# Fidelity D & D Bancorp Inc: Form 10-Q for the period ended Mar 31, 2013

- Company: [Fidelity D & D Bancorp Inc](/companies/fdbc.md) (CIK 1098151)
- Form: 10-Q
- Filed: 2013-05-13
- Accepted by EDGAR: May 13, 2013, 12:53 ET
- Period: 2013-03-31
- Accession: 0001144204-13-028177
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1098151/000114420413028177/v344454_10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1098151/000114420413028177/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2013-03-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Interest expense | 3 months, 2013-01-01 to 2013-03-31 | $735.0k | us-gaap:InterestExpense |
| Income tax | 3 months, 2013-01-01 to 2013-03-31 | $477.0k | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2013-01-01 to 2013-03-31 | $1.4m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2013-01-01 to 2013-03-31 | $0.60 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2013-01-01 to 2013-03-31 | $0.60 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2013-01-01 to 2013-03-31 | 2,335,778 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 3 months, 2013-01-01 to 2013-03-31 | $10.8m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 3 months, 2013-01-01 to 2013-03-31 | $111.0k | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Cash and equivalents | at 2013-03-31 | $20.7m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Total assets | at 2013-03-31 | $608.2m | us-gaap:Assets |
| Total liabilities | at 2013-03-31 | $548.4m | us-gaap:Liabilities |
| Short-term borrowings | at 2013-03-31 | $13.6m | us-gaap:ShortTermBorrowings |
| Shareholders' equity | at 2013-03-31 | $59.8m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 66,445 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, 2013 compared to December 31, 2012 and a comparison of the results of operations for the three months ended March 31, 2013 and 2012. Current performance may not be indicative of future results. This discussion should be read in conjunction with the Company’s 2012 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 deterioration and the prolonged economic malaise 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 there under;
- possible impacts of the capital and liquidity requirements proposed by the Basel III standards and other regulatory pronouncements, regulations and rules;
- governmental monetary and fiscal policies, as well as legislative and regulatory changes;
- 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;
- slow economic conditions;
- 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 continued to fall from 7.8% at December 31, 2012 to 7.6% at March 31, 2013, its lowest level since 2008. While the unemployment rate has been declining nationally, the unemployment rate in the Scranton-Wilkes-Barre Metropolitan Statistical Area (local), after elevating in January and February to 11.2% and 10.2%, dropped back down to 9.5% at March 31, 2013, a slight 0.1 percentage point increase from 9.4% at December 31, 2012. Local economists and state labor analysts predict that unemployment rates will decline as the national economy improves. However, this economic improvement is anticipated to be slow-moving. The Scranton Metropolitan housing and real estate markets remain soft with median home values declining by 1% from year-end 2012. Sustaining 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 portfolio.

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, net gains or losses from sales of loans, securities and foreclosed assets held-for-sale, the write-down to market value of foreclosed properties held-for-sale and from credit-related other-than-temporary impairment (OTTI) charges on investment securities. Non-interest expense consists of compensation and related employee benefit expenses, occupancy, equipment, data processing, advertising, marketing, FDIC insurance premiums, professional fees, loan collection, other real estate owned (ORE) expenses, supplies and other operating overhead.

### Comparison of the results of operations

### Three months ended March 31 2013 and 2012

### Overview

Net income for the first quarter of 2013 was $1.4 million, or $0.60 per diluted share, compared to $1.3 million, or $0.56 per diluted share in the same 2012 quarter. An increase in net interest income coupled with a smaller provision for loan losses and marginally more non-interest income fully offset a minor increase in non-interest expense.

Return on average assets (ROA) and return on average shareholders’ equity (ROE) were 0.91% and 9.49%, respectively, for the three months ended March 31, 2013 compared to 0.82% and 9.23%, respectively, for the three months ended March 31, 2012. The higher ROA and ROE was caused by the increase in net income.

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

Net interest income increased $0.1 million, or 2%, in the first quarter of 2013 to $5.2 million, from $5.1 million recorded in the first quarter of 2012. The net interest rate spread increased to 3.66% for the three months ended March 31, 2013 from 3.55% for the three months ended March 31, 2012. Similarly, during the same period, the net interest margin increased to 3.84% from 3.73%. The rise in net interest income, spread and margin was due primarily to a $29.8 million increase in average residential mortgage loan balances that helped offset the impact lower yields had on interest-earning assets more so than did the lower rates paid on interest-bearing liabilities. The negative impact of the decrease in total average interest-earning assets of $2.4 million in the first quarter of 2013 compared to the first quarter of 2012 coupled with a 3 basis point decline in yield was not enough to offset the favorable impact of the decrease in interest-bearing liabilities of $27.6 million mostly from a decrease in money market, CD accounts and long-term debt with a 14 basis point decline in rates paid. The decline in interest-bearing funding was partially offset by a $23.7 million increase in average non-interest bearing deposits that helped further reduce funding costs by an additional 16 basis points during the quarter.

Total interest income decreased $0.1 million, or 1%, from $6.1 million for the quarter ended March 31, 2012 to $6.0 million for the first quarter of 2013. The decrease in interest income was due to a decline in the average yields in most all of the interest-earning asset portfolios offset partially by a larger average mortgage loan portfolio. The decline in the average yield of investments of 21 basis points in conjunction with a $10.8 million decrease in average interest-earning investment balances, resulted in a decrease of $0.1 million in investment interest income.

Interest expense for the three months ended March 31, 2013 was $0.7 million, a decrease of $0.2 million, or 22%, from $0.9 million recorded during the three months ended March 31, 2012. The decrease in interest expense was primarily due to decreases in the average cost paid on interest-bearing deposits and a lower level of long-term debt. The cost of interest-bearing deposits, which declined 12 basis points during the first quarter of 2013 compared to the same quarter of 2012, was caused mostly by lower rates paid on CDs of 32 basis points. The decrease in interest expense from borrowed funds was from the first quarter 2012 payoff of a $5.0 million, 3.61% FHLB advance that was scheduled to mature in 2013.

The low interest rate environment caused yields from earning assets to further decline and will most likely continue to do so throughout 2013 and therefore may compress the Company’s net interest margin. At 70 basis points, the Company’s cost of interest-bearing liabilities for the quarter ended March 31, 2013 is 14 basis points lower than the 0.84% paid in the first quarter of 2012. Other than retaining maturing long-term CDs, reducing deposit rates further would have a minimal cost-saving effect. The Company has been developing, with success, a strategy to strengthen its relationship with new and existing business customers thereby generating a higher level of average non-interest bearing DDA balances and reducing the Company’s overall cost of funds. Strategically deploying these funds into interest earning-assets such as the loan portfolio is an effective margin-enhancing strategy that the Company expects to continue to pursue and expand upon in 2013 thereby stabilizing net interest margin at acceptable levels.

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 on deposits and repurchase agreements and to seek revenue enhancing strategies to combat the trend in declining interest income. The Company’s marketing department, in concert with ALM, lenders and deposit gatherers, continues to develop prudent strategies that will grow the loan portfolio and accumulate low-cost deposits in order to contain the Company’s interest rate margin.

The tables that follow set forth a comparison of average balances and their corresponding fully tax-equivalent (FTE) interest income and expense and annualized tax-equivalent yield and cost for the periods indicated:

*(dollars in thousands)*

| Assets Interest-earning assets | Three months ended March 31, 2013 Average balance | Interest | Yield / rate | March 31, 2012 Average balance | Interest | Yield / rate |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| **Interest-bearing deposits** | **$17,419** | **$12** | **0.29%** | $44,765 | $28 | 0.25% |
| **Investments:** |  |  |  |  |  |  |
| Agency - GSE | **17,472** | **45** | **1.04** | 26,114 | 76 | 1.17 |
| MBS - GSE residential | **50,452** | **135** | **1.08** | 50,094 | 206 | 1.65 |
| State and municipal | **27,342** | **436** | **6.46** | 28,405 | 465 | 6.59 |
| Other | **9,059** | **20** | **0.88** | 10,471 | 20 | 0.77 |
| Total investments | **104,325** | **636** | **2.47** | 115,084 | 767 | 2.68 |
| **Loans and leases:** |  |  |  |  |  |  |
| Commercial | **241,763** | **3,023** | **5.07** | 235,631 | 3,080 | 5.26 |
| Consumer | **55,447** | **908** | **6.64** | 55,859 | 948 | 6.82 |
| Residential real estate | **153,611** | **1,588** | **4.19** | 123,758 | 1,457 | 4.73 |
| Total loans and leases | **450,821** | **5,519** | **4.97** | 415,248 | 5,485 | 5.31 |
| **Federal funds sold** | **441** | **-** | **0.26** | 289 | - | 0.25 |
| Total interest-earning assets | **573,006** | **6,167** | **4.36%** | 575,386 | 6,280 | 4.39% |
| Non-interest earning assets | **44,950** |  |  | 41,246 |  |  |
| **Total Assets** | **$617,956** |  |  | $616,632 |  |  |
| **Liabilities and shareholders' equity** |  |  |  |  |  |  |
| **Interest-bearing liabilities** |  |  |  |  |  |  |
| **Deposits:** |  |  |  |  |  |  |
| Savings | **$108,875** | **$56** | **0.21%** | $108,786 | $59 | 0.22% |
| Interest-bearing checking | **83,170** | **26** | **0.13** | 77,106 | 23 | 0.12 |
| MMDA | **80,543** | **104** | **0.52** | 105,615 | 151 | 0.57 |
| CDs \< $100,000 | **74,874** | **198** | **1.07** | 82,089 | 281 | 1.38 |
| CDs \> $100,000 | **41,271** | **130** | **1.28** | 41,234 | 169 | 1.65 |
| Clubs | **1,380** | **1** | **0.15** | 1,365 | 1 | 0.16 |
| Total interest-bearing deposits | **390,113** | **515** | **0.54** | 416,195 | 684 | 0.66 |
| **Repurchase agreements** | **17,377** | **9** | **0.21** | 16,036 | 15 | 0.38 |
| **Borrowed funds** | **16,239** | **211** | **5.26** | 19,081 | 239 | 5.04 |
| Total interest-bearing liabilities | **423,729** | **735** | **0.70%** | 451,312 | 938 | 0.84% |
| Non-interest bearing deposits | **130,864** |  |  | 107,175 |  |  |
| Non-interest bearing liabilities | **3,811** |  |  | 3,355 |  |  |
| Total liabilities | **558,404** |  |  | 561,842 |  |  |
| Shareholders' equity | **59,552** |  |  | 54,790 |  |  |
| **Total liabilities and shareholders' equity** | **$617,956** |  |  | $616,632 |  |  |
| Net interest income |  | **$5,432** |  |  | $5,342 |  |
| Net interest spread |  |  | **3.66%** |  |  | 3.55% |
| Net interest margin |  |  | **3.84%** |  |  | 3.73% |
| Cost of funds |  |  | **0.54%** |  |  | 0.68% |

- 31 -

In the preceding tables, interest income was adjusted to a tax-equivalent basis, 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 between 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 $65.7 thousand and $16.7 thousand for the first quarters of 2013 and 2012, respectively, are included in interest income from loans. 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 net interest income by total average interest-earning assets. Cost of funds includes the effect of average non-interest bearing deposits as a funding source.

#### 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 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 the senior loan officer, the chief risk officer, 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 $0.6 million were recorded for the first quarter of 2013 compared to $0.7 million during the first quarter of 2012. Though the Company’s non-performing assets declined $6.2 million, compared to March 31, 2012, the first quarter 2013 provision was necessary to fund the allowance as a result of growth in the loan portfolio and to reinforce the allowance for the potential credit risks that still exist from an uncertain local economic climate. The allowance for loan losses was $8.2 million as of March 31, 2013, compared to approximately $9.0 million for December 31, 2012. The decrease in the allowance at March 31, 2013 reflects a charge down of a commercial real estate loan that was specifically reserved for in the fourth quarter of 2012.

#### Other income

For the three months ended March 31, 2013, non-interest income amounted to $2.0 million, a $0.1 million improvement, compared to $1.9 million in the same 2012 quarter. The improvement in 2013 was principally from $0.1 million more gains from the sales of loans and in the current year quarter, there were no OTTI charges incurred from impaired pooled trust preferred securities compared to $0.1 million in the first quarter of 2012. These items were partially offset by lower realized gains from the sales and principal recoveries of investment securities.

#### Other operating expenses

Other operating expenses increased $0.1 million, or 3%, in the first quarter of 2013 compared to the first quarter of 2012. Salary and employee benefits increased $0.1 million, or 5%, due to normal salary merit increases, higher amounts of employee incentive related expenses, the hiring of a chief operating officer in the third quarter of 2012 and higher benefit costs related to employee health insurance. The $0.1 million increase in advertising and marketing was due principally to spending for branch signage and television, newspaper and billboard media including creative production for the launch of a new Company campaign. This effort should help create additional retail and business household acquisition opportunities for the Company’s sales and relationship staff. The increase in ORE expenses of $71 thousand was due to property additions and carrying more ORE properties, on average, in the first quarter of 2013 compared to 2012. The $0.1 million, or 18%, decrease in the other expense category was caused mostly by the non-recurring prepayment fee of $0.2 million incurred from the payoff of $5.0 million in long-term debt in first quarter of 2012.

### Comparison of financial condition at

### March 31, 2013 and December 31, 2012

#### Overview

Consolidated assets increased $6.7 million, or 1%, to $608.2 million as of March 31, 2013 from $601.5 million at December 31, 2012. The increase included growth in short-term borrowings of $5.5 million, consisting of repurchase agreements and a $0.8 million increase in shareholders’ equity from $1.4 million of net income partially offset by $0.3 million of dividends declared net of activity in the Company’s dividend reinvestment plan. The funding sources along with cash on hand were used to finance growth in the loan portfolio.

### 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 in the consolidated balance sheet with an adjustment to shareholders’ equity, net of tax, presented under the caption “Accumulated other comprehensive income (loss).” 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, 2013, the carrying value of investment securities amounted to $99.5 million, or 16% of total assets, compared to $100.7 million, or 17% of total assets, at December 31, 2012. On March 31, 2013, approximately 52% 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, unexpected deposit outflow, facility expansion or operations.

As of March 31, 2013, investment securities were comprised of HTM and AFS securities with carrying values of $0.3 million and $99.2 million, respectively. The AFS debt and equity securities were recorded with a combined net unrealized loss in the amount of $0.2 as of March 31, 2013 compared to an unrealized gain of $0.4 million as of December 31, 2012, respectively, or a net decline of $0.6 million during the first three months of 2013.

The Company’s investment policy is designed to complement its lending activity. During the three months ended March 31, 2013, the carrying value of total investments decreased $1.2 million, or 1%. With $15.8 million of growth in the loan portfolio, currently offering better returns than can be obtained in the capital markets, growth in investments will be considered after loan demand, facility expansion and unexpected deposit outflow. The Company will however, maintain a diverse investment portfolio to help mitigate overall risk and maintain a strong balance sheet.

A comparison of investment securities at March 31, 2013 and December 31, 2012 is as follows:

*(dollars in thousands)*

|  | March 31, 2013 Amount% |  | December 31, 2012 Amount% |  |
| --- | ---: | ---: | ---: | ---: |
| MBS - GSE residential | **$51,197** | **51.5%** | $50,842 | 50.5% |
| State & municipal subdivisions | **30,737** | **30.8** | 29,857 | 29.6 |
| Agency - GSE | **15,289** | **15.4** | 17,740 | 17.6 |
| Pooled trust preferred securities | **1,799** | **1.8** | 1,825 | 1.8 |
| Equity securities - financial services | **474** | **0.5** | 466 | 0.5 |
| Total | **$99,496** | **100.0%** | $100,730 | 100.0% |

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. If at the time of sale, call or maturity the proceeds exceed the security’s amortized cost, previous credit impairment charges may be fully or partially recovered.

The Company owns 13 tranches of pooled trust preferred securities (PreTSLs). As of March 31, 2013, the market for these securities and other issues of PreTSLs remained inactive. The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which PreTSLs trade, then by a significant decrease in the volume of trades relative to historical levels. There has not been a new PreTSL issue since 2007. Newly imposed restrictions for institutions to qualify and receive favorable capital treatment have lessened the likelihood of new issues coming to market. There are currently very few market participants who are willing and/or able to transact for these securities. The Company has determined that the volume of trading activity in PreTSLs is minor, restricted mostly to speculative hedge fund traders, transacted on a bid basis and can take as long as weeks to fill orders and for the transactions to settle. Therefore, the Company has concluded that the market for these securities is inactive where pricing quotes are sparse, incorporate large illiquidity premiums, and exist with dislocation between spreads and default activity resulting in difficulties in assessing relative observable market inputs to determine fair value. To determine PreTSL valuations, the Company uses an independent third party that employs *Moody’s Wall Street Analytics*. Therefore, in lieu of a market-quote approach to determine fair value of the PreTSL portfolio, a fair value “Level 3” modeled income approach is utilized. The income approach maximizes the use of observable inputs and minimizes the use of unobservable inputs and is more representative of fair value than the market-quote approach in markets that are inactive. Core assumption categories are: probability of default; loss given defaults; industry-wide correlations, discount rate and structural behavior. Discounted cash flows are modeled via Monte Carlo simulation to determine the orderly liquidation value as an indication of fair value of all tranches of each PreTSL.

For the three months ended March 31, 2013, the Company engaged a structured finance products specialist firm to analyze the seven securities (eight tranches) in the portfolio that have an amortized cost basis. The analysis establishes a base of fundamental cash flow values to determine whether the Company will receive all of its principal and interest. One security (PreTSL XXVII) was deemed to have a high probability of receiving all principal and interest payments and thus impairment was considered temporary. The firm applied the following steps and assumptions to the remaining six securities to arrive at a single best estimate of cash flow that is used as a basis to determine the presence of OTTI:

- Data about the transaction structure, as defined in the offering indenture and the underlying collateral, was collected;
- The credit quality of the collateral was estimated using issuer specific probability of default for each security. Deferral of interest payments are treated as defaults. Once an issuer defaults, the potential for the tendency is correlated among other issuers. The loss given default, or the amount of cash lost to the investor is assumed to be 100% with no recovery of principal and no prepayments;
- The analysis uses a Monte Carlo simulation framework to simulate the time-to-default on a portfolio of obligors based on individual obligor default probabilities and inter-obligor correlations;
- Cash flow modeling was performed using the output from the simulation engine to arrive at the single best estimate of cash flow for each tranche;
- Present value techniques as prescribed in the accounting guidance are used to determine the expected cash flows of each of the tranches. The present value technique for one of the OTTI securities is based upon a discount rate determined at the time of acquisition. For the other six OTTI securities, the discount rate used in the present value calculation is the yield to accrete beneficial interest;
- The present value results are then compared to the present value cash flow results from the immediately prior measurement date. An adverse change in estimated cash flow from the previous measurement date is indicative of credit related OTTI. If the present value of the cash flow is less than the amortized cost basis, the difference is charged to current earnings as an impairment loss on investment securities.

The results of the OTTI analysis (refer to Note 4, “Investment securities”, within the notes to the consolidated financial statements for a complete description of the analysis performed) determined as of and for the three months ended March 31, 2013, the estimated value, based on the expected discounted cash flow, of all securities was sufficient to recover the amortized cost basis, and therefore no credit-related OTTI was needed for the three months ended March 31, 2013 compared to $0.1 million for the three months ended March 31, 2012. Credit-related OTTI is charged to current earnings as a component of other income in the consolidated statements of income. Future analyses could yield results that may be indicative of further impairment and may therefore require additional write-downs and corresponding credit related OTTI charges to current earnings.

#### 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. The Company was not required to purchase FHLB stock during 2013 and 2012. Excess stock is typically repurchased from the Company at par if the amount of borrowings decline to a predetermined level. In addition, the Company typically earns a return or dividend on the amount invested. In order to preserve its capital, in 2008 the FHLB declared a suspension on the redemption of its stock and ceased payment of quarterly dividends until such time it becomes prudent to reinstate either or both. In 2010, the FHLB announced a partial lifting of the stock redemption provision of the suspension. Since then, the Company has been able to periodically redeem its shares. Also, in all four quarters of 2012 and the first quarter of 2013 the FHLB declared cash dividends – the first since the 2008 suspension. Future redemptions and dividend payments will be predicated on the financial performance and health of the FHLB. Management believes that the FHLB will continue to be a primary source of wholesale liquidity for both short- and long-term funding and has concluded that its investment in FHLB stock is not other than temporarily impaired. There can be no assurance that future negative changes to the financial condition of the FHLB may not require the Company to recognize an impairment charge with respect to such holdings. The Company will continue to monitor the financial condition of the FHLB and assess its future ability to resume normal dividend payments and stock redemption activities.

#### Loans held-for-sale (HFS)

Upon origination, residential mortgages and certain small business administration (SBA) guaranteed loans may be classified as 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 at 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, 2013 and December 31, 2012, loans HFS consisted of residential mortgage loans.

As of March 31, 2013, loans HFS amounted to $2.1 million which approximated fair value, compared to $10.5 million, respectively, at December 31, 2012. During the three months ended March 31, 2013, residential mortgage loans with principal balances of $27.7 million were sold into the secondary market and the Company recognized net gains of approximately $0.5 million, compared to $18.8 million and $0.4 million, respectively during the three months ended March 31, 2012. There were no sales of SBA loans during the first quarters of 2013 and 2012. Gains of $41 thousand, deferred from sales in the fourth quarter of 2012, were recognized in the first quarter of 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, 2013 and December 31, 2012, the servicing portfolio balance of sold residential mortgage loans was $220.8 million and $214.7 million, respectively.

#### Loans and leases

The focus of our Company is expanding and developing relationships within our primary market. We originate loans primarily in Lackawanna and Luzerne counties for commercial and industrial (C&I), commercial real estate (CRE), residential mortgages, consumer, home equity and construction loans. The volume of activity is in direct proportion to demand, and current and anticipated interest rate levels. Although our local economy does show signs of improvement, our strategy remains steadfast of being conservative while providing assistance to our customers and prospects as well as helping our local economy. We strive to keep risk exposure at a manageable level through loan participations (sharing loans with other financial institutions to reduce exposure), the utilization of various guaranty programs and adjusting our advance rate based upon perceived risk.

As a preferred lender under the Small Business Administration (SBA) we have opportunities to provide credit facilities to the business community, help the area grow and prosper while at the same time reducing credit risk to our Bank. We continue to invest in our employees through training, software enhancements, customer relationships and portfolio management.

### Commercial and industrial

Comparing the commercial and industrial (C&I) loan portfolio at December 31, 2012 of $65.1 million and $64.1 million at March 31, 2013, there was a minimal reduction of $1.0 million or 2%. This decrease is primarily attributed to normal activity such as principal pay downs and/or line of credit reductions.

### Commercial real estate

The commercial real estate loan portfolio increased $7.4 million, or 4%, from $173.2 million at December 31, 2012 to $180.6 million as of March 31, 2013. The majority of this increase is attributed to an expansion of existing relationships.

### Consumer

The consumer loan portfolio decreased slightly by $1.4 million, or 2%, from $90.6 million at December 31, 2012 to $89.2 million at March 31, 2013. Within the portfolio, home equity installment loans and auto loans remained relatively flat, while home equity lines of credit increased slightly. The primary driver of the decrease in the portfolio related to personal loans as demand shifted into other low rate consumer products. Mortgage refinances continue to impact the home equity installment portfolio as consumers pay down debt. Beginning in March 2013, business development efforts were directed to building the home equity installment portfolio through promotional campaigns. During the first quarter of 2013, the Company began acquiring leases, through assignment, from an existing customer relationship. The Company expects to continue with this relationship and has no plans to expand the leasing program further at this time.

### Residential

The residential portfolio increased $10.0 million, or 10%, from $104.7 million at December 31, 2012 to $114.7 million at March 31, 2013. During the fourth quarter of 2012, the Company reintroduced a mortgage loan modification program with the focus on retaining mortgage loans with maturities of 10 years or less. The program attributed primarily to the increase in the residential loan portfolio in the first quarter of 2013.

The composition of the loan portfolio at March 31, 2013 and December 31, 2012, is summarized as follows:

*(dollars in thousands)*

|  | March 31, 2013 Amount% |  | December 31, 2012 Amount% |  |
| --- | ---: | ---: | ---: | ---: |
| Commercial and industrial | **$64,099** | **14.3%** | $65,110 | 15.0% |
| Commercial real estate: |  |  |  |  |
| Non-owner occupied | **89,884** | **20.0** | 81,998 | 18.9 |
| Owner occupied | **82,413** | **18.4** | 80,509 | 18.6 |
| Construction | **8,324** | **1.9** | 10,679 | 2.5 |
| Consumer: |  |  |  |  |
| Home equity installment | **32,419** | **7.2** | 32,828 | 7.6 |
| Home equity line of credit | **34,208** | **7.6** | 34,169 | 7.9 |
| Auto loans and leases | **17,373** | **3.9** | 17,411 | 4.0 |
| Other | **5,176** | **1.2** | 6,139 | 1.4 |
| Residential: |  |  |  |  |
| Real estate | **105,751** | **23.5** | 96,765 | 22.3 |
| Construction | **8,988** | **2.0** | 7,948 | 1.8 |
| Gross loans | **448,635** | **100.0%** | 433,556 | 100.0% |
| Less: |  |  |  |  |
| Allowance for loan losses | **(8,236)** |  | (8,972) |  |
| Unearned lease revenue | **(24)** |  | - |  |
| Net loans | **$440,375** |  | $424,584 |  |
| Loans held-for-sale | **$2,066** |  | $10,545 |  |

#### 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 (two-year 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 feels 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 and the provision for loan losses. The Company’s Special Assets Committee meets formally on a quarterly basis, or more frequently if necessary, and the applicable lenders discuss each relationship under review and reach a consensus on the appropriate estimated loss amount based on current accounting guidelines. The Special Assets Committee’s focus is on ensuring the pertinent facts are considered and the reserve amounts pursuant to the accounting principles are reasonable. The assessment process 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, 2013 were $1.3 million compared to $0.5 million for the three months ended March 31, 2012. The increase is related to commercial real estate net charge-offs of $1.2 million during the current year’s first quarter compared to $0.3 million for the same period in 2012. This increase was mostly due to the charge down of one owner occupied commercial real estate non-accrual loan. The loan carried a specific reserve as of December 31, 2012 based on the estimated net realizable value of the loan’s collateral. The collateral was sold on May 10, 2013 and no additional material charge offs or expenses were incurred. Commercial and industrial loans recorded a net charge off of $40 thousand during the quarter ended March 31, 2013 compared to a recovery of $8 thousand in the same 2012 quarter. A consumer loan net recovery of $34 thousand was recorded for the three months ended March 31, 2013 versus a $0.2 million net charge-off in the 2012 quarter. Residential real estate net charge-offs totaled $39 and $17 thousand during the respective periods. 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 $8.2 million as of March 31, 2013, compared to $9.0 million at December 31, 2012. 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. Given continuing pressure on property values and the overall sluggishness of the economy, there could be additional instances which become identified in future periods that may require additional charge-offs and/or increases to the allowance.

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, 2013 | As of and for the twelve months ended December 31, 2012 | As of and for the three months ended March 31, 2012 |
| --- | ---: | ---: | ---: |
| Balance at beginning of period | **$8,972** | $8,108 | $8,108 |
| Charge-offs: |  |  |  |
| Commercial and industrial | **44** | 185 | - |
| Commercial real estate | **1,244** | 1,335 | 275 |
| Consumer | **39** | 737 | 207 |
| Residential | **39** | 231 | 17 |
| Total | **1,366** | 2,488 | 499 |
| Recoveries: |  |  |  |
| Commercial and industrial | **4** | 26 | 8 |
| Commercial real estate | **3** | 46 | - |
| Consumer | **73** | 30 | 3 |
| Residential | **-** | - | - |
| Total | **80** | 102 | 11 |
| Net charge-offs | **1,286** | 2,386 | 488 |
| Provision for loan losses | **550** | 3,250 | 700 |
| Balance at end of period | **$8,236** | $8,972 | $8,320 |
| Net charge-offs (annualized) to average total loans outstanding | **1.14%** | 0.56% | 0.47% |
| Allowance for loan losses to net charge-offs (annualized) | **1.60** **x** | 3.76 x | 4.26 x |
| Allowance for loan losses to total loans | **1.83%** | 2.02% | 1.97% |
| Loans 30 - 89 days past due and accruing | **$4,014** | $2,920 | $5,557 |
| Loans 90 days or more past due and accruing | **$841** | $1,723 | $179 |
| Non-accrual loans | **$9,742** | $12,121 | $12,857 |
| Allowance for loan losses to loans 90 days or more past due and accruing | **9.79** **x** | 5.21 x | 46.55 x |
| Allowance for loan losses to non-accrual loans | **0.85** **x** | 0.74 x | 0.65 x |
| Allowance for loan losses to non-performing loans | **0.78** **x** | 0.65 x | 0.64 x |
| Average total loans | **$450,821** | $426,636 | $415,248 |

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 year-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, 2013, non-performing assets represented 2.47% of total assets reduced from 2.94% at December 31, 2012, mainly resulting from the reduction of residential and commercial loans 90 days or more past due, coupled with a reduction in residential, consumer and commercial loans on non-accrual status.

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.

As of March 31, 2013, non-performing assets were comprised of loans past due 90 days or more and accruing, non-accruing commercial loans, non-accruing real estate loans, non-accrual consumer loans, troubled debt restructurings, non-accrual securities and ORE. Most of the loans are collateralized, thereby mitigating the Company’s potential for loss. At March 31, 2013, $1.0 million of corporate bonds consisting of pooled trust preferred securities were on non-accrual status compared to $1.1 million at December 31, 2012. For a further discussion on the Company’s securities portfolio, see Note 4, “Investment securities”, within the notes to the consolidated financial statements and the section entitled “Investments”, contained within this management’s discussion and analysis section.

Non-performing loans decreased from $13.8 million on December 31, 2012 to $10.6 million at March 31, 2013. At the end of 2012, there were seventeen loans to sixteen unrelated borrowers aggregating $1.7 million in the over 90 day category ranging from less than $1 thousand to $0.6 million. At March 31, 2013, the over 90 days past due portion was $0.8 million and was comprised of eight loans to seven unrelated borrowers, ranging from $1 thousand to $0.2 million. Of the eight loans past due over 90 days, three loans, aggregating $0.4 million were residential mortgages to unrelated borrowers. In addition, two loans were secured commercial loans aggregating $0.4 million. The Company seeks payments from all past due customers through an aggressive customer communication process and, although payments were made on these loans after the quarter ended, the loans remained past due.

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, 2012, there were 65 loans to 57 unrelated borrowers ranging from less than $1 thousand to $3.2 million in the non-accrual category. At March 31, 2013, there were 60 loans to 51 unrelated borrowers ranging from less than $1 thousand to $2.0 million in the non-accrual category. The decrease in non-accrual loans in the first quarter of 2013 was related to loans that were charged off, transferred to ORE or went back to accrual status.

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 $2.2 million at March 31, 2013 and December 31, 2012 which consisted mostly of $1.1 million of accruing commercial real estate loans and $1.1 million of non-accrual commercial real estate loans.

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

### As of and for the three months ended March 31, 2013

*(dollars in thousands)*

| 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 | **2** | **10** | **8** | **20** |
| Ending balance | **$40** | **$1,051** | **$1,058** | **$2,149** |

As of and for the year ended December 31, 2012

*(dollars in thousands)*

| Troubled Debt Restructures: | Accruing Commercial & industrial | Commercial real estate | Non-accruing Commercial real estate | Total |
| --- | ---: | ---: | ---: | ---: |
| Beginning balance | $44 | $5,270 | $1,395 | $6,709 |
| Pay downs / payoffs | 2 | 4,998 | 129 | 5,129 |
| Advance on balance | - | 789 | - | 789 |
| Charge offs | - | - | 200 | 200 |
| Ending balance | $42 | $1,061 | $1,066 | $2,169 |

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. Concessions made to borrowers typically involve an extension of the loan’s maturity date or a change in the loan’s amortization period. The Company believes concessions have been made in the best interests of the borrower and the Company. The Company has not reduced interest rates or forgiven principal with respect to these loans. 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.

At March 31, 2013, the non-accrual loans aggregated $9.7 million as compared to $12.1 million at December 31, 2012. The net decrease in the level of non-accrual loans during the period ending March 31, 2013 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 $0.6 million, charge-offs of $1.3 million, $0.8 million of transfers to ORE and $0.3 million of loans that returned to performing status. Loans past due 90 days or more and accruing were $0.8 million at March 31, 2013, compared to $1.7 million as of December 31, 2012. The ratio of non-performing loans to total loans was 2.35% at March 31, 2013 compared to 3.12% at December 31, 2012.

Payments received from non-accrual loans are recognized on a cash method. Payments are first applied against the outstanding principal balance, then to the recovery of any charged-off loan amounts. Any excess is treated as a recovery of interest income. For the first quarter of 2013, $11 thousand in cash basis interest income was recognized. There was no cash basis income recognized during the first quarter of 2012. If the non-accrual loans that were outstanding as of March 31, 2013 had been performing in accordance with their original terms, the Company would have recognized interest income with respect to such loans of $0.1 million during the quarter ended March 31, 2013.

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

*(dollars in thousands)*

|  | March 31, 2013 | December 31, 2012 | March 31, 2012 |
| --- | ---: | ---: | ---: |
| Loans past due 90 days or more and accruing | **$841** | $1,723 | $179 |
| Non-accrual loans \* | **9,742** | 12,121 | 12,857 |
| Total non-performing loans | **10,583** | 13,844 | 13,036 |
| Troubled debt restructurings | **1,091** | 1,103 | 5,314 |
| Other real estate owned and repossessed assets | **2,302** | 1,607 | 1,973 |
| Non-accrual securities | **1,032** | 1,132 | 889 |
| Total non-performing assets | **$15,008** | $17,686 | $21,212 |
| Total loans, including loans held-for-sale | **$450,677** | $444,101 | $422,272 |
| Total assets | **$608,171** | $601,525 | $639,280 |
| Non-accrual loans to total loans | **2.16%** | 2.73% | 3.04% |
| Non-performing loans to total loans | **2.35%** | 3.12% | 3.09% |
| Non-performing assets to total assets | **2.47%** | 2.94% | 3.32% |

\* In the table above, the amount includes non-accrual TDRs of $1.1 million, $1.1 million and $1.2 million as of March 31, 2013, December 31, 2012 and March 31, 2012, respectively.

The composition of non-performing loans as of March 31, 2013 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 | $64,099 | $233 | $18 | $251 | 0.39% |
| Commercial real estate: |  |  |  |  |  |
| Non-owner occupied | 89,884 | - | 1,825 | 1,825 | 2.03% |
| Owner occupied | 82,413 | 139 | 3,708 | 3,847 | 4.67% |
| Construction | 8,324 | - | 1,119 | 1,119 | 13.44% |
| Consumer: |  |  |  |  |  |
| Home equity installment | 32,419 | 25 | 838 | 863 | 2.66% |
| Home equity line of credit | 34,208 | - | 415 | 415 | 1.21% |
| Auto loans and leases | 17,349 | 2 | - | 2 | 0.01% |
| Other | 5,176 | 1 | 42 | 43 | 0.83% |
| Residential: |  |  |  |  |  |
| Real estate | 105,751 | 441 | 1,777 | 2,218 | 2.10% |
| Construction | 8,988 | - | - | - | - |
| Loans held-for-sale | 2,066 | - | - | - | - |
| Total | $450,677 | $841 | $9,742 | $10,583 | 2.35% |

- 40 -

#### Foreclosed assets held-for-sale

Foreclosed assets held-for-sale aggregated $2.3 million at March 31, 2013 and $1.6 million at December 31, 2012. The following table sets forth the activity in the ORE component of foreclosed assets held-for-sale:

*(dollars in thousands)*

|  | March 31, 2013 Amount | # | December 31, 2012 Amount | # |
| --- | ---: | ---: | ---: | ---: |
| Balance at beginning of period | **$1,600** | **12** | $1,169 | 6 |
| Additions | **828** | **5** | 1,778 | 14 |
| Paydowns | **(5)** |  | (92) |  |
| Write downs | **(25)** |  | (86) |  |
| Charge downs | **(7)** |  | - |  |
| Sold | **(89)** | **(1)** | (1,169) | (8) |
| Balance at end of period | **$2,302** | **16** | $1,600 | 12 |

As of December 31, 2012, the ORE balance consisted of: nine properties totaling $0.8 million from 2012 additions; two properties aggregating $0.2 million acquired in 2011 and one property acquired in 2010 for $0.6 million. As of March 31, 2013, five more properties were added to ORE and one was sold, bringing the total to sixteen, which contributed an additional $0.8 million to ORE for the first quarter of 2013. The property that sold was added to ORE in 2012. Of these five properties added in the first quarter of 2013, one was commercial real estate and four were residential real estate. Of the sixteen ORE properties as of March 31, 2013, which stemmed from fifteen unrelated borrowers, fifteen were listed for sale and one was pending listing with local realtors.

#### Bank premises and equipment, net

Net of depreciation, bank premises and equipment decreased $0.3 million, or 2%, in the three months ended March 31, 2013. The decrease was principally caused by $0.3 million of periodic depreciation charges partially offset by $57 thousand of expenditures mostly related to technology upgrades.

### 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. Deposit products include transaction accounts such as: savings; clubs; interest-bearing checking (NOW); money market and non-interest bearing checking (DDA). The Company also offers short- and long-term deposit accounts such as certificates of deposit. Certificates of deposit, or CDs, are deposits with stated maturities which can range from seven days to ten years. The flow of deposits 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, 2013 Amount% |  | December 31, 2012 Amount% |  |
| --- | ---: | ---: | ---: | ---: |
| Money market | **$81,008** | **15.8%** | $76,571 | 14.9% |
| Interest-bearing checking | **79,386** | **15.4** | 87,981 | 17.1 |
| Savings and clubs | **112,886** | **21.9** | 107,447 | 20.8 |
| Certificates of deposit | **118,331** | **23.0** | 116,626 | 22.7 |
| Total interest-bearing | **391,611** | **76.1** | 388,625 | 75.5 |
| Non-interest bearing | **122,855** | **23.9** | 126,035 | 24.5 |
| Total deposits | **$514,466** | **100.0%** | $514,660 | 100.0% |

Compared to December 31, 2012, total deposits slightly declined by $0.2 million, or less than 1%, during the quarter ended March 31, 2013. The decrease stems from declines in interest-bearing checking, $8.5 million, and non-interest bearing deposits, $3.2 million; partially offset by growth in: money market accounts, $4.4 million; CDs, $1.7 million; savings and clubs, $5.4 million. 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.

The low interest rate environment continues to cause customers to seek short-term alternatives for their deposits. Savings and clubs experienced a $5.4 million increase as customers searched for a short-term product to house cash balances. A promotional campaign focused on attracting and retaining certificates of deposit balances facilitated the $1.7 million increase in CD’s, while money market accounts were aided by large depositors shifting balances with a $4.4 million rise within the portfolio. The decrease in interest-bearing checking and non-interest bearing accounts was primarily the result of cash re-deployments. The Company’s focus continues to be on the acquisition and retention of retail and business households with a strong emphasis on deepening and broadening those relationships.

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. 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 these 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 March 31, 2013 and December 31, 2012, CDARS represented $11.8 million and $10.2 million, respectively, or 2%, of total deposits.

Excluding CDARS, certificates of deposit accounts of $100,000 or more amounted to $41.6 million and $41.8 million at March 31, 2013 and December 31, 2012, respectively. Certificates of deposit of $250,000 or more amounted to $16.1 million and $16.2 million as of March 31, 2013 and December 31, 2012.

Including CDARS, approximately 41% of the CDs, with a weighted-average interest rate of 0.81%, are scheduled to mature in 2013 and an additional 28%, with a weighted-average interest rate of 1.16%, are scheduled to mature in 2014. Renewing CDs may re-price to lower or higher market rates depending on the 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. In this current low interest rate environment, a widespread preference has been for customers with maturing CDs to hold their deposits in readily available transaction accounts. When interest rates begin to rise, the Company expects CDs to trend back toward historical levels.

#### 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. The FDIC Depositor Protection Act of 2009 requires banks to provide a perfected security interest to the purchasers of uninsured repurchase agreements. 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 three months of 2013 increased $5.5 million, or 69%, from year-end December 31, 2012.

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

*(dollars in thousands)*

|  | March 31, 2013 Amount% |  | December 31, 2012 Amount% |  |
| --- | ---: | ---: | ---: | ---: |
| Securities sold under repurchase agreements | **$13,593** | **45.9%** | $8,056 | 33.5% |
| Long-term FHLB advances | **16,000** | **54.1** | 16,000 | 66.5 |
| Total | **$29,593** | **100.0%** | $24,056 | 100.0% |

## Market risk

As filed, 24,327 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) has 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, 2013, the Company maintained a one-year cumulative gap of positive (asset sensitive) $89.1 million, or 15%, 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. 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, 2013:

*(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 | $11,699 | $- | $- | $9,031 | $20,730 |
| Investment securities (1)(2) | 5,392 | 15,800 | 24,249 | 56,293 | 101,734 |
| Loans and leases(2) | 163,953 | 72,720 | 120,277 | 85,491 | 442,441 |
| Fixed and other assets | - | 10,146 | - | 33,120 | 43,266 |
| Total assets | $181,044 | $98,666 | $144,526 | $183,935 | $608,171 |
| Total cumulative assets | $181,044 | $279,710 | $424,236 | $608,171 |  |
| Non-interest-bearing transaction deposits (3) | $- | $12,298 | $33,760 | $76,797 | $122,855 |
| Interest-bearing transaction deposits (3) | 88,919 | 16,935 | 113,928 | 53,498 | 273,280 |
| Certificates of deposit | 13,140 | 45,683 | 50,680 | 8,828 | 118,331 |
| Repurchase agreements | 13,593 | - | - | - | 13,593 |
| Long-term debt | - | - | - | 16,000 | 16,000 |
| Other liabilities | - | - | - | 4,333 | 4,333 |
| Total liabilities | $115,652 | $74,916 | $198,368 | $159,456 | $548,392 |
| Total cumulative liabilities | $115,652 | $190,568 | $388,936 | $548,392 |  |
| Interest sensitivity gap | $65,392 | $23,750 | $(53,842) | $24,479 |  |
| Cumulative gap | $65,392 | $89,142 | $35,300 | $59,779 |  |
| Cumulative gap to total assets | 10.8% | 14.7% | 5.8% | 9.8% |  |

(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, 2013 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, 2013 levels:

| Earnings at risk: | % change Rates +200 | Rates -200 |
| --- | ---: | ---: |
| Net interest income | 7.1% | (3.5)% |
| Net income | 21.8 | (10.4) |
| Economic value at risk: |  |  |
| Economic value of equity | (9.8) | (6.2) |
| Economic value of equity as a percent of total assets | (1.0) | (0.7) |

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, 2013, the Company’s risk-based capital ratio was 13.5%.

The table below summarizes estimated changes in net interest income over a twelve-month period beginning April 1, 2013, 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 | $22,001 | $1,457 | 7.1% |
| +100 basis points | 21,131 | 587 | 2.9 |
| Flat rate | 20,544 | - | - |
| -100 basis points | 20,206 | (338) | (1.6) |
| -200 basis points | 19,824 | (720) | (3.5) |

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 of the Company. Sources of liquidity are cash and cash equivalents, asset maturities and pay-downs within one year, loans HFS and 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. 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 utilizes a contingency funding plan (CFP) that sets a framework for handling liquidity issues in the event circumstances arise which the Company deems to be less than normal. To accomplish this, the Company established guidelines for identifying, measuring, monitoring and managing the resolution of potentially serious liquidity crises. The Company’s 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, 2013 the Company had not experienced any adverse liquidity issues that would give rise to its inability to raise liquidity in an emergency situation.

During the three months ended March 31, 2013, the Company used approximately $1.1 million of cash. During the period, the Company’s operations provided approximately $10.8 million mostly from $9.4 million of net cash inflow from originating and selling residential mortgage loans, $5.2 million of net cash inflow from the components of net interest income partially offset from net non-interest expense /income related payments. Liquidity generated from operations, cash generated from repurchase agreements and cash on hand were used to fund growth in the loan portfolio, dividend payments and equipment acquisition. The $20.7 million cash at March 31, 2013 is expected to be used to grow interest-earning assets, mostly to fund growth in the loan portfolio, facility and technology upgrades and deposit outflow.

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, 2012.

As of March 31, 2013, the Company maintained $20.7 million in cash and cash equivalents and $101.3 million of investments AFS and loans HFS. Also as of March 31, 2013, the Company had approximately $136.3 million available to borrow from the FHLB, $21.0 million from correspondent banks, $21.1 million from the FRB and $30.0 million from the CDARS program. The combined total of $330.4 million represented 54% of total assets at March 31, 2013. Management believes this level of liquidity to be strong and adequate to support current operations.

#### Capital

During three months ended March 31, 2013, total shareholders' equity increased $0.8 million due principally from the $1.4 million in net income, $0.4 million from capital contributions from the activities in the Company’s dividend reinvestment and employee stock purchase plans (DRP and ESPP, respectively), partially offset by $0.6 million of dividends declared and by a $0.4 million decline in the fair value of the Company’s investment portfolio.

As of March 31, 2013, the Company reported a net unrealized loss position of $0.1 million, net of tax, from the securities AFS portfolio compared to a net unrealized gain of $0.2 million as of December 31, 2012. During the past several years, the prolonged sluggish economy has created uncertainty and illiquidity in the financial and capital markets and has created unpredictable volatility on the fair value estimates for securities in banks’ investment portfolios. Management believes that most of the volatility in fair value of securities is due to changes in interest rates and liquidity complications in the financial markets and to a lesser extent to the deterioration in the creditworthiness of the issuers. When U.S. Treasury rates rise, investment securities’ pricing will decline and fair values of investment securities will also decline. Bond prices move inversely to the movement of interest rates. During the first quarter of 2013, the fair value of the Company’s pooled trust preferred securities declined marginally, but the unrealized loss also declined as the amortized cost was reduced by cash payments. The Company did not incur credit related impairment charges in the first quarter of 2013. However non-credit, pre-tax impairment of $61 thousand was recorded during the quarter, a decline from the $0.1 million recorded in the first quarter of 2012. Nonetheless, given the fragile condition of the capital markets, especially in the pooled trust preferred segment, 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, a consistent source of capital from the Company’s loyal employees and shareholders.

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 appropriate risk-weighting pursuant to regulatory guidelines, requires a gross-up in the risk-weighting of securities that are rated below investment grade, thus significantly inflating the total risk-weighted assets. This requirement had an adverse impact on the total capital and Tier I capital ratios in both 2013 and 2012. 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, 2013, 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, 2013:

*(dollars in thousands)*

| As of March 31, 2013: 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 | **$64,267** | **13.5%** | **≥ $** | **38,156** | **≥** | **8.0%** |  | **N/A** |  | **N/A** |
| Bank | **$64,002** | **13.4%** | **≥ $** | **38,155** | **≥** | **8.0%** | **≥ $** | **47,694** | **≥** | **10.0%** |
| Tier I capital (to risk-weighted assets) |  |  |  |  |  |  |  |  |  |  |
| Consolidated | **$58,195** | **12.2%** | **≥ $** | **19,078** | **≥** | **4.0%** |  | **N/A** |  | **N/A** |
| Bank | **$58,010** | **12.2%** | **≥ $** | **19,078** | **≥** | **4.0%** | **≥ $** | **28,617** | **≥** | **6.0%** |
| Tier I capital (to average assets) |  |  |  |  |  |  |  |  |  |  |
| Consolidated | **$58,195** | **9.5%** | **≥ $** | **24,705** | **≥** | **4.0%** |  | **N/A** |  | **N/A** |
| Bank | **$58,010** | **9.4%** | **≥ $** | **24,689** | **≥** | **4.0%** | **≥ $** | **30,861** | **≥** | **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 2012 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, 2013.

## 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 2012 Form 10-K filed with the Securities and Exchange Commission on March 26, 2013.

Filed May 13, 2013.
Source: SEC EDGAR, the filing index for accession 0001144204-13-028177. Last ingested by Listed: Nov 6, 2026, 18:40 ET. No prices; not investment advice.