant Vice President, Risk Manager Carol K. Kennedy, Consumer Lending Officer Jeremy G. Mattern, Assistant Vice President, Credit Administration Manager Peter K. Ort, Branch Manager Matthew Q. Raptosh, Assistant Vice President, Commercial Lender Stephanie L. Strickler, CFMP, Assistant Vice President, Marketing Manager N. Robert Sunday, III, Assistant Vice President, Compliance Officer Kayelene Sunderland, Assistant Vice President, Wealth Management/ Trust Administrator D. Michael Whalen, General Manager, Kish Travel Penny L. Zesiger, Assistant Vice President, Residential Lender KISH BANK EMPlOyEES Natalie B. Allison, Commercial Documentation Specialist Tammy S. Anna, Customer Service Teller Amber V. Arnold, Deposit Operations Specialist Christina L. Bagrosky, Customer Service Teller Barry L. Bargo, Courier Douglas C. Baxter, Accounting Manager Melissa D. Beale, Customer Service Teller Sara M. Bean, Marketing and Communications Specialist Emily S. Bloom, Executive Assistant Julie L. Bond, Personal Banker Stacy A. Boozel, Mortgage Operations Specialist Megan M. Boyer, Customer Service Teller Linda M. Brechbiel, Administrative Assistant Terry L. Buckwalter, Customer Service Courier Brittany A. Byler, Customer Service Teller Ruth H. Carper, Mortgage Operations Underwriter Karen L. Carter, Mortgage Operations Underwriter Stephanie L. Chilcote, Lending Assistant Ashley A. Clark, Deposit Operations Specialist Brenda Collins, Mortgage Operations Specialist Alisha D. Cooper, Personal Banker Mary A. Cowher, Branch Manager Richard D. Crider, ALCO Specialist Jason M. Cunningham, Branch Manager Kati E. Deans, Mortgage Operations Specialist Peggy J. Dearing, Operations Assistant Jannifer N. Diehl, Loan Operations Specialist Mary S. Dietz, Collections Manager Megan D. Dietz, Investment Services Assistant Angela D. Drake, Service Support Specialist Brandi M. Dufford, Deposit Operations Specialist Amanda S. Dutrow, Administrative Assistant Alexis E. Ertley, Personal Banker Keatyn M. Fletcher, Loan Operations Specialist Ellen V. Fornicola, Personal Banker Troy J. Frank, Network Administrator Joshua A. Fritchman, Financial Analyst Jodie M. Gibboney, Personal Banker Karen S. Gilbert, Commercial Documentation Specialist Beth N. Metz Gilmore, Human Resources Assistant Janice Y. Glick, Personal Banking Specialist Jessica L. Grove, Loan Operations Specialist Candee A. Gutshall, Branch Operations Specialist Sharon A. Hall, Personal Banker Lisa J. Hamler, Customer Service Teller Jeffrey T. Hayes, Financial Advisor KISH TRAVEl EMPlOyEES Sandra K. Berardis, Travel Specialist Jolene Byler, Travel Specialist Donna R. Feicke, Administrative Assistant Sandra L. Hunley, Travel Specialist Antonietta M. Naimo, Personal Banker Seth J. Napikoski, Credit Analyst Carol A. Noland, BSA/Fraud Specialist Stanley E. Null, Courier Titus D. O, Personal Banker Valerie Ochs, Branch Manager D. James Owen, Residential Lender Melissa A. Paladino, Application Support Specialist Constance F. Palm, Residential Lender Chelsea N. Pannebaker, Customer Service Teller Anne E. Parks, Customer Service Teller Susan K. Peachey, Branch Operations Specialist Janet Pekar, Customer Service Teller Stephanie Powell, Deposit Operations Specialist Susan C. Rainey, Customer Service Teller Jesse L. Reed, Assistant Branch Manager Amber N. Resto, Personal Banker Linnea G. Ripka, Loan Operations Assistant Billie A. Rupert, Investment Services Assistant Krista M. Rupert, Customer Service Teller Elise C. Santarelli, Credit Analyst Leslie J. Sauer, Accounting Specialist Melissa A. Sellers, Consumer Lender April L. Shawver, Personal Banker Alison M. Shoop, Customer Service Teller Kylie M. Singer, Personal Banker Jolene S. Snare, Customer Service Teller Julie A. Snare, Payroll & Benefits Administrator Glenn E. Snyder, Jr., Facilities Manager Paula A. Stimeling, Mortgage Operations Specialist Wendy S. Strohecker, Deposit Operations Manager Crystal M. Sunderland, Service Support Specialist Angela E. Swartzentruber, Personal Banker Christopher E. Sweeney, Financial Planner Cynthia G. Swineford, Customer Service Teller Patricia A. Trinclisti, Customer Service Teller Donald L. Varner, Facilities Supervisor Jeanne L. Wagner, Customer Service Teller Dana E. Watson, Operations Assistant Rebecca M. Watt, Mortgage Operations Manager Elaine S. Weller, Branch Manager Debra J. Wert, Commercial Documentation Specialist Rick W. Wert, Information Security Administrator Danielle A. Yeater, Commercial Loan Operations Specialist Crystal D. Yoder, Customer Service Teller Delores K. Yoder, Commercial Documentation Specialist Judy A. Yoder, Customer Service Teller Roland G. Yoder, Courier Nancy A. Zimmerman, Personal Banker Alicia R. Zook, Customer Service Teller KISH INSURANCE EMPlOyEES Jennifer R. Beachel, Systems Operations Utilization Manager Arlene M. Byler, Commercial Lines Customer Service Representative Duane J. Coy, Insurance Specialist Megan S. Diemert, Personal Lines Insurance Specialist Marlene K. Johnson, Personal Lines Customer Service Representative Amber E. Oborski, Personal Lines Customer Service Representative Gina K. Perrin, Personal Lines Insurance Specialist Tracy S. Powell, Personal Lines Customer Service Representative Cindy J. Robinson, Commercial Lines Customer Service Representative J. Anthony Willard, Commercial Lines Insurance Specialist Natalie D. Xanthopoulos, Insurance Specialist Ashley L. Henry, Profitability Specialist R. Michael Henry, Technical Support Specialist Sallie M. Hicks, Branch Operations Specialist Donald F. Hindman, Courier Christina A. Hinkle, Commercial Documentation Specialist Lara A. Hoffman, Regional Assistant Branch Manager Sandra D. Hummel, Operations Assistant Lauren M. Jeranka, Loan Documentation Review Manager Karen M. Johnson, Personal Banker Paula J. Kauffman, Commercial Loan Operations Specialist Michael S. Kearns, Data Analyst John J. Keeler, Commercial Relationship Manager Lisa A. Kennedy, Training & Organizational Development Manager Brittany E. Kern, Services and Systems Analyst Darla S. King, Service Support Specialist Abbey N. Knepp, Services and Systems Analyst Cynthia G. Knorr, File Clerk Chelcee L. Kyle, Customer Service Teller Carolyn M. Leacy, Customer Service Teller Lori A. Legradi, Customer Service Teller Heidi C. Leonard, Consumer Lender Carmella J. Long, Personal Banker Tina K. McCurdy, Branch Operations Specialist Jackson K. McDonald, Credit Analyst Kathryn A. McKnight, Collections Assistant Kristie R. McKnight, Commercial Lender Trainee Duane K. McMullen, Jr., Accounting Specialist Shelley V. Merrell, Deposit Operations Specialist Mary A. Miller, Administrative Assistant Joanna M. Minium, Loan Operations Assistant Jennifer A. Mitchell, Mortgage Operations Underwriter Amanda J. Myers, Customer Service Teller Tina L. Nace, Loan Operations Specialist 50 51 

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