Kish Bancorp, Inc.
Annual Report 2018

Plain-text annual report

B E T T E R L I V E S , B E T T E R C O M M U N I T I E S . 2 0 1 8 A N N U A L R E P O R T W I L L I A M H A Y E S C H A I R M A N O F T H E B O A R D , P R E S I D E N T A N D C H I E F E X E C U T I V E O F F I C E R C O N T E N T S 1 Chairman’s Letter to the Shareholders 4 Financial Highlights 5 Independent Auditor’s Report 6 Financial Statements 11 Notes to Consolidated Financial Statements 56 Board of Directors and Officers KISH CLIENTS ON THE COVER (LEFT TO RIGHT): A. Christian Baum, Founder of Co.Space and Giv Local; Doreen Perks, Founder of Bob Perks Cancer Assistance Fund; Sherren and Pastor Harold McKenzie, Unity Church of Jesus Christ; Angie Thompson, Co-Owner of Thompson’s Candle Co.; and Luke Lake, General Manager of Lake Auto. C H A I R M A N ’ S L E T T E R T O T H E S H A R E H O L D E R S At Kish, it is not about what we do, it is about why we do it. the bulk of the more than $62 million expansion in the That “why” is the focus of everything we do, and in 2018, loan portfolio. The commercial lending team turned in that focus produced results that speak louder than words. another banner year of growth and business relation- So, this letter will begin with the measures that capture ship acquisition, while residential mortgage lending also the headlines of Kish Bancorp’s financial performance achieved another record year by originating more than for 2018 and a reiteration of the cover of the prior year’s $66 million in mortgage loans. The Bank’s capacity to annual report: Clear Vision, Compelling Results. remain competitive during the year was strengthened by Net income for the year rose by 45.63% over the prior year, or $1.89 million, to $6.03 million from $4.14 million in 2017. When the accounting adjustments associated the successful implementation of interest rate swap trans- actions that enabled us to offer long-term fixed rates while maintaining margins and balance sheet flexibility. with the Tax Cuts and Jobs Act are eliminated from 2017 Sustained loan and asset growth quickly translated into reported earnings, net income increased by 32.30%, the need to identify and attract new sources of funding. or $1.47 million, from $4.56 million. Earnings per share The corresponding focus on growing core deposits was growth, adjusted for October’s two-for-one stock split, reflected in several new checking promotions, each of reflected robust earnings expansion as well, increasing which was accompanied by substantial retail deposit 41.90% over the prior year, to a fully diluted $2.37 per growth. Overall, deposits grew by $28.7 million by year share from $1.67 the prior year. By every measure and end, although deposit growth was a carefully managed from every perspective, 2018 was truly a record year. Now area given the difficult challenges presented by Fed let’s discuss the performances that built these results and actions and a flattening yield curve. Deposit relationships the “why” that drives this team to excel across the full were also the focus of facilities enhancement and expan- spectrum of what we do as a company. sion projects, specifically in Bellefonte and Allensville. The outstanding results achieved in 2018 can be tracked through the excellent foundation built in recent years as Both of these branch facilities now reflect the evolution of a streamlined Expect More branch of the future. well as the performance metrics of every Kish business No discussion of 2018 operating results would be com- unit and support function. This letter will try to do justice plete without acknowledging the continuing growth of to the diversity of team efforts that produced so many the Bank’s affiliates. The addition of Benefit Management stellar outcomes, but the discussion must begin and end Group, now called Kish Benefits Consulting (KBC), was a with the driver of 2018 results: the sustained growth of major step forward that required broad organizational sup- the core banking unit. Following a strong 2017, Kish Bank began 2018 with a full head of steam. As the year progressed, continued loan growth, supported by a strengthening economy and turmoil among Kish’s banking competitors, enabled the Bank to sustain its efforts to expand the customer base, especially in the growth market of Centre County. Perhaps because business lending and mortgage lending are most influenced by a relationship-focused approach, these port and collaboration, but KBC responded by integrating seamlessly and contributing to profitability in its first year as part of the organization. Benefits management consult- ing represents a significant addition to the offering of val- ued solutions to our business clients. KBC’s performance, combined with double-digit growth in profitability from the wealth management unit, Kish Financial Solutions, and Kish Insurance, as well as sustained positive results from Kish Travel, added materially to our financial results in 2018. areas of our business remained central to our efforts to A major advancement for Kish shareholders occurred in drive growth and attract new customers and contributed 2018’s fourth quarter when Kish Bancorp (KISB) shares 1 were upgraded to the OTCQX exchange from the less liq- Finally, as I mentioned in the opening paragraph, a word uid pink sheets and saw a corresponding improvement in about the “why” of this extraordinary organization. 2018 price and trading execution. That up-listing was preceded was so incredible because it witnessed great performances by the announcement of a two-for-one stock split and a by so many teams at Kish, working independently and as split-adjusted dividend increase to $0.25 per share from one, and it reaffirmed a simple truth that we have always $0.23. As Kish Bancorp continues on its growth trajec- known. It takes great people to build great companies, and tory toward $1 billion in assets, the team is preparing for we are building a great company that made tremendous a major elevation in financial reporting and regulatory strides during the year because of a singular focus on reporting requirements. As we look to the future, let me close by noting that despite the strong performance in 2018, I am also awed by the scope and complexity of the plans for the next several years—plans that will fully position Kish to compete and thrive in a rapidly evolving digital environment. It will be an environment where client preferences for access to our services will change dramatically, yet expectations achieving sustained success through an unwavering focus on performance for our customers. As a team, we believe in our hearts that we can make the lives of our team members, our clients, and our communities better by our efforts. And, whether you are a customer, team member, shareholder, or simply a member of the communities served by Kish, we trust you have experienced and appre- ciate that belief and commitment. for highly personalized attention will be sustained and Thank you for your interest and support. Kish Bancorp will even elevated. That is why we are embarking upon two continue to benefit from your engagement and recommen- of the most significant initiatives in our long history of dations to others. innovation. The planning and construction of the Kish Innovation Center will begin to take shape in 2019. This facility, planned for completion in 2020, will enhance the digital delivery of banking services in an environment that is much lower cost and less dependent on physical bricks and mortar. That facility will become reality on the heels of our core system modernization initiative that will be accomplished over the next fourteen months. Both of these major initiatives will be designed to enhance competitiveness and efficiency as part of a larger focus on our Twin Rails strategy, which is the merger of our tradi- tional relationship approach with new emerging digital delivery channels, and the advancement of the Bank’s IT infrastructure. We understand that it will be the effective deployment of our shareholders’ capital that will be critical to Kish’s drive to succeed and thrive in that environment. Sincerely, William P. Hayes Chairman of the Board, President and Chief Executive Officer PICTURED OPPOSITE PAGE (CLOCKWISE FROM TOP), KISH EMPLOYEES: Lucas Craig, AVP, Financial Advisor; Crystal Yoder, Per- sonal Banker; Terry Horner, VP, Business Development Officer; Jackie Confer, AVP, Business Development Officer; and Alta Corman-Wolf, VP, Residential Lender. W H Y ? We believe that we can make the lives of those around us, our employees, our clients, and our communities BETTER! 2 3 F I N A N C I A L H I G H L I G H T S I N D E P E N D E N T A U D I T O R ’ S R E P O R T 2018 2017 2016 2015 2014 Board of Directors and Stockholders $ 6,029,683 $ 4,139,770 $ 4,616,894 $ 4,494,241 $ 4,358,608 Kish Bancorp, Inc. 6,670,247 2,396,453 5,141,399 2,301,564 5,254,277 2,130,197 5,125,151 2,112,600 5,130,129 2,005,848 REPORT ON THE FINANCIAL STATEMENTS FOR THE YEAR Net Income Net Income Before Taxes Total Dividends Declared AT YEAR END (in $000s) 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 Loans/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 $ 850,508 $ 811,192 $ 725,071 $ 696,895 $ 659,600 630,440 682,350 59,728 6,642 10 0.72% 10.71% 39.74% 92.39% 7.80% 11.95% 1.04% 0.00% 569,010 653,687 56,339 5,698 913 0.54% 7.45% 55.60% 87.05% 7.65% 11.65% 0.99% 0.17% 488,588 561,928 53,593 6,011 271 0.65% 8.54% 46.14% 86.95% 8.22% 13.10% 1.22% 0.06% 445,425 542,629 51,281 5,752 492 0.66% 8.89% 47.01% 82.09% 8.18% 12.62% 1.27% 0.12% 414,061 508,616 48,853 6,009 219 0.67% 9.54% 46.02% 81.41% 8.32% 13.07% 1.43% 0.05% $ 2.41 2.37 0.94 23.41 26.01 $ 1.69 1.67 0.92 22.50 24.77 $ 1.90 1.89 0.86 21.63 24.06 $ 1.87 1.84 0.86 20.89 23.23 $ 1.82 1.80 0.82 19.98 22.44 We have audited the accompanying consolidated financial statements of Kish Bancorp, Inc. and subsidiaries, which comprise the consolidated balance sheets as of December 31, 2018 and 2017; the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for the years then ended; and the related notes to the consolidated financial statements. MANAGEMENT’S RESPONSIBILITY FOR THE FINANCIAL STATEMENTS Management is responsible for the preparation and fair presentation of these consolidated financial statements, in accor- dance with accounting principles generally accepted in the United States of America; this includes the design, implemen- tation, 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 con- ducted 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 are free of material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consoli- dated financial statements. The procedures selected depend on the auditor’s judgment, including 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 consoli- dated financial statements. Average Shares Outstanding (#) 2,499,673 2,459,168 2,430,134 2,407,260 2,398,414 Net Income (in millions) Earnings & Dividends (per share)** Stock Valuation (per share)** We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. OPINION In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the finan- cial position of Kish Bancorp, Inc. and subsidiaries as of December 31, 2018 and 2017, and the results of their operations and their cash flows for the years then ended, in accordance with accounting principles generally accepted in the United States of America. *Due to fluctuations in the mark to market valuation for investment securities, these are not included in the totals for average assets and average equity. **For comparability, per share data for the years 2014 through 2017 have been adjusted to reflect the two-for-one stock split in 2018. S.R. Snodgrass, P.C. • 2009 Mackenzie Way, Suite 340 • Cranberry Township, Pennsylvania 16066 • Phone: 724-934-0344 • Fax: 724-934-0345 4 5 Cranberry Township, Pennsylvania March 4, 2019 C O N S O L I D A T E D B A L A N C E S H E E T KISH BANCORP, INC. 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, at fair value Equity Securities Investment Securities held to maturity, fair value of $7,095,937 and $6,162,790  Loans held for sale Loans Less allowance for loan losses Net loans Premises and equipment, net Goodwill Regulatory stock Bank-owned life insurance Accrued interest and other assets December 31, 2018 2017 $ 10,146,566 $ 22,622,212 32,768,778 7,964,222 35,923,762 43,887,984 3,119,532 124,731,597 3,450,017 3,492,344 135,995,777 4,051,862 7,000,000 156,565 6,000,000 1,279,431 637,082,546 6,642,410 630,440,136 574,708,035 5,697,810 569,010,225 14,182,308 2,143,699 6,110,700 15,422,560 10,983,033 12,996,668 2,143,699 6,149,000 15,437,997 10,746,897 TOTAL ASSETS $ 850,508,925 $ 811,191,883 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 $ 93,954,532 $ 12,234,873 64,318,889 253,787,230 258,054,517 682,350,041 22,484,169 78,024,955 7,921,055 790,780,220 85,526,265 11,986,932 63,773,855 233,973,580 258,426,421 653,687,053 8,930,710 85,931,850 6,303,539 754,853,152 Preferred stock, $.50 par value; 500,000 shares authorized, no shares issued and outstanding  Common stock, $.50 par value; 8,000,000 shares authorized, 2,697,500 and1,348,750 shares issued, at 2018 and 2017, respectively  Additional paid-in capital Retained earnings Accumulated other comprehensive (loss) income Treasury stock, at cost (130,609 and 171,584 shares in 2018 and 2017, respectively)  TOTAL STOCKHOLDERS' EQUITY - - 1,348,750 2,460,838 59,882,848 (1,301,777 ) (2,661,954 ) 59,728,705 674,375 2,066,936 56,207,032 509,366 (3,118,978 ) 56,338,731 C O N S O L I D A T E D S T A T E M E N T O F I N C O M E KISH BANCORP, INC. CONSOLIDATED STATEMENT OF INCOME Year Ended December 31, 2018 2017 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 $ 27,894,432 $ 1,193,287 2,582,358 1,065,457 592,171 636,019 33,963,724 5,764,414 35,536 2,406,694 8,206,644 25,757,080 955,000 22,855,386 1,336,603 2,655,876 1,332,272 345,042 602,245 29,127,424 3,864,807 22,677 2,138,665 6,026,149 23,101,275 600,000 NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 24,802,080 22,501,275 NONINTEREST INCOME Service fees on deposit accounts Investment securities gains, net Equity securities losses, net Gain on sale of loans Earnings on bank-owned life insurance Insurance commissions Travel agency commissions Wealth management Benefit management Other Total noninterest income NONINTEREST EXPENSE Salaries and employee benefits Occupancy and equipment Data processing Professional fees Advertising Federal deposit insurance Pennsylvania shares tax Other Total noninterest expense 1,691,041 3,471 (181,665 ) 858,426 421,086 1,225,075 311,250 1,516,089 473,720 1,121,147 7,439,640 15,556,450 2,982,508 2,293,683 243,482 265,547 390,700 615,828 3,223,275 25,571,473 1,614,103 101,117 - 866,798 429,766 1,128,094 377,295 1,399,589 - 607,702 6,423,346 14,633,030 2,878,318 2,089,133 315,071 252,065 237,000 598,948 2,880,774 23,884,340 Income before income taxes Income taxes (includes revaluation of net deferred tax asset due to tax reform in the amount of $416,852 for the year ended 2017)  6,670,247 5,040,282 640,564 1,001,629 NET INCOME EARNINGS PER SHARE Basic Diluted $ 6,029,683 $ 4,038,653 $ $ 2.41 $ 2.37 $ 1.69 1.67 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 850,508,925 $ 811,191,883 See accompanying notes to the consolidated financial statements. See accompanying notes to consolidated financial statements. 2 3 6 7 C O N S O L I D A T E D S T A T E M E N T O F C O M P R E H E N S I V E I N C O M E KISH BANCORP, INC. CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME C O N S O L I D A T E D S T A T E M E N T O F C H A N G E S I N S T O C K H O L D E R S ’ E Q U I T Y Net income Other comprehensive income (loss) Securities available for sale: Year Ended December 31, 2017 4,139,770 2018 6,029,683 $ $ Change in unrealized holding (losses) gains on available-for-sale securities Tax effect Change in comprehensive income related to cash flow hedges Tax effect Reclassification adjustment for net gains realized in net income Tax effect Total other comprehensive (loss) income (1,323,406 ) 277,918 (58,167 ) 12,215 (3,471 ) 729 (1,094,182 ) 485,646 (165,120 ) 93,989 (31,956 ) (101,117 ) 34,380 315,822 Total comprehensive income $ 4,935,501 $ 4,455,592 See accompanying notes to the consolidated financial statements. 4 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 ) s s o L ( e m o c n I d e n i a t e R s g n i n r a E l a n o i t i d d A n i - d i a P l a t i p a C n o m m o C k c o t S . C N I , P R O C N A B H S I K Y T I U Q E ’ S R E D L O H K C O T S N I S E G N A H C F O T N E M E T A T S D E T A D I L O S N O C 9 7 3 , 3 9 5 , 3 5 $ ) 1 5 0 , 7 1 9 , 3 ( $ 5 2 7 , 9 0 1 $ 6 4 6 , 2 5 4 , 4 5 $ 4 8 6 , 3 7 2 , 2 $ 5 7 3 , 4 7 6 $ 6 1 0 2 , 1 3 r e b m e c e D , e c n a l a B - - 2 2 9 , 1 3 2 2 8 , 5 1 3 0 7 7 , 9 3 1 , 4 - ) 6 1 0 , 5 1 1 ( 2 6 6 , 6 1 3 ) 5 6 5 , 1 0 3 , 2 ( ) 7 3 6 , 9 7 1 ( 4 9 3 , 7 3 5 0 2 7 , 8 8 4 ) 1 0 7 , 1 2 ( ) 7 3 6 , 9 7 1 ( 1 9 6 , 0 1 5 9 1 8 , 3 8 2 2 8 , 5 1 3 ) 9 1 8 , 3 8 ( 0 7 7 , 9 3 1 , 4 ) 5 6 5 , 1 0 3 , 2 ( 2 2 9 , 1 3 ) 0 2 7 , 8 8 4 ( ) 6 1 0 , 5 1 1 ( 1 0 7 , 1 2 2 6 6 , 6 1 3 3 0 7 , 6 2 ) s e r a h s 4 8 1 , 4 2 ( 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 ) s e r a h s 8 4 7 , 5 2 ( s n o i t p o k c o t s f o e s i c r e x E ) s e r a h s 6 4 0 , 1 ( 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 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 m o c n i e v i s n e h e r p m o c r e h t o d e t a l u m u c c a m o r f s t c e f f e x a t e m o c n i n i a t r e c f o n o i t a c i f i s s a l c e R 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 s s o l e v i s n e h e r p m o c r e h t O e m o c n i t e N ) s e r a h s 0 7 8 , 6 ( 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 6 9 7 , 4 2 ( k c o t s y r u s a e r t f o e l a S ) e r a h s r e p 2 9 . 0 $ ( s d n e d i v i d h s a C 1 3 7 , 8 3 3 , 6 5 $ ) 8 7 9 , 8 1 1 , 3 ( $ 6 6 3 , 9 0 5 $ 2 3 0 , 7 0 2 , 6 5 $ 6 3 9 , 6 6 0 , 2 $ 5 7 3 , 4 7 6 $ 7 1 0 2 , 1 3 r e b m e c e D , e c n a l a B - - - 1 0 4 , 8 4 3 8 6 , 9 2 0 , 6 ) 2 8 1 , 4 9 0 , 1 ( - ) 1 1 2 , 6 8 1 ( 5 8 0 , 7 1 4 ) 1 6 5 , 7 1 5 ( ) 3 5 4 , 6 9 3 , 2 ( 2 1 2 , 9 8 0 , 1 0 1 6 , 8 3 2 ) 4 1 7 , 3 1 ( ) 1 6 5 , 7 1 5 ( 9 8 6 , 9 4 7 ) 1 6 9 , 6 1 7 ( ) 2 8 1 , 4 9 0 , 1 ( 3 8 6 , 9 2 0 , 6 1 6 9 , 6 1 7 ) 5 7 3 , 4 7 6 ( ) 3 5 4 , 6 9 3 , 2 ( 1 0 4 , 8 4 ) 0 1 6 , 8 3 2 ( ) 1 1 2 , 6 8 1 ( 4 1 7 , 3 1 5 8 0 , 7 1 4 3 2 5 , 9 3 3 5 7 3 , 4 7 6 ) s e r a h s 6 8 2 , 5 1 ( 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 ) 0 5 7 , 8 4 3 , 1 ( d n e d i v i d a f o m r o f e h t n i d e t c e f f e t i l p s k c o t S ) s e r a h s 8 1 0 , 1 ( 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 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 ) s e r a h s 6 3 4 , 8 3 ( s n o i t p o k c o t s f o e s i c r e x E s e i t i r u c e s y t i u q e m o r f s t c e f f e n i a t r e c f o n o i t a c i f i s s a l c e R 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 ) s e r a h s 8 1 5 , 7 1 ( 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 5 2 2 , 4 4 ( k c o t s y r u s a e r t f o e l a S ) e r a h s r e p 4 9 . 0 $ ( s d n e d i v i d h s a C s s o l e v i s n e h e r p m o c r e h t O e m o c n i t e N 5 0 7 , 8 2 7 , 9 5 $ ) 4 5 9 , 1 6 6 , 2 ( $ ) 7 7 7 , 1 0 3 , 1 ( $ 8 4 8 , 2 8 8 , 9 5 $ 8 3 8 , 0 6 4 , 2 $ 0 5 7 , 8 4 3 , 1 $ 8 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 5 8 9 C O N S O L I D A T E D S T A T E M E N T O F C A S H F L O W S KISH BANCORP, INC. CONSOLIDATED STATEMENT OF CASH FLOWS N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S KISH BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS OPERATING ACTIVITIES Net income Adjustments to reconcile net income to net cash provided by operating activities: $ 6,029,683 $ 4,139,770 A summary of the significant accounting and reporting policies applied in the presentation of the accompanying consolidated financial statements follows: Year Ended December 31, 2018 2017 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Provision for loan losses Investment securities gains, net Equity security losses Proceeds from sale of loans held for sale Origination of loans held for sale Gain on sales of loans Depreciation, amortization, and accretion Deferred income taxes Increase in accrued interest receivable Increase in accrued interest payable Earnings on bank-owned life insurance Gain on sale of other assets Compensation expense Other, net Net cash provided by operating activities INVESTING ACTIVITIES Maturities of certificates of deposit Acquisition of Benefit Management Group Proceeds from Bank Owned Life Insurance Investment securities available for sale: Proceeds from sale of investments Proceeds from repayments and maturities Purchases Investment held to maturity: Purchases Proceeds from sale of equity securities Increase in loans, net Purchase of regulatory stock Redemption of regulatory stock Purchase of premises and equipment Proceeds from sale of other real estate owned Net cash used for investing activities FINANCING ACTIVITIES Increase in deposits, net Increase (decrease) in short-term borrowings, net Proceeds from other borrowings Repayments of other borrowings Purchases of treasury stock Proceeds from sale of treasury stock Exercise of stock options Cash dividends Net cash provided by financing activities Increase in cash and cash equivalents CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR CASH AND CASH EQUIVALENTS AT END OF YEAR SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the year for: Interest on deposits and borrowings Income taxes SUPPLEMENTAL DISCLOSURE OF NON-CASH CASH FLOW INFORMATION Real estate acquired in settlement of loans $ $ $ See accompanying notes to consolidated financial statements. 955,000 (3,471 ) 181,665 37,559,342 (35,578,050 ) (858,426 ) 1,291,020 250,189 (170,155 ) 197,152 (421,086 ) (14,910 ) 465,486 1,143,565 11,027,004 373,000 - 428,241 - 14,475,505 (4,751,525 ) (1,000,000 ) 420,180 (62,384,910 ) (1,250,200 ) 1,288,500 (2,265,909 ) 222,368 (54,444,750 ) 28,662,988 13,553,459 6,867,416 (14,774,310 ) (517,561 ) 1,089,212 (186,211 ) (2,396,453 ) 32,298,541 (11,119,206 ) 43,887,984 32,768,778 $ 600,000 (101,117 ) - 32,239,960 (31,646,497 ) (866,798 ) 1,339,186 283,626 (147,625 ) 329,023 (429,766 ) - 348,584 (1,858,280 ) 4,230,066 - (475,000 ) - 11,101,516 10,284,013 - - - (81,330,229 ) (1,493,400 ) 1,863,800 (1,246,667 ) 117,996 (61,177,971 ) 91,759,445 (5,852,208 ) 6,565,000 (9,982,027 ) (179,637 ) 537,394 (115,016 ) (2,301,564 ) 80,431,387 23,483,482 20,404,502 43,887,984 8,009,492 $ 150,000 5,693,614 1,225,000 - $ 308,000 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, Kish Bank (the “Bank”), Kish Travel Services, Inc., Tri-Valley Properties, LLC, and the Bank’s subsidiary, Kish Agency, Inc. 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 Pennsylvania Department of Banking and Securities 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. The consolidated financial statements include the accounts of Kish Bancorp, Inc. and its subsidiaries, Kish Bank and Kish Travel Services, Inc., after elimination of all significant 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. Debt 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 as of December 31, 2018 and 2017. Interest and dividends on investment securities is recognized as income when earned. 7 10 11 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Investment Securities (Continued) Loans (Continued) Securities are evaluated at least on 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 fair 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 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. Equity Securities Equity securities are held at fair value. Holding gains and losses are recorded in income. Dividends are recognized as income when earned. Regulatory Stock Common stock of the Federal Home Loan Bank (“FHLB”) of Pittsburgh represents ownership in an institution that is wholly owned by other financial institutions. These equity securities are accounted for at cost and are shown separately on the Consolidated Balance Sheet as regulatory stock. 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 that management has the intent and ability to hold for the foreseeable future or until maturity or payoff generally 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 the 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 fair value. 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. Allowance for Loan Losses 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. 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 homogeneous loans and are measured for impairment collectively. Loans that experience insignificant payment delays, which are defined as 90 days or less, generally are not classified as impaired. Management determines the significance of payment delays on a case-by-case basis, taking into consideration all circumstances 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. 12 13 8 9 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Allowance for Loan Losses (Continued) Income Taxes In addition to the allowance for loan losses, the Company also estimates probable losses related to unfunded lending commitments, such as letters of credit, financial guarantees, and unfunded loan commitments. Unfunded lending commitments are subject to individual reviews and are analyzed and segregated by risk according to the Company’s internal risk rating scale. These risk classifications, in conjunction with an analysis of historical loss experience, current economic conditions, performance trends within specific portfolio segments, and any other pertinent information, result in the estimation of the reserve for unfunded lending commitments. Provision for credit losses related to the loan portfolio and unfunded lending commitments are reported in the Consolidated Statement of Income. Premises and Equipment Land is carried at cost. Premises and equipment are stated at cost, less accumulated depreciation. Depreciation is 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. Leasehold improvements are depreciated over the shorter of the term of the lease or useful life. Expenditures for maintenance and repairs are charged against income as incurred. Costs of major additions and improvements are capitalized. Goodwill 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. 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. Treasury shares are not deemed outstanding for earnings per share calculations. Stock Split The Board of Directors declared a two-for-one stock split effected in the form of a stock dividend payable October 11, 2018. All references to share and per share amounts in the consolidated financial statements, except the Consolidated Balance Sheet, and accompanying notes to the consolidated financial statements have been retroactively restated to reflect the stock split. Stock Options As of December 31, 2018 and 2017, the Company recorded compensation expense of $48,401 and $31,922, respectively, related to share-based compensation awards. At December 31, 2018, there was approximately $87,744 in unrecognized compensation cost related to unvested share-based compensation awards granted. That cost is expected to be recognized over the next three years. 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 Expected Dividend Yield Risk-Free Interest Rate Expected Volatility Expected Life (in Years) 2018 2017 3.39 % 3.24 % 2.73 % 2.35 % 9.40 % 11.08 % 10.00 10.00 The weighted-average fair value of each stock option granted for 2018 and 2017 was $1.91 and $2.02, respectively. Stock options exercised during the years ended December 31, 2018 and 2017 were 38,436 and 25,748, respectively. 14 15 10 11 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Mortgage Servicing Rights (“MSRs”) Derivatives and Hedging Activities (Continued) 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, 2018 and 2017, the Company recorded gross servicing rights of $558,745 and $630,259, respectively, with a reserve for impairment of $169,523 and $214,725, 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. Derivatives and Hedging Activities The Company engages in a number of business activities that are vulnerable to interest rate risk. The associated variability in cash flows related to interest rate risk may impact the results of operations of the Company. The Company’s hedging objective is to reduce, to the extent possible, unpredictable cash flows associated with interest rate risk, via approved hedging strategies, related to business strategies and business objectives. All derivatives are recorded on the Consolidated Balance Sheet at fair value. The accounting for changes in the fair value of derivatives depends on whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. Changes in the fair value of derivatives designated as fair value hedges are recorded in earnings, together and in the same income statement line item with changes in the fair value of the related hedged item. Changes in the fair value of derivatives designated as cash flow hedges are recorded in accumulated other comprehensive loss and are reclassified into the line item in the income statement in which the hedged item is recorded and in the same period in which the hedged item affects earnings. Hedge ineffectiveness and gains and losses on the excluded component of a derivative in assessing hedge effectiveness are recorded in earnings. Revenue Recognition The Company’s revenue is comprised of net interest income on financial assets and liabilities, which is explicitly excluded from the scope of the new guidance, and noninterest income. Certain components of noninterest income such as interest rate swap income, income from rabbi trust investments, trading securities gains, gains on sales of mortgage loans, and gains on sales of securities available for sale are accounted for under other U.S. GAAP standards, and are therefore out of scope of the ASC 606 revenue standard. Insurance commissions, service charges on deposit accounts, debit card processing fees, and trust and investment advisory fees are within the scope of the ASC 606 revenue standard. As such, the Company is currently reviewing contracts related to these revenue streams and at this point does not anticipate any material changes to revenue recognition upon adoption; however, the Company’s review is still ongoing. The Company plans to adopt the revenue recognition guidance on January 1, 2019 and anticipates using the modified retrospective transition method upon adoption. 16 17 12 13 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 2. EARNINGS PER SHARE Newly Adopted Accounting Standards In January 2016, the FASB finalized ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This accounting standard: (a) requires separate presentation of equity instruments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) on the balance sheet and measured at fair value with changes in fair value recognized in net income; (b) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (c) eliminates the requirement to disclose the fair values of financials instruments measured at amortized cost for entities that are not significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (d) requires public business entities to use the exit price notion when measuring the fair value of financials instruments for disclosure purposes; (e) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (f) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The adoption resulted in the Company recognizing a one-time cumulative effect adjustment of $716,961 between accumulated other comprehensive loss and retained earnings on the Consolidated Balance Sheet for the fair value of equity securities included in accumulated other comprehensive loss as of the beginning of the period. The adjustment had no impact on net income on any prior periods presented. The Company has adopted this standard during the reporting period. On a prospective basis, the Company implemented changes to the measurement of the fair value of financials instruments using an exit price notion for disclosure purposes included in Note 17 to the financial statements. The December 31, 2017, fair value of each class of financial instruments disclosure did not utilize the exit price notion when measuring fair value, and, therefore, may not be comparable to the December 31, 2018 disclosure. 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 issued 2,697,500 2,697,500 2018 2017 Average treasury stock shares (145,755 ) (193,032 ) 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  (52,072 ) (45,300 ) 2,499,673 2,459,168 747 224 48,853 29,866 2,549,273 2,489,258 Options to purchase 210,466 shares of common stock at a price of $12.75 to $29.63, as of December 31, 2018, and 48,974 shares of restricted stock ranging in price from $18.25 to $30.25 were not included in the computation of diluted earnings per share. To include these shares would have been antidilutive. Options to purchase 212,870 shares of common stock at a price of $12.75 to $27.00, as of December 31, 2017, and 50,392 shares of restricted stock ranging in price from $30.00 to $55.13 were not included in the computation of diluted earnings per share. To include these shares would have been antidilutive. 18 19 14 15 3. INVESTMENT SECURITIES 3. INVESTMENT SECURITIES (Continued) The amortized cost, gross unrealized gains and losses, and fair value of investment securities are as follows: 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, 2018 and 2017. Gross 2018 Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value Available for Sale: U.S. treasury securities U.S. government agency securities Obligations of states and political subdivisions  Corporate securities Mortgage-backed securities in government-sponsored entities  $ 6,995,422 $ 36,722,369 - $ - (301,712 ) $ 6,693,710 (951,146 ) 35,771,223 46,044,802 236,722 (106,440 ) 46,175,084 19,331,836 21,052 (294,807 ) 19,058,081 17,320,809 17,651 (304,961 ) 17,033,499 Total Available for Sale $ 126,415,238 $ 275,425 $ (1,959,066 ) $ 124,731,597 Held to Maturity: Corporate Securities $ 7,000,000 $ 95,937 $ - $ 7,095,937 Gross 2017 Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value Available for Sale: U.S. treasury securities U.S. government agency securities Obligations of states and political subdivisions  Corporate securities Mortgage-backed securities in government-sponsored entities  $ 6,996,146 $ 32,743,522 - $ - (250,696 ) $ 6,745,450 (675,334 ) 32,068,188 51,262,205 667,103 (66,648 ) 51,862,660 23,894,085 176,694 (122,423 ) 23,948,356 21,456,583 80,649 (166,109 ) 21,371,123 Total Available for Sale $ 136,352,541 $ 924,446 $ (1,281,210 ) $ 135,995,777 Held to Maturity: Corporate Securities $ 6,000,000 $ 162,790 $ - $ 6,162,790 Less than Twelve Months 2018 Twelve Months or Greater Total Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses $ - $ - - $ 6,693,710 $ (301,712 ) $ 6,693,710 $ (301,712 ) - 35,771,223 (951,146 ) 35,771,223 (951,146 ) 5,043,758 6,964,881 (5,817 ) 12,264,334 (100,623 ) 17,308,092 (106,440 ) (42,206 ) 8,719,132 (252,601 ) 15,684,013 (294,807 ) 817,977 $ 12,826,616 $ (1,151 ) 14,481,602 (303,810 ) 15,299,579 (304,961 ) (49,174 ) $ 77,930,001 $ (1,909,892 ) $ 90,756,617 $ (1,959,066 ) Less than Twelve Months 2017 Twelve Months or Greater Total Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses $ 975,350 $ (10,735 ) $ 5,770,100 $ (239,961 ) $ 6,745,450 $ (250,696 ) 11,417,325 (120,511 ) 20,650,863 (554,823 ) 32,068,188 (675,334 ) 6,087,843 3,083,422 (54,512 ) 697,451 (29,545 ) 7,571,993 (12,136 ) 6,785,294 (66,648 ) (92,877 ) 10,655,415 (122,423 ) 15,075,655 (113,514 ) 2,460,569 (52,595 ) 17,536,224 (166,109 ) $ 36,639,595 $ (328,817 ) $ 37,150,976 $ (952,392 ) $ 73,790,571 $ (1,281,210 ) 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 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 20 21 16 17 3. INVESTMENT SECURITIES (Continued) 3. INVESTMENT SECURITIES (Continued) U.S. treasury securities. The unrealized loss on 4 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, 2018. U.S. government agency securities. The unrealized loss on 35 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, 2018. Obligations of states and political subdivisions. The Company’s unrealized losses on 32 municipal bonds relate to investments within the governmental service sector. The unrealized losses are primarily caused by interest rate increases. 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, 2018. Corporate securities. The Company had unrealized losses on investments in 26 different debt securities that were primarily the result of interest rate increases. 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 these securities and it is not more likely than not that the Company will be required to sell the investments before recovery of the amortized cost basis, it does not consider these investments to be other- than-temporarily impaired at December 31, 2018. Mortgage-backed securities in government-sponsored entities. The unrealized losses on 18 of the Company’s investments in mortgage-backed securities were caused by interest rate increases. The Company purchased 0 of these investments at a premium relative to its face amount, and the contractual cash flows of the investments are guaranteed by an agency of the U.S. government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost basis of the Company’s 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 investments and it is not more likely than not that the Company will be required to sell the investments before recovery of its amortized cost basis, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2018. The amortized cost and fair value of debt securities at December 31, 2018, 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. Available for Sale Held to Maturity Due in one year or less Due after one year through five years Due after five years through ten years Due after ten years Amortized Cost Fair Value Amortized Fair Cost Value - $ - - $ 9,158,013 $ 9,138,559 $ - 72,283,428 71,468,860 36,032,633 35,382,650 7,000,000 7,095,937 - 8,941,164 8,741,528 - Total $ 126,415,238 $ 124,731,597 $ 7,000,000 $ 7,095,937 Investment securities with a carrying value of $112,773,196 and $130,015,638 at December 31, 2018 and 2017, 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 Proceeds from calls Gross gains Gross losses Equity Securities 2018 $ 1,055,000 3,471 2017 - $ 9,508,717 - 28,806 - (404,908 ) At December 31, 2017, the Company had $4,051,862 in equity securities recorded at fair value. Prior to January 1, 2018, equity securities were stated at fair value with unrealized gains and losses reported as a separate component of accumulated other comprehensive income, net of tax. At December 31, 2017, net unrealized gains of $716,961 had been recognized in accumulated other comprehensive income. On January 1, 2018, these unrealized gains and losses were reclassified out of accumulated other comprehensive income and into retained earnings with subsequent changes in fair value being recognized in net equity securities gains (losses). The following summary of unrealized and realized gains and losses recognized in net income on equity securities during the year ended December 31, 2018: Net gains (losses) recognized in equity securities during the year Less: Net gains (losses) realized on sale of equity securities during the year Unrealized gains (losses) recognized in equity securities held at reporting date $ $ 2017 2018 (181,665 ) $ 907,546 - (242,430 ) $ 907,546 60,765 22 23 18 19 4. LOANS 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 2018 2017 $ 216,677,128 $ 190,488,417 102,347,634 98,104,822 29,875,122 27,793,961 39,747,975 38,247,171 8,256,192 9,644,462 240,178,495 210,429,202 637,082,546 574,708,035 6,642,410 5,697,810 Net loans $ 630,440,136 $ 569,010,225 Mortgage loans serviced by the Company for others amounted to $55,853,584 and $63,196,825 at December 31, 2018 and 2017, respectively. Unearned fees included in loans receivable amounted to $14,400 and $15,662 at December 31, 2018 and 2017, 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, 2018 and 2017, 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, 2018 and 2017, is as follows: Balance Amounts Balance Amounts Balance 2016 Additions Collected 2017 Additions Collected 2018 $ 13,199,731 $ 4,782,315 $ (1,280,296 ) $ 16,701,750 $ 2,077,750 $ (1,743,239 ) $ 17,036,261 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 five-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 non-classified loans. The following qualitative factors are analyzed to determine allocations for non-classified 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 24 25 20 21 5. ALLOWANCE FOR LOAN LOSSES (Continued) 5. ALLOWANCE FOR LOAN LOSSES (Continued) These qualitative factors are reviewed each quarter and adjusted based upon relevant changes within the Bank’s operating environment. During 2018, management decreased the qualitative factors reserve percentage for the commercial and industrial and commercial real estate pool of loans because of improving economic conditions both locally and nationally. Further reductions in the commercial and industrial and commercial real estate qualitative factors reserve percentages were made due to the consistent and experienced loan and credit staff in these areas. The qualitative factor reserve percentage for the commercial real estate pool of loans also decreased due to the downward trend of past due loans. Management decreased qualitative factors on reserve percentages for commercial and industrial loan participations transacted with the BancAlliance portfolio for related changes in the economic and business conditions and in the competitive, legal, and regulatory environment of this sector. Management increased the qualitative factors reserve percentage for commercial and industrial, commercial real estate, and the residential pool of loans due to an increase in the volume of these loan portfolios. The qualitative factors reserve for commercial Ag were increased due to changes in economic and business conditions. Management decreased the qualitative factors reserve percentage for Lending Club due to portfolio balances declining approximately one-third of where they were upon inception. Strong asset quality supported by low levels of past-due, non-accrual, and classified loans, and a diversified portfolio with minimal levels of concentration support management’s decision to have the remaining qualitative factor reserve percentages unchanged in 2018. 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 the lowest risk, 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: 2018 State and Commercial Political Real Estate Industrial Agricultural Subdivisions Consumer Real Estate Unallocated Commercial and Residential Total Allowance for loan  losses: Beginning balance  Charge-offs Recoveries Provision $ 2,498,768 $ 1,230,243 $ (35,963 ) 13,754 220,767 - 304,875 (144,384 ) 266,516 $ (9,559 ) 946 242,327 182,082 $ 134,224 $ 1,363,855 $ (184,719 ) - 427,441 - (121,164 ) 21,430 - 62,047 6,579 22,122 $ 5,697,810 (351,405 ) 341,005 955,000 - - 140,223 Ending balance  $ 2,659,259 $ 1,428,801 $ 500,230 $ 188,661 $ 96,537 $ 1,606,577 $ 162,345 $ 6,642,410 Ending balance  individually evaluated  for impairment  $ 16,523 $ 2,967 $ 47,255 $ - $ - $ 27,843 $ - $ 94,588 Ending balance  collectively evaluated  for impairment  $ 2,642,736 $ 1,425,834 $ 452,975 $ 188,661 $ 96,537 $ 1,578,734 $ 162,345 $ 6,547,822 Loans: Individually evaluated  for impairment  $ 1,556,745 $ 147,735 $ 308,024 $ - $ - $ 527,519 $ 2,540,023 Collectively evaluated  for impairment  215,120,383 102,199,899 29,567,098 39,747,975 8,256,192 239,650,976 634,542,523 Ending balance  $ 216,677,128 $ 102,347,634 $ 29,875,122 $ 39,747,975 $ 8,256,192 $ 240,178,495 $ 637,082,546 26 27 22 23 5. ALLOWANCE FOR LOAN LOSSES (Continued) 5. ALLOWANCE FOR LOAN LOSSES (Continued) Commercial and Commercial Real Estate Industrial 2017 State and Political Residential Agricultural Subdivisions Consumer 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  Ending balance  $ 2,387,561 $ 1,086,099 $ (210,459 ) 8,132 346,471 (550,350 ) 7,677 653,880 215,719 $ - 900 49,897 204,977 $ 155,602 $ 1,383,750 $ (53,881 ) - 33,986 - (127,675 ) 12,297 - 94,000 (22,895 ) 577,461 $ 6,011,169 (942,365 ) 29,006 600,000 - - (555,339 ) $ 2,498,768 $ 1,230,243 $ 266,516 $ 182,082 $ 134,224 $ 1,363,855 $ 22,122 $ 5,697,810 $ 2,796 $ 12,286 $ 31,341 $ - $ - $ 28,059 $ - $ 74,482 $ 2,495,972 $ 1,217,957 $ 235,175 $ 182,082 $ 134,224 $ 1,335,796 $ 22,122 $ 5,623,328 $ 4,680,918 $ 382,014 $ 297,105 $ 77,085 $ - $ 470,589 $ 5,907,711 185,807,499 97,722,808 27,496,856 38,170,086 9,644,462 209,958,613 568,800,324 $ 190,488,417 $ 98,104,822 $ 27,793,961 $ 38,247,171 $ 9,644,462 $ 210,429,202 $ 574,708,035 From 2017 to 2018, the reserve requirement for commercial real estate loans increased by $160,491, for residential real estate loans increased by $242,722, for agricultural loans increased by $233,714, and for commercial and industrial loans increased by $198,558 during the same period. This was a result of increases in outstanding balances in each loan category during 2018. In addition, agricultural loans increased due to a large increase in substandard and commercial and industrial loans increased due to a large increase in substandard and Special Mention. At December 31, 2018, total impaired and criticized assets and classified assets for commercial real estate loans was $4.5 million. This is a $684,173 decrease from December 31, 2017, or a decrease of 13.2%. This difference was due to a decrease in impaired and criticized assets of $3.2 million, net an increase of $2.6 million in classified assets. Credit Quality Information The following tables represent the commercial credit exposures by internally-assigned grades for the years ended December 31, 2018 and 2017, 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. Credit Quality Information (Continued) 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 and Commercial Real Estate Industrial 2018 State and Political Agricultural Subdivisions Total Pass Special Mention Substandard Doubtful Total Pass Special Mention Substandard Doubtful Total $ 212,159,157 $ 90,408,028 $ 24,713,695 $ 39,747,975 $ 367,028,855 - 14,366,012 3,344,988 11,021,024 - 6,049,471 - 1,172,983 - 1,203,521 $ 216,677,128 $ 102,347,634 $ 29,875,122 $ 39,747,975 $ 388,647,859 - 918,582 5,130,889 30,538 - 2017 Commercial and State and Political Commercial Real Estate Industrial Agricultural Subdivisions Total $ 185,286,273 $ 94,080,746 $ 27,222,926 $ 38,247,171 $ 344,837,116 - 4,381,674 960,585 - - 4,422,711 - 4,454,996 $ 190,488,417 $ 98,104,821 $ 27,793,962 $ 38,247,171 $ 354,634,371 779,433 3,112,341 879,449 32,285 489,900 81,136 - 28 29 24 25 5. ALLOWANCE FOR LOAN LOSSES (Continued) 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: 2018 Residential Real Estate Total Consumer Performing Nonperforming Total Performing Nonperforming Total $ 8,256,192 $ 239,975,590 $ 248,231,782 202,905 $ 8,256,192 $ 240,178,495 $ 248,434,687 202,905 - 2017 Residential Real Estate Total Consumer $ 9,644,462 $ 210,212,909 $ 219,857,371 216,293 $ 9,644,462 $ 210,429,202 $ 220,073,664 216,293 - 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: 2018 30-59 Days  90 Days or Greater  Past Due Past Due Past Due Past Due Current 60-89 Days  Total Total Loans 90 Days and Accruing 5. ALLOWANCE FOR LOAN LOSSES (Continued) Age Analysis of Past-Due Loans by Class (Continued) 2017 30-59 Days  90 Days or Greater  Past Due Past Due Past Due Past Due Current 60-89 Days  Total Total Loans 90 Days and Accruing Commercial real estate Commercial and industrial  Agricultural State and political subdivisions Consumer Residential real estate Total $ - $ - $ 4,422,711 $ 4,422,711 $ 186,065,706 $ 190,488,417 $ - 6,334 32,285 47,177 - - 38,619 47,177 27,746,784 27,793,961 98,104,822 98,066,203 - 2,407 687,599 $ 737,183 $ - 38,247,171 38,247,171 - - 2,407 9,642,055 9,644,462 - 216,293 903,892 209,525,310 210,429,202 6,334 $ 4,671,289 $ 5,414,806 $ 569,293,229 $ 574,708,035 $ - - - - - - - - - Consumer mortgage loans held by the Company in the process of foreclosure amounted to $308,895 as of December 31, 2018. Impaired Loans 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. Commercial real estate Commercial and industrial  Agricultural State and political subdivisions Consumer Residential real estate Total $ 162,971 $ - $ 1,172,983 $ 1,335,954 $ 215,341,174 $ 216,677,128 $ - - - - 102,347,634 102,347,634 78,222 10,000 30,538 118,760 29,756,362 29,875,122 - - 39,747,975 39,747,975 5,029 5,029 8,251,163 8,256,192 1,476 202,905 496,085 239,682,410 240,178,495 291,704 $ 537,926 $ 11,476 $ 1,406,426 $ 1,955,828 $ 635,126,718 $ 637,082,546 $ - - - - - - - - - - - 30 31 26 27 5. ALLOWANCE FOR LOAN LOSSES (Continued) 5. ALLOWANCE FOR LOAN LOSSES (Continued) Impaired Loans (Continued) Impaired Loans (Continued) The following tables include the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount as of December 31: 2018 Unpaid Recorded Principal Related Investment Balance Allowance Investment Recognized Average Recorded Interest Income $ 1,377,295 $ 1,377,295 $ - $ 2,797,828 $ 10,874 - - 42,895 42,895 - - 175,644 57,604 - - 324,290 - - 324,290 - - - 6,390 - 259,406 - 2,900 - - 4,290 1,744,480 1,744,480 - 3,296,872 18,064 179,449 179,449 16,523 179,626 11,794 147,735 265,129 147,735 265,129 2,967 47,255 25,189 239,601 9,819 13,996 - - 203,230 - - 203,230 - - 27,843 - 4,292 192,642 - - 10,152 795,543 795,543 94,588 641,350 45,761 With no related allowance recorded:  Commercial real estate Commercial and industrial Agricultural State and political subdivisions  Consumer Residential real estate With an allowance recorded: Commercial real estate Commercial and industrial Agricultural State and political subdivisions  Consumer Residential real estate Total: Commercial real estate Commercial and industrial Agricultural State and political subdivisions  Consumer Residential real estate Commercial real estate Commercial and industrial Agricultural State and political subdivisions  Consumer Residential real estate Unpaid Recorded Principal Related Investment Balance Average Recorded Interest Income Allowance Investment Recognized 2017 With no related allowance recorded:  $ 4,646,148 $ 4,646,148 $ 203,505 94,659 203,505 94,659 - $ 5,834,297 $ 243,207 - 101,588 - 11,811 10,859 5,490 77,085 77,085 - 290,815 - 290,815 - - - 80,931 - 579,843 3,715 - 5,489 5,312,212 5,312,212 - 6,839,866 37,364 With an allowance recorded: Commercial real estate Commercial and industrial Agricultural State and political subdivisions  Consumer Residential real estate Total: 34,770 178,509 202,446 34,770 178,509 202,446 2,796 12,286 31,341 714,262 90,889 205,897 1,907 12,509 9,318 - - 179,774 - - 179,774 - - 28,059 - 19,333 198,159 - - 9,026 595,499 595,499 74,482 1,228,540 32,760 Commercial real estate Commercial and industrial Agricultural State and political subdivisions  Consumer Residential real estate 4,680,918 4,680,918 382,014 297,105 382,014 297,105 2,796 6,548,559 334,096 12,286 307,485 31,341 77,085 77,085 - 470,589 - 470,589 - - 28,059 80,931 19,333 778,002 13,718 23,368 14,808 3,715 - 14,515 1,556,745 1,556,744 16,523 2,977,454 22,668 Total $ 5,907,711 $ 5,907,711 $ 74,482 $ 8,068,406 $ 70,124 147,735 308,024 147,735 308,024 2,967 47,255 200,833 297,205 9,819 16,896 - - 527,519 - - 527,520 - - 27,843 6,390 4,292 452,048 - - 14,442 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. Interest income that would have been recorded on nonaccrual loans in accordance with their original terms totaled approximately $600,000 in 2018 and $1.2 million in 2017. Total $ 2,540,023 $ 2,540,023 $ 94,588 $ 3,938,222 $ 63,825 32 33 28 29 5. ALLOWANCE FOR LOAN LOSSES (Continued) 6. PREMISES AND EQUIPMENT Nonaccrual Loans (Continued) Major classifications of premises and equipment are summarized as follows: The following table includes the loan balances on nonaccrual status as of December 31: Commercial real estate Commercial and industrial Agricultural Residential real estate Total Troubled Debt Restructuring (TDRs) 2018 2017 $ 1,172,983 $ 4,422,711 32,285 - - 30,538 202,905 216,293 $ 1,406,426 $ 4,671,289 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. 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, either through a charge-off to the allowance or a specific reserve. Segment and class status are determined by the loan’s classification at origination. As of December 31, 2018, a specific reserve allocation of $94,588 has been established against the troubled debt restructurings and no charge-offs for the troubled debt restructurings were required. The restructuring of the below loan was due to an extension of the maturity date. No modifications involved any changes in principal balance for 2018 or 2017. There were no loans modified in a troubled debt restructuring from January 1, 2016 through December 31, 2017, that subsequently defaulted (i.e., 90 days or more past due following a modification) during the years ended December 31, 2018 and 2017, respectively. There were no loan modifications that were considered troubled debt restructurings for the year ended December 31, 2017. Loan modifications that are considered troubled debt restructurings completed during the year ended December 31, 2018 were as follows: 2018 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 2018 2017 $ 2,200,547 $ 1,307,103 18,496,846 17,762,296 7,242,320 6,840,866 27,939,713 25,910,265 13,757,405 12,913,597 $ 14,182,308 $ 12,996,668 Depreciation charged to operations was $1,074,414 in 2018 and $1,016,345 in 2017. 7. GOODWILL As of the years ended December 31, 2018 and 2017, goodwill had a gross carrying amount of $2,757,712 and accumulated amortization of $614,013 for a net carrying value of $2,143,699. The carrying amount of goodwill was tested for impairment in the fourth quarter, after the annual forecasting process. There was no impairment for the years ended December 31, 2018 and 2017. 8. DEPOSITS The scheduled maturities of time deposits approximate the following: Year Ending December 31, 2019 2020 2021 2022 2023 Thereafter $ $ Amount 132,592,762 74,426,994 25,907,659 18,120,019 5,748,166 1,258,916 258,054,517 The aggregate of all time deposit accounts of $250,000 or more amounted to $65,257,519 and $93,941,525 at December 31, 2018 and 2017, respectively. The total amount of Brokered Deposits included above for each of the years ended December 31, 2018 and 2017 were $2,800,000 and $5,662,000, respectively. Depositors with over 5% of total deposits include one depositor at $14.9 million as of December 31, 2018. Troubled debt restructurings: Commercial and industrial 1 $ 17,577 $ 17,577 34 35 30 31 9. SHORT-TERM BORROWINGS 10. OTHER BORROWINGS (Continued) Short-term borrowings include overnight repurchase agreements through the FHLB, federal funds purchased, and repurchase agreements with customers. Short-term borrowings also include funds from a $5,000,000 unsecured line of credit with a commercial bank for the years ended December 31, 2018 and 2017, 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 2018 2017 $ 22,484,169 $ 8,930,710 19,831,315 5,333,368 23,647,311 10,018,072 2.52 % 0.35 % 1.34 % 0.58 % The collateral pledged on the repurchase agreements by the remaining contractual maturity of the repurchase agreements in the Consolidated Balance Sheets as of years ended December 31, 2018 and 2017, is presented in the following table. Remaining Contractual Maturity Overnight and Continuous December 31, 2018 December 31, 2017 Securities of U.S Government Agencies, U.S Treasuries and obligations of state and political subdivisions pledged, fair value  Repurchase agreements $ 7,465,235 $ 2,104,169 3,600,854 2,550,710 10. OTHER BORROWINGS The following table sets forth information concerning other borrowings: Maturity Range Weighted- Stated Interest Average Rate Range At December 31, Description From To Interest Rate Fixed rate 05/03/19 08/04/26 2.05 Fixed rate amortizing 02/04/19 07/15/24 1.72 Mid-term repos 01/29/19 01/29/19 1.30 Subordinated capital notes  Note payable 03/24/24 03/03/26 5.07 03/17/35 11/23/35 4.47 From To 2018 2017 % 1.04 % 1.08 1.30 4.00 % $ 50,621,498 $ 50,297,498 1.96 10,097,457 13,328,352 1.30 1,000,000 6,000,000 4.75 4.15 5.25 10,120,000 10,120,000 4.79 6,186,000 6,186,000 $ 78,024,955 $ 85,931,850 Maturities of other borrowings at December 31, 2018, are summarized as follows: Year Ending December 31, 2019 2020 2021 2022 2023 2024 and after $ Amount 2,267,495 14,890,735 11,854,060 12,916,000 11,653,167 24,443,498 $ 78,024,955 Weighted- Average Rate 1.17 % 1.70 2.05 2.18 1.98 4.01 2.58 % 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, 2018, the Bank’s maximum borrowing capacity with the FHLB was approximately $292.8 million. 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, 2018 is approximately $7.1 million. The Bank also maintains a $10.0 million, $10.0 million, and a $5.0 million federal funds line of credit with three other financial institutions. The Bank did not have outstanding borrowings related to these lines of credit at December 31, 2018. In 2014, 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. In 2015, 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 had a fixed rate of 6.11 percent until November 23, 2015, at which time the rate converted to floating, 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. In 2014, the Company issued $3,620,000 of fixed rate subordinated capital notes with stated maturities of March 24, 2024 through December 26, 2024. These securities bear a fixed annual rate of 4.75 percent. The Company may redeem them, in whole or in part, at face value on or after March 24, 2019. These borrowings are included in the liabilities section of the Company’s Consolidated Balance Sheet. 36 37 32 33 10. OTHER BORROWINGS (Continued) 11. DERIVATIVE FINANICAL INSTRUMENTS (Continued) In 2015, the Company issued $6,500,000 of fixed rate subordinated capital notes with stated maturities of September 22, 2025 through March 3, 2026. The fixed securities bear an annual rate of 5.25 percent. The Company may redeem them, in whole or in part, at face value on or after September 22, 2020. These borrowings are included in the liabilities section of the Company’s Consolidated Balance Sheet. In 2015, the Company issued $650,000 of fixed rate senior debt with stated maturities of September 2020 through November 2020. The fixed rate securities bear an annual rate of 4.00 percent. These borrowings are included in the liabilities section of the Company’s Consolidated Balance Sheet. 11. DERIVATIVE FINANICAL INSTRUMENTS Risk Management Objective of Using Derivatives The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its assets and liabilities and through the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to certain variable rate borrowings. The Company also has interest rate derivatives that result from a service provided to certain qualifying customers and, therefore, are not used to manage interest rate risk in the Company’s assets or liabilities. The Company manages a matched book with respect to its derivative instruments in order to minimize its net risk exposure resulting from such transactions. The Company has contracted with a third party to engage pay-fixed interest rate swap contracts and the outstanding as of December 31, 2018, is being utilized to hedge $20.0 million in floating rate debt. At December 31, 2018 and 2017, the information pertaining to outstanding interest rate swap agreements is as follows: 2018 2017 Notional amount Weighted-average pay rate $ 20,000,000 $ 2.50 % 6,000,000 1.99 % Receive rate Weighted-average maturity in years Unrealized gain relating to interest rate swaps 3-Month Libor  7.4 40,384 3-Month Libor  7.0 93,989 For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income (outside of earnings), net of tax, and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings. The Company assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged transactions. The Company did not recognize any hedge ineffectiveness in earnings during the period ended December 31, 2018. Cash Flow Hedges of Interest Rate Risk The Company’s objectives in using interest rate derivatives are to add stability to interest income and expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company has entered into interest rate swaps as part of its interest rate risk management strategy. These interest rate swaps are designated as cash flow hedges and involve the receipt of variable rate amounts from a counterparty in exchange for the Company making fixed interest payments. As of December 31, 2018, the Company had three interest rate swaps with a notional amount of $20.0 million associated with the Company’s cash outflows, which are associated with various floating-rate amounts. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate liabilities. During the next twelve months, the Company estimates that $0 will be reclassified as an increase in interest expense. Credit-Risk-Related Contingent Features The Company has agreements with certain of its derivative counterparties that contain the following provisions:    if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations; if the Company fails to maintain its status as a well/adequately capitalized institution, then the counterparty could terminate the derivative positions, and the Company would be required to settle its obligations under the agreements; if the Company fails to maintain a specified minimum leverage ratio, then the Company could be declared in default on its derivative obligations. At December 31, 2018, the fair value of derivatives in a net asset position, which includes accrued interest and any credit valuation adjustments related to these agreements, was $40,384. At December 31, 2018, the Company had required cash collateral with certain of its derivative counterparties in the amount of $1,410,000 and was holding cash collateral of certain derivative counterparties in the amount of $260,000. If the Company had breached any of the above provisions at December 31, 2018, it would have been required to settle its obligations under the agreements at termination value and would have been required to pay any additional amounts due in excess of amounts previously posted as collateral with the respective counterparty. 38 39 34 35 11. DERIVATIVE FINANICAL INSTRUMENTS (Continued) 12. INCOME TAXES Fair Values of Derivative Instruments on the Balance Sheet The provision for federal income taxes consists of: The following table presents the fair values of derivative instruments in the balance sheet: Assets Liabilities Balance Sheet Fair Value Location Balance Sheet Fair Value Location Other assets $ 40,384 Other liabilities $ - Other assets $ 93,989 Other liabilities $ (3,511 ) December 31, 2018 Interest rate derivatives December 31, 2017 Interest rate derivatives Derivative Instruments The Company enters into interest rate swaps that allow its commercial loan customers to effectively convert a variable-rate commercial loan agreement to a fixed-rate loan agreement. Under these agreements, the Company enters into a variable-rate loan agreement with a customer in addition to an interest rate swap agreement, which serves to effectively swap the customer’s variable rate into a fixed rate. The Company then enters into a swap agreement with a third party in order to economically hedge its exposure through the customer agreement. Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives may use Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, at December 31, 2018, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined they are not significant. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy. Notional Amount December 31, Interest 2018 2017 Rate Paid Third Party interest rate swap Maturing in 2024 Maturing in 2025 Maturing in 2026 $ 6,000,000 $ 6,000,000 Fixed $ 6,000,000 $ - Fixed $ 8,000,000 $ - Fixed Interest Rate Received 3-Month Libor 3-Month Libor 3-Month Libor Fair Value December 31, 2018 2017 $ 172,609 $ 90,478 $ (48,386 ) $ $ (83,839 ) $ - - $ 20,000,000 $ 6,000,000 $ 40,384 $ 90,478 Current Deferred Change in corporate tax rate Total provision 2018 2017 $ 390,375 $ 718,003 250,189 (133,226 ) - 416,852 $ 640,564 $ 1,001,629 The tax effects of deductible and taxable temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2018 and 2017 are as follows: 2018 2017 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 Unrealized loss on available-for-sale securities Other Deferred tax assets Deferred tax liabilities: Premises and equipment Goodwill Deferred loan fees Partnerships Other Unrealized gain on available-for-sale securities Unrealized gain on swaps - balance sheet hedge Fair value adjustment - equity securities Deferred tax liabilities Net deferred tax assets 76,185 17,159 $ 1,394,906 $ 1,196,540 230,860 230,166 15,060 - 927,273 92,342 316,275 278,459 125,256 248,405 - 353,116 1,235 3,174 2,516,931 2,989,480 68,532 677,740 484,726 342,831 340,247 61,970 177,933 170,142 3,346 - 115,664 19,737 7,523 141,849 - 1,419,754 1,195,832 3,346 $ 1,097,177 $ 1,793,648 No valuation allowance was established at December 31, 2018 and 2017, 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. 40 41 36 37 12. 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 Change in corporate tax rate Other Actual tax expense and effective rate  2018 % of 2017 % of Amount Pretax Income Amount Pretax Income 34.0 % $ 1,400,752 (17.6 ) (474,336 ) (0.9 ) (74,099 ) (8.1 ) - 12.1 (211,753 ) 21.0 % $ 1,748,076 (7.1 ) (907,417 ) (46,308 ) (1.1 ) - (416,852 ) (3.2 ) 624,130 $ 640,564 9.6 % $ 1,001,629 19.5 % The Tax Cuts and Jobs Act, enacted on December 22, 2017, lowered the federal corporate income tax rate from 35% to 21% effective January 1, 2018. As a result, the carrying value of net deferred tax assets was reduced, which increased income tax expense by $416,852 effective December 31, 2017. 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 2014 have been closed for purposes of examination by the Internal Revenue Service and the Pennsylvania Department of Revenue. 13. 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 $404,238 and $355,319 for the years ended December 31, 2018 and 2017, respectively. The fair value of plan assets includes $2,536,411 and $1,882,945 pertaining to the value of the Company’s common stock that is held by the plan as of December 31, 2018 and 2017, respectively. Deferred Compensation Plan The Company has a nonqualified deferred compensation plan that allows directors and senior executives to defer fees and salaries. Outstanding balances under this arrangement for 2018 and 2017 were $1,099,333 and $1,096,030, respectively, and are reported as “Other liabilities” on the Consolidated Balance Sheet. Expenses related to this plan were a loss of $88,572 and a gain of $160,022 for December 31, 2018 and 2017, respectively. 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 60,000 shares of the Company’s common stock to the plan. 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 $379,583 and $316,662 for the years ended December 31, 2018 and 2017, respectively. The following is a summary of the status of the Company’s restricted stock as of December 31, 2018, and changes therein during the year then ended: Nonvested at January 1, 2017 Granted Vested Forfeited Nonvested at December 31, 2017 Granted Vested Forfeited Number of Weighted- Shares of Average Restricted Stock Grant Date Fair Value 42,364 $ 24,184 (15,580 ) (576 ) 50,392 $ 15,286 (15,853 ) (865 ) 20.05 27.27 20.02 22.04 23.50 29.63 22.33 22.71 Nonvested at December 31, 2018 48,960 $ 25.80 42 43 38 39 13. EMPLOYEE BENEFITS (Continued) Stock Option Plan 13. EMPLOYEE BENEFITS (Continued) Stock Option Plan (Continued) The Company has a fixed director and employee stock-based compensation plan. The plan has total options available to grant of 760,000 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, 2017 Granted Exercised Forfeited/Expired Outstanding, December 31, 2017 Granted Exercised Forfeited/Expired Weighted- Average Exercise Price Number of Options 214,282 $ 31,356 (25,748 ) (7,020 ) 212,870 $ 37,640 (38,436 ) (1,608 ) 18.23 27.00 16.96 21.46 19.57 29.63 17.74 27.69 Outstanding, December 31, 2018 210,466 $ 21.64 Exercisable at year-end 139,348 $ 18.71 The following table summarizes the characteristics of stock options at December 31, 2018: Exercise Outstanding Exercisable Contractual Average Average Exercise Average Exercise Grant Date Price Shares Life Price Shares Price 03/26/09 04/01/10 04/28/11 04/02/12 04/01/13 04/01/14 09/22/14 04/01/15 04/01/16 10/31/16 12/12/16 04/03/17 04/02/18 $ $ $ $ $ $ $ $ $ $ $ $ $ 12.75 6,400 17.06 14,400 14.88 10,600 15.00 12,200 16.63 18,760 18.25 11,008 19.75 1,000 19.48 29,300 22.00 35,648 2,000 22.40 22.38 2,000 27.00 30,710 29.63 36,440 0.23 $ 1.24 $ 2.32 $ 3.25 $ 4.25 $ 5.25 $ 5.72 $ 6.25 $ 7.25 $ 7.83 $ 7.95 $ 8.25 $ 9.25 $ 12.75 6,400 $ 17.06 14,400 $ 14.88 10,600 $ 15.00 12,200 $ 16.63 18,760 $ 18.25 11,008 $ 19.75 1,000 $ 19.48 29,300 $ 22.00 23,084 $ 1,320 $ 22.40 1,320 $ 22.38 9,956 $ 27.00 - $ 29.63 12.75 17.06 14.88 15.00 16.63 18.25 19.75 19.48 22.00 22.40 22.38 27.00 29.63 210,466 139,348 44 45 40 41 14. COMMITMENTS In the normal course of business, there are outstanding commitments and contingent liabilities such as commitments to extend credit, financial guarantees, and letters of credit that are not reflected in the accompanying consolidated financial statements. The Company does not anticipate any losses as a result of these transactions. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Balance Sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in the particular classes of financial instruments that consisted of the following: Commitments to extend credit Standby letters of credit Total 2018 2017 $ 149,468,932 $ 157,013,677 4,996,216 5,308,908 $ 154,465,148 $ 162,322,585 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 its 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, 2018, are as follows: 2019 2020 2021 2022 2023 Thereafter Minimum Lease Payment $ 396,969 377,181 336,934 331,897 333,915 3,934,757 Total $ 5,711,653 Rent expense under leases for each of the years ended December 31, 2018 and 2017, was $379,674 and $358,994, respectively. 14. COMMITMENTS (Continued) 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. 15. 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, 2018 and 2017 was $3,150,000 and $2,399,000, 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 Pennsylvania Banking Code restricts the availability of capital surplus for dividend purposes. At December 31, 2018, the Bank had a capital surplus of $5,723,535 which was not available for distribution to the Company as dividends. 16. 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 2015, BASEL III was implemented that required the Bank to maintain an additional Common Equity Tier 1 capital ratio. 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, 2018 and 2017, 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, Common Equity Tier I, Tier I risk-based, and Tier I leverage capital ratios must be at least 10 percent, 6.50 percent, 6 percent, and 5 percent, respectively. 46 47 42 43 16. REGULATORY CAPITAL (Continued) 16. REGULATORY CAPITAL (Continued) The Company’s actual capital ratios are presented in the following table that shows the Company met all regulatory capital requirements: The Bank’s actual capital ratios are presented in the following table which shows the Bank met all regulatory capital requirements: 2018 2017 Amount Ratio Amount Ratio 2018 2017 Amount Ratio Amount Ratio Total capital (to risk-weighted assets) Actual For capital adequacy purposes To be well capitalized Common Equity Tier I (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 $ 81,649,007 11.95 % $ 75,941,873 11.65 % 54,674,300 8.00 68,342,875 10.00 65,202,302 10.00 8.00 52,161,842 $ 58,785,380 30,754,294 44,422,869 8.60 % $ 53,675,439 4.50 29,341,036 6.50 42,381,496 8.23 % 4.50 6.50 $ 64,693,336 41,005,725 54,674,300 9.47 % $ 59,490,667 6.00 39,121,381 8.00 52,161,842 9.12 % 6.00 8.00 $ 64,693,336 33,756,857 42,196,071 7.67 % $ 59,490,667 4.00 32,364,684 5.00 40,455,855 7.35 % 4.00 5.00 Total capital (to risk-weighted assets) Actual For capital adequacy purposes To be well capitalized Common Equity Tier I (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 $ 78,784,431 11.47 % $ 73,198,801 11.25 % 54,946,308 8.00 68,682,885 10.00 65,087,718 10.00 8.00 52,070,175 $ 71,948,760 10.48 % $ 66,939,931 10.28 % 4.50 30,907,298 6.50 44,643,875 4.50 29,289,473 6.50 42,307,017 $ 71,948,760 10.48 % $ 66,939,931 10.28 % 6.00 41,209,731 8.00 54,946,308 6.00 39,052,631 8.00 52,070,175 $ 71,948,760 27,473,154 34,341,443 8.55 % $ 66,939,931 4.00 26,035,087 5.00 32,543,859 8.29 % 4.00 5.00 17. FAIR VALUE MEASUREMENTS The following disclosures show the hierarchical 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: Level II: Quoted prices are available in active markets for identical assets or liabilities as of the reported date. 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. 48 49 44 45 17. FAIR VALUE MEASUREMENTS (Continued) 17. FAIR VALUE MEASUREMENTS (Continued) The following tables present the assets reported on the Consolidated Balance Sheet at their fair value on a recurring basis as of December 31, 2018 and 2017, 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  Equity securities December 31, 2018 Level III Level I Level II Total $ - $ 6,693,710 $ - 35,771,223 - $ 6,693,710 - 35,771,223 - 46,175,084 - 19,058,081 - 46,175,084 - 19,058,081 - 17,033,499 3,450,017 - - 17,033,499 - 3,450,017 Total $ 3,450,017 $ 124,731,597 $ - $ 128,181,614 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  Equity securities December 31, 2017 Level III Level I Level II Total $ - $ 6,745,450 $ - 32,068,188 - $ 6,745,450 - 32,068,188 - 51,862,660 - 23,948,356 - 51,862,660 - 23,948,356 - 21,371,123 4,051,862 - 21,371,123 - - 4,051,862 Total $ 4,051,862 $ 135,995,777 $ - $ 140,047,639 Investment Securities The fair market 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 value for certain held-to-maturity securities were determined utilizing discounted cash flow models, due to the absence of a current market to provide reliable market quotes for the instruments. Impaired Loans The Company has measured impairment on loans generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties. In some cases, management may adjust the appraised value due to the age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed. Additionally, management makes estimates about expected costs to sell the property which are also included in the net realizable value. If the fair value of the collateral dependent loan is less than the carrying amount of the loan, a specific reserve for the loan is made in the allowance for loan losses, or a charge-off is taken to reduce the loan to the fair value of the collateral (less estimated selling costs) and the loan is included in the table above as a Level III measurement. Other Real Estate Owned (OREO) OREO is carried at the lower of the recorded investment in the property or its fair value less estimated costs of sale. In some cases, management may adjust the appraised value due to age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed. The fair value of OREO is based on the appraised value of the property, which is generally unadjusted by management and is based on comparable sales for similar properties in the same geographic region as the subject property, and is included as a Level II measurement. In this case, the property is categorized as Level III measurement, because the adjustment is considered to be an “unobservable” input. Income and expenses from operations and further declines in the fair value of the collateral subsequent to foreclosure are included in net expenses from OREO. Mortgage Servicing Rights Mortgage servicing rights are accounted for under the amortization method and are adjusted to the lower of aggregate cost or estimated fair value as appropriate. Fair value is estimated by projecting and discounting future cash flows. Various assumptions including future cash flows, market discount rates, expected prepayment rates, servicing costs, and other factors are used in the valuation of mortgage servicing rights. 50 51 46 47 17. FAIR VALUE MEASUREMENTS (Continued) 17. FAIR VALUE MEASUREMENTS (Continued) The following tables present the assets measured on a nonrecurring basis on the Consolidated Balance Sheet at their fair value as of December 31, 2018 and 2017, by level within the fair value hierarchy. Impaired loans that are collateral dependent are written down to fair value through the establishment of specific reserves. Techniques used to value the collateral that secure the impaired loans include: quoted market prices for identical assets classified as Level I inputs and observable inputs employed by certified appraisers for similar assets classified as Level II inputs. In cases where valuation techniques included inputs that are unobservable and are based on estimates and assumptions developed by management based on the best information available under each circumstance, the asset valuation is classified as Level III input. Other real estate owned is measured at fair value, less cost to sell at the date of foreclosure. Valuations are periodically performed by management and the assets are carried at the lower of carrying amount, or fair value less cost to sell. The fair value for mortgage servicing rights is estimated by discounting contractual cash flows and adjusting for prepayment estimates. Discount rates are based upon rates generally charged for such loans with similar characteristics. Assets: Impaired loans Mortgage servicing rights Assets: Impaired loans Other real estate owned Mortgage servicing rights December 31, 2018 Level I Level II Level III Total $ - $ - - $ 2,351,777 $ 2,351,777 - 389,223 389,223 December 31, 2017 Level I Level II Level III Total $ - $ - - - $ 5,833,229 $ 5,833,229 - 255,000 255,000 - 415,533 415,533 The following tables provide a listing of significant unobservable inputs used in the fair value measurement process for items valued utilizing Level III techniques as of December 31, 2018 and 2017. Valuation December 31, 2018 Impaired loans Fair Value Techniques Unobservable Inputs $ 1,793,513 Discount Rate Discounted Cash Flows Range 4.00% - 6.75% discount Weighted Average (5.40%)  Impaired loans $ 558,265 Property appraisals Management discount for property type and recent market volatility 15.00% discount Weighted Average (15.00%)  Mortgage servicing rights $ 389,223 Discounted cash flows Discount rate Prepayment speeds Valuation December 31, 2017 Impaired loans Fair Value Techniques Unobservable Inputs $ 2,064,013 Discount Rate Discounted Cash Flows 3.81 - 4.42% discount Weighted Average (4.12%)  1.09 - 2.20 prepayment factor Weighted Average (1.25%)  Range 4.23% - 6.75% discount Weighted Average (5.40%)  Impaired loans $ 3,769,216 Property appraisals Management discount for property type and recent market volatility 15% - 24.4% discount Weighted Average (22.87%)  Other real estate owned $ 255,000 Property appraisals Management discount for property type and recent market volatility 0% - 50% discount Weighted Average (12.07%)  Mortgage servicing rights $ 415,533 Discounted cash flows Discount rate Prepayment speeds 2.89 - 3.48% discount Weighted Average (3.185%)  1.32 - 2.76 prepayment factor Weighted Average (1.53%)  52 53 48 49 18. FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS 19. ACCUMULATED OTHER COMPREHENSIVE INCOME The estimated fair values of the Company’s financial instruments not required to be measured or reported at fair value at December 31 are as follows: The following table presents the changes in accumulated other comprehensive income (loss) by component net of tax for the year ended December 31, 2018 and 2017: Carrying Value Fair Value 2018 Level I Level II Level III Financial assets: Net Unrealized Gains on Investment Securities  Cash Flow Hedges Total Investment securities held to maturity Net loans Hedges 7,000,000 7,095,937 630,440,136 601,794,275 40,384 40,384 - 7,095,937 - - - - 601,794,275 - 40,384 Financial liabilities: Deposits Other borrowings $ 682,350,041 $ 680,258,979 $ 424,295,482 $ - 78,024,955 76,510,385 - $ 255,963,497 - 76,510,385 For cash and cash equivalents, certificates of deposits, loans held for sale, regulatory stock, bank-owned life insurance, accrued interest receivable, short-term borrowings, and accrued interest payable, the carrying value is a reasonable estimate of fair value. Carrying Value Fair Value 2017 Level I Level II Level III Financial assets: Investment securities held to maturity Net loans Hedges 6,000,000 6,162,790 569,010,225 551,495,272 93,989 93,989 - 6,162,790 - - - - 551,495,272 - 93,989 Financial liabilities: Deposits Other borrowings $ 653,687,053 $ 652,211,264 $ 395,260,633 $ - 85,931,850 84,682,347 - $ 256,940,459 - 84,682,347 For cash and cash equivalents, certificates of deposits, loans held for sale, regulatory stock, bank-owned life insurance, accrued interest receivable, short-term borrowings, and accrued interest payable, the carrying value is a reasonable estimate of fair value. Accumulated other comprehensive income, January 1, 2017  Other comprehensive income before reclassification  Amounts reclassified from accumulated other comprehensive loss  Reclassification of certain income tax effects from AOCI  Accumulated other comprehensive income, December 31, 2017  Other comprehensive loss before reclassification  Amounts reclassified from accumulated other comprehensive loss  Reclassification of certain income tax effects from AOCI  Accumulated other comprehensive income, December 31, 2018  $ 109,725 - 109,725 320,526 62,033 382,559 (66,737 ) - (66,737 ) 83,819 - 83,819 $ 447,333 $ 62,033 $ 509,366 (1,045,488 ) (45,952 ) (1,091,440 ) (2,742 ) - (2,742 ) (716,961 ) - (716,961 ) $ (1,317,858 ) $ 16,081 $ (1,301,777 ) The following table presents significant amounts reclassified out of each component of accumulated other comprehensive income (loss) for the year ended December 31, 2018 and 2017: Amount Reclassified from Accumulated Other Comprehensive Income Affected Line Item in the Consolidated Statement of Income where Net Income is Presented Unrealized gains on investment $ securities, December 31, 2018 $ 3,471 Investment securities gains, net (729 ) Income taxes 2,742 Unrealized gains on investment $ securities, December 31, 2017 $ 101,117 Investment securities gains, net (34,380 ) Income taxes 66,737 20. SUBSEQUENT EVENTS Management has reviewed events occurring through March 4, 2019, the date the financial statements were issued, and no subsequent events occurred requiring accrual or disclosure. 54 55 50 51 B O A R D O F D I R E C T O R S A N D O F F I C E R S BOARD OF DIRECTORS OF KISH BANCORP, INC. William P. Hayes, Chairman James J. Lakso, Vice Chairman Eric J. Barron, Member William L. Dancy, Member Spyros A. Degleris, Member Edward A. Friedman, Member Paul G. Howes, Member William S. Lake, Member Kathleen L. Rhine, Member Paul H. Silvis, Member Francis V. Vaughn, Member George V. Woskob, Member BOARD OF DIRECTORS OF KISH BANK William P. Hayes, Chairman James J. Lakso, Vice Chairman William L. Dancy, Member Spyros A. Degleris, Member Edward A. Friedman, Member Gregory T. Hayes, Member Paul G. Howes, Member William S. Lake, Member Kathleen L. Rhine, Member Paul H. Silvis, Member Francis V. Vaughn, Member George V. Woskob, Member CENTRE COUNTY REGIONAL BOARD A. Christian Baum, Member Spyros A. Degleris, Member Adam R. Fernsler, Member Edward A. Friedman, Member H. Amos Goodall, Jr., Member Alan G. Hawbaker, Member Paul G. Howes, Member Oscar W. Johnston, Member Michael J. Krentzman, Member Kathleen L. Rhine, Member Paul H. Silvis, Member George V. Woskob, Member Brandon M. Zlupko, Member HUNTINGDON COUNTY REGIONAL BOARD Arthur J. DeCamp, Member Wayne A. Hearn, Member Stephen C. Huston, Member James J. Lakso, Member Pamela F. Prosser, Member Burgess A. Smith, Member Delmont R. Sunderland, Member Angela D. Thompson, Member James A. Troha, Member Frances V. Vaughn, Member MIFFLIN COUNTY REGIONAL BOARD Christina Calkins-Mazur, Member Susan L. Cannon, Member William L. Dancy, Member James W. Felmlee, Member Melinda K. Kenepp, Member William S. Lake, Member Harvard K. McCardle, Member 56 Alan J. Metzler, Member Gary L. Oden, Member Phyllis L. Palm, Member John Pannizzo, Member KISH BANK EXECUTIVE OFFICERS William P. Hayes, Chairman and Chief Executive Officer Gregory T. Hayes, President and Chief Operating Officer Peter D. Collins, Executive Vice President, Chief Credit Officer Mark J. Cvrkel, Executive Vice President, Chief Financial Officer Robert S. McMinn, Executive Vice President, General Counsel Richard A. Sarfert, Executive Vice President, Chief Lending Officer James L. Shilling, Jr., Executive Vice President, Chief Business Services Officer KISH BANK SENIOR OFFICERS Douglas C. Baxter, Senior Vice President, Accounting and Controls Manager Kimberly A. Bubb, Senior Vice President, Director of Digital Technology Innovation Wade E. Curry, LUTCF, Senior Vice President, Investment Services Terra L. Decker, Senior Vice President, Information Security and Compliance Risk Director Kimberly M. Dove, Senior Vice President, Director of Operations Thomas Minichiello, III, Senior Vice President, Head of Retail Banking Amy M. Muchler, Senior Vice President, Educational Outreach and Service Quality Manager Debra K. Weikel, Senior Vice President, Retail Credit Officer Suzanne M. White, Senior Vice President, Human Resources and Organizational Development Director Stanley N. Ayers, Vice President, Special Assets 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 Alta Corman-Wolf, Vice President, Residential Lender John P. Cunningham, II, Vice President, Regional Market Manager Jeffrey A. Gum, Vice President, Managing Director of Kish Benefits Consulting Ann K. Guss, Vice President, Residential Lender Allana L. Hartung, Vice President, Commercial Relationship Manager Jeffrey T. Hayes, Vice President, Financial Advisor Terry P. Horner, Vice President, Business Development Officer Brad L. Huyck, Vice President, Information Technology Manager Garen M. Jenco, Vice President, Market Research and Analytics Manager Holly A. Johnson, Vice President, Market Manager Marsha K. Kuhns, Vice President, Residential Lender John Q. Massie, Vice President, Commercial Relationship Manager Virginia A. McAdoo, Vice President, Lending Services Manager Kristie R. McKnight, Vice President, Commercial Relationship Manager Peter K. Ort, Vice President, Branch Manager Denise F. Quinn, Vice President, Commercial Relationship Manager Kevin D. Rimmey, Vice President, Commercial Relationship Manager Melissa K. Royer, Vice President, Client Solutions Technical Advisor Cheryl E. Shope, Vice President, Residential Lender Glenn E. Snyder, Vice President, Facilities Manager and Security Officer Wendy S. Strohecker, Vice President, Bank Operations Manager N. Robert Sunday, III, Vice President, Compliance Officer Kayelene G. Sunderland, Vice President, Wealth Management and Trust Administrator Jeffrey D. Wilson, Vice President, CEO, Kish Agency 4255 East Main Street, Belleville, PA 17004 | 1-888-554-4748 | www.KishBank.com 

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