# Fidelity D & D Bancorp Inc: Form 10-Q for the period ended Mar 31, 2014

- Company: [Fidelity D & D Bancorp Inc](/companies/fdbc.md) (CIK 1098151)
- Form: 10-Q
- Filed: 2014-05-07
- Accepted by EDGAR: May 7, 2014, 12:06 ET
- Period: 2014-03-31
- Accession: 0001098151-14-000024
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1098151/000109815114000024/fdbc-20140331x10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1098151/000109815114000024/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2014-03-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Interest expense | 3 months, 2014-01-01 to 2014-03-31 | $707.0k | us-gaap:InterestExpense |
| Income tax | 3 months, 2014-01-01 to 2014-03-31 | $492.0k | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2014-01-01 to 2014-03-31 | $1.5m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2014-01-01 to 2014-03-31 | $0.61 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2014-01-01 to 2014-03-31 | $0.61 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2014-01-01 to 2014-03-31 | 2,402,029 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 3 months, 2014-01-01 to 2014-03-31 | $1.6m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 3 months, 2014-01-01 to 2014-03-31 | $433.0k | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Cash and equivalents | at 2014-03-31 | $32.1m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Total assets | at 2014-03-31 | $654.4m | us-gaap:Assets |
| Total liabilities | at 2014-03-31 | $586.6m | us-gaap:Liabilities |
| Short-term borrowings | at 2014-03-31 | $12.3m | us-gaap:ShortTermBorrowings |
| Shareholders' equity | at 2014-03-31 | $67.8m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 65,827 characters.

The following is management's discussion and analysis of the significant changes in the consolidated financial condition of the Company as of March 31, 2014 compared to December 31, 2013 and a comparison of the results of operations for the three months ended March 31, 2014 and 2013. Current performance may not be indicative of future results. This discussion should be read in conjunction with the Company’s 2013 Annual Report filed on Form 10-K.

### Forward-looking statements

Certain of the matters discussed in this Quarterly Report on Form 10-Q may constitute forward-looking statements for purposes of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, and as such may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. The words “expect,” “anticipate,” “intend,” “plan,” “believe,” “estimate,” and similar expressions are intended to identify such forward-looking statements.

The Company’s actual results may differ materially from the results anticipated in these forward-looking statements due to a variety of factors, including, without limitation:

- the effects of economic conditions on current customers, specifically the effect of the economy on loan customers’ ability to repay loans;
- the costs and effects of litigation and of unexpected or adverse outcomes in such litigation;
- the impact of new laws and regulations, including the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the regulations promulgated thereunder;
- impacts of the new capital and liquidity requirements of the Basel III standards and other regulatory pronouncements, regulations and rules;
- governmental monetary and fiscal policies, as well as legislative and regulatory changes;
- effects of short- and long-term federal budget and tax negotiations and their effect on economic and business conditions;
- the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Financial Accounting Standards Board and other accounting standard setters;
- the risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities and interest rate protection agreements, as well as interest rate risks;
- the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds and other financial institutions operating in our market area and elsewhere, including institutions operating locally, regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, computer and the internet;
- technological changes;
- acquisitions and integration of acquired businesses;
- the failure of assumptions underlying the establishment of reserves for loan losses and estimations of values of collateral and various financial assets and liabilities;
- volatilities in the securities markets;
- acts of war or terrorism; and
- disruption of credit and equity markets.

The Company cautions readers not to place undue reliance on forward-looking statements, which reflect analyses only as of the date of this document. The Company has no obligation to update any forward-looking statements to reflect events or circumstances after the date of this document.

Readers should review the risk factors described in other documents that we file or furnish, from time to time, with the Securities and Exchange Commission, including Annual Reports to Shareholders, Annual Reports filed on Form 10-K and other current reports filed or furnished on Form 8-K.

### General

Nationally, the unemployment rate was unchanged at 6.7% at both March 31, 2014 and December 31, 2013, remaining at the lowest level since 2008, and down from 7.5% a year earlier. While the unemployment rate has been declining nationally, the unemployment rate in the Scranton-Wilkes-Barre Metropolitan Statistical Area (local) still remains above national and state levels. According to the U.S. Bureau of Labor Statistics, the local unemployment rate at March 31, 2014 was 8.0%, an increase of 0.3 percentage points from 7.7% at December 31, 2013. The unemployment rate was driven up by a smaller labor force and less jobs. In a recent study in the “Metro Monitor” by the Brookings Institution that tracked the economic performance of 100 metropolitan areas, the Scranton/ Wilkes-Barre metropolitan is last in the race to climb out of the recession. The study is based on four indicators: jobs, unemployment, output (gross product) and house prices. The area has experienced a slow recovery and hasn’t experienced the bounce back yet that other cities did. Notwithstanding these issues, high levels of unemployment and the prolonged weakness in the local housing and real estate markets may negatively impact the performance and condition of the Company’s loan portfolios.

The Company’s earnings depend primarily on net interest income. Net interest income is the difference between interest income and interest expense. Interest income is generated from yields earned on interest-earning assets, which consist principally of loans and investment securities. Interest expense is incurred from rates paid on interest-bearing liabilities, which consist of deposits and borrowings. Net interest income is determined by the Company’s interest rate spread (the difference between the yields earned on its interest-earning assets and the rates paid on its interest-bearing liabilities) and the relative amounts of interest-earning assets and interest-bearing liabilities. Interest rate spread is significantly impacted by: changes in interest rates and market yield curves and their related impact on cash flows; the composition and characteristics of interest-earning assets and interest-bearing liabilities; differences in the maturity and re-pricing characteristics of assets compared to the maturity and re-pricing characteristics of the liabilities that fund them and by the competition in the marketplace.

The Company’s earnings are also affected by the level of its non-interest income and expenses and by the provisions for loan losses and income taxes. Non-interest income consists of service charges on the Company’s loan and deposit products, interchange fees, trust and asset management service fees, increases in the cash surrender value of the bank owned life insurance and from net gains or losses from sales of loans and securities. Non-interest expense consists of: compensation and related employee benefit costs; occupancy; equipment; data processing; advertising and marketing; FDIC insurance premiums; professional fees; loan collection; net other real estate owned (ORE) expenses; supplies and other operating overhead.

### Comparison of the results of operations

### Three months ended March 31, 2014 and 2013

### Overview

For the three months ended March 31, 2014, the Company generated net income of $1.5 million, or $0.61 per diluted share, compared to $1.4 million, or $0.60 per diluted share, for the three months ended March 31, 2013. The 4% increase in earnings was due to higher net interest income, lower non-interest expense and a $0.3 million, or 45%, lower provision for loan loss requirement, offset partially by a decrease in non-interest income. Non-interest income decreased mostly because of lower total net gains on sales of fewer loans. Other non-interest expenses decreased $0.1 million, or 2%, in the current quarter compared to the 2013 like period from lower expenses related to loan collections and foreclosed assets held-for-sale.

Return on average assets (ROA) and return on average shareholders’ equity (ROE) were 0.92% and 8.80%, respectively, for the three months ended March 31, 2014 compared to 0.91% and 9.49% for the same period in 2013. The slight improvement in ROA was caused by the increase in net income and the decrease in ROE was caused by an increase in shareholders’ equity that was boosted by 2013 earnings.

#### Net interest income and interest sensitive assets / liabilities

Net interest income increased $0.1 million, or 1%, from $5.2 million for the quarter ended March 31, 2013 to $5.3 million for the quarter ended March 31, 2014, with increased interest income and reduced interest expense combining for the increase. The Company experienced a $20.1 million net increase in average interest-bearing deposits, but a six basis point decline on average rates paid due to a 15 basis point decline on rates paid on certificates of deposit, or CDs. The lower rates paid on CDs in conjunction with a $4.4 million decline in their average balances resulted in a $51 thousand decrease in interest expense from time deposits. Interest expense from interest-bearing transaction deposits increased $26 thousand mostly due to higher average balances, from successful efforts in generating business deposits and also from rates paid on promotional deposit-gathering offerings and negotiated rates. The portfolio of interest-earning assets increased $20.4 million and helped offset the negative impact of a nine basis point net reduction in the yields earned from loans and investments. The increase in interest income was driven by a 62 basis point increase in the yield earned on investment securities that more than offset the lower interest earned from the loan portfolio. Though average balances of the security portfolio decreased $3.6 million, its overall performance was bolstered by the Company’s fourth quarter 2013 sale of its entire portfolio of corporate bonds. The corporate bond portfolio consisted of pooled trust preferred securities that were essentially non-performing. The proceeds of the sale were re-deployed into earning-assets. The loan portfolio increased $30.1 million on average, but its earning’s performance was negatively impacted by a 35 basis point reduction in yield. Average loan volume increases of $23.3 million in the commercial and residential mortgage loans helped boost interest income despite a decline in yield of 39 basis points in commercial loans and four basis points in residential mortgage loans. The positive earnings performance of the commercial and residential loan portfolios, however, was not enough to offset the 111 basis points in lower yields earned on a $6.8 million larger average balance of consumer loans, which generated $60 thousand less interest income for the three months ended March 31, 2014 compared to March 31, 2013. The increase in interest income of $34 thousand combined with lower interest expense caused the net interest income growth in the current year quarter compared to the 2013 quarter.

The fully-taxable equivalent (FTE) net interest rate spread and margin decreased by four and five basis points, respectively, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The decline in the interest rate spread was caused by a more rapid decline in earning-asset yields compared to the rates paid on their funding sources, while the margin declined due to a lower yielding larger average portfolio of interest-earning assets. The overall cost of funds, which includes the impact of non-interest bearing deposits, was reduced by four basis points for the quarter ended March 31, 2014 compared to the first quarter of 2013 because of lower rates paid on a higher balance of average interest-bearing liabilities.

In 2014, the Company expects to continue to operate in a low, but steeping yield curve environment– increasing at the mid- to long-end of the curve and stable, but near zero at the shortest end. A rate environment with rising long-term interest rates positions the Company to improve its interest income performance from new and maturing long-term earning assets. For 2014, the Company anticipates net interest income to stabilize or improve marginally. The FOMC has not adjusted the short-term federal funds rate upward and is not expected to do so well into 2015, helping contain funding costs. Growth in the commercial loan portfolio and growth in certain targeted segments of the consumer loan portfolio will be the Company’s strategy for 2014, and when coupled with historically low funding costs, should help contain the interest rate margin.

At 65 basis points, the Company’s cost of interest-bearing liabilities for the three months ended March 31, 2014 is five basis points lower than the cost for the first three months of 2013. Other than retaining maturing long-term CDs, reducing deposit rates from all-time lows would have a minor cost-savings impact. As noted, interest rates along the treasury yield curve have been slowly rising. Competition could potentially pressure banks to increase term deposit rates. On the asset side, the prime interest rate, the benchmark rate that banks use as a base rate for adjustable rate loans, is not expected to rise in the near term thereby further pressuring net interest income should deposit rates begin to steadily rise. To help combat the imminent change to the economic landscape, the Company has successfully developed and will continue to strengthen its association with existing customers, develop new business relationships, generate new loan volumes, retain and generate higher levels of average non-interest bearing deposit balances. Strategically deploying these funds into interest earning-assets such as in the retail and commercial loan portfolios is an effective margin-enhancing strategy that the Company expects to pursue and expand upon to help stabilize net interest margin.

The Company’s Asset Liability Management (ALM) team meets regularly to discuss among other things, interest rate risk and when deemed necessary adjusts interest rates and to discuss and seek revenue enhancing strategies to combat the trend in declining interest income. The Company’s marketing department, together with ALM, lenders and deposit gatherers, continues to develop prudent strategies that will grow the loan portfolio and accumulate low-cost deposits to improve net interest income performance.

The table that follows sets forth a comparison of average balances of assets and liabilities and their related net tax equivalent yields and rates for the years indicated. Interest income was adjusted to a tax-equivalent basis (FTE), using the corporate federal tax rate of 34% to recognize the income from tax-exempt interest-earning assets as if the interest was taxable. This treatment allows a uniform comparison among yields on interest-earning assets. Loans include loans HFS and non-accrual loans but exclude the allowance for loan losses. Net deferred loan cost amortization of $64.3 thousand and $65.7 thousand for the first quarters of 2014 and 2013, respectively, are included in interest income from loans. In 2013, securities include non-accrual securities. Average balances are based on amortized cost and do not reflect net unrealized gains or losses. Net interest margin is calculated by dividing annualized net interest income - FTE by total average interest-earning assets. Cost of funds includes the effect of average non-interest bearing deposits as a funding source:

*(dollars in thousands)*

| Assets Interest-earning assets | Three months ended March 31, 2014 Average balance | Interest | Yield / rate | March 31, 2013 Average balance | Interest | Yield / rate |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| **Interest-bearing deposits** | **$11,792** | **$7** | **0.25%** | $17,419 | $12 | 0.29% |
| **Investments:** |  |  |  |  |  |  |
| Agency - GSE | **15,597** | **54** | **1.40** | 17,472 | 45 | 1.04 |
| MBS - GSE residential | **49,080** | **191** | **1.58** | 50,452 | 135 | 1.08 |
| State and municipal | **33,456** | **499** | **6.05** | 27,342 | 436 | 6.46 |
| Other | **2,551** | **24** | **3.86** | 9,059 | 20 | 0.88 |
| Total investments | **100,684** | **768** | **3.09** | 104,325 | 636 | 2.47 |
| **Loans and leases:** |  |  |  |  |  |  |
| Commercial | **262,673** | **3,033** | **4.68** | 241,763 | 3,023 | 5.07 |
| Consumer | **62,197** | **848** | **5.53** | 55,447 | 908 | 6.64 |
| Residential real estate | **156,005** | **1,595** | **4.15** | 153,611 | 1,588 | 4.19 |
| Total loans and leases | **480,875** | **5,476** | **4.62** | 450,821 | 5,519 | 4.97 |
| **Federal funds sold** | **40** | **-** | **0.30** | 441 | - | 0.26 |
| Total interest-earning assets | **593,391** | **6,251** | **4.27%** | 573,006 | 6,167 | 4.36% |
| Non-interest earning assets | **47,700** |  |  | 44,950 |  |  |
| **Total Assets** | **$641,091** |  |  | $617,956 |  |  |
| **Liabilities and shareholders' equity** |  |  |  |  |  |  |
| **Interest-bearing liabilities** |  |  |  |  |  |  |
| **Deposits:** |  |  |  |  |  |  |
| Savings | **$109,496** | **$55** | **0.20%** | $108,875 | $56 | 0.21% |
| Interest-bearing checking | **101,162** | **42** | **0.17** | 83,170 | 26 | 0.13 |
| MMDA | **86,412** | **115** | **0.54** | 80,543 | 104 | 0.52 |
| CDs \< $100,000 | **71,193** | **166** | **0.95** | 74,874 | 198 | 1.07 |
| CDs \> $100,000 | **40,534** | **111** | **1.11** | 41,271 | 130 | 1.28 |
| Clubs | **1,388** | **0** | **0.14** | 1,380 | 1 | 0.15 |
| Total interest-bearing deposits | **410,185** | **489** | **0.48** | 390,113 | 515 | 0.54 |
| **Repurchase agreements** | **16,104** | **8** | **0.21** | 17,377 | 9 | 0.21 |
| **Borrowed funds** | **16,399** | **211** | **5.21** | 16,239 | 211 | 5.26 |
| Total interest-bearing liabilities | **442,688** | **708** | **0.65%** | 423,729 | 735 | 0.70% |
| Non-interest bearing deposits | **127,736** |  |  | 130,864 |  |  |
| Non-interest bearing liabilities | **3,595** |  |  | 3,811 |  |  |
| Total liabilities | **574,019** |  |  | 558,404 |  |  |
| Shareholders' equity | **67,072** |  |  | 59,552 |  |  |
| **Total liabilities and shareholders' equity** | **$641,091** |  |  | $617,956 |  |  |
| Net interest income - FTE |  | **$5,543** |  |  | $5,432 |  |
| Net interest spread |  |  | **3.62%** |  |  | 3.66% |
| Net interest margin |  |  | **3.79%** |  |  | 3.84% |
| Cost of funds |  |  | **0.50%** |  |  | 0.54% |

29

#### Provision for loan losses

The provision for loan losses represents the necessary amount to charge against current earnings, the purpose of which is to increase the allowance for loan losses (the allowance) to a level that represents management’s best estimate of known and inherent losses in the Company’s loan portfolio. Loans determined to be uncollectible are charged off against the allowance. The required amount of the provision for loan losses, based upon the adequate level of the allowance, is subject to the ongoing analysis of the loan portfolio. The Company’s Special Assets Committee meets periodically to review problem loans. The committee is comprised of management, including credit administration officers, loan officers, loan workout officers and collection personnel. The committee reports quarterly to the Credit Administration Committee of the Board of Directors.

Management continuously reviews the risks inherent in the loan portfolio. Specific factors used to evaluate the adequacy of the loan loss provision during the formal process include:

- specific loans that could have loss potential;
- levels of and trends in delinquencies and non-accrual loans;
- levels of and trends in charge-offs and recoveries;
- trends in volume and terms of loans;
- changes in risk selection and underwriting standards;
- changes in lending policies, procedures and practices;
- experience, ability and depth of lending management;
- national and local economic trends and conditions; and
- changes in credit concentrations.

Provisions for loan losses of $0.3 million were recorded during the first quarter of 2014, compared to $0.6 million as of March 31, 2013. The Company’s non-performing loans declined to $3.7 million as of March 31, 2014, a $2.1 million decrease from year-end 2013. Although credit quality is improving, additions to the provision in the first quarter of 2014 were required to reserve in connection with loan growth in the period, protect against inherent losses that existed in the portfolio, and reinforce the allowance for the potential credit risks that still existed from an uncertain local economic climate. The allowance for loan losses was $8.9 million as of both March 31, 2014 and December 31, 2013. For a discussion on the allowance for loan losses, see “Allowance for loan losses,” located in the comparison of financial condition section of management’s discussion and analysis contained herein.

#### Other income

For the three months ended March 31, 2014, non-interest income amounted to $1.7 million, a $0.3 million, or 16%, decrease compared to $2.0 million recorded during the three months ended March 31, 2013. A slowdown in mortgage loan origination and mortgage loan refinance activities resulted in $0.4 million less in gains recognized from the sales of fewer mortgage loans in the current year quarter compared to the same quarter of 2013. In conjunction with the waning activity in the residential lending area, mortgage loan fees declined $0.1 million during the quarter ended March 31, 2014 compared to March 31, 2013. These items were partially offset by the cumulative amount of $0.2 million from additional interchange, security gains, net loan servicing fees, rental income and trust service fees.

#### Other operating expenses

For the three months ended March 31, 2014, total other operating expenses decreased $0.1 million, or 2%, compared to the three months ended March 31, 2013. The decline in loan collection expenses of $0.2 million for the quarter ended March 31, 2014 compared to the same period in 2013 was mainly attributable to the accelerated pace by which problem loans migrate into foreclosure and the 2013 charges for the final expenses on a large problematic loan. The net expense to carry other real estate (ORE) including, carrying costs, write-down to fair value, gains and losses from their sales and disposition of other foreclosed assets held-for-sale, decreased $58 thousand primarily due to a net gain recognized on the sale of foreclosed assets of $48 thousand for the three months ended March 31, 2014 compared to a net loss from sales of $19 thousand recognized for the three months ended March 31, 2013. Though the assessment base upon which the FDIC insurance premium rate is applied increased, a lower assessment rate caused a $27 thousand, or 21%, decrease in the assessment in the current year quarter compared to the first quarter of 2013. Advertising and marketing expenses increased $80 thousand, or 32%, during the three months ended March 31, 2014 compared to the same period in 2013. The increase was caused mostly by $0.2 million in contributions to educational organizations through the “Educational Improvement Tax Credit” (EITC) program administered by the state of Pennsylvania. The increase in donations was partially offset by a decrease in other advertising and marketing related expenses of $80 thousand caused by the delay in launching the Company’s annual home equity loan campaign to the second quarter of 2014 and less use of media advertising in 2014 compared to 2013. The increase in premises and equipment was predominantly caused by higher facilities maintenance in conjunction with this winter’s comparatively extreme weather conditions and higher equipment repair and upkeep caused by higher technology maintenance in the current year quarter. The higher professional services is related to 2013 legal accrual adjustments and the timing of legal service needs for the Company’s trust department. The decrease in the other component of operating expenses of $0.1 million was caused by the decrease in shares tax expense due to the timing and receipt of state-sponsored educational tax credits.

### Comparison of financial condition at

### March 31, 2014 and December 31, 2013

#### Overview

Consolidated assets increased $30.6 million, or 5%, to $654.4 million as of March 31, 2014 from $623.8 million at December 31, 2013. The increase in assets was funded through growth in deposits of $25.1 million, short-term borrowings of $3.7 million and a $1.8 million increase in shareholders’ equity. Net income of $1.5 million and $0.5 million in other comprehensive income partially offset by $0.4 million of dividends declared net of activity in the Company’s dividend reinvestment plan drove equity growth. The increase in the funding sources was used to fund loan and investment growth with the excess available to fund future liquidity needs.

### Funds Deployed:

#### Investment securities

At the time of purchase, management classifies investment securities into one of three categories: trading, available-for-sale (AFS) or held-to-maturity (HTM). To date, management has not purchased any securities for trading purposes. Most of the securities the Company purchases are classified as AFS even though there is no immediate intent to sell them. The AFS designation affords management the flexibility to sell securities and position the balance sheet in response to capital levels, liquidity needs or changes in market conditions. Securities AFS are carried at fair value on the consolidated balance sheets with unrealized gains and losses, net of deferred income taxes, reported separately within shareholders’ equity as a component of accumulated other comprehensive income (loss) (OCI). Securities designated as HTM are carried at amortized cost and represent debt securities that the Company has the ability and intent to hold until maturity.

As of March 31, 2014, the carrying value of investment securities amounted to $102.2 million, or 16% of total assets, compared to $97.4 million, or 16% of total assets, at December 31, 2013. On December 31, 2013, 49% of the carrying value of the investment portfolio was comprised of U.S. Government Sponsored Enterprise residential mortgage-backed securities (MBS – GSE residential or mortgage-backed securities) that amortize and provide monthly cash flow that the Company can use for reinvestment, loan demand, unexpected deposit outflow, facility expansion or operations.

As of March 31, 2014, investment securities were comprised of AFS securities with a carrying value of $102.2 million. The AFS securities were recorded with a net unrealized gain of $2.7 million as of March 31, 2014 compared to a net unrealized gain of $1.9 million as of December 31, 2013, or a net improvement of $0.8 million during the first quarter of 2014. As interest rates along the treasury yield curve rise, especially at the intermediate and long end, the value of bonds tend to decline. Whether or not the value of Company’s investment portfolio will continue to exceed its amortized cost will be dependent on the direction and magnitude of interest rate movements and the duration of the Company’s bonds. Management has concluded that the present unrealized losses in the portfolio are wholly attributable to the movement in interest rates and not the credit quality of the collateral that secures these investments. With interest rates on the rise, the market values of bank’s debt securities portfolio could be subject to market value declines.

Quarterly, management performs a review of the investment portfolio to determine the causes of declines in the fair value of each security. The Company uses inputs provided by independent third parties to determine the fair value of its investment securities portfolio. Inputs provided by the third parties are reviewed and corroborated by management. Evaluations of the causes of the unrealized losses are performed to determine whether impairment exists and whether the impairment is temporary or other-than-temporary. Considerations such as the Company’s intent and ability to hold the securities to maturity, recoverability of the invested amounts over the intended holding period, the length of time and the severity in pricing decline below cost, the interest rate environment, the receipt of amounts contractually due and whether or not there is an active market for the securities, for example, are applied, along with an analysis of the financial condition of the issuer for management to make a realistic judgment of the probability that the Company will be unable to collect all amounts (principal and interest) due in determining whether a security is other-than-temporarily impaired. If a decline in value is deemed to be other-than-temporary, the amortized cost of the security is reduced by the credit impairment amount and a corresponding charge to current earnings is recognized. As noted above, management has determined that the unrealized losses in the portfolio were due to the movement in interest rates and not the credit quality.

During the first three months of 2014, the carrying value of total investments increased $4.8 million, or 5%. The increase was due to the deployment of the proceeds from the sale of the Company’s corporate bonds, consisting of pooled trust preferred securities that occurred late in the fourth quarter of 2013. For the remainder of 2014, the Company expects marginal growth in the investment portfolio and will be used to complement loan growth, the latter providing the potential for stronger earnings performance. The Company expects to maintain a diverse and, in terms of total assets, a proportionately level investment portfolio throughout 2014.

A comparison of investment securities at March 31, 2014 and December 31, 2013 is as follows:

*(dollars in thousands)*

|  | March 31, 2014 Amount% |  | December 31, 2013 Amount% |  |
| --- | ---: | ---: | ---: | ---: |
| MBS - GSE residential | **$50,375** | **49.3%** | $49,686 | 51.0% |
| State & municipal subdivisions | **35,660** | **34.9** | 32,611 | 33.5 |
| Agency - GSE | **15,622** | **15.3** | 14,601 | 15.0 |
| Equity securities - financial services | **556** | **0.5** | 525 | 0.5 |
| Total | **$102,213** | **100.0%** | $97,423 | 100.0% |

#### Federal Home Loan Bank Stock

Investment in FHLB stock is required for membership in the organization and is carried at cost since there is no market value available. The amount the Company is required to invest is dependent upon the relative size of outstanding borrowings the Company has with the FHLB of Pittsburgh. Excess stock is repurchased from the Company at par if the amount of borrowings decline to a predetermined level. In addition, the Company earns a return or dividend based on the amount invested. The dividends received from the FHLB totaled $15 thousand and $2 thousand for the three months ended March 31, 2014 and 2013, respectively. The dividend rate has continued to rise in each of the quarters of 2013 and into 2014. The balance in FHLB stock was $2.2 million and $2.6 million as of March 31, 2014 and December 31, 2013, respectively.

Loans held-for-sale (HFS)

Upon origination, most residential mortgages and certain small business administration (SBA) guaranteed loans may be classified as held-for-sale (HFS). In the event of market rate increases, fixed-rate loans and loans not immediately scheduled to re-price would no longer produce yields consistent with the current market. In low interest rate environments, the Company would be exposed to prepayment risk and, as rates on adjustable-rate loans decrease, interest income would be negatively affected. Consideration is given to the Company’s current liquidity position and projected future liquidity needs. To better manage prepayment and interest rate risk, loans that meet these conditions may be classified as HFS. The carrying value of loans HFS is based on the lower of cost or estimated fair value. If the fair values of these loans decline below their original cost, the difference is written down and charged to current earnings. Subsequent appreciation in the portfolio is credited to current earnings but only to the extent of previous write-downs. As of March 31, 2014 and December 31, 2013, loans HFS consisted of residential mortgage loans.

As of March 31, 2014 and December 31, 2013, loans HFS had a carrying amount of $0.5 million and $0.9 million, respectively, which approximated their fair values. During the three months ended March 31, 2014, residential mortgage loans with principal balances of $7.0 million were sold into the secondary market and the Company recognized net gains of $0.1 million, compared to $27.7 million and $0.5 million, respectively during the three months ended March 31, 2013. Gains of $41 thousand, deferred from sales of SBA loans in the fourth quarter of 2012, were recognized in the first quarter of 2013. There were no gains recognized from sales of SBA loans in the first quarter of 2014. With a decline in the residential mortgage origination and loan modification activities, the Company does not expect to achieve the same level of gains from loan sales as it had in 2013.

The Company retains mortgage servicing rights (MSRs) on loans sold into the secondary market. MSRs are retained so that the Company can foster personal relationships with its loyal customer base. At March 31, 2014 and December 31, 2013, the servicing portfolio balance of sold residential mortgage loans was $251.8 million and $250.2 million, respectively.

#### Loans and leases

The Company’s continued focus to improve asset quality in 2014 has resulted in a reduction of $2.1 million in non-performing loans. Asset quality will certainly continue to be a priority. A practical determination of our risk-rating matrices, the expertise of our external auditors, guidance from our regulators and the experience of the Company’s chief risk officer, loan work-out area and the chief lending officer with relationship managers will provide the framework for continued improvement and detection of potential problems. The utilization of loan participations (sharing loans with other financial institutions) and various government guaranty programs will help us to reduce risk in the future.

The continued use of a formal calling program which builds customer loyalty, a teamwork approach, and the knowledge of our relationship managers and branch personnel will provide the emphasis to achieve our targeted loan growth goals for 2014. Growing relationships, reliance on a strong referral base, targeting prospects, and offering seasonal promotions will also provide opportunities for growth. As the leading community bank in our marketplace in the Small Business Administration (SBA) program, our community involvement in the local chambers and civic organizations continues to give us a competitive edge. Our objective remains, steady growth by continuing to identify customer needs and provide appropriate products and services based upon the expertise of the Company’s personnel.

### Commercial and industrial

Comparing the commercial and industrial (C&I) loan portfolio at December 31, 2013 of $74.6 million and $75.7 million at March 31, 2014, there was an increase of $1.1 million, or 2%. Loan demand remains steady and minimal growth is likely to continue.

### Commercial real estate

The commercial real estate loan portfolio increased $3.3 million, or 2%, from $186.3 million at December 31, 2013 to $189.6 million as of March 31, 2014. The majority of growth was in the owner occupied real estate category, which historically has proven to have less risk and has been targeted as a growth opportunity. Focused growth in this portfolio is expected to continue.

### Consumer

The consumer loan portfolio increased by $1.5 million, or 2%, from $98.8 million at December 31, 2013 to $100.3 million at March 31, 2014. The increase in this portfolio is attributed to the auto loans and leases category. During the second quarter, there are strategies in place to increase the home equity category.

### Residential

The residential loan portfolio decreased $0.6 million, or 1%, from $118.6 million at December 31, 2013 to $118.0 million at March 31, 2014. Runoff in this category is expected, but will be replaced, to some extent, by the booking of mortgages with a maturity date of fifteen years or less.

The composition of the loan portfolio at March 31, 2014 and December 31, 2013, is summarized as follows:

*(dollars in thousands)*

|  | March 31, 2014 Amount% |  | December 31, 2013 Amount% |  |
| --- | ---: | ---: | ---: | ---: |
| Commercial and industrial | **$75,717** | **15.7%** | $74,551 | 15.6% |
| Commercial real estate: |  |  |  |  |
| Non-owner occupied | **90,647** | **18.7** | 89,255 | 18.7 |
| Owner occupied | **89,373** | **18.5** | 86,294 | 18.0 |
| Construction | **9,609** | **1.9** | 10,765 | 2.2 |
| Consumer: |  |  |  |  |
| Home equity installment | **34,161** | **7.1** | 34,480 | 7.2 |
| Home equity line of credit | **37,202** | **7.7** | 36,836 | 7.7 |
| Auto and leases | **23,725** | **4.9** | 22,261 | 4.7 |
| Other | **5,242** | **1.1** | 5,205 | 1.1 |
| Residential: |  |  |  |  |
| Real estate | **110,675** | **22.9** | 110,365 | 23.1 |
| Construction | **7,292** | **1.5** | 8,188 | 1.7 |
| Gross loans | **483,643** | **100.0%** | 478,200 | 100.0% |
| Less: |  |  |  |  |
| Allowance for loan losses | **(8,899)** |  | (8,928) |  |
| Unearned lease revenue | **(79)** |  | (56) |  |
| Net loans | **$474,665** |  | $469,216 |  |
| Loans held-for-sale | **$451** |  | $917 |  |

#### Allowance for loan losses

Management evaluates the credit quality of the Company’s loan portfolio and performs a formal review of the adequacy of the allowance for loan losses (the allowance) on a quarterly basis. The allowance reflects management’s best estimate of the amount of credit losses in the loan portfolio. Management’s judgment is based on the evaluation of individual loans, past experience, the assessment of current economic conditions and other relevant factors including the amounts and timing of cash flows expected to be received on impaired loans. Those estimates may be susceptible to significant change. The provision for loan losses represents the amount necessary to maintain an appropriate allowance. Loan losses are charged directly against the allowance when loans are deemed to be uncollectible. Recoveries from previously charged-off loans are added to the allowance when received.

Management applies two primary components during the loan review process to determine proper allowance levels. The two components are a specific loan loss allocation for loans that are deemed impaired and a general loan loss allocation for those loans not specifically allocated. The methodology to analyze the adequacy of the allowance for loan losses is as follows:

- identification of specific impaired loans by loan category;
- calculation of specific allowances where required for the impaired loans based on collateral and other objective and quantifiable evidence;
- determination of loans with similar credit characteristics within each class of the loan portfolio segment and eliminating the impaired loans;
- application of historical loss percentages (trailing twelve-quarter average) to pools to determine the allowance allocation;
- application of qualitative factor adjustment percentages to historical losses for trends or changes in the loan portfolio, and/or current economic conditions.

Allocation of the allowance for different categories of loans is based on the methodology as explained above. A key element of the methodology to determine the allowance is the Company’s credit risk evaluation process, which includes credit risk grading of individual commercial loans. Commercial loans are assigned credit risk grades based on the Company’s assessment of conditions that affect the borrower’s ability to meet its contractual obligations under the loan agreement. That process includes reviewing borrowers’ current financial information, historical payment experience, credit documentation, public information and other information specific to each individual borrower. Upon review, the commercial loan credit risk grade is revised or reaffirmed. The credit risk grades may be changed at any time management determines an upgrade or downgrade may be warranted. The credit risk grades for the commercial loan portfolio are taken into account in the reserve methodology and loss factors are applied based upon the credit risk grades. The loss factors applied are based upon the Company’s historical experience as well as what management believes to be best practices and within common industry standards. Historical experience reveals there is a direct correlation between the credit risk grades and loan charge-offs. The changes in allocations in the commercial loan portfolio from period-to-period are based upon the credit risk grading system and from periodic reviews of the loan portfolio.

Each quarter, management performs an assessment of the allowance for loan losses. The Company’s Special Assets Committee meets monthly and the applicable lenders discuss each relationship under review and reach a consensus on the appropriate estimated loss amount, if applicable, based on current accounting guidance. The Special Assets Committee’s focus is on ensuring the pertinent facts are considered regarding not only loans considered for specific reserves, but also the collectability of loans that may be past due. The assessment process also includes the review of all loans on a non-accruing basis as well as a review of certain loans to which the lenders or the Company’s Credit Administration function have assigned a criticized or classified risk rating.

Total net charge-offs for the three months ended March 31, 2014 were $0.3 million compared to $1.3 million for the three months ended March 31, 2013. This represented a year-over-year improvement due to a general increase in overall credit quality. The first quarter of 2014 charge-offs were taken on a variety of consumer and commercial loans in relatively small amounts. For a discussion on the provision for loan losses, see the “Provision for loan losses,” located in the results of operations section of management’s discussion and analysis contained herein.

The allowance for loan losses was $8.9 million as of March 31, 2014 and December 31, 2013. Management believes that the current balance in the allowance for loan losses is sufficient to withstand the identified potential credit quality issues that may arise and others unidentified but inherent to the portfolio. Potential problem loans are those where there is known information that leads management to believe repayment of principal and/or interest is in jeopardy and the loans are currently neither on non-accrual status nor past due 90 days or more. There could be additional instances which become identified in future periods that may require additional charge-offs and/or increases to the allowance due to continued sluggishness in the economy and pressure on property values.

During the fourth quarter of 2013, the Company changed its methodology to determine historical loss percentages from a two-year average that was calculated annually to a trailing twelve-quarter average. Management determined that utilizing a trailing twelve-quarter average minimizes the impact of certain anomalies caused by irregular occurrences such as infrequent large loan charge-offs. In addition, during the fourth quarter of 2013, management changed its methodology used to calculate the allowance for loan losses by eliminating certain loans from the calculation that have very little risk of not being collected. Such loans would include the guaranteed portion of all commercial loans that carry a guarantee by the SBA and all loan categories that are fully secured by cash collateral. The change in the averaging convention had an immaterial impact on the March 31, 2014 allowance calculation. By excluding the cash secured and guarantee portion of SBA loans, as of March 31, 2014 the Company was able to reduce the allowance requirement by approximately $51 thousand.

The following tables set forth the activity in the allowance for loan losses and certain key ratios for the period indicated:

*(dollars in thousands)*

|  | As of and for the three months ended March 31, 2014 | As of and for the twelve months ended December 31, 2013 | As of and for the three months ended March 31, 2013 |
| --- | ---: | ---: | ---: |
| Balance at beginning of period | **$8,928** | $8,972 | $8,972 |
| Charge-offs: |  |  |  |
| Commercial and industrial | **28** | 56 | 44 |
| Commercial real estate | **152** | 2,091 | 1,244 |
| Consumer | **118** | 400 | 39 |
| Residential | **59** | 218 | 39 |
| Total | **357** | 2,765 | 1,366 |
| Recoveries: |  |  |  |
| Commercial and industrial | **11** | 30 | 4 |
| Commercial real estate | **1** | 30 | 3 |
| Consumer | **16** | 110 | 73 |
| Residential | **-** | 1 | - |
| Total | **28** | 171 | 80 |
| Net charge-offs | **329** | 2,594 | 1,286 |
| Provision for loan losses | **300** | 2,550 | 550 |
| Balance at end of period | **$8,899** | $8,928 | $8,236 |
| Net charge-offs (annualized) to average total loans outstanding | **0.27%** | 0.56% | 1.14% |
| Allowance for loan losses to net charge-offs (annualized) | **6.76** **x** | 3.44 x | 1.60 x |
| Allowance for loan losses to total loans | **1.84%** | 1.86% | 1.83% |
| Loans 30 - 89 days past due and accruing | **$2,702** | $5,268 | $4,014 |
| Loans 90 days or more past due and accruing | **$20** | $155 | $841 |
| Non-accrual loans | **$3,709** | $5,668 | $9,742 |
| Allowance for loan losses to loans 90 days or more |  |  |  |
| past due and accruing | **444.95** **x** | 57.60 x | 9.79 x |
| Allowance for loan losses to non-accrual loans | **2.40** **x** | 1.58 x | 0.85 x |
| Allowance for loan losses to non-performing loans | **2.39** **x** | 1.53 x | 0.78 x |
| Average total loans | **$480,875** | $461,539 | $450,821 |

The allowance for loan losses can generally absorb losses throughout the loan portfolio. However, in some instances an allocation is made for specific loans or groups of loans. Allocation of the allowance for loan losses for different categories of loans is based on the methodology used by the Company, as previously explained. The changes in the allocations from period-to-period are based upon quarter-end reviews of the loan portfolio.

#### Non-performing assets

The Company defines non-performing assets as accruing loans past due 90 days or more, non-accrual loans, troubled debt restructured loans (TDRs), other real estate owned (ORE), repossessed assets and non-accrual investment securities. As of March 31, 2014, non-performing assets represented 1.07% of total assets, favorable results compared with 1.44% as of December 31, 2013 and 2.47% at March 31, 2013. The improvement resulted from a significant reduction in non-performing loans, elimination of the non-accrual securities (pooled trust preferred securities), and a reduction in troubled debt restructurings. Most of the non-performing loans are collateralized, thereby mitigating the Company’s potential for loss.

The following table sets forth non-performing assets data as of the period indicated:

*(dollars in thousands)*

|  | March 31, 2014 | December 31, 2013 | March 31, 2013 |
| --- | ---: | ---: | ---: |
| Loans past due 90 days or more and accruing | **$20** | $155 | $841 |
| Non-accrual loans \* | **3,709** | 5,668 | 9,742 |
| Total non-performing loans | **3,729** | 5,823 | 10,583 |
| Troubled debt restructurings | **763** | 1,045 | 1,091 |
| Other real estate owned and repossessed assets | **2,511** | 2,086 | 2,302 |
| Non-accrual securities | **-** | - | 1,032 |
| Total non-performing assets | **$7,003** | $8,954 | $15,008 |
| Total loans, including loans held-for-sale | **$484,015** | $479,061 | $450,677 |
| Total assets | **$654,429** | $623,825 | $608,171 |
| Non-accrual loans to total loans | **0.77%** | 1.18% | 2.16% |
| Non-performing loans to total loans | **0.77%** | 1.22% | 2.35% |
| Non-performing assets to total assets | **1.07%** | 1.44% | 2.47% |

\* In the table above, the amount includes non-accrual TDRs of $1.0 million as of March 31, 2014 and December 31, 2013 and $1.1 million as of March 31, 2013.

In the review of loans for both delinquency and collateral sufficiency, management concluded that there were a number of loans that lacked the ability to repay in accordance with contractual terms. The decision to place loans on non-accrual status is made on an individual basis after considering factors pertaining to each specific loan. Generally, commercial loans are placed on non-accrual status when management has determined that payment of all contractual principal and interest is in doubt or the loan is past due 90 days or more as to principal and interest, unless well-secured and in the process of collection. Consumer loans secured by residential real estate and residential mortgage loans are placed on non-accrual status at 120 days past due as to principal and interest, and unsecured consumer loans are charged-off when the loan is 90 days or more past due as to principal and interest. Uncollected interest income accrued on all loans placed on non-accrual is reversed and charged to interest income.

Non-performing loans, consisting of loans over 90 days past due and accruing and non-accrual loans, decreased $2.1 million, or 36%, from $5.8 million on December 31, 2013 to $3.7 million at March 31, 2014. As of year-end 2013, the over 90 days past due portion was $0.2 million, which consisted of four loans to four unrelated borrowers, ranging from $7 thousand to $0.1 million. At quarter end March 31, 2014, there was one loan past due over 90 days totaling $20 thousand. The Company seeks payments from all past due customers through an aggressive customer communication process. A past due loan will be placed on non-accrual at the 90 day point when it is deemed that a customer is non-responsive and uncooperative to collection efforts.

At December 31, 2013, there were 47 loans to 37 unrelated borrowers ranging from less than $1 thousand to $1.0 million in the non-accrual category. At March 31, 2014 there were 37 loans to 35 borrowers on non-accrual ranging from less than $1 thousand to $1.0 million. The decrease in non-accrual loans was related to loans that were charged off, paid off, transferred to ORE or moved back to accrual status.

At March 31, 2014, the non-accrual loans aggregated $3.7 million as compared to $5.7 million at December 31, 2013. The net decrease in the level of non-accrual loans during the period ending March 31, 2014 occurred as follows: additions to the non-accrual loan component of the non-performing assets totaling $0.7 million were made during the period; these were offset by reductions or payoffs of $0.1 million, charge-offs of $0.3 million, $1.2 million of transfers to ORE and $0.1 million of loans that returned to performing status. In addition, during the first quarter of 2014, $1.0 million of non-accrual loans were transferred from loans to premises and equipment as more fully described under the caption “Premises and equipment”, contained in this management’s discussion and analysis below. Loans past due 90 days or more and accruing were $20 thousand at March 31, 2014, compared to $0.2 million as of December 31, 2013. The ratio of non-performing loans to total loans was 0.77% at March 31, 2014 compared to 1.22% at December 31, 2013.

The composition of non-performing loans as of March 31, 2014 is as follows:

*(dollars in thousands)*

|  | Gross loan balances | Past due 90 days or more and still accruing | Non- accrual loans | Total non- performing loans | % of gross loans |
| --- | ---: | ---: | ---: | ---: | ---: |
| Commercial and industrial | $75,717 | $- | $62 | $62 | 0.08% |
| Commercial real estate: |  |  |  |  |  |
| Non-owner occupied | 90,647 | - | 640 | 640 | 0.71% |
| Owner occupied | 89,373 | - | 1,567 | 1,567 | 1.75% |
| Construction | 9,609 | - | 281 | 281 | 2.92% |
| Consumer: |  |  |  |  |  |
| Home equity installment | 34,161 | - | 211 | 211 | 0.62% |
| Home equity line of credit | 37,202 | - | 138 | 138 | 0.37% |
| Auto loans and leases | 23,646 | 20 | - | 20 | 0.08% |
| Other | 5,242 | - | 22 | 22 | 0.42% |
| Residential: |  |  |  |  |  |
| Real estate | 110,675 | - | 788 | 788 | 0.71% |
| Construction | 7,292 | - | - | - | - |
| Loans held-for-sale | 451 | - | - | - | - |
| Total | $484,015 | $20 | $3,709 | $3,729 | 0.77% |

Payments received from non-accrual loans are recognized on a cash method. Payments are first applied to the outstanding principal balance, then to the recovery of any charged-off loan amounts. Any excess is treated as a recovery of interest income. If the non-accrual loans that were outstanding as of March 31, 2014 had been performing in accordance with their original terms, the Company would have recognized interest income with respect to such loans of $52 thousand.

The Company, on a regular basis, reviews changes to loans to determine if they meet the definition of a TDR. TDRs arise when a borrower experiences financial difficulty and the Company grants a concession that it would not otherwise grant based on current underwriting standards in order to maximize the Company’s recovery. TDRs aggregated $1.7 million at March 31, 2014, which was a slight decrease from the December 31, 2013 total of $2.0 million, the result of loan payoffs during the first quarter of 2014.

The following tables set forth the activity in TDRs as and for the periods indicated:

*(dollars in thousands)*

| As of and for the three months ended March 31, 2014 Troubled Debt Restructures: | Accruing Commercial & industrial | Commercial real estate | Non-accruing Commercial real estate | Total |
| --- | ---: | ---: | ---: | ---: |
| Beginning balance | **$35** | **$1,010** | **$967** | **$2,012** |
| Pay downs / payoffs | **10** | **272** | **13** | **295** |
| Ending balance | **$25** | **$738** | **$954** | **$1,717** |

*(dollars in thousands)*

| As of and for the year ended December 31, 2013 Troubled Debt Restructures: | Accruing Commercial & industrial | Commercial real estate | Non-accruing Commercial real estate | Total |
| --- | ---: | ---: | ---: | ---: |
| Beginning balance | $42 | $1,061 | $1,066 | $2,169 |
| Pay downs / payoffs | 7 | 51 | 99 | 157 |
| Ending balance | $35 | $1,010 | $967 | $2,012 |

37

If applicable, a TDR loan classified as non-accrual would require a minimum of six months of payments before consideration for a return to accrual status. The concessions granted consisted of temporary interest-only payments or a reduction in the rate of interest to a below-market rate for a contractual period of time for a contractual period of time. The Company believes concessions have been made in the best interests of the borrower and the Company. If loans characterized as a TDR perform according to the restructured terms for a satisfactory period of time, the TDR designation may be removed in a new calendar year if the loan yields a market rate of interest.

#### Foreclosed assets held-for-sale

Foreclosed assets held-for-sale aggregated $2.5 million at March 31, 2014 and $2.1 million at December 31, 2013. The following table sets forth the activity in the ORE component of foreclosed assets held-for-sale:

*(dollars in thousands)*

|  | March 31, 2014 Amount | # | December 31, 2013 Amount | # |
| --- | ---: | ---: | ---: | ---: |
| Balance at beginning of period | **$2,078** | **15** | $1,600 | 12 |
| Additions | **1,131** | **5** | 2,381 | 15 |
| Pay downs | **-** |  | (34) |  |
| Write downs | **-** |  | (443) |  |
| Sold | **(711)** | **(6)** | (1,426) | (12) |
| Balance at end of period | **$2,498** | **14** | $2,078 | 15 |

As of March 31, 2014, ORE consisted of fourteen properties from unrelated borrowers totaling $2.5 million. Five of these properties ($1.1 million total) were added in 2014; five were added in 2013 ($514 thousand total); two were added in 2012 ($289 thousand); one was added in 2011 ($152 thousand) and one was added in 2010 ($400 thousand).

One property ($150 thousand) has a pending insurance claim, six properties ($1.5 million) were listed for sale, two ($136 thousand) had signed sales agreements, two ($253 thousand) were in litigation, and three properties ($455 thousand) were awaiting disposition plans.

Other non-real estate foreclosed assets held-for-sale included an automobile with a book value of $13 thousand at March 31, 2014. At December 31, 2013, other repossessed assets consisted of an automobile with a book value of $8 thousand which was sold during 2014.

#### Premises and equipment

Net of depreciation, premises and equipment increased $0.8 million during the first quarter of 2014. During the quarter, the Company received through foreclosure the deed that secured the collateral for a non-owner occupied commercial real estate loan that was on non-accrual status. During the first quarter, the loan, in the amount $1.0 million, was transferred from loans to foreclosed assets held-for-sale and then to bank premises. The Company expects to use the property for future facility expansion.

#### Other assets and liabilities

The $1.1 million increase in other assets was due principally to a $0.6 million purchase of an investment security that did not settle until after quarter end. The purchase obligation is reflected in an equal amount in other liabilities. Other assets also increased by progress payments on facility construction projects and by residual values associated with recording new automobile leases, net of lease disposals.

### Funds Provided:

#### Deposits

The Company is a community based commercial depository financial institution, member FDIC, which offers a variety of deposit products with varying ranges of interest rates and terms. Generally, deposits are obtained from consumers, businesses and public entities within the communities that surround the Company’s 11 branch offices and all deposits are insured by the FDIC up to the full extent permitted by law. Deposit products consist of transaction accounts including: savings; clubs; interest-bearing checking; money market and non-interest bearing checking (DDA). The Company also offers short- and long-term time deposits or certificates of deposit (CDs). CDs are deposits with stated maturities which can range from seven days to ten years. Deposit inflow and outflow is influenced by economic conditions, changes in the interest rate environment, pricing and competition. To determine interest rates on its deposit products, the Company considers local competition, spreads to earning-asset yields, liquidity position and rates charged for alternative sources of funding such as short-term borrowings and FHLB advances.

The following table represents the components of deposits as of the date indicated:

*(dollars in thousands)*

|  | March 31, 2014 Amount% |  | December 31, 2013 Amount% |  |
| --- | ---: | ---: | ---: | ---: |
| Money market | **$86,193** | **15.5%** | $83,512 | 15.8% |
| Interest-bearing checking | **113,749** | **20.5** | 100,315 | 18.9 |
| Savings and clubs | **111,859** | **20.2** | 109,253 | 20.6 |
| Certificates of deposit | **110,869** | **20.0** | 113,699 | 21.5 |
| Total interest-bearing | **422,670** | **76.2** | 406,779 | 76.8 |
| Non-interest bearing | **132,096** | **23.8** | 122,919 | 23.2 |
| Total deposits | **$554,766** | **100.0%** | $529,698 | 100.0% |

Total deposits increased $25.1 million, or 5%, from $529.7 million at December 31, 2013 to $554.8 million at March 31, 2014. Interest-bearing checking and noninterest-bearing checking had significant growth at $13.4 million, or 13%, and $9.2 million, or 7%. The principal cause of the increase was due to the timing of the receipt of public tax deposits. Public deposits are usually received mid-quarter, are retained for a relatively short period of time with disbursements occurring shortly after they are received. Success in deposit gathering strategies including periodic promotions helped boost non-maturing deposits for retail customers while business transaction accounts experienced minor cash outflow. The Company’s focus will be to continue to partner with business clientele, establish new and continue to cultivate existing banking relationships. In 2014, we expect to experience moderate deposit growth from year-end 2013 levels.

The rates along the intermediate and long end of the treasury yield curve continued to slowly rise while rates at the short end, where transaction deposits are typically priced, remained relatively flat. The long-end has not risen enough to induce depositors to move their cash reserves into longer-term CDs and as such, banks will most likely increase rates cautiously slow until there is a clear indication that the rates along the curve rise, steepen and stabilize. Managing the yield curve in a changing rate environment is imperative to maintain interest rate spread. The current environment continues to cause business and retail customers to seek short-term alternatives for their deposits. When rates begin to rise, however, there is no assurance that customers will continue to hold their deposits with the Company or they may seek higher rates from term CDs, thereby increasing funding costs. The Company will continue to pursue and retain retail and business households with an emphasis on deepening and broadening those relationships thereby containing interest expense.

The Company uses the Certificate of Deposit Account Registry Service (CDARS) reciprocal program to obtain FDIC insurance protection for customers who have large deposits that at times may exceed the FDIC maximum amount of $250,000 per person. In the CDARS program, deposits with varying terms and interest rates, originated in the Company’s own markets, are exchanged for deposits of other financial institutions that are members in the CDARS network. By placing the deposits in other participating institutions, the deposits of our customers are fully insured by the FDIC. In return for deposits placed with network institutions, the Company receives from network institutions deposits that are approximately equal in amount and are comprised of terms similar to those placed for our customers. Deposits the Company receives, or reciprocal deposits, from other institutions are considered brokered deposits by regulatory definitions. As of both March 31, 2014 and December 31, 2013, CDARS represented $10.3 million, or 2%, of total deposits.

Excluding CDARS, certificates of deposit accounts of $100,000 or more amounted to $40.2 million and $41.2 million at March 31, 2014 and December 31, 2013, respectively. Certificates of deposit of $250,000 or more amounted to $15.3 million and $15.7 million as of March 31, 2014 and December 31, 2013, respectively.

Including CDARS, approximately 41% of the CDs, with a weighted-average interest rate of 0.75%, are scheduled to mature in 2014 and an additional 27%, with a weighted-average interest rate of 1.11%, are scheduled to mature in 2015. Renewing CDs may re-price to lower or higher market rates depending on the rate on the maturing CD, the pace and direction of interest rate movements, the shape of the yield curve, competition, the rate profile of the maturing accounts and depositor preference for alternative, non-term products. The widespread preference has been for customers with maturing CDs to hold their deposits in readily available transaction accounts. Though the CD portfolio has declined $2.8 million, or by less than 3%, the Company projects a flat to marginal increase in its CDs in 2014.

#### Borrowings

Borrowings are used as a complement to deposit generation as an alternative funding source whereby the Company will borrow under customer repurchase agreements in the local market, advances from the Federal Home Loan Bank of Pittsburgh (FHLB) and other correspondent banks for asset growth and liquidity needs.

Repurchase agreements are non-insured interest-bearing liabilities that have a perfected security interest in qualified investments of the Company as required by the FDIC Depositor Protection Act of 2009. Repurchase agreements are offered through a sweep product. A sweep account is designed to ensure that on a daily basis, an attached DDA is adequately funded and excess funds are transferred, or swept, into an interest-bearing overnight repurchase agreement account. Due to the constant inflow and outflow of funds of the sweep product, their balances tend to be somewhat volatile, similar to a DDA. Customer liquidity is the typical cause for variances in repurchase agreements, which during the first quarter of 2014 increased $6.2 million, or 100%, from year-end December 31, 2013. In addition, short-term borrowings may include overnight balances which the Company may require to fund daily liquidity needs such as deposit and repurchase agreement cash outflow, loan demand and operations. At March 31, 2014, the Company did not have balances in overnight borrowings compared to $2.5 million as of December 31, 2013.

The following table represents the components of borrowings as of the date indicated:

*(dollars in thousands)*

|  | March 31, 2014 Amount% |  | December 31, 2013 Amount% |  |
| --- | ---: | ---: | ---: | ---: |
| Overnight borrowings | **$-** | **-%** | $2,472 | 10.0% |
| Securities sold under repurchase agreements | **12,327** | **43.5** | 6,171 | 25.0 |
| Long-term FHLB advances | **16,000** | **56.5** | 16,000 | 64.9 |
| Total | **$28,327** | **100.0%** | $24,643 | 100.0% |

## Market risk

As filed, 24,451 characters.

#### Management of interest rate risk and market risk analysis.

The adequacy and effectiveness of an institution’s interest rate risk management process and the level of its exposures are critical factors in the regulatory evaluation of an institution’s sensitivity to changes in interest rates and capital adequacy. Management believes the Company’s interest rate risk measurement framework is sound and provides an effective means to measure, monitor, analyze, identify and control interest rate risk in the balance sheet.

The Company is subject to the interest rate risks inherent in its lending, investing and financing activities. Fluctuations of interest rates will impact interest income and interest expense along with affecting market values of all interest-earning assets and interest-bearing liabilities, except for those assets or liabilities with a short term remaining to maturity. Interest rate risk management is an integral part of the asset/liability management process. The Company has instituted certain procedures and policy guidelines to manage the interest rate risk position. Those internal policies enable the Company to react to changes in market rates to protect net interest income from significant fluctuations. The primary objective in managing interest rate risk is to minimize the adverse impact of changes in interest rates on net interest income along with creating an asset/liability structure that maximizes earnings.

*Asset/Liability Management.* One major objective of the Company when managing the rate sensitivity of its assets and liabilities is to stabilize net interest income. The management of and authority to assume interest rate risk is the responsibility of the Company’s Asset/Liability Committee (ALCO), which is comprised of senior management and members of the board of directors. ALCO meets quarterly to monitor the relationship of interest sensitive assets to interest sensitive liabilities. The process to review interest rate risk is a regular part of managing the Company. Consistent policies and practices of measuring and reporting interest rate risk exposure, particularly regarding the treatment of non-contractual assets and liabilities, are in effect. In addition, there is an annual process to review the interest rate risk policy with the board of directors which includes limits on the impact to earnings from shifts in interest rates.

*Interest Rate Risk Measurement.* Interest rate risk is monitored through the use of three complementary measures: static gap analysis, earnings at risk simulation and economic value at risk simulation. While each of the interest rate risk measurements has limitations, collectively, they represent a reasonably comprehensive view of the magnitude of interest rate risk in the Company and the distribution of risk along the yield curve, the level of risk through time and the amount of exposure to changes in certain interest rate relationships.

*Static Gap.* The ratio between assets and liabilities re-pricing in specific time intervals is referred to as an interest rate sensitivity gap. Interest rate sensitivity gaps can be managed to take advantage of the slope of the yield curve as well as forecasted changes in the level of interest rate changes.

To manage this interest rate sensitivity gap position, an asset/liability model commonly known as cumulative gap analysis is used to monitor the difference in the volume of the Company’s interest sensitive assets and liabilities that mature or re-price within given time intervals. A positive gap (asset sensitive) indicates that more assets will re-price during a given period compared to liabilities, while a negative gap (liability sensitive) indicates the opposite effect. The Company employs computerized net interest income simulation modeling to assist in quantifying interest rate risk exposure. This process measures and quantifies the impact on net interest income through varying interest rate changes and balance sheet compositions. The use of this model assists the ALCO to gauge the effects of the interest rate changes on interest-sensitive assets and liabilities in order to determine what impact these rate changes will have upon the net interest spread. At March 31, 2014, the Company maintained a one-year cumulative gap of positive (asset sensitive) $63.8 million, or 10%, of total assets. The effect of this positive gap position provided a mismatch of assets and liabilities which may expose the Company to interest rate risk during periods of falling interest rates. Conversely, in an increasing interest rate environment, net interest income could be positively impacted because more assets than liabilities will re-price upward during the one-year period.

Certain shortcomings are inherent in the method of analysis discussed above and presented in the next table. Although certain assets and liabilities may have similar maturities or periods of re-pricing, they may react in different degrees to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. Certain assets, such as adjustable-rate mortgages, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the table amounts. The ability of many borrowers to service their adjustable-rate debt may decrease in the event of an interest rate increase.

The following table illustrates the Company’s interest sensitivity gap position at March 31, 2014:

*(dollars in thousands)*

|  | Three months or less | More than three months to twelve months | More than one year to three years | More than three years | Total |
| --- | ---: | ---: | ---: | ---: | ---: |
| Cash and cash equivalents | $16,643 | $- | $- | $15,456 | $32,099 |
| Investment securities (1)(2) | 3,066 | 10,356 | 22,552 | 68,415 | 104,389 |
| Loans and leases(2) | 178,870 | 69,473 | 111,760 | 115,013 | 475,116 |
| Fixed and other assets | - | 10,485 | - | 32,340 | 42,825 |
| Total assets | $198,579 | $90,314 | $134,312 | $231,224 | $654,429 |
| Total cumulative assets | $198,579 | $288,893 | $423,205 | $654,429 |  |
| Non-interest-bearing transaction deposits (3) | $- | $13,223 | $36,300 | $82,573 | $132,096 |
| Interest-bearing transaction deposits (3) | 123,850 | 18,618 | 110,321 | 59,012 | 311,801 |
| Certificates of deposit | 16,660 | 40,400 | 45,634 | 8,175 | 110,869 |
| Repurchase agreements | 12,327 | - | - | - | 12,327 |
| Long-term debt | - | - | 16,000 | - | 16,000 |
| Other liabilities | - | - | - | 3,487 | 3,487 |
| Total liabilities | $152,837 | $72,241 | $208,255 | $153,247 | $586,580 |
| Total cumulative liabilities | $152,837 | $225,078 | $433,333 | $586,580 |  |
| Interest sensitivity gap | $45,742 | $18,073 | $(73,943) | $77,977 |  |
| Cumulative gap | $45,742 | $63,815 | $(10,128) | $67,849 |  |
| Cumulative gap to total assets | 7.0% | 9.8% | -1.5% | 10.4% |  |

(1) Includes FHLB stock and the net unrealized gains/losses on available-for-sale securities.

(2) Investments and loans are included in the earlier of the period in which interest rates were next scheduled to adjust or the period in which they are due. In addition, loans were included in the periods in which they are scheduled to be repaid based on scheduled amortization. For amortizing loans and MBS – GSE residential, annual prepayment rates are assumed reflecting historical experience as well as management’s knowledge and experience of its loan products.

(3) The Company’s demand and savings accounts were generally subject to immediate withdrawal. However, management considers a certain amount of such accounts to be core accounts having significantly longer effective maturities based on the retention experiences of such deposits in changing interest rate environments. The effective maturities presented are the recommended maturity distribution limits for non-maturing deposits based on historical deposit studies.

*Earnings at Risk and Economic Value at Risk Simulations.* The Company recognizes that more sophisticated tools exist for measuring the interest rate risk in the balance sheet that extend beyond static re-pricing gap analysis. Although it will continue to measure its re-pricing gap position, the Company utilizes additional modeling for identifying and measuring the interest rate risk in the overall balance sheet. The ALCO is responsible for focusing on “earnings at risk” and “economic value at risk”, and how both relate to the risk-based capital position when analyzing the interest rate risk.

*Earnings at Risk.* An earnings at risk simulation measures the change in net interest income and net income should interest rates rise and fall. The simulation recognizes that not all assets and liabilities re-price one-for-one with market rates (e.g., savings rate). The ALCO looks at “earnings at risk” to determine income changes from a base case scenario under an increase and decrease of 200 basis points in interest rate simulation models.

*Economic Value at Risk.* An earnings at risk simulation measures the short-term risk in the balance sheet. Economic value (or portfolio equity) at risk measures the long-term risk by finding the net present value of the future cash flows from the Company’s existing assets and liabilities. The ALCO examines this ratio quarterly utilizing an increase and decrease of 200 basis points in interest rate simulation models. The ALCO recognizes that, in some instances, this ratio may contradict the “earnings at risk” ratio.

The following table illustrates the simulated impact of an immediate 200 basis points upward or downward movement in interest rates on net interest income, net income and the change in the economic value (portfolio equity). This analysis assumed that interest-earning asset and interest-bearing liability levels at March 31, 2014 remained constant. The impact of the rate movements was developed by simulating the effect of the rate change over a twelve-month period from the March 31, 2014 levels:

| Earnings at risk: | % change Rates +200 | Rates -200 |
| --- | ---: | ---: |
| Net interest income | 7.0% | (2.7)% |
| Net income | 19.5 | (7.4) |
| Economic value at risk: |  |  |
| Economic value of equity | (9.2) | (15.6) |
| Economic value of equity as a percent of total assets | (1.2) | (2.0) |

Economic value has the most meaning when viewed within the context of risk-based capital. Therefore, the economic value may normally change beyond the Company’s policy guideline for a short period of time as long as the risk-based capital ratio (after adjusting for the excess equity exposure) is greater than 10%. At March 31, 2014, the Company’s risk-based capital ratio was 15.5%.

The table below summarizes estimated changes in net interest income over a twelve-month period beginning April 1, 2014, under alternate interest rate scenarios using the income simulation model described above:

*(dollars in thousands)*

| Simulated change in interest rates | Net interest income | $% variance | variance |
| --- | ---: | ---: | ---: |
| +200 basis points | $23,057 | $1,517 | 7.0% |
| +100 basis points | 22,121 | 581 | 2.7 |
| Flat rate | 21,540 | - | - |
| -100 basis points | 21,347 | (193) | (0.9) |
| -200 basis points | 20,955 | (585) | (2.7) |

Simulation models require assumptions about certain categories of assets and liabilities. The models schedule existing assets and liabilities by their contractual maturity, estimated likely call date or earliest re-pricing opportunity. MBS – GSE residential securities and amortizing loans are scheduled based on their anticipated cash flow including estimated prepayments. For investment securities, the Company uses a third-party service to provide cash flow estimates in the various rate environments. Savings, money market and interest-bearing checking accounts do not have stated maturities or re-pricing terms and can be withdrawn or re-price at any time. This may impact the margin if more expensive alternative sources of deposits are required to fund loans or deposit runoff. Management projects the re-pricing characteristics of these accounts based on historical performance and assumptions that it believes reflect their rate sensitivity. The model reinvests all maturities, repayments and prepayments for each type of asset or liability into the same product for a new like term at current product interest rates. As a result, the mix of interest-earning assets and interest bearing-liabilities is held constant.

#### Liquidity

Liquidity management ensures that adequate funds will be available to meet customers’ needs for borrowings, deposit withdrawals and maturities, facility expansion and normal operating expenses. Sources of liquidity are cash and cash equivalents, asset maturities and pay-downs within one year, loans HFS, investments AFS, growth of core deposits and repurchase agreements, utilization of borrowing capacities from the FHLB, correspondent banks, CDARs, the Discount Window of the Federal Reserve Bank of Philadelphia (FRB) and proceeds from the issuance of capital stock. Though regularly scheduled investment and loan payments are dependable sources of daily liquidity, sales of both loans HFS and investments AFS, deposit activity and investment and loan prepayments are significantly influenced by general economic conditions and the interest rate environment. During low and declining interest rate environments, prepayments from interest-sensitive assets tend to accelerate and provide significant liquidity that can be used to invest in other interest-earning assets but at lower market rates. Conversely, in periods of high or rising interest rates, prepayments from interest-sensitive assets tend to decelerate causing cash flow from mortgage loans and mortgage-backed securities to decrease. Rising interest rates may also cause deposit inflow to accelerate but priced at higher market interest rates. Rising rates may also cause deposit outflow due to higher rates offered by the Company’s competition for similar products. The Company closely monitors activity in the capital markets and takes appropriate action to ensure that the liquidity levels are adequate for funding, investing and operating activities.

The Company’s contingency funding plan (CFP) sets a framework for handling liquidity issues in the event circumstances arise which the Company deems to be less than normal. The Company established guidelines for identifying, measuring, monitoring and managing the resolution of potentially serious liquidity crises. The CFP outlines required monitoring tools, acceptable alternative funding sources and required actions during various liquidity scenarios. Thus, the Company has implemented a proactive means for the measurement and resolution for handling potentially significant adverse liquidity conditions. At least quarterly, the CFP monitoring tools, current liquidity position and monthly projected liquidity sources and uses are presented and reviewed by the Company’s ALCO. As of March 31, 2014, the Company had not experienced any adverse issues that would give rise to its inability to raise liquidity in an emergency situation.

During the three months ended March 31, 2014, the Company generated $18.9 million of cash. During the period, the Company was in receipt of public tax deposits that it received later than normal during the first quarter. Cash received from the sale of PreTSL portfolio in the fourth quarter of 2013 was used to fund growth in loan and re-deployment in the investment portfolios. The growth in the loan portfolio occurred in all sectors with the commercial portfolio leading the growth. The Company expects to continue to grow the commercial loan portfolio in 2014 using growth in deposits, repos and operations. The seasonal nature of deposit balances from municipalities and other public funding sources requires the Company to be prepared for the inherent volatility and the unpredictable timing of cash outflow from this customer base. The CFP is a tool to help the Company ensure that alternative funding sources are available to meet its liquidity needs.

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the financing needs of its customers and in connection with the overall interest rate management strategy. These instruments involve, to a varying degree, elements of credit, interest rate and liquidity risk. In accordance with GAAP, these instruments are either not recorded in the consolidated financial statements or are recorded in amounts that differ from the notional amounts. Such instruments primarily include lending commitments and lease obligations.

Lending commitments include commitments to originate loans and commitments to fund unused lines of credit. 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 some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

In addition to lending commitments, the Company has contractual obligations related to operating lease commitments. Operating lease commitments are obligations under various non-cancelable operating leases on buildings and land used for office space and banking purposes. The Company’s position with respect to lending commitments and significant contractual obligations, both on a short- and long-term basis has not changed materially from December 31, 2013.

As of March 31, 2014, the Company maintained $32.1 million in cash and cash equivalents and $102.7 million of investments AFS and loans HFS. Also as of March 31, 2014, the Company had approximately $165.7 million available to borrow from the FHLB, $21.0 million from correspondent banks, $28.7 million from the FRB and $31.2 million from the CDARS program. The combined total of $381.4 million represented 58% of total assets at March 31, 2014. Management believes this level of liquidity to be strong and adequate to support current operations.

#### Capital

During the three months ended March 31, 2014, total shareholders' equity increased $1.8 million, or 3%, due principally from the $1.5 million in net income added into retained earnings and the $0.5 million, after-tax improvement in the net unrealized gain position in the Company’s investment portfolio. Capital was further enhanced by $0.3 million from investments in the Company’s common stock via the Employee Stock Purchase (ESPP) and Dividend Reinvestment (DRP) Plans. These items were partially offset by the $0.6 million of cash dividends declared on the Company’s common stock.

As of March 31, 2014, the Company reported a net unrealized gain position of $1.8 million, net of tax, from the securities AFS portfolio compared to a net unrealized gain of $1.2 million as of December 31, 2013. The increase in unrealized gains during the first quarter of 2014 was due mostly to an increase in unrealized gains on municipal securities. Management believes that volatility in fair value of the Company’s securities is due to changes in interest rates and not deterioration in the creditworthiness of the issuers. When, U.S. Treasury rates rise, investment securities’ pricing declines and fair values of investment securities also decline. With the yield curve slowly increasing at the mid- to long-range, the Company expects pricing in the bond portfolio to decline. Bond prices move inversely to the movement of interest rates. As such, there is no assurance that future realized and unrealized losses will not be recognized from the Company’s portfolio of investment securities. To help maintain a healthy capital position, the Company expects to continue to issue stock to participants in the DRP and ESPP plans. The DRP affords the Company the option to acquire shares in open market purchases and/or issue shares directly from the Company to issue stock to participants. These two plans have been a consistent source of capital from the Company’s loyal employees and shareholders and their participation in these plans will continue to help strengthen the Company’s balance sheet. Beginning in 2009, the Company’s board of directors had allowed a benefit to our loyal shareholders as a discount on the purchase price for shares issued directly from the Company through the DRP and voluntary cash feature. During the first quarter of 2014, the DRP was amended to discontinue a portion of the discount on the voluntary cash feature as the board of directors had determined that the Company’s capital position has achieved sufficient levels.

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk-weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

Under these guidelines, assets and certain off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets. The guidelines require all banks and bank holding companies to maintain a minimum ratio of total risk-based capital to total risk-weighted assets (Total Risk Adjusted Capital) of 8%, including Tier I capital to total risk-weighted assets (Tier I Capital) of 4% and Tier I capital to average total assets (Leverage Ratio) of at least 4%. As of March 31, 2014, the Company and the Bank exceeded all capital adequacy requirements to which it was subject.

The Company continues to closely monitor and evaluate alternatives to enhance its capital ratios as the regulatory and economic environments change. The following table depicts the capital amounts and ratios of the Company and the Bank as of March 31, 2014:

*(dollars in thousands)*

| As of March 31, 2014 Total capital (to risk-weighted assets) | Actual Amount | Ratio | For capital adequacy purposes Amount |  | Ratio |  | To be well capitalized under prompt corrective action provisions Amount |  | Ratio |  |
| --- | ---: | ---: | --- | ---: | --- | ---: | --- | ---: | --- | ---: |
| Consolidated | **$71,941** | **15.5%** | **≥** | **$37,231** | **≥** | **8.0%** |  | **N/A** |  | **N/A** |
| Bank | **$71,416** | **15.4%** | **≥** | **$37,186** | **≥** | **8.0%** | **≥** | **$46,482** | **≥** | **10.0%** |
| Tier I capital (to risk-weighted assets) |  |  |  |  |  |  |  |  |  |  |
| Consolidated | **$65,967** | **14.2%** | **≥** | **$18,616** | **≥** | **4.0%** |  | **N/A** |  | **N/A** |
| Bank | **$65,565** | **14.1%** | **≥** | **$18,593** | **≥** | **4.0%** | **≥** | **$27,889** | **≥** | **6.0%** |
| Tier I capital (to average assets) |  |  |  |  |  |  |  |  |  |  |
| Consolidated | **$65,967** | **10.3%** | **≥** | **$25,636** | **≥** | **4.0%** |  | **N/A** |  | **N/A** |
| Bank | **$65,565** | **10.2%** | **≥** | **$25,617** | **≥** | **4.0%** | **≥** | **$32,021** | **≥** | **5.0%** |

The Company advises readers to refer to the Supervision and Regulation section of Management’s Discussion and Analysis of Financial Condition and Results of Operation, of its 2013 Form 10-K for a discussion on the regulatory environment and recent legislation and rulemaking.

## Controls and procedures

As filed, 1,065 characters.

As of the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation was carried out by the Company’s management, with the participation of its President and Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934. Based on such evaluation, the President and Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports the Company files or furnishes under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations, and are effective. The Company made no changes in its internal controls over financial reporting or in other factors that materially affected, or are reasonably likely to materially affect, these controls during the last fiscal quarter ended March 31, 2014.

## Risk factors

As filed, 210 characters.

Management of the Company does not believe there have been any material changes to the risk factors that were disclosed in the 2013 Form 10-K filed with the Securities and Exchange Commission on March 19, 2014.

Filed May 7, 2014.
Source: SEC EDGAR, the filing index for accession 0001098151-14-000024. Last ingested by Listed: Nov 6, 2026, 18:40 ET. No prices; not investment advice.