Equibles

10-Q

FRANKLIN FINANCIAL SERVICES CORP /PA/ (FRAF)

10-Q 2021-11-08 For: 2021-09-30
View Original
Added on April 10, 2026

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2021

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from__________ to___________

Commission file number 001-38884

FRANKLIN FINANCIAL SERVICES CORPORATION

(Exact name of registrant as specified in its charter)

Pennsylvania 25-1440803
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
20 South Main Street, Chambersburg, PA 17201-0819
--- ---
(Address of principal executive offices) (Zip Code)

(717) 264-6116

(Registrant's telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:


Title of class Symbol Name of exchange on which registered
Common stock FRAF Nasdaq Capital Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x Smaller reporting company x Emerging growth company ¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act) Yes ¨ No x

There were 4,432,298 outstanding shares of the Registrant’s common stock as of October 31, 2021.

INDEX

Part I - FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Balance Sheets as of September 30, 2021 and December 31, 2020 (unaudited) 1
Consolidated Statements of Income for the Three and Nine Months endedSeptember 30, 2021 2
and 2020 (unaudited)
Consolidated Statements of Comprehensive Income for the Three and Nine Months ended 3
September 30, 2021 and 2020 (unaudited)
Consolidated Statements of Changes in Shareholders’ Equity for the Three and Nine Months 3
ended September 30, 2021 and 2020 (unaudited)
Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2021 5
and 2020 (unaudited)
Notes to Consolidated Financial Statements (unaudited) 6
Item 2 Management’s Discussion and Analysis ofResults of Operations and Financial Condition 29
Item 3 Quantitative and Qualitative Disclosures about Market Risk 49
Item 4 Controls and Procedures 49
Part II - OTHER INFORMATION
Item 1 Legal Proceedings 51
Item 1A Risk Factors 51
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 51
Item 3 Defaults Upon Senior Securities 51
Item 4 Mine Safety Disclosures 51
Item 5 Other Information 52
Item 6 Exhibits 52
SIGNATURE PAGE 53

Part I FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Balance Sheets

(Dollars in thousands, except share and per share data)
December 31,
2020
Assets
Cash and due from banks 20,477 $ 17,059
Short-term interest-bearing deposits in other banks 78,416 40,087
Total cash and cash equivalents 98,893 57,146
Long-term interest-bearing deposits in other banks 10,742 12,741
Debt securities available for sale, at fair value 545,788 396,940
Equity securities 473 391
Restricted stock 495 468
Loans held for sale 4,114 9,446
Loans 1,018,168 1,009,704
Allowance for loan losses (15,366) (16,789)
Net Loans 1,002,802 992,915
Premises and equipment, net 18,063 13,105
Right of use asset 4,892 5,272
Bank owned life insurance 22,076 22,288
Goodwill 9,016 9,016
Deferred tax asset, net 3,632 2,401
Other assets 11,455 12,909
Total assets 1,732,441 $ 1,535,038
Liabilities
Deposits
Noninterest-bearing checking 311,770 $ 259,060
Money management, savings, and interest checking 1,162,081 1,019,348
Time 70,444 76,165
Total deposits 1,544,295 1,354,573
Subordinate notes 19,581 19,555
Lease liability 4,981 5,332
Other liabilities 10,746 10,402
Total liabilities 1,579,603 1,389,862
Commitments and contingent liabilities
Shareholders' equity
Common stock, 1 par value per share,15,000,000 shares authorized with
4,710,872 shares issued and 4,431,447 shares outstanding at September 30, 2021 and
4,710,872 shares issued and 4,389,355 shares outstanding at December 31, 2020 4,711 4,711
Capital stock no par value, 5,000,000 shares authorized with no
shares issued and outstanding — —
Additional paid-in capital 42,949 42,589
Retained earnings 114,378 102,520
Accumulated other comprehensive income (2,173) 3,190
Treasury stock, 279,425 shares at September 30, 2021 and 321,517 shares at
December 31, 2020, at cost (7,027) (7,834)
Total shareholders' equity 152,838 145,176
Total liabilities and shareholders' equity 1,732,441 $ 1,535,038

All values are in US Dollars.

The accompanying notes are an integral part of these unaudited financial statements.

1

Consolidated Statements of Income

For the Three Months Ended For the Nine Months Ended
(Dollars in thousands, except per share data) (unaudited) September 30, September 30,
2021 2020 2021 2020
Interest income
Loans, including fees $ 9,805 $ 9,499 $ 28,373 $ 29,346
Interest and dividends on investments:
Taxable interest 1,906 1,159 5,284 3,270
Tax exempt interest 526 504 1,588 1,028
Dividend income 1 3 17 12
Interesting-bearing deposits in other banks 66 72 178 412
Total interest income 12,304 11,237 35,440 34,068
Interest expense
Deposits 447 687 1,390 2,933
Subordinate notes 263 167 788 167
Total interest expense 710 854 2,178 3,100
Net interest income 11,594 10,383 33,262 30,968
Provision for (recovery of) loan losses — 375 (1,900) 5,350
Net interest income after provision for loan losses 11,594 10,008 35,162 25,618
Noninterest income
Investment and trust services fees 1,740 1,433 5,282 4,469
Loan service charges 224 206 647 620
Gain on sale of loans 529 504 1,866 876
Deposit service charges and fees 674 497 1,613 1,459
Other service charges and fees 397 382 1,214 1,065
Debit card income 550 491 1,642 1,347
Increase in cash surrender value of Bank owned life insurance 109 110 336 346
Bank owned life insurance gain 147 — 147 812
Gains (losses) on sales of debt securities — (16) 91 (26)
Change in fair value of equity securities (9) (39) 83 (139)
Gain on sale of premise 1,776 — 1,776 —
Other 45 35 202 74
Total noninterest income 6,182 3,603 14,899 10,903
Noninterest Expense
Salaries and employee benefits 5,958 5,421 17,861 16,337
Net occupancy 908 838 2,675 2,533
Marketing and advertising 413 384 1,153 1,303
Legal and professional 579 499 1,552 1,324
Data processing 1,040 871 2,857 2,511
Pennsylvania bank shares tax 308 263 708 701
FDIC Insurance 181 128 563 276
ATM/debit card processing 342 285 967 828
Telecommunications 101 110 314 323
Nonservice pension 257 88 651 176
Other 899 762 1,964 2,509
Total noninterest expense 10,986 9,649 31,265 28,821
Income before federal income taxes 6,790 3,962 18,796 7,700
Federal income tax expense (benefit) 928 500 2,833 (548)
Net income $ 5,862 $ 3,462 $ 15,963 $ 8,248
Per share
Basic earnings per share $ 1.32 $ 0.79 $ 3.61 $ 1.90
Diluted earnings per share $ 1.31 $ 0.79 $ 3.60 $ 1.89

The accompanying notes are an integral part of these unaudited financial statements.

2

Consolidated Statements of Comprehensive Income

For the Three Months Ended For the Nine Months Ended
September 30, September 30,
(Dollars in thousands) (unaudited) 2021 2020 2021 2020
Net Income $ 5,862 $ 3,462 $ 15,963 $ 8,248
Debt Securities:
Unrealized (losses) gains arising during the period (3,819) 2,631 (6,698) 9,283
Reclassification adjustment for losses (gains) included in net income (1) — 16 (91) 26
Net unrealized (losses) gains (3,819) 2,647 (6,789) 9,309
Tax effect 802 (555) 1,426 (1,956)
Net of tax amount (3,017) 2,092 (5,363) 7,353
Total other comprehensive (loss) income (3,017) 2,092 (5,363) 7,353
Total Comprehensive Income $ 2,845 $ 5,554 $ 10,600 $ 15,601
(1) Reclassified to net gains on sales of debt securities

The accompanying notes are an integral part of these unaudited financial statements.

‎

3

Consolidated Statements of Changes in Shareholders’ Equity

For the three and nine months ended September 30, 2021 and 2020

Accumulated
Additional Other
Common Paid-in Retained Comprehensive Treasury
(Dollars in thousands, except per share data) (unaudited) Stock Capital Earnings Income (Loss) Stock Total
Balance at July 1, 2021 $ 4,711 $ 42,774 $ 109,930 $ 844 $ (7,103) $ 151,156
Net income — — 5,862 — — 5,862
Other comprehensive income — — — (3,017) — (3,017)
Cash dividends declared, 0.32 per share — — (1,414) — — (1,414)
Acquisition of treasury stock — — — — (387) (387)
Treasury shares issued under dividend reinvestment plan — 129 — — 458 587
Stock Compensation Plans:
Treasury shares issued — — — — 5 5
Compensation expense — 46 — — — 46
Balance at September 30, 2021 $ 4,711 $ 42,949 $ 114,378 $ (2,173) $ (7,027) $ 152,838
Balance at January 1, 2021 $ 4,711 $ 42,589 $ 102,520 $ 3,190 $ (7,834) $ 145,176
Net income — — 15,963 — — 15,963
Other comprehensive income — — — (5,363) — (5,363)
Cash dividends declared, 0.93 per share — — (4,105) — — (4,105)
Acquisition of treasury stock — — — — (1,105) (1,105)
Treasury shares issued under dividend reinvestment plan — 381 — — 1,630 2,011
Stock Compensation Plans:
Treasury shares issued — (182) — — 282 100
Compensation expense — 161 — — — 161
Balance at September 30, 2021 $ 4,711 $ 42,949 $ 114,378 $ (2,173) $ (7,027) $ 152,838

All values are in US Dollars.

Balance at July 1, 2020 $ 4,711 $ 42,461 $ 97,124 $ (725) $ (8,731) $ 134,840
Net income — — 3,462 — — 3,462
Other comprehensive income — — — 2,092 — 2,092
Cash dividends declared, 0.30 per share — — (1,306) — — (1,306)
Treasury shares issued under dividend reinvestment plan — (13) — — 435 422
Stock Compensation Plans:
Treasury shares issued — — — — 7 7
Common shares issue — 1 — — — 1
Compensation expense — 56 — — — 56
Balance at September 30, 2020 $ 4,711 $ 42,505 $ 99,280 $ 1,367 $ (8,289) $ 139,574
Balance at January 1, 2020 $ 4,710 $ 42,268 $ 94,946 $ (5,986) $ (8,410) $ 127,528
Net income — — 8,248 — — 8,248
Other comprehensive income — — — 7,353 — 7,353
Cash dividends declared, 0.90 per share — — (3,914) — — (3,914)
Acquisition of treasury stock — — — — (1,172) (1,172)
Treasury shares issued under dividend reinvestment plan — 78 — — 1,284 1,362
Stock Compensation Plans:
Treasury shares issued — 1 — — 9 10
Common shares issued 1 17 — — — 18
Compensation expense — 141 — — — 141
Balance at September 30, 2020 $ 4,711 $ 42,505 $ 99,280 $ 1,367 $ (8,289) $ 139,574

All values are in US Dollars.

The accompanying notes are an integral part of these unaudited financial statements.

4

Consolidated Statements of Cash Flows

Nine Months Ended<br>‎September 30,
2021 2020
(Dollars in thousands) (unaudited)
Cash flows from operating activities
Net income $ 15,963 $ 8,248
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 925 998
Net amortization of loans and investment securities 503 1,620
Amortization of subordinate debt issuance costs 26 6
(Recovery of) provision for loan losses (1,900) 5,350
(Increase) decrease in fair value of equity securities (83) 139
Debt securities (gains) losses, net (91) 26
Loans originated for sale (81,204) (66,296)
Proceeds from sale of loans 88,402 58,838
Gain on sale of loans (1,866) (876)
Increase in cash surrender value of bank owned life insurance (336) (346)
(Increase) decrease in fair value of derivative (20) 32
Gains from surrender of life insurance policies (147) (812)
Income tax benefit of statutory treatment of net operating loss carryback — (1,112)
Stock option compensation 161 141
Decrease (increase) in other assets 4,184 (2,764)
Decrease in other liabilities (647) (817)
Net cash provided by operating activities 23,870 2,375
Cash flows from investing activities
Net decrease (increase) in long-term interest-bearing deposits in other banks 1,999 (5,489)
Proceeds from sales and calls of investment securities available for sale 16,060 1,390
Proceeds from maturities and pay-downs of securities available for sale 27,057 31,450
Purchase of investment securities available for sale (200,913) (183,927)
Net increase in restricted stock (27) (3)
Net increase in loans (6,240) (88,838)
Proceeds from surrender of bank owned life insurance policy 685 3,623
Capital expenditures (7,367) (451)
Net cash used in investing activities (168,746) (242,245)
Cash flows from financing activities
Net increase in demand deposits, interest-bearing checking, and savings accounts 195,443 221,388
Net decrease in time deposits (5,721) (10,031)
Proceeds from subordinated notes, net of issuance costs — 19,541
Dividends paid (4,105) (3,914)
Purchase of Treasury shares (1,105) (1,172)
Cash received from option exercises 100 28
Treasury shares issued under dividend reinvestment plan 2,011 1,362
Net cash provided by financing activities 186,623 227,202
Increase (decrease) in cash and cash equivalents 41,747 (12,668)
Cash and cash equivalents at the beginning of the period 57,146 83,828
Cash and cash equivalents at the end of the period $ 98,893 $ 71,160
Supplemental Disclosures of Cash Flow Information
Cash paid during the year for:
Interest on deposits and other borrowed funds $ 2,268 $ 3,158
Income taxes $ 1,872 $ 1,548
Noncash Activities
Lease liabilities arising from obtaining right-of-use assets $ — $ 105

The accompanying notes are an integral part of these unaudited financial statements.

5

FRANKLIN FINANCIAL SERVICES CORPORATION and SUBSIDIARIES

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Basis of Presentation

The consolidated financial statements include the accounts of Franklin Financial Services Corporation (the Corporation), and its wholly owned subsidiaries, Farmers and Merchants Trust Company of Chambersburg (the Bank) and Franklin Future Fund Inc. Farmers and Merchants Trust Company of Chambersburg is a commercial bank that has one wholly owned subsidiary, Franklin Financial Properties Corp. Franklin Financial Properties Corp. holds real estate assets that are leased by the Bank. Franklin Future Fund Inc. is a non-bank investment company. The activities of the non-bank subsidiary are not significant to the consolidated totals. All significant intercompany transactions and account balances have been eliminated.

In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the consolidated financial position, results of operations, and cash flows as of September 30, 2021, and for all other periods presented have been made.

Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted. It is suggested that these consolidated financial statements be read in conjunction with the audited consolidated financial statements and notes thereto included in the Corporation’s 2020 Annual Report on Form 10-K. The consolidated results of operations for the three and nine-month periods ended September 30, 2021 are not necessarily indicative of the operating results for the full year. Management has evaluated subsequent events for potential recognition and/or disclosure through the date these consolidated financial statements were issued.

The consolidated balance sheet at December 31, 2020 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by GAAP for complete consolidated financial statements.

For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, interest-bearing deposits in other banks and cash items with original maturities less than 90 days.

Earnings per share are computed based on the weighted average number of shares outstanding during each period end. A reconciliation of the weighted average shares outstanding used to calculate basic earnings per share and diluted earnings per share follows:

For the Three Months Ended For the Nine Months Ended
September 30, September 30,
(Dollars and shares in thousands, except per share data) 2021 2020 2021 2020
Weighted average shares outstanding (basic) 4,441 4,358 4,421 4,350
Impact of common stock equivalents 26 4 19 9
Weighted average shares outstanding (diluted) 4,467 4,362 4,440 4,359
Anti-dilutive options excluded from calculation 30 93 31 74
Net income $ 5,862 $ 3,462 $ 15,963 $ 8,248
Basic earnings per share $ 1.32 $ 0.79 $ 3.61 $ 1.90
Diluted earnings per share $ 1.31 $ 0.79 $ 3.60 $ 1.89

‎

6

Note 2. Recent Accounting Pronouncements

Recently issued but not yet effective accounting standards
ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
Description This standard requires credit losses on most financial assets measured at amortized cost and certain other instruments to be measured using an expected credit loss model (referred to as the current expected credit loss (CECL) model). Under this model, entities will estimate credit losses over the entire contractual term of the instrument (considering estimated prepayments, but not expected extensions or modifications unless reasonable expectation of a troubled debt restructuring exists) from the date of initial recognition of that instrument. The ASU replaces the current accounting model for purchased credit impaired loans and debt securities. The allowance for credit losses for purchased financial assets with a more-than insignificant amount of credit deterioration since origination (“PCD assets”), should be determined in a similar manner to other financial assets measured on an amortized cost basis. However, upon initial recognition, the allowance for credit losses is added to the purchase price to determine the initial amortized cost basis. The subsequent accounting for PCD financial assets is the same expected loss model described above.
Effective Date January 1, 2023
Effect on the Consolidated Financial Statements We have formed an implementation team led by the Corporation's Risk Management function. The team is reviewing the requirements of the ASU and evaluating methods and models for implementation. As of the beginning of the first reporting period in which the new standard is adopted, the Corporation expects to recognize a one-time cumulative-effect adjustment to the allowance for loan losses, which will flow through retained earnings. After adoption, the new standard will result in earlier recognition of additions to the allowance for loan losses and possibly a larger allowance for loan loss balance with a corresponding increase in the provision for loan losses in results of operations; however, the Corporation is continuing to evaluate the impact of the pending adoption of the new standard on its consolidated financial statements. A third-party vendor has been selected to assist with the CECL calculations and the implementation process has started. The Corporation is running the CECL model in test mode in 2021.
ASU 2019-05, Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief
Description This ASU allows entities to irrevocably elect, upon adoption of ASU 2016-13, the fair value option on financial instruments that (1) were previously recorded at amortized cost and (2) are within the scope of ASC 326-20 if the instruments are eligible for the fair value option under ASC 825-10. The fair value option election does not apply to held-to-maturity debt securities. Entities are required to make this election on an instrument-by-instrument basis. ASU 2019-05 has the same effective date as ASU 2016-13. On October 16, 2019, FASB approved its August 2019 proposal to grant certain small public companies a delay in the effective date of ASU 2016-13. For the Corporation, the delay makes the ASU effective January 2023. Since the Corporation currently meets the SEC definition of a small reporting company, the delay will be applied to the Corporation. Early adoption is permitted.
Effective Date January 1, 2023
Effect on the Consolidated Financial Statements The Corporation continues to review the ASU as part of its adoption of ASU 2016-13.
ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting
Description This ASU provides temporary, optional guidance to ease the potential burden in accounting for, or recognizing the effects of, the transition away from the LIBOR or other interbank offered rate on financial reporting. To help with the transition to new reference rates, the ASU provides optional expedients and exceptions for applying GAAP to affected contract modifications and hedge accounting relationships. The main provisions include: (1) a change in a contract's reference interest rate would be accounted for as a continuation of that contract rather than as the creation of a new one for contracts, including loans, debts, leases, and other arrangements that meet specific criteria, and (2) when updating its hedging strategies in response to reference rate reform, an entity would be allowed to preserve its accounting. The guidance is applicable only to contracts or hedge accounting relationships that reference LIBOR or another reference rate expected to be discontinued. Because the guidance is meant to help entities through the transition period, it will be in effect for a limited time and will not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022, except for hedging relationships existing as of December 31, 2022, for which an entity has elected certain optional expedients that are retained through the end of the hedging relationship.
Effective Date March 12, 2020 through December 31, 2022
Effect on the Consolidated Financial Statements The Corporation continues to review the ASU as part of its adoption but does not expect it to have a material effect on the consolidated financial statements.

7

Note 3. Accumulated Other Comprehensive Income (Loss)

The components of accumulated other comprehensive income (loss), net of income tax effects, included in shareholders' equity are as follows:

September 30, December 31,
(Dollars in thousands) 2021 2020
Net unrealized gains on debt securities $ 5,782 $ 12,571
Tax effect (1,214) (2,640)
Net of tax amount $ 4,568 $ 9,931
Accumulated pension adjustment $ (8,533) $ (8,533)
Tax effect 1,792 1,792
Net of tax amount $ (6,741) $ (6,741)
Total accumulated other comprehensive (loss) income $ (2,173) $ 3,190

Note 4. Investments

Available for Sale (AFS) Securities

The amortized cost and estimated fair value of AFS securities as of September 30, 2021 and December 31, 2020 are as follows:

(Dollars in thousands) Gross Gross
Amortized unrealized unrealized Fair
September 30, 2021 cost gains losses value
U.S. Government and Agency $ 89,813 $ 126 $ (293) $ 89,646
Municipal 226,582 7,184 (1,490) 232,276
Corporate 24,786 311 (141) 24,956
Agency mortgage-backed 126,238 1,217 (1,338) 126,117
Private-label mortgage-backed 27,073 50 (74) 27,049
Asset-backed 45,514 359 (129) 45,744
Total $ 540,006 $ 9,247 $ (3,465) $ 545,788
(Dollars in thousands) Gross Gross
--- --- --- --- --- --- --- --- ---
Amortized unrealized unrealized Fair
December 31, 2020 cost gains losses value
U.S. Government and Agency $ 12,594 $ 20 $ (40) $ 12,574
Municipal 236,253 11,020 (219) 247,054
Corporate 20,421 22 (155) 20,288
Agency mortgage-backed 70,443 1,905 (107) 72,241
Private-label mortgage-backed 8,412 56 (15) 8,453
Asset-backed 36,246 249 (165) 36,330
Total $ 384,369 $ 13,272 $ (701) $ 396,940

At September 30, 2021 and December 31, 2020, the fair value of debt securities pledged to secure public funds and trust deposits totaled $168.0 million and $137.4 million, respectively. The Bank has no investment in a single issuer that exceeds 10% of shareholders’ equity, except for securities issued by the U.S. Treasury and U.S. government sponsored entities.

The amortized cost and estimated fair value of debt securities at September 30, 2021, by contractual maturity are shown below. Actual maturities may differ from contractual maturities because of prepayment or call options embedded in the securities. Securities not due at a single maturity date are presented separately.

8

(Dollars in thousands) Amortized<br>‎cost Fair<br>‎value
Due in one year or less $ 2,613 $ 2,644
Due after one year through five years 21,770 22,368
Due after five years through ten years 268,783 274,542
Due after ten years 48,015 47,324
341,181 346,878
Mortgage-backed and asset-backed 198,825 198,910
$ 540,006 $ 545,788

The composition of the net realized gains (losses) on debt securities for the three and nine months ended are as follows:

For the Three Months Ended For the Nine Months Ended
September 30, September 30,
(Dollars in thousands) 2021 2020 2021 2020
Proceeds $ — $ 1,225 $ 16,060 $ 1,390
Gross gains realized — 7 169 7
Gross losses realized — (23) (78) (33)
Net gains (losses) realized $ — $ (16) $ 91 $ (26)
Tax (provision) benefit on net gains (losses) realized $ — $ 3 $ (19) $ 5

Impairment:

The debt securities portfolio contained 204 securities with $234.8 million of temporarily impaired fair value and $3.5 million in unrealized losses at September 30, 2021. The total unrealized loss position has increased $2.8 million since year-end 2020.

For securities with an unrealized loss, Management applies a systematic methodology in order to perform an assessment of the potential for other-than-temporary impairment. In the case of debt securities, investments considered for other-than-temporary impairment: (1) had a specified maturity or repricing date; (2) were generally expected to be redeemed at par; and (3) were expected to achieve a recovery in market value within a reasonable period of time. In addition, the Bank considers whether it intends to sell these securities or whether it will be forced to sell these securities before the earlier of amortized cost recovery or maturity. The impairment identified on debt securities and subject to assessment at September 30, 2021, was deemed to be temporary and required no further adjustments to the financial statements, unless otherwise noted.

‎

9

The following table reflects temporary impairment in the AFS portfolio, aggregated by investment category, length of time that individual securities have been in a continuous unrealized loss position and the number of securities in each category as of September 30, 2021 and December 31, 2020:

September 30, 2021
Less than 12 months 12 months or more Total
Fair Unrealized Fair Unrealized Fair Unrealized
(Dollars in thousands) Value Losses Count Value Losses Count Value Losses Count
U.S. Government and Agency $ 59,916 $ (280) 15 $ 3,946 $ (13) 5 $ 63,862 $ (293) 20
Municipal 48,450 (971) 55 12,248 (519) 11 60,698 (1,490) 66
Corporate 8,447 (96) 17 1,455 (45) 2 9,902 (141) 19
Agency mortgage-backed 76,682 (1,179) 64 5,710 (159) 6 82,392 (1,338) 70
Private-label mortgage-backed 12,920 (74) 9 — — — 12,920 (74) 9
Asset-backed 1,952 (90) 14 3,074 (39) 6 5,026 (129) 20
Total temporarily impaired $ 208,367 $ (2,690) 174 $ 26,433 $ (775) 30 $ 234,800 $ (3,465) 204
December 31, 2020
--- --- --- --- --- --- --- --- --- --- --- --- --- --- --- ---
Less than 12 months 12 months or more Total
Fair Unrealized Fair Unrealized Fair Unrealized
(Dollars in thousands) Value Losses Count Value Losses Count Value Losses Count
U.S. Government and Agency $ 3,966 $ (21) 5 $ 4,185 $ (19) 11 $ 8,151 $ (40) 16
Municipal 27,022 (219) 28 — — — 27,022 (219) 28
Corporate 7,576 (37) 13 3,040 (118) 4 10,616 (155) 17
Agency mortgage-backed 18,390 (101) 17 3,355 (6) 5 21,745 (107) 22
Private-label mortgage-backed 2,506 (15) 2 — — — 2,506 (15) 2
Asset-backed 1,458 (12) 2 11,452 (153) 15 12,910 (165) 17
Total temporarily impaired $ 60,918 $ (405) 67 $ 22,032 $ (296) 35 $ 82,950 $ (701) 102

The following table represents the cumulative credit losses on debt securities recognized in earnings for:

Nine Months Ended
(Dollars in thousands) September 30,
2021 2020
Balance of cumulative credit-related OTTI at January 1 $ 272 $ 272
Decreases for previously recognized credit losses on securities that paid off (15) —
Balance of credit-related OTTI at September 30 $ 257 $ 272

Equity Securities at Fair Value

The Corporation owns one equity investment with a readily determinable fair value. At September 30, 2021 and December 31, 2020, this investment was reported at fair value of $473 thousand and $391 thousand, respectively, with changes in value reported through income.

Note 5. Loans

The Bank reports its loan portfolio based on the primary collateral of the loan. It further classifies these loans by the primary purpose, either consumer or commercial. The Bank’s residential real estate loans include long-term loans to individuals and businesses secured by mortgages on the borrower’s real property and include home equity loans. Construction loans are made to finance the purchase of land and the construction of residential and commercial buildings thereon and are secured by mortgages on real estate. Commercial real estate loans include construction, owner and non-owner occupied properties and farm real estate. Commercial loans are made to businesses of various sizes for a variety of purposes including property, plant and equipment, working capital and loans to government municipalities. Commercial lending is concentrated in the Bank’s primary market, but also includes purchased loan participations. Consumer loans are comprised of installment loans and unsecured personal lines of credit.

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Each class of loans involves a different kind of risk. However, risk factors such as changes in interest rates, general economic conditions and changes in collateral values are common across all classes. The risk of each loan class is presented below.

Residential Real Estate 1-4 Family

The largest risk in residential real estate loans to retail customers is the borrower’s inability to repay the loan due to the loss of the primary source of income. The Bank attempts to mitigate this risk through prudent underwriting standards including employment history, current financial condition and credit history. These loans are generally owner occupied and serve as the borrower’s primary residence. Commercial purpose loans, secured by residential real estate, are usually dependent upon repayment from the rental income or other business purposes. These loans are generally non-owner occupied. In addition to the real estate collateral, these loans may have personal guarantees or UCC filings on other business assets. If a payment default occurs on a 1-4 family residential real estate loan, the collateral serves as a source of repayment, but may be subject to a change in value due to economic conditions.

Residential Real Estate Construction

This class includes loans to individuals for construction of a primary residence and tocontractors and developers to improve real estate and construct residential properties. Construction loans to individuals generally bear the same risk as 1-4 family residential loans. Additional risks may include cost overruns, delays in construction or contractor problems.

Loans to contractors and developers are primarily dependent on the sale of improved lots or finished homes for repayment. Risks associated with these loans include the borrower’s character and capacity to complete a development, the effect of economic conditions on the valuation of lots or homes, cost overruns, delays in construction or contractor problems. In addition to real estate collateral, these loans may have personal guarantees or UCC filings on other business assets, depending on the financial strength and experience of the developer. Real estate construction loans are monitored on a regular basis by either an independent third party or the responsible loan officer, depending on the size and complexity of the project. This monitoring process includes at a minimum, the submission of invoices or American Institute of Architects (AIA) documents detailing the cost incurred by the borrower, on-site inspections, and an authorizing signature for disbursement of funds.

Commercial Real Estate

Commercial real estate loans may be secured by various types of commercial property including retail space, office buildings, warehouses, hotels and motels, manufacturing facilities, and agricultural land.

Commercial real estate loans present a higher level of risk than residential real estate loans. Repayment of these loans is normally dependent on cash-flow generated by the operation of a business that utilizes the real estate. The successful operation of the business, and therefore repayment ability, may be affected by general economic conditions outside of the control of the operator. On most commercial real estate loans ongoing monitoring of cash flow and other financial performance indictors is completed annually through financial statement analysis. In addition, the value of the collateral may be negatively affected by economic conditions and may be insufficient to repay the loan in the event of default. In the event of foreclosure, commercial real estate may be more difficult to liquidate than residential real estate.

Commercial

Commercial loans are made for various business purposes to finance equipment, inventory, accounts receivables, and operating liquidity. These loans are generally secured by business assets or equipment, non-real estate collateral and/or personal guarantees.

Commercial loans present a higher level of credit risk than other loans because repayment ability is usually dependent on cash-flow from a business operation that can be affected by general economic conditions. On most Commercial real estate loans ongoing monitoring of cash flow and other financial performance indictors is completed at least annually through financial statement analysis. In the event of a default, collateral for these loans may be more difficult to liquidate, and the valuation of the collateral may decline more quickly than loans secured by other types of collateral.

Loans to governmental municipalities are also included in the Commercial class. These loans generally have less risk than Commercial & Industrial (C&I) loans due to the taxing authority of the municipality and its ability to assess fees on services.

This class also includes loans made as part of the Paycheck Protection Program (PPP). The PPP is a small business loan program, administered by the Small Business Administration (SBA), designed to assist in allowing small businesses to keep workers on the payroll during the COVID-19 pandemic. When workers are kept on the payroll for the qualifying period, the loan could be forgiven if the small business incurs eligible expenses. The PPP loans are 100 percent guaranteed by the SBA and have a maturity of two years or five years with a fixed interest rate of 1% for the life of the loan. Because the PPP loans are 100% guaranteed by the SBA, they present no credit risk to the Bank once the SBA guarantee is fulfilled. However, if the SBA does not grant loan forgiveness, the PPP loan would present the same risk factors as any other commercial loan.

Consumer

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These loans are made for a variety of reasons to consumers and include term loans and personal lines-of credit. The loans may be secured or unsecured. Repayment is primarily dependent on the income of the borrower and to a lesser extent the sale of collateral. The underwriting of these loans is based on the consumer’s ability and willingness to repay and is determined by the borrower’s employment history, current financial condition and credit background. Collateral for these loans, if any, usually depreciates quickly and therefore, may not be adequate to repay the loan if it is repossessed. Therefore, the overall health of the economy, including unemployment rates and wages, will have an effect on the credit quality in this loan class.

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A summary of loans outstanding, by class, at the end of the reporting periods is as follows:

September 30, December 31,
(Dollars in thousands) 2021 2020
Residential Real Estate 1-4 Family
Consumer first liens $ 75,649 $ 77,373
Commercial first lien 58,630 59,851
Total first liens 134,279 137,224
Consumer junior liens and lines of credit 65,279 60,935
Commercial junior liens and lines of credit 4,943 4,425
Total junior liens and lines of credit 70,222 65,360
Total residential real estate 1-4 family 204,501 202,584
Residential real estate - construction
Consumer 8,195 6,751
Commercial 13,883 9,558
Total residential real estate construction 22,078 16,309
Commercial real estate 527,092 503,977
Commercial 257,693 281,257
Total commercial 784,785 785,234
Consumer 6,804 5,577
1,018,168 1,009,704
Less: Allowance for loan losses (15,366) (16,789)
Net Loans $ 1,002,802 $ 992,915
Included in the loan balances are the following:
Net unamortized deferred loan (fees) costs $ 853 $ 8
Paycheck Protection Program (PPP) loans (included in Commercial loans above)
Two-year loans $ 31 $ 5,378
Five-year loans 21,711 46,912
Total Paycheck Protection Program loans $ 21,742 $ 52,290
Unamortized deferred PPP loan fees (included in Net unamortized deferred loan fees above)
Two-year loans $ — $ (165)
Five-year loans (821) (1,178)
Total unamortized deferred PPP loan fees $ (821) $ (1,343)
Loans pledged as collateral for borrowings and commitments from:
FHLB $ 733,661 $ 840,850
Federal Reserve Bank 51,653 50,605
$ 785,314 $ 891,455

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Note 6. Loan Quality and Allowance for Loan Losses

The following table presents, by class, the activity in the Allowance for Loan Losses (ALL) for the periods shown:

Residential Real Estate 1-4 Family
First Junior Liens & Commercial
(Dollars in thousands) Liens Lines of Credit Construction Real Estate Commercial Consumer Unallocated Total
ALL at June 30, 2021 $ 459 $ 220 $ 349 $ 7,878 $ 5,309 $ 102 $ 738 $ 15,055
Charge-offs — — — — (3) (126) — (129)
Recoveries — — — — 436 4 — 440
Provision 33 25 18 810 (856) 157 (187) —
ALL at September 30, 2021 $ 492 $ 245 $ 367 $ 8,688 $ 4,886 $ 137 $ 551 $ 15,366
ALL at December 31, 2020 $ 555 $ 226 $ 294 $ 9,163 $ 5,679 $ 97 $ 775 $ 16,789
Charge-offs — — (28) (13) (11) (162) — (214)
Recoveries — 170 — 1 497 23 — 691
Provision (63) (151) 101 (463) (1,279) 179 (224) (1,900)
ALL at September 30, 2021 $ 492 $ 245 $ 367 $ 8,688 $ 4,886 $ 137 $ 551 $ 15,366
ALL at June 30, 2020 $ 580 $ 197 $ 242 $ 8,837 $ 5,845 $ 105 $ 749 $ 16,555
Charge-offs - — — — — (28) — (28)
Recoveries - — — — 243 6 — 249
Provision (2) 14 17 372 (52) 11 15 375
ALL at September 30, 2020 $ 578 $ 211 $ 259 $ 9,209 $ 6,036 $ 94 $ 764 $ 17,151
ALL at December 31, 2019 $ 416 $ 119 $ 187 $ 6,607 $ 4,021 $ 84 $ 532 $ 11,966
Charge-offs - — — — (365) (87) — (452)
Recoveries 4 — — — 267 16 — 287
Provision 158 92 72 2,602 2,113 81 232 5,350
ALL at September 30, 2020 $ 578 $ 211 $ 259 $ 9,209 $ 6,036 $ 94 $ 764 $ 17,151

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The following table presents, by class, loans that were evaluated for the ALL under the specific reserve (individually) and those that were evaluated under the general reserve (collectively) and the amount of the ALL established in each class as of the periods shown:

Residential Real Estate 1-4 Family
First Junior Liens & Commercial
(Dollars in thousands) Liens Lines of Credit Construction Real Estate Commercial Consumer Unallocated Total
September 30, 2021
Loans evaluated for ALL:
Individually $ 659 $ — $ 426 $ 11,371 $ — $ — $ — $ 12,456
Collectively 133,620 70,222 21,652 515,721 257,693 6,804 — 1,005,712
Total $ 134,279 $ 70,222 $ 22,078 $ 527,092 $ 257,693 $ 6,804 $ — $ 1,018,168
ALL established for <br>‎  loans evaluated:
Individually $ — $ — $ — $ 1,308 $ — $ — $ — $ 1,308
Collectively 492 245 367 7,380 4,886 137 551 14,058
ALL at September 30, 2021 $ 492 $ 245 $ 367 $ 8,688 $ 4,886 $ 137 $ 551 $ 15,366
December 31, 2020
Loans evaluated for ALL:
Individually $ 637 $ — $ 512 $ 16,104 $ — $ — $ — $ 17,253
Collectively 136,587 65,360 15,797 487,873 281,257 5,577 — 992,451
Total $ 137,224 $ 65,360 $ 16,309 $ 503,977 $ 281,257 $ 5,577 $ — $ 1,009,704
ALL established for <br>‎  loans evaluated:
Individually $ — $ — $ — $ 228 $ — $ — $ — $ 228
Collectively 555 226 294 8,935 5,679 97 775 16,561
ALL at December 31, 2020 $ 555 $ 226 $ 294 $ 9,163 $ 5,679 $ 97 $ 775 $ 16,789

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The following table shows additional information about those loans considered to be impaired as of the periods shown:

Impaired Loans
With No Allowance With Allowance
(Dollars in thousands) Unpaid Unpaid
Recorded Principal Recorded Principal Related
September 30, 2021 Investment Balance Investment Balance Allowance
Residential Real Estate 1-4 Family
First liens $ 659 $ 684 $ — $ — $ —
Junior liens and lines of credit — — — — —
Total 659 684 — — —
Residential real estate - construction 426 729 — — —
Commercial real estate 5,684 6,479 5,687 5,796 1,308
Commercial — — — — —
Total $ 6,769 $ 7,892 $ 5,687 $ 5,796 $ 1,308
December 31, 2020
--- --- --- --- --- --- --- --- --- --- ---
Residential Real Estate 1-4 Family
First liens $ 637 $ 637 $ — $ — $ —
Junior liens and lines of credit — — — — —
Total 637 637 — — —
Residential real estate - construction 512 729 — — —
Commercial real estate 10,402 11,107 5,702 5,702 228
Commercial — — — — —
Total $ 11,551 $ 12,473 $ 5,702 $ 5,702 $ 228

The following table shows the average balance of impaired loans and related interest income for the periods shown:

Three Months Ended Nine Months Ended
September 30, 2021 September 30, 2021
Average Interest Average Interest
(Dollars in thousands) Recorded Income Recorded Income
Investment Recognized Investment Recognized
Residential Real Estate 1-4 Family
First liens $ 663 $ 8 $ 655 $ 24
Junior liens and lines of credit — — — —
Total 663 8 655 24
Residential real estate - construction 428 — 483 —
Commercial real estate 15,450 122 15,813 310
Commercial — — — —
Total $ 16,541 $ 130 $ 16,951 $ 334
Three Months Ended Nine Months Ended
September 30, 2020 September 30, 2020
Average Interest Average Interest
(Dollars in thousands) Recorded Income Recorded Income
Investment Recognized Investment Recognized
Residential Real Estate 1-4 Family
First liens $ 645 $ 12 $ 651 $ 30
Junior liens and lines of credit — — — —
Total 645 12 651 30
Residential real estate - construction 517 — 519 —
Commercial real estate 16,580 93 13,041 280
Commercial — — — —
Total $ 17,742 $ 105 $ 14,211 $ 310

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16

At September 30, 2021, the Bank had $38.0 thousand of residential properties in the process of foreclosure compared to $68.0 thousand at the end of 2020. The following table presents the aging of payments of the loan portfolio:

(Dollars in thousands) Loans Past Due and Still Accruing Total
Current 30-59 Days 60-89 Days 90 Days+ Total Non-Accrual Loans
September 30, 2021
Residential Real Estate 1-4 Family
First liens $ 133,998 $ 9 $ 231 $ — $ 240 $ 41 $ 134,279
Junior liens and lines of credit 70,105 79 — — 79 38 70,222
Total 204,103 88 231 — 319 79 204,501
Residential real estate - construction 21,652 — — — — 426 22,078
Commercial real estate 519,065 — — — — 8,027 527,092
Commercial 257,540 53 — — 53 100 257,693
Consumer 6,779 21 1 3 25 — 6,804
Total $ 1,009,139 $ 162 $ 232 $ 3 $ 397 $ 8,632 $ 1,018,168
December 31, 2020
--- --- --- --- --- --- --- --- --- --- --- --- --- --- ---
Residential Real Estate 1-4 Family
First liens $ 137,056 $ 43 $ 58 $ 26 $ 127 $ 41 $ 137,224
Junior liens and lines of credit 65,212 115 23 — 138 10 65,360
Total 202,268 158 81 26 265 51 202,584
Residential real estate - construction 15,797 — — — — 512 16,309
Commercial real estate 495,609 74 261 — 335 8,033 503,977
Commercial 280,930 219 — — 219 108 281,257
Consumer 5,525 38 2 12 52 — 5,577
Total $ 1,000,129 $ 489 $ 344 $ 38 $ 871 $ 8,704 $ 1,009,704

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The following table reports the risk rating for those loans in the portfolio that are assigned an individual risk rating. Consumer purpose loans are assigned a rating of either pass or substandard based on the performance status of the loans. Substandard consumer loans are comprised of loans 90 days or more past due and still accruing, and nonaccrual loans. Commercial purpose loans may be assigned any rating in accordance with the Bank’s internal risk rating system.

Pass OAEM Substandard Doubtful
(Dollars in thousands) (1-5) (6) (7) (8) Total
September 30, 2021
Residential Real Estate 1-4 Family
First liens $ 134,279 $ — $ — $ — $ 134,279
Junior liens and lines of credit 70,222 — — — 70,222
Total 204,501 — — — 204,501
Residential real estate - construction 21,652 — 426 — 22,078
Commercial real estate 471,021 38,595 17,476 — 527,092
Commercial 255,693 1,780 220 — 257,693
Consumer 6,804 — — — 6,804
Total $ 959,671 $ 40,375 $ 18,122 $ — $ 1,018,168
December 31, 2020
--- --- --- --- --- --- --- --- --- --- ---
Residential Real Estate 1-4 Family
First liens $ 137,156 $ — $ 68 $ — $ 137,224
Junior liens and lines of credit 65,350 — 10 — 65,360
Total 202,506 — 78 — 202,584
Residential real estate - construction 15,797 — 512 — 16,309
Commercial real estate 449,478 35,947 18,552 — 503,977
Commercial 270,272 10,698 287 — 281,257
Consumer 5,565 — 12 — 5,577
Total $ 943,618 $ 46,645 $ 19,441 $ — $ 1,009,704

The following table presents information on the Bank’s Troubled Debt Restructuring (TDR) loans as of:

Troubled Debt Restructurings
Within the Last 12 Months
That Have Defaulted
(Dollars in thousands) Troubled Debt Restructurings On Modified Terms
Number of Recorded Number of Recorded
Contracts Investment Performing* Nonperforming* Contracts Investment
September 30, 2021
Residential real estate - construction 1 $ 427 $ — $ 427 — $ —
Residential real estate 5 658 617 41 — —
Commercial real estate - owner occupied 4 1,181 831 350 — —
Commercial real estate - farm land 6 2,173 2,173 — — —
Commercial real estate - construction and land development 2 1,600 1,360 240 — —
Commercial real estate 2 303 107 196 — —
Total 20 $ 6,342 $ 5,088 $ 1,254 — $ —
December 31, 2020
Residential real estate - construction 1 $ 434 $ 434 $ — — $ —
Residential real estate 4 637 637 — — —
Commercial real estate - owner occupied 4 1,224 1,224 — — —
Commercial real estate - farm land 6 2,257 2,257 — — —
Commercial real estate - construction and land development 2 6,129 6,129 — — —
Commercial real estate 2 330 122 208 — —
Total 19 $ 11,011 $ 10,803 $ 208 — $ —

*The performing status is determined by the loan’s compliance with the modified terms.

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The following table reports new TDR loans during 2021, concession granted and the recorded investment as of September 30, 2021:

New During Period
Nine Months Ended Number of Pre-TDR After-TDR Recorded
September 30, 2021 Contracts Modification Modification Investment Concession
Residential real estate 1 $ 41 $ 41 $ 41 multiple

The following table reports new TDR loans during 2020, concession granted and the recorded investment as of September 30, 2021:

New During Period
Twelve Months Ended Number of Pre-TDR After-TDR Recorded
December 31, 2020 Contracts Modification Modification Investment Concession
Commercial real estate - farm land 1 $ 650 $ 650 $ 653 multiple
Commercial real estate - owner occupied 2 426 426 423 maturity
3 $ 1,076 $ 1,076 $ 1,076

Note 7. Leases

The Corporation leases various assets in the course of its operations that are subject to recognition on the balance sheet. The Corporation considers all of its leases to be operating leases and it has no finance leases. The leased assets are comprised of equipment, and buildings and land (collectively real estate). The equipment leases are shorter-term than the real estate leases, and generally have a fixed payment over a defined term without renewal options. Certain equipment leases have purchase options and it was determined the option was not reasonably certain to be exercised. The real estate leases are longer-term and may contain renewal options after the initial term, but none of the real estate leases contain a purchase option. The renewal options on real estate leases were reviewed and if it was determined the option was reasonably certain to be renewed, the option term was considered in the determination of the lease liability. There is only one real estate lease with a variable payment based on an index included in the lease liability. None of the leases contain any restrictive covenants and there are no significant leases that have not yet commenced. The discount rate used to determine the lease liability is based on the Bank’s fully secured borrowing rate from the Federal Home Loan Bank for a term similar to the lease term. Operating lease expense is included in net occupancy expense in the consolidated statements of income.

Lease costs:

The components of total lease cost were as follows:

Three Months Ended<br>‎September 30, Nine Months Ended<br>‎September 30,
(Dollars in thousands) 2021 2020 2021 2020
Operating lease cost $ 522 $ 149 $ 522 $ 466
Short-term lease cost 94 2 95 5
Variable lease cost 74 11 74 39
Total lease cost $ 690 $ 162 $ 691 $ 510

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Supplemental Lease Information:

Nine Months Ended<br>‎September 30,
(Dollars in thousands) 2021 2020
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases $ 491 $ 447
Weighted-average remaining lease term (years) 11.2 12.5
Weighted-average discount rate 3.36% 3.54%

Lease Obligations:

Future undiscounted lease payments for operating leases with initial terms of one year or more as of September 30, 2021 are as follows:

(Dollars in thousands)
2021 $ 166
2022 640
2023 650
2024 628
2025 588
2026 and beyond 3,396
Undiscounted cash flow 6,068
Imputed Interest (1,087)
Total lease liability $ 4,981

Note 8. Other Real Estate Owned

The Bank had no other real estate owned at September 30, 2021 and December 31, 2020.

Note 9. Derivatives

The Corporation is exposed to certain risks arising from both its business operations and economic conditions.  The Corporation principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Corporation manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its assets and liabilities.

The Corporation’s existing credit derivatives result from participations in interest rate swaps provided by external lenders as part of loan participation arrangements.  Derivatives not designated as hedges are not speculative and result from a service the Corporation provides to certain lenders which participate in loans.

The table below presents the fair value of the Corporation’s derivative financial instruments as well as their classification on the Balance Sheet.

Fair Value of Derivative Instruments
Derivative Liabilities
(Dollars in thousands) September 30, 2021 December 31, 2020
Notional amount Balance Sheet Location Fair Value Notional amount Balance Sheet Location Fair Value
Derivatives not designated as hedging instruments
Other Contracts $ 6,699 Other Liabilities $ 20 $ 6,836 Other Liabilities $ 40
Total derivatives not designated as hedging instruments $ 20 $ 40

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20

The table below presents the effect of the Corporation’s derivative financial instruments that are not designated as hedging instruments on the Income Statement.

Effect of Derivatives as Hedging Instruments on the Income Statement
Derivatives Not Designated as Hedging Instruments under Subtopic 815-20 Location of Gain or (Loss) Recognized in Income on Derivative Amount of Gain or (Loss) Recognized in Income on Derivatives
(Dollars in thousands) Three Months Ended Nine Months Ended
September 30, 2021 September 30, 2020 September 30, 2021 September 30, 2020
Other Contracts Other income $ 3 $ - $ 20 $ (33)

As of September 30, 2021, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $21 thousand.

Note 10. Pension

The components of pension expense for the periods presented are as follows:

Three Months Ended Nine Months Ended
September 30, September 30,
(Dollars in thousands) 2021 2020 2021 2020
Components of net periodic cost:
Service cost $ 107 $ 83 $ 312 $ 249
Interest cost 96 131 279 394
Expected return on plan assets (280) (269) (834) (809)
Settlement expense 158 — 356 —
Recognized net actuarial loss 283 226 850 678
Total pension expense $ 364 $ 171 $ 963 $ 512

The service cost component of pension expense is recorded in the salaries and employee benefits line and all other cost components are recorded in the nonservice pension line of the Consolidated Statements of Income.

Note 11. Fair Value Measurements and Fair Values of Financial Instruments

Management uses its best judgment in estimating the fair value of the Corporation’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Corporation could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective period-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates maybe different than the amounts reported at each year-end. The Corporation uses the exit price notion to measure the fair value of financial instruments.

FASB ASC Topic 820, “Financial Instruments”, requires disclosure of the fair value of financial assets and liabilities, including those financial assets and liabilities that are not measured and reported at fair value on a recurring and nonrecurring basis. The Corporation does not report any nonfinancial assets at fair value. FASB ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under FASB ASC Topic 820 are as follows:

Level 1: Valuation is based on unadjusted, quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2: Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. There may be substantial differences in the assumptions used for securities within the same level. For example, prices for U.S. Agency securities have fewer assumptions and are closer to level

21

1 valuations than the private label mortgage-backed securities that require more assumptions and are closer to level 3 valuations.

Level 3: Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Corporation’s assumptions regarding what market participants would assume when pricing a financial instrument.

An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The following information regarding the fair value of the Corporation’s financial instruments should not be interpreted as an estimate of the fair value of the entire Corporation since a fair value calculation is only provided for a limited portion of the Corporation’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Corporation’s disclosures and those of other companies may not be meaningful.

The following methods and assumptions were used to estimate the fair values of the Corporation’s financial instruments measured at fair value on a recurring and nonrecurring basis.

Equity Securities: Equity securities are valued using quoted market prices from nationally recognized markets (Level 1). Equity securities are measured at fair value on a recurring basis.

Investment securities: Fair values of investment securities available-for-sale were primarily measured using information from a third-party pricing service. This service provides pricing information by utilizing evaluated pricing models supported with market data information. Standard inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data from market research publications. Level 2 investment securities are primarily comprised of debt securities issued by states and municipalities, corporations, mortgage-backed securities issued by government agencies, and government-sponsored enterprises. Fair values were estimated primarily by obtaining quoted prices for similar assets in active markets or through the use of pricing models. Investment securities are measured at fair value on a recurring basis.

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals conducted by an independent, licensed appraiser, less cost to sell. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach (Level 2). If the appraiser makes an adjustment to account for differences between the comparable sales and income data available for similar loans, or if management adjusts the appraised value, then the fair value is considered Level 3. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted in accordance with the allowance policy. No partial charge-offs on impaired loans were taken in the third quarter of 2021. Impaired loans are measured at fair value on a nonrecurring basis.

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22

Recurring Fair Value Measurements

For financial assets and liabilities measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2021 and December 31, 2020 are as follows:

(Dollars in thousands) Fair Value at September 30, 2021
Asset Description Level 1 Level 2 Level 3 Total
Equity securities, at fair value $ 473 $ — $ — $ 473
Available for sale:
U.S. Government and Agency securities 79,499 10,147 — 89,646
Municipal securities — 232,276 — 232,276
Corporate securities — 24,956 — 24,956
Agency mortgage-backed securities — 126,117 — 126,117
Private-label mortgage-backed securities — 27,049 — 27,049
Asset-backed securities — 45,744 — 45,744
Total assets $ 79,972 $ 466,289 $ — $ 546,261
(Dollars in thousands) Fair Value at December 31, 2020
--- --- --- --- --- --- --- --- ---
Asset Description Level 1 Level 2 Level 3 Total
Equity securities, at fair value $ 391 $ — $ — $ 391
Available for sale:
U.S. Government and Agency securities — 12,574 — 12,574
Municipal securities — 247,054 — 247,054
Corporate securities — 20,288 — 20,288
Agency mortgage-backed securities — 72,241 — 72,241
Private-label mortgage-backed securities — 8,453 — 8,453
Asset-backed securities — 36,330 — 36,330
Total assets $ 391 $ 396,940 $ — $ 397,331

The fair value of derivative liabilities measured at fair value at September 30, 2021 and December 31, 2020 was $21 thousand and $40 thousand, respectively, and was considered immaterial.

Nonrecurring Fair Value Measurements

For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2021 and December 31, 2020 are as follows:

(Dollars in Thousands) Fair Value at September 30, 2021
Asset Description Level 1 Level 2 Level 3 Total
Impaired loans (1) $ — $ — $ 4,379 $ 4,379
Total assets $ — $ — $ 4,379 $ 4,379
(Dollars in Thousands) Fair Value at December 31, 2020
--- --- --- --- --- --- --- --- ---
Asset Description Level 1 Level 2 Level 3 Total
Impaired loans (1) $ — $ — $ 5,474 $ 5,474
Total assets $ — $ — $ 5,474 $ 5,474

(1)Includes assets that may have been charged-down to fair value during the reporting period or have a specific reserve established.

The Corporation did not record any liabilities at fair value for which measurement of the fair value was made on a nonrecurring basis at September 30, 2021. For financial assets and liabilities measured at fair value on a recurring basis, there were no transfers of financial assets or liabilities between Level 1 and Level 2 during the period ending September 30, 2021.

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The following table presents additional quantitative information about Level 3 assets measured at fair value on a nonrecurring basis at September 30, 2021 and December 31, 2020:

(Dollars in thousands) Range
September 30, 2021 Fair Value Valuation Technique Unobservable Input Weighted Average
Impaired loans $ 4,379 Appraisal Appraisal Adjustment on:
Real estate assets 20% (20%)
Non-real estate assets 100% (100%)
Cost to sell 8%
Range
December 31, 2020 Fair Value Valuation Technique Unobservable Input (Weighted Average)
Impaired Loans $ 5,474 Appraisal Appraisal Adjustment 0% - 100% (66%)
Cost to sell 8%

The carrying amounts and estimated fair value of financial instruments not carried at fair value are as follows:

September 30, 2021
Carrying Fair
(Dollars in thousands) Amount Value Level 1 Level 2 Level 3
Financial assets, carried at cost:
Cash and cash equivalents $ 98,893 $ 98,893 $ 98,893 $ — $ —
Long-term interest-bearing deposits in other banks 10,742 10,742 10,742 — —
Loans held for sale 4,114 4,223 — 4,223 —
Net loans 1,002,802 1,013,357 — — 1,013,357
Accrued interest receivable 5,543 5,543 — — 5,543
Financial liabilities:
Deposits $ 1,544,295 $ 1,580,215 $ — $ 1,580,215 $ —
Subordinate notes 19,581 20,169 — 20,169 —
Accrued interest payable 90 90 — 90 —
December 31, 2020
Carrying Fair
(Dollars in thousands) Amount Value Level 1 Level 2 Level 3
Financial assets, carried at cost:
Cash and cash equivalents $ 57,146 $ 57,146 $ 57,146 $ — $ —
Long-term interest-bearing deposits in other banks 12,741 12,741 12,741 — —
Loans held for sale 9,446 9,446 — 9,446 9,446 —
Net loans 992,915 990,867 — — 990,867
Accrued interest receivable 6,410 6,410 — — 6,410
Financial liabilities:
Deposits $ 1,354,573 $ 1,355,086 $ — $ 1,355,086 $ —
Subordinate notes 19,555 19,750 — 19,750 —
Accrued interest payable 180 180 — 180 —

Note 12. Subordinated Notes

At September 30, 2021, the Corporation had $20.0 million of unsecured subordinated debt notes payable, $15.0 million which mature on September 1, 2030 and $5.0 million which mature on September 1, 2035. The notes are recorded on the consolidated balance sheet net of remaining debt issuance costs totaling $419.0 thousand at September 30, 2021, which is being amortized on a pro-rata basis over a 5-year and 10-year period, based on the call dates of the notes, on an effective interest method. The subordinated notes totaling $15.0 million have a fixed interest rate of

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5.00% through September 1, 2025, then convert to a variable rate of 90-day Secured Overnight Financing Rate (SOFR) plus 4.93% for the applicable interest periods through maturity. The subordinated notes totaling $5.0 million have a fixed interest rate of 5.25% through September 1, 2030, then convert to a variable rate of 90-day SOFR plus 4.92% for the applicable interest periods through maturity. The Corporation may, at its option, redeem the notes, in whole or in part, at any time 5-years prior to the maturity. The notes are structured to qualify as Tier 2 Capital for the Corporation and there are no debt covenants on the notes.

Note 13. Capital Ratios

Capital adequacy for the Bank is currently defined by regulatory agencies through the use of several minimum required ratios. The capital ratios to be considered “well capitalized” are: (1) Common Equity Tier 1 (CET1) of 6.5%, (2) Tier 1 Leverage of 5%, (3) Tier 1 Risk-Based Capital of 8%, and (4) Total Risk-Based Capital of 10%. In addition, a capital conservation buffer of 2.50% is applicable to all of the capital ratios except for the Tier 1 Leverage ratio. The capital conservation buffer is equal to the lowest value of the three applicable capital ratios less the regulatory minimum for each respective capital measurement. The Bank’s capital conservation buffer at September 30, 2021 was 8.23% compared to the regulatory buffer of 2.50%. Compliance with the capital conservation buffer is required in order to avoid limitations to certain capital distributions and is in addition to the minimum required capital requirements. As of September 30, 2021, the Bank was “well capitalized”.

In 2019, the Community Bank Leverage Ratio (CBLR) was approved by federal banking agencies as an optional capital measure available to Qualifying Community Banking Organizations (QCBO). If a bank qualifies as a QCBO and maintains a CBLR of 9% or greater, the bank would be considered “well-capitalized” for regulatory capital purposes and exempt from complying with the risk-based capital rule described above. The CBLR rule took effect January 1, 2020 and banks could opt-in through an election in the first quarter 2020 regulatory filing. The Bank met the criteria of a QCBO but did not opt-in to the CBLR.

The consolidated asset limit on small bank holding companies is $3.0 billion and a company with assets under that limit is not subject to the consolidated capital rules but may file reports that include capital amounts and ratios. The Corporation has elected to file those reports.

The following table summarizes the regulatory capital requirements and results as of September 30, 2021 and December 31, 2020 for the Corporation and the Bank:

Regulatory Ratios
Adequately Well
September 30, December 31, Capitalized Capitalized
(Dollars in thousands) 2021 2020 Minimum Minimum
Common Equity Tier 1 Risk-based Capital Ratio (1)
Franklin Financial Services Corporation 14.91% 14.32% N/A N/A
Farmers & Merchants Trust Company 14.97% 14.07% 4.50% 6.50%
Tier 1 Risk-based Capital Ratio (2)
Franklin Financial Services Corporation 14.91% 14.32% N/A N/A
Farmers & Merchants Trust Company 14.97% 14.07% 6.00% 8.00%
Total Risk-based Capital Ratio (3)
Franklin Financial Services Corporation 18.16% 17.69% N/A N/A
Farmers & Merchants Trust Company 16.23% 15.33% 8.00% 10.00%
Tier 1 Leverage Ratio (4)
Franklin Financial Services Corporation 8.53% 8.69% N/A N/A
Farmers & Merchants Trust Company 8.57% 8.54% 4.00% 5.00%
(1) Common equity Tier 1 capital/ total risk-weighted assets (2) Tier 1 capital / total risk-weighted assets
(3) Total risk-based capital / total risk-weighted assets, (4) Tier 1 capital / average quarterly assets

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Note 14. Revenue Recognition

All of the Corporation’s revenue from contracts with customers within the scope of ASC 606 is recognized in non-interest income as presented in its consolidated statements of income. Revenue generating activities that fall within the scope of ASC 606 are described as follows:

Investment and Trust Service Fees – these represent fees from wealth management (assets under management), fees from the management and settlement of estates and commissions from the sale of investment and insurance products.

Asset management fees are generally assessed based on a tiered fee schedule, based on the value of assets under management, and are recognized monthly when the service obligation is completed. Fees recognized were $1.6 million for the third quarter of 2021, compared to $1.3 million in the third quarter of 2020 and $4.9 million for the first nine months of 2021, compared to $4.2 million for the first nine months of 2020.

Fees for estate management services are based on the estimated fair value of the estate. These fees are generally recognized monthly over an 18-month period that Management has determined to represent the average time to fulfill the performance obligations of the contract. Management has the discretion to adjust this time period as needed based upon the nature and complexity of an individual estate. Fees recognized were $130 thousand for the third quarter of 2021, compared to $45 thousand in the third quarter of 2020 and $313 thousand for the first nine months of 2021, compared to $118 thousand for the first nine months of 2020.

Commissions from the sale of investment and insurance products are recognized upon the completion of the transaction. Commissions recognized were $34 thousand for the third quarter of 2021, compared to $39 thousand for the third quarter of 2020 and $118 thousand for the first nine months of 2021, compared to $162 thousand for the first nine months of 2020.

Loan Service Charges – these represent fees on loans for services or charges that occur after the loan has been booked, for example, late payment fees. These also include fees for mortgages settled for third-party mortgage companies. All of these fees are transactional in nature and are recognized upon completion of the transaction which represents the performance obligation.

Deposit Service Charges and Fees – these represent fees from deposit customers for transaction based, account maintenance, and overdraft services. Transaction based fees include, but are not limited to, stop payment fees and overdraft fees. These fees are recognized at the time of the transaction when the performance obligation has been fulfilled. Account maintenance fees and account analysis fees are earned over the course of a month, representing the period of the performance obligation, and are recognized monthly.

Debit Card Income – this represents interchange fees from cardholder transactions conducted through the card payment network. Cardholders use the debit card to conduct point-of-sale transactions that produce interchange fees. The fees are transaction based and the fee is recognized with the processing of the transaction. These fees are reported net of cardholder rewards.

Other Service Charges and Fees – these are comprised primarily of merchant card fees, credit card fees, ATM surcharges and interchange fees and wire transfer fees. Merchant card fees represent fees the Bank earns from a third party for enrolling a customer in the processor’s program. Credit card fees represent a fee earned by the Bank for a successful referral to a card-issuing company. ATM surcharges and interchange fees are the result of Bank customers conducting ATM transactions that generate fee income and are processed through multiple card networks. All of these fees are transaction based and are recognized at the time of the transaction.

Gains/Losses on the Sale of Other Real Estate – these are recognized when control of the property transfers to the buyer.

Contract Balances

A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s noninterest revenue streams are largely based on transactional activity, or standard month-end revenue accruals such as asset management fees based on month-end market values. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into longer-term revenue contracts with customers, and therefore, does not experience significant contract balances.

Contract Acquisition Costs

The Corporation expenses all contract acquisition costs as costs are incurred.

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1Note 15. Commitments and Contingencies

In the normal course of business, the Bank is a party to financial instruments that are not reflected in the accompanying financial statements and are commonly referred to as off-balance-sheet instruments. These financial instruments are entered into primarily to meet the financing needs of the Bank’s customers and include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk not recognized in the consolidated balance sheet.

The Corporation’s exposure to credit loss in the event of nonperformance by other parties to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contract or notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as they do for on-balance-sheet instruments.

The Bank had the following outstanding commitments for the periods presented:

September 30, December 31,
(Dollars in thousands) 2021 2020
Financial instruments whose contract amounts represent credit risk
Commercial commitments to extend credit $ 308,157 $ 280,939
Consumer commitments to extend credit (secured) 80,611 71,761
Consumer commitments to extend credit (unsecured) 5,349 5,224
$ 394,117 $ 357,924
Standby letters of credit $ 22,939 $ 22,334

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 with the exception of home equity lines and personal lines of credit and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank, is based on Management’s credit evaluation of the counterparty. Collateral for most commercial commitments varies but may include accounts receivable, inventory, property, plant, and equipment, and income-producing commercial properties. Collateral for secured consumer commitments consists of liens on residential real estate.

Standby letters of credit are instruments issued by the Bank, which guarantee the beneficiary payment by the Bank in the event of default by the Bank’s customer in the nonperformance of an obligation or service. Most standby letters of credit are extended for one-year periods. Generally, the credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds collateral supporting those commitments for which collateral is deemed necessary primarily in the form of certificates of deposit and liens on real estate. Management believes that the proceeds obtained through a liquidation of such collateral would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees. In the second quarter of 2018, the Bank established a $2.4 million allowance against letters of credit issued in connection with a commercial borrower that declared bankruptcy. In the first quarter of 2020, the Bank reversed $250 thousand of this reserve as one letter of credit was cancelled. In the second quarter of 2021, the Bank reversed $636 thousand of this reserve as a second letter of credit was cancelled. At September 30, 2021, this reserve was $1.5 million. Except for the liability recorded for standby letters of credit, liabilities for credit loss associated with off-balance sheet commitments were not material at September 30, 2021 and December 31, 2020.

Most of the Bank’s business activity is with customers located within its primary market and does not involve any significant concentrations of credit to any one entity or industry.

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Legal Proceedings

The nature of the Corporation’s business generates a certain amount of litigation.

The Corporation establishes accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probable, and the amount of the loss can be reasonably estimated. When the Corporation is able to do so, it also determines estimates of possible losses, whether in excess of any accrued liability or where there is no accrued liability.

These assessments are based on the analysis of currently available information and are subject to significant judgment and a variety of assumptions and uncertainties. As new information is obtained, the Corporation may change its assessments and, as a result, take or adjust the amounts of its accruals and change its estimates of possible losses or ranges of possible losses. Due to the inherent subjectivity of the assessments and the unpredictability of outcomes of legal proceedings, any amounts that may be accrued or included in estimates of possible losses or ranges of possible losses may not represent the actual loss to the Corporation from any legal proceeding. Its exposure and ultimate losses may be higher, possibly significantly higher, than amounts it may accrue or amounts it may estimate.

In management’s opinion, the Corporation does not anticipate, at the present time, that the ultimate aggregate liability, if any, arising out of all litigation to which the Corporation is a party at this time will have a material adverse effect on its financial position. The Corporation cannot now determine, however, whether or not any claim asserted against it will have a material adverse effect on its results of operations in any future reporting period, which will depend on, among other things, the amount of loss resulting from the claim and the amount of income otherwise reported for the reporting period. Thus, at September 30, 2021, the Corporation is unable to provide an evaluation of the likelihood of an unfavorable outcome or an estimate of the amount or range of potential loss with respect to such other matters and, accordingly, have not yet established any specific accrual for such other matters.

Note 16. Reclassification

Certain prior period amounts may have been reclassified to conform to the current year presentation. Such reclassifications did not affect prior year net income or shareholders’ equity.

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Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition

Management’s Discussion and Analysis of Results of Operations and Financial Condition

For the Three and Nine Months Ended September 30, 2021 and 2020

Forward Looking Statements

Certain statements appearing herein which are not historical in nature are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements refer to a future period or periods, reflecting management’s current views as to likely future developments, and use words such as “may,” “will,” “expect,” “believe,” “estimate,” “anticipate,” or similar terms. Because forward-looking statements involve certain risks, uncertainties and other factors over which the Corporation has no direct control, actual results could differ materially from those contemplated in such statements. These factors include (but are not limited to) the following: general economic conditions, particularly with regard to the negative impact of severe, wide-ranging and continuing disruptions caused by, and resulting from, the spread of the coronavirus COVID-19 pandemic and affects thereof, including governmental responses thereto, changes in interest rates, changes in the Corporation’s cost of funds, changes in government monetary policy, changes in government regulation and taxation of financial institutions, changes in the rate of inflation, changes in technology, the intensification of competition within the Corporation’s market area, and other similar factors. We caution readers not to place undue reliance on these forward-looking statements. They only reflect management’s analysis as of this date. The Corporation does not revise or update these forward-looking statements to reflect events or changed circumstances.

Critical Accounting Policies

Management has identified critical accounting policies for the Corporation. These policies are particularly sensitive, requiring significant judgements, estimates and assumptions to be made by Management. There were no changes to the critical accounting policies disclosed in the 2020 Annual Report on Form 10-K in regards to application or related judgments and estimates used. Please refer to Item 7 of the Corporation’s 2020 Annual Report on Form 10-K for a more detailed disclosure of the critical accounting policies.

Results of Operations

Summary

Franklin Financial Services Corporation reported consolidated earnings of $5.9 million ($1.31 per diluted share) for the third quarter of 2021 compared to $3.5 million ($.79 per diluted share) for the same period in 2020, and $5.3 million ($1.19 per diluted share) for the second quarter of 2021. Net income for year-to-date 2021 was $16.0 million ($3.60 per diluted share) compared to $8.2 million ($1.89 per diluted share) for the same nine-month period in 2020. Net income for both the third quarter of 2021 and the year-to-date period of 2021 was boosted by a gain of $1.8 million on the sale of the Bank’s headquarters building, as previously reported.

A summary of operating results for the third quarter of 2021 and year-to-date 2021 are as follows:

Net interest income was $11.6 million, inclusive of $1.2 million of interest and fees from Paycheck Protection Program (PPP) loans, for the third quarter of 2021 compared to $10.8 million (including $865 thousand of interest and fees from the PPP program) for the second quarter of 2021 and $10.4 million for the third quarter of 2020. Year-to-date, net interest income was $33.3 million (including $2.8 million of PPP interest and fees) compared to $31.0 million for the same period in 2020. The net interest margin decreased to 2.89% for the third quarter of 2021 from 3.02% for the same quarter of the prior year. On a year-to-date comparison basis, the net interest margin was 2.91% for 2021 compared to 3.25% in 2020.  The yield on earning assets decreased in both the third quarter of 2021 versus 2020 third quarter comparison (down 0.20%) and the year over year comparison (down 0.48%) as all asset classes had lower yields as market rates remained low during the year. The year-to-date cost of interest-bearing deposits decreased from 0.39% in 2020 to 0.16% in 2021 while the cost of total deposits decreased from 0.32% in 2020 to 0.13% in 2021 as the Bank reduced deposit rates to offset lower asset yields. ‎

Earning assets for the third quarter of 2021 averaged $1.6 billion compared to $1.4 billion for the same period in 2020, and year-to-date 2021 average earning assets were 20.6% greater than 2020. The 2021 average balance of the investment portfolio increased $214.1 million over the same year-to-

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date comparative period, primarily in the municipal bond portfolio. The average balance of the loan portfolio increased from $983.2 million for the first nine months of 2020 to $1.0 billion in 2021. The average balance of the commercial loan portfolio increased $12.9 million, due to the addition of PPP loans which totaled $21.7 million at September 30, 2021 and averaged $50.3 million for the year-to-date period. The average balance of deposits for the year increased $242.5 million (19.9%) over the same period in 2020 with every deposit category increasing except for time deposits. ‎

The provision for loan loss expense for the third quarter of 2021 was $0 compared to a $1.1 million reversal in the second quarter of 2021, and a provision expense of $375 thousand for the third quarter of 2020. Year-to-date, the provision for loan loss expense was a reversal of $1.9 million compared to a $5.4 million provision expense for the same period in 2020. The 2020 provision expense was the result of an increase in several qualitative factors in the allowance for loan loss calculation due to the projected economic effects and impact of the COVID-19 pandemic. As of September 30, 2021, several qualitative factors were reduced throughout the year reflecting a lower risk of loss in the loan portfolio, and the twenty-quarter historical average charge-off rate used in the calculation decreased, thereby resulting in a reversal of the provision for loan loss expense. The allowance for loan loss ratio was 1.51% of gross loans as of September 30, 2021, compared to 1.66% at December 31, 2020. Excluding the PPP loans, the allowance for loan loss ratio was 1.54% at the end of the third quarter of 2021 and 1.75% at year-end 2020. ‎

Noninterest income totaled $6.2 million for the third quarter of 2021 compared to $4.5 million in the second quarter of 2021 and $3.6 million for the comparable quarter of 2020. Year-to-date, noninterest income was $14.9 million compared to $10.9 million in 2020. The third quarter of 2021 and the year-to-date period were both boosted by a gain of $1.8 million on the sale of the Bank’s headquarters building, as previously reported. Other significant year-to-date variances include increases in Investment and Trust Services fees ($813 thousand), gains on the sale of mortgages ($990 thousand) and debit card income ($295 thousand). These increases were partially offset by a decrease of $665 thousand from gains on bank owned life insurance. ‎

Noninterest expense for the third quarter of 2021 was $11.0 million compared to $10.1 million in the prior quarter and $9.6 million for the third quarter of 2020. Year-to-date, noninterest expense was $31.3 million in 2021 compared to $28.8 million in 2020. The following categories contributed to the year-over-year increase: salaries and benefits increased $1.5 million, FDIC insurance increased $287 thousand, data processing expense increased $346 thousand, and nonservice pension expense increased $388 thousand. Other expenses decreased $545 thousand due primarily to a $636 thousand expense reversal relating to the reversal of a previously established off-balance sheet liability reserve. ‎

The effective tax rate was 13.7% and 15.1% for the third quarter and year-to-date period of 2021, respectively.

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Total assets at September 30, 2021 were $1.732 billion compared $1.535 billion at December 31, 2020. Significant balance sheet changes since December 31, 2020, include:

Short-term interest-bearing deposits in other banks increased $38.3 million and the investment portfolio increased $148.8 million. ‎

The net loan portfolio increased $9.9 million over the year-end 2020 balance. The increase occurred primarily in the residential real estate construction portfolio. Commercial loans were flat from year-end 2020, as new production was completely offset by a $30.5 million reduction in PPP loans. The Bank held $21.7 million in PPP loans at September 30, 2021 ($52.3 million at December 31, 2020) with $821 thousand of deferred PPP fees remaining to be recognized. ‎

As of September 30, 2021, the Bank had no loans under a COVID modified payment schedule and all loans previously on modified payment have returned to contractual payment schedules. ‎

Deposits increased $189.7 million (14.0%) over year-end 2020, with all deposit products showing an increase except time deposits. Money management accounts and interest-bearing checking products showed the largest increases over the prior year-end.  ‎

Shareholders’ equity increased $7.7 million from December 31, 2020, due primarily to an increase of $11.9 million in retained earnings during 2021 partially offset by a decrease of $5.4 million in accumulated other comprehensive income (AOCI) as the fair value of the investment portfolio declined during the year. At September 30, 2021, the book value of the Corporation’s common stock was $34.49 per share and the tangible book value was $32.46 per share. In December 2020, an open market repurchase plan was approved to repurchase 150,000 shares over a one-year period. As of September 30, 2021, 35,244 shares have been repurchased under the plan.

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Key performance ratios as of, or for the three months ended September 30, 2021 and 2020 and the year ended December 31, 2020 are listed below:

September 30, December 31, September 30,
(Dollars in thousands, except per share) 2021 2020 2020
Balance Sheet Highlights
Total assets $ 1,732,441 $ 1,535,038 $ 1,511,213
Investment and equity securities 546,261 397,331 346,774
Loans, net 1,002,802 992,915 1,005,807
Deposits 1,544,295 1,354,573 1,336,749
Shareholders' equity 152,838 145,176 139,574
Summary of Operations
Interest income $ 35,440 $ 45,939 $ 34,068
Interest expense 2,178 3,978 3,100
Net interest income 33,262 41,961 30,968
(Recovery of) provision for loan losses (1,900) 4,625 5,350
Net interest income after provision for loan losses 35,162 37,336 25,618
Noninterest income 14,899 15,084 10,903
Noninterest expense 31,265 39,362 28,821
Income before income taxes 18,796 13,058 7,700
Federal income tax expense (benefit) 2,833 258 (548)
Net income $ 15,963 $ 12,800 $ 8,248
Performance Measurements
Return on average assets* 1.29% 0.91% 0.80%
Return on average equity* 14.46% 9.56% 8.33%
Return on average tangible equity (1)* 15.40% 10.24% 8.94%
Efficiency ratio (1) 63.70% 67.32% 66.93%
Net interest margin* 2.91% 3.21% 3.25%
Shareholders' Value (per common share)
Diluted earnings per share $ 3.60 $ 2.93 $ 1.89
Basic earnings per share 3.61 2.94 1.90
Regular cash dividends declared 0.93 1.20 0.90
Book value 34.49 33.07 31.93
Tangible book value (1) 32.46 31.02 29.87
Market value 31.77 27.03 21.38
Market value/book value ratio 92.11% 81.74% 66.96%
Market value/tangible book value ratio 97.88% 87.13% 71.58%
Price/earnings multiple* 6.62 9.23 6.77
Current quarter dividend yield* 3.90% 4.44% 5.61%
Dividend payout ratio year-to-date 25.72% 40.83% 47.45%
Safety and Soundness
Average equity/average assets 8.94% 9.48% 9.62%
Risk-based capital ratio (Total) 18.16% 17.69% 17.62%
Leverage ratio (Tier 1) 8.53% 8.69% 8.75%
Common equity ratio (Tier 1) 14.91% 14.32% 14.21%
Nonperforming loans/gross loans 0.85% 0.87% 0.93%
Nonperforming assets/total assets 0.50% 0.57% 0.63%
Allowance for loan losses as a % of loans 1.51% 1.66% 1.68%
Net loans (recovered) charged-off/average loans* -0.06% -0.02% 0.02%
Assets under Management
Trust assets under management (fair value) $ 907,441 $ 836,381 $ 775,013
Held at third-party brokers (fair value) 115,120 112,624 106,238

*Year-to-date annualized

(1)   See the section titled “GAAP versus Non-GAAP Presentation” that follows.

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GAAP versus non-GAAP Presentations – The Corporation supplements its traditional GAAP measurements with certain non-GAAP measurements to evaluate its performance and to eliminate the effect of intangible assets.  By eliminating intangible assets (Goodwill), the Corporation believes it presents a measurement that is comparable to companies that have no intangible assets or to companies that have eliminated intangible assets in similar calculations. However, not all companies may use the same calculation method for each measurement. The non-GAAP measurements are not intended to be used as a substitute for the related GAAP measurements. Non-GAAP financial measures should be viewed in addition to, and not as an alternative for, our reported results prepared in accordance with GAAP. In the event of such a disclosure or release, the Securities and Exchange Commission’s Regulation G requires: (i) the presentation of the most directly comparable financial measure calculated and presented in accordance with GAAP and (ii) a reconciliation of the differences between the non-GAAP financial measure presented and the most directly comparable financial measure calculated and presented in accordance with GAAP. The following table shows the calculation of the non-GAAP measurements.

(Dollars in thousands, except per share) Nine Months Ended Twelve Months Ended Nine Months Ended
September 30, 2021 December 31, 2020 September 30, 2020
Return on Tangible Equity (non-GAAP)
Net income $ 15,963 $ 12,800 $ 8,248
Average shareholders' equity 147,198 133,958 132,095
Less average intangible assets (9,016) (9,016) (9,016)
Average tangible equity (non-GAAP) 138,182 124,942 123,079
Return on average tangible equity (non-GAAP)* 15.40% 10.24% 8.94%
Tangible Book Value (per share) (non-GAAP)
Shareholders' equity $ 152,838 $ 145,176 $ 139,574
Less intangible assets (9,016) (9,016) (9,016)
Tangible book value (non-GAAP) 143,822 136,160 130,558
Shares outstanding (in thousands) 4,431 4,389 4,371
Tangible book value per share (non-GAAP) 32.45814 31.02 29.87
Efficiency Ratio
Noninterest expense $ 31,265 $ 39,362 $ 28,821
Net interest income 33,262 41,961 30,968
Plus tax equivalent adjustment to net interest income 1,098 1,407 1,028
Plus noninterest income, net of securities transactions 14,725 15,104 11,068
Total revenue 49,085 58,472 43,064
Efficiency ratio (Noninterest expense/total revenue) 63.70% 67.32% 66.93%
* Year-to-date annualized

Net Interest Income

The largest source of the Corporation’s earnings is net interest income, which is defined as the difference between income on interest-earning assets and the expense of interest-bearing liabilities supporting those assets. Principal categories of interest-earning assets are loans and securities, while deposits, short-term borrowings and long-term debt are the principal categories of interest-bearing liabilities. Demand deposits enhance net interest income because they are noninterest-bearing deposits. For the purpose of this discussion, balance sheet items refer to the average balance for the year and net interest income is adjusted to a fully taxable-equivalent basis. This tax-equivalent adjustment facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Corporation’s 21% Federal statutory rate.

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Comparison of the three months ended September 30, 2021 to the three months ended September 30, 2020:

Tax equivalent net interest income increased $1.2 million to $12.0 million in the third quarter of 2021 compared to $10.8 million for the same period in 2020. Balance sheet volume contributed $478 thousand to tax equivalent net interest income and changes in rates contributed $709 thousand.

The following table presents average balances, tax-equivalent (T/E) interest income, and yields earned or rates paid on the assets or liabilities. Nonaccrual loans are included in the average loan balance used to calculate the yield. All nontaxable interest income has been adjusted to a tax-equivalent basis using a tax rate of 21%.

For the Three Months Ended September 30,
2021 2020
Average Income or Average Average Income or Average
(Dollars in thousands) balance expense yield/rate balance expense yield/rate
Interest-earning assets:
Interest-bearing obligations in other banks $ 109,617 $ 66 0.24% $ 75,686 $ 72 0.38%
Investment securities:
Taxable 434,380 1,907 1.74% 231,803 1,162 1.99%
Tax Exempt 91,742 663 2.89% 84,740 635 3.00%
Investments 526,122 2,570 1.94% 316,543 1,797 2.25%
Loans:
Commercial, industrial and agricultural 845,154 8,785 4.09% 871,753 8,460 3.82%
Residential mortgage 70,614 604 3.48% 73,497 641 3.64%
Home equity loans and lines 84,133 535 2.52% 72,655 614 3.35%
Consumer 6,968 109 6.21% 6,707 42 2.48%
Loans 1,006,869 10,033 3.92% 1,024,612 9,757 3.75%
Total interest-earning assets 1,642,608 $ 12,669 3.06% 1,416,841 $ 11,626 3.26%
Other assets 70,210 62,990
Total assets $ 1,712,818 $ 1,479,831
Interest-bearing liabilities:
Deposits:
Interest-bearing checking $ 489,639 $ 138 0.11% $ 401,668 $ 165 0.16%
Money Management 544,660 208 0.15% 468,782 264 0.22%
Savings 114,224 16 0.06% 96,919 15 0.06%
Time 69,602 85 0.48% 80,693 243 1.19%
Total interest-bearing deposits 1,218,125 447 0.15% 1,048,062 687 0.26%
Subordinated Notes 19,575 263 5.37% 12,364 167 5.36%
Total interest-bearing liabilities 1,237,700 710 0.23% 1,060,426 854 0.32%
Noninterest-bearing deposits 305,617 267,404
Other liabilities 15,201 15,402
Shareholders' equity 154,300 136,599
Total liabilities and shareholders' equity $ 1,712,818 $ 1,479,831
T/E net interest income/Net interest margin 11,959 2.89% 10,772 3.02%
Tax equivalent adjustment (365) (389)
Net interest income $ 11,594 $ 10,383
Net Interest Spread 2.83% 2.94%
Cost of Funds 0.18% 0.26%
Cost of Deposits 0.12% 0.21%

Provision for Loan Losses

The Bank had provision for loan loss expense of $0 for the third quarter of 2021, compared to an expense of $375 thousand in the third quarter of 2020. For more information refer to the Loan Quality and Allowance for Loan Losses discussion in the Financial Condition section.

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Noninterest Income

For the third quarter of 2021, noninterest income increased $2.6 million from the same period in 2020. Investment and trust service fees increased primarily due to an increase in asset management fees. Deposit service charges and fees increased due to the addition of new deposit products. The life insurance gain was from a bank-owned life insurance policy. The gain on sale of premise was from the sale of the current headquarters at 20 South Main Street Chambersburg, PA as previously reported.

The following table presents a comparison of noninterest income for the three months ended September 30, 2021 and 2020:

For the Three Months Ended
September 30, Change
(Dollars in thousands) 2021 2020 Amount %
Noninterest Income
Investment and trust services fees $ 1,740 $ 1,433 $ 307 21.4
Loan service charges 224 206 18 8.7
Gain on sale of loans 529 504 25 5.0
Deposit service charges and fees 674 497 177 35.6
Other service charges and fees 397 382 15 3.9
Debit card income 550 491 59 12.0
Increase in cash surrender value of life insurance 109 110 (1) (0.9)
Bank owned life insurance gain 147 — 147 NA
Net gains on sales of debt securities — (16) 16 100.0
Change in fair value of equity securities (9) (39) 30 (76.9)
Gain on sale of premise 1,776 — 1,776 NA
Other 45 35 10 28.6
Total noninterest income $ 6,182 $ 3,603 $ 2,579 71.6

Noninterest Expense

Noninterest expense for the third quarter of 2021 increased $1.3 million compared to the same period in 2020. Salary expense increased primarily due to additional expense for incentive compensation programs. Data processing expenses were higher due to increases in usage of the Bank’s mobile banking platforms. Nonservice pension increased due to pension settlement expenses.

The following table presents a comparison of noninterest expense for the three months ended September 30, 2021 and 2020:

For the Three Months Ended
(Dollars in thousands) September 30, Change
Noninterest Expense 2021 2020 Amount %
Salaries and benefits $ 5,958 $ 5,421 $ 537 9.9
Net occupancy 908 838 70 8.4
Marketing and advertising 413 384 29 7.6
Legal and professional 579 499 80 16.0
Data processing 1,040 871 169 19.4
Pennsylvania bank shares tax 308 263 45 17.1
FDIC insurance 181 128 53 41.4
ATM/debit card processing 342 285 57 20.0
Telecommunications 101 110 (9) (8.2)
Nonservice pension 257 88 169 192.0
Other 899 762 137 18.0
Total noninterest expense $ 10,986 $ 9,649 $ 1,337 13.9

Provision for Income Taxes

For the third quarter of 2021, the Corporation recorded a Federal income tax expense of $928 thousand compared to $500 thousand for the same quarter in 2020. The effective tax rate for the third quarter of 2021 was 13.7% compared to 12.6% for the third quarter of 2020. The increase in the effective tax rate was due primarily to higher pre-tax income driven by the large change in the provision for loan loss expense year-over-year. The federal statutory tax rate is 21% for 2021 and 2020.

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Comparison of the nine months ended September 30, 2021 to the nine months ended September 30, 2020:

Tax equivalent net interest income increased $2.4 million to $34.4 million in the first nine months of 2021 compared to $32.0 million for the same period in 2020. Balance sheet volume contributed $3.2 million to tax equivalent net interest income but was offset by a $863 thousand change in rates.

The following table presents average balances, tax-equivalent (T/E) interest income, and yields earned or rates paid on the assets or liabilities. Nonaccrual loans are included in the average loan balance used to calculate the yield. All nontaxable interest income has been adjusted to a tax-equivalent basis using a tax rate of 21%.

For the Nine Months Ended September 30,
2021 2020
Average Income or Average Average Income or Average
(Dollars in thousands) balance expense yield/rate balance expense yield/rate
Interest-earning assets:
Interest-bearing obligations in other banks $ 104,340 $ 178 0.23% $ 74,043 $ 412 0.74%
Investment securities:
Taxable 374,436 5,301 1.89% 198,661 3,282 2.20%
Tax Exempt 92,310 1,997 2.89% 53,983 1,293 3.20%
Investments 466,746 7,298 2.09% 252,644 4,575 2.41%
Loans:
Commercial, industrial and agricultural 850,191 25,355 3.94% 837,301 25,909 4.08%
Residential mortgage 68,413 1,792 3.51% 70,265 2,067 4.01%
Home equity loans and lines 83,052 1,577 2.54% 69,075 1,946 3.75%
Consumer 6,929 338 6.52% 6,579 187 3.79%
Loans 1,008,585 29,062 3.82% 983,220 30,109 4.05%
Total interest-earning assets 1,579,671 $ 36,538 3.09% 1,309,907 $ 35,096 3.57%
Other assets 66,296 63,925
Total assets $ 1,645,967 $ 1,373,832
Interest-bearing liabilities:
Deposits:
Interest-bearing checking $ 463,368 $ 372 0.11% $ 366,575 $ 637 0.23%
Money Management 529,257 612 0.15% 449,777 1,347 0.40%
Savings 110,792 47 0.06% 90,945 90 0.13%
Time 71,946 359 0.67% 83,226 859 1.37%
Total interest-bearing deposits 1,175,363 1,390 0.16% 990,523 2,933 0.39%
Subordinated Notes 19,567 788 5.37% 4,152 167 5.36%
Total interest-bearing liabilities 1,194,930 2,178 0.24% 994,675 3,100 0.42%
Noninterest-bearing deposits 288,558 230,911
Other liabilities 15,281 16,151
Shareholders' equity 147,198 132,095
Total liabilities and shareholders' equity $ 1,645,967 $ 1,373,832
T/E net interest income/Net interest margin 34,360 2.91% 31,996 3.25%
Tax equivalent adjustment (1,098) (1,028)
Net interest income $ 33,262 $ 30,968
Net Interest Spread 2.85% 3.15%
Cost of Funds 0.20% 0.34%
Cost of Deposits 0.13% 0.32%

Provision for Loan Losses

The Bank recorded a reversal of $1.9 million in the provision for loan loss for the first nine months of 2021, compared to an expense of $5.4 million in the first nine months of 2020. For more information refer to the Loan Quality and Allowance for Loan Losses discussion in the Financial Condition section.

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Noninterest Income

For the first nine months of 2021, noninterest income increased $4.0 million from the same period in 2020. Trust and investment service fees increased primarily due to an increase in asset management fees. Gain on sale of loans increased as mortgage production was higher in 2021 compared to 2020. Debit card income increased due to an increase in activity. The gain on sale of premise was from the sale of the current headquarters at 20 South Main Street Chambersburg, PA as previously reported.

The following table presents a comparison of noninterest income for the nine months ended September 30, 2021 and 2020:

For the Nine Months Ended
September 30, Change
(Dollars in thousands) 2021 2020 Amount %
Noninterest Income
Investment and trust services fees $ 5,282 $ 4,469 $ 813 18.2
Loan service charges 647 620 27 4.4
Gain on sale of loans 1,866 876 990 113.0
Deposit service charges and fees 1,613 1,459 154 10.6
Other service charges and fees 1,214 1,065 149 14.0
Debit card income 1,642 1,347 295 21.9
Increase in cash surrender value of life insurance 336 346 (10) (2.9)
Bank owned life insurance gain 147 812 (665) (81.9)
Net gains on sales of debt securities 91 (26) 117 450.0
Change in fair value of equity securities 83 (139) 222 (159.7)
Gain on sale of premise 1,776 — 1,776 NA
Other 202 74 128 173.0
Total noninterest income $ 14,899 $ 10,903 $ 3,996 36.7

Noninterest Expense

Noninterest expense for the first nine months of 2021 increased $2.4 million compared to the same period in 2020. Salary expense increased primarily due to health insurance costs from the Bank’s self-insured plan, as claims increased in 2021 versus the same period in 2020, and higher expenses for incentive compensation programs. Data processing expenses were higher due to increases in usage of the Bank’s mobile banking platforms. FDIC insurance expense increased primarily due to growth of the Bank’s balance sheet. Nonservice pension increased due to pension settlement expenses. Other expenses decreased in 2021 due to a $636 thousand allowance previously established for an off-balance sheet liability that was reversed with an offsetting amount reversed from other expense, compared to a $250 thousand reversal in the prior year-to-date period related to the same off-balance sheet liability.

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The following table presents a comparison of noninterest expense for the nine months ended September 30, 2021 and 2020:

For the Nine Months Ended
(Dollars in thousands) September 30, Change
Noninterest Expense 2021 2020 Amount %
Salaries and employee benefits $ 17,861 $ 16,337 $ 1,524 9.3
Net occupancy 2,675 2,533 142 5.6
Marketing and advertising 1,153 1,303 (150) (11.5)
Legal and professional 1,552 1,324 228 17.2
Data processing 2,857 2,511 346 13.8
Pennsylvania bank shares tax 708 701 7 1.0
FDIC insurance 563 276 287 104.0
ATM/debit card processing 967 828 139 16.8
Telecommunications 314 323 (9) (2.8)
Nonservice pension 651 176 475 269.9
Other 1,964 2,509 (545) (21.7)
Total noninterest expense $ 31,265 $ 28,821 $ 2,444 8.5

Provision for Income Taxes

For the first nine months of 2021, the Corporation recorded a Federal income tax expense of $2.8 million compared to a tax benefit of $548 million for the same period in 2020. Part of the tax benefit in 2020 was a $1.1 million tax benefit from the Coronavirus Aid, Relief and Economic Security Act (the CARES Act) which allowed for net operating losses (NOL) from prior years to be carried back to past year instead of forward to future periods. The effective tax rate for the first nine months of 2021 was 15.1% compared to 7.3% (excluding the NOL benefit) for the first nine months of 2020. The increase in the effective tax rate was due primarily to higher pre-tax income driven by the large change in the provision for loan loss expense year-over-year. The benefit of tax-exempt income increased only slightly year-over-year. The federal statutory tax rate is 21% for 2021 and 2020.

Financial Condition

Cash and Cash Equivalents:

Cash and cash equivalents totaled $98.9 million at September 30, 2021, an increase of $41.8 million from the prior year-end balance of $57.1 million. Interest-bearing deposits are held primarily at the Federal Reserve ($77.0 million).

Investment Securities:

AFS Securities: The AFS securities portfolio has increased $155.6 million on a cost basis since year-end 2020. The portfolio is comprised primarily of municipal securities and U.S. Agency mortgage-backed securities at approximately 43% and 23% of the portfolio fair value, respectively. The average life of the portfolio was 6.6 years.

The AFS securities portfolio had a net unrealized gain of $5.8 million at September 30, 2021 compared to a net unrealized gain of $12.6 million at the prior year-end. The portfolio averaged $466.7 million with a yield of 2.09% for the first nine months of 2021. This compares to an average of $252.6 million and a yield of 2.41% for the same period in 2020.

The municipal bond portfolio is well diversified geographically (220 issuers) and is comprised primarily of general obligation bonds (65%). Many municipal bonds have credit enhancements in the form of private bond insurance or other credit support. The largest geographic municipal bond exposure is in the states of Texas (14%), California (12%), Michigan (11%), and Pennsylvania (10%). The average rating of the municipal portfolio from Moody’s is AA. No municipal bonds are rated below investment grade.

Temporary impairment in the investment portfolio, measured by gross unrealized losses, was $3.5 million, compared to $701 thousand at December 31, 2020. The municipal bond portfolio had the largest unrealized loss of $1.5 million, 43% of the total unrealized loss ($3.5 million). There are 204 securities in this portfolio with an unrealized loss and the loss in this portfolio is deemed to be non-credit related and no other-than-temporary impairment charges have been recorded.

The corporate portfolio is comprised of 5 variable rate bank issued trust preferred securities with a fair value of $4.1 million and 43 fixed rate bank issued subordinated notes with a fair value of $20.8 million. This portfolio has an unrealized loss of $141 thousand on 19 securities with a fair value of $9.9 million. The trust-preferred securities held by the Bank are single entity issues, not pooled trust preferred securities. None of these issuers have suspended or missed a

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dividend or interest payment. At September 30, 2021, the Bank believes it will be able to collect all interest and principal due on these bonds and no other-than-temporary-impairment charges were recorded.

The unrealized loss in the asset-backed securities portfolio decreased $36 thousand from December 31, 2020. FFELP (Federal Family Education Loan Program) bonds make up the majority of this sector and have a 97% guarantee from the U.S. Department of Education. The FFELP bonds are all rated AAA. Management fully expects to be paid back at par and no other-than-temporary impairment charges have been recorded.

Restricted Stock at Cost: The Bank held $495 thousand of restricted stock at September 30, 2021. Except for $30 thousand, this investment represents stock in FHLB Pittsburgh. The Bank is required to hold this stock to be a member of FHLB and it is carried at cost of $100 per share. The level of FHLB stock held is determined by FHLB and is comprised of a minimum membership amount plus a variable activity amount. FHLB stock is evaluated for impairment primarily based on an assessment of the ultimate recoverability of its cost. As a government sponsored entity, FHLB has the ability to raise funding through the U.S. Treasury that can be used to support its operations. There is not a public market for FHLB stock and the benefits of FHLB membership (e.g., liquidity and low-cost funding) add value to the stock beyond purely financial measures. Management intends to remain a member of the FHLB and believes that it will be able to fully recover the cost basis of this investment.

See Note 4 of the accompanying financial statements for additional information on Investment Securities.

Loans:

Residential real estate: This category is comprised of consumer purpose loans secured by residential real estate and to a lesser extent, commercial purpose loans secured by residential real estate. The consumer purpose category represents traditional residential mortgage loans and home equity products (primarily junior liens and lines of credit). Commercial purpose loans in this category represent loans made for various business needs but are secured with residential real estate. In addition to the real estate collateral, it is possible that additional security is provided by personal guarantees or UCC filings. These loans are underwritten as commercial loans and are not originated to be sold.

Total residential real estate loans increased by $1.9 million over year-end 2020. For the first nine months of 2021, the Bank originated $81.2 million and sold $88.4 million in mortgages through third party brokerage agreements. The Bank does not originate or hold any loans that would be considered sub-prime or Alt-A and does not generally originate mortgages outside of its primary market area.

Residential real estate construction: This category contains loans for the vertical construction of 1-4 family residential properties. The largest component of this category represents loans to residential real estate developers ($13.9 million), while loans for individuals to construct personal residences totaled $8.2 million at September 30, 2021. The Bank’s exposure to residential construction loans is concentrated primarily in south central Pennsylvania. Real estate construction loans, including residential real estate and land development loans, occasionally provide an interest reserve in order to assist the developer during the development stage when minimal cash flow is generated. All real estate construction loans are underwritten in the same manner, regardless of the use of an interest reserve.

Commercial real estate (CRE): This category includes commercial, industrial, farm and agricultural loans and land development loans, where real estate serves as the primary collateral for the loans. Total commercial real estate loans increased to $527.1 million from $504.0 million at the end of 2020. The largest sectors (by collateral) in the commercial real estate category are: hotels and motels ($77.6 million), apartment units ($71.8 million), office building ($54.6 million), land development ($47.3 million), and manufacturing facility ($38.8 million). The majority of the Bank’s hotel exposure is located along the Interstate 81 (I-81) corridor through south-central Pennsylvania. The portfolio is comprised of properties operating under 18 flagged brands and 3 independent operators.

Also included in CRE are real estate construction loans totaling $89.2 million. At September 30, 2021, the Bank had $26.0 million in real estate construction loans funded with an interest reserve and capitalized $558 thousand of interest in 2021 from these reserves on active projects for commercial construction. Real estate construction loans are monitored on a regular basis by either an independent third-party inspector or the assigned loan officer depending on loan amount or complexity of the project. This monitoring process includes at a minimum, the submission of invoices and American Institute of Architects (AIA) documents (depending on the complexity of the project) detailing costs incurred by the borrower, on-site inspections, and a signature by the assigned loan officer for disbursement of funds.

Commercial: This category includes commercial, industrial, farm, agricultural, and municipal loans. Commercial loans decreased $23.6 million to $257.7 million at September 30, 2021, compared to $281.3 million at the end of 2020, primarily due to PPP forgiveness. At September 30, 2021, the Bank had approximately $150 million in tax-free loans in the commercial portfolio. The largest sectors (by industry) in the commercial category are: public administration ($60.4 million), utilities ($52.7 million), real estate rental and leasing ($14.4 million), educational services ($12.9 million) and transportation and warehousing ($10.2 million). This category also includes $21.7 million of PPP loans that are 100% guaranteed by the SBA.

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Participations: The Bank may supplement its own commercial loan production by purchasing loan participations. These participations are primarily located in south-central Pennsylvania. At September 30, 2021, the outstanding commercial participations accounted for 6.9%, or $69.9 million, of total gross loans compared to 6.8% and $68.7 million at December 31, 2020. The Bank’s total exposure (including outstanding balances and unfunded commitments) to purchased participations is $81.7 million, compared to $84.0 million at December 31, 2020. The commercial loan participations are comprised of $16.4 million of Commercial loans and $53.5 million of CRE loans, reported in the respective loan class.

Consumer loans: This category increased by $1.2 million to $6.8 million at September 30, 2021, compared to $5.6 million at prior year-end and is mainly comprised of unsecured personal lines of credit.

The following table presents a summary of loans outstanding, by class as of:

September 30, December 31, Change
(Dollars in thousands) 2021 2020 Amount %
Residential Real Estate 1-4 Family
Consumer first liens $ 75,649 $ 77,373 $ (1,724) (2.2)
Commercial first lien 58,630 59,851 (1,221) (2.0)
Total first liens 134,279 137,224 (2,945) (2.1)
Consumer junior liens and lines of credit 65,279 60,935 4,344 7.1
Commercial junior liens and lines of credit 4,943 4,425 518 11.7
Total junior liens and lines of credit 70,222 65,360 4,862 7.4
Total residential real estate 1-4 family 204,501 202,584 1,917 0.9
Residential real estate - construction
Consumer 8,195 6,751 1,444 21.4
Commercial 13,883 9,558 4,325 45.3
Total residential real estate construction 22,078 16,309 5,769 35.4
Commercial real estate 527,092 503,977 23,115 4.6
Commercial 257,693 281,257 (23,564) (8.4)
Total commercial 784,785 785,234 (449) (0.1)
Consumer 6,804 5,577 1,227 22.0
1,018,168 1,009,704 8,464 0.8
Less: Allowance for loan losses (15,366) (16,789) 1,423 (8.5)
Net Loans $ 1,002,802 $ 992,915 $ 9,887 1.0
Paycheck Protection Program (PPP) loans (included in Commercial loans above)
--- --- --- --- --- --- --- ---
Two-year loans $ 31 $ 5,378
Five-year loans 21,711 46,912
Total Paycheck Protection Program loans $ 21,742 $ 52,290 $ (30,548) (58.4)

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Loan Quality:

Management utilizes a risk rating scale ranging from 1-Prime to 9-Loss to evaluate loan quality. This risk rating scale is used primarily for commercial purpose loans. Consumer purpose loans are identified as either a pass or substandard rating based on the performance status of the loans. Substandard consumer loans are loans that are 90 days or more past due and still accruing. Loans rated 1 – 4 are considered Pass credits. Loans rated 5 are Pass credits but have been identified as credits that are likely to warrant additional attention and monitoring. Loans rated 6-Other Asset Especially Mentioned (OAEM) or worse begin to receive enhanced monitoring and reporting by the Bank. Loans rated 7-Substandard or 8-Doubtful exhibit the greatest financial weakness and present the greatest possible risk of loss to the Bank. Nonaccrual loans are rated no better than 7-Substandard. The following factors represent some of the factors used in determining the risk rating of a borrower: cash flow, debt coverage, liquidity, management, and collateral. Risk ratings, for pass credits, are generally reviewed annually for term debt and at renewal for revolving or renewing debt. The Bank monitors loan quality by reviewing three primary measurements: (1) loans rated 6-OAEM or worse (collectively “watch list”), (2) delinquent loans, and (3) net-charge-offs.

Watch list loans exhibit financial weaknesses that increase the potential risk of default or loss to the Bank. However, inclusion on the watch list, does not by itself, mean a loss is certain. The watch list totaled $58.5 million at September 30, 2021 compared to $66.1 million at December 31, 2020. The improvement in the watch list loans occurred primarily in 6-OAEM rated commercial loans. The watch list includes both performing and nonperforming loans. Included in the watchlist total are $8.6 million of nonaccrual loans. The credit composition of the watch list (loans rated 6, 7, or 8), by primary collateral is shown in Note 6 of the accompanying financial statements.

Delinquent loans are a result of borrowers’ cash flow and/or alternative sources of cash being insufficient to repay loans. The Bank’s likelihood of collateral liquidation to repay the loans becomes more probable the further behind a borrower falls, particularly when loans reach 90 days or more past due. Management monitors the performance status of loans by the use of an aging report. The aging report can provide an early indicator of loans that may become severely delinquent and possibly result in a loss to the Bank. See Note 6 in the accompanying financial statements for a table that presents the aging of payments in the loan portfolio.

Nonaccruing loans generally represent Management’s determination that the borrower will be unable to repay the loan in accordance with its contractual terms and that collateral liquidation may or may not fully repay both interest and principal. It is the Bank’s policy to evaluate the probable collectability of principal and interest due under terms of loan contracts for all loans 90-days or more past due, nonaccrual loans, or impaired loans. Further, it is the Bank’s policy to discontinue accruing interest on loans that are not adequately secured and in the process of collection. Upon determination of nonaccrual status, the Bank subtracts any current year accrued and unpaid interest from its income, and any prior year accrued and unpaid interest from the allowance for loan losses. Management continually monitors the status of nonperforming loans, the value of any collateral and potential of risk of loss. Nonaccrual loans are rated no better than 7-Substandard.

The Bank’s Loan Management Committee reviews these loans and risk ratings on a quarterly basis in order to proactively identify and manage problem loans. In addition, a committee meets monthly to discuss possible workout strategies for all credits rated 7-Substandard or worse. Management also tracks other commercial loan risk measurements including high loan to value loans, concentrations, participations and policy exceptions and reports these to the Board Enterprise Risk Management Committee of the Board of Directors. The Bank also uses an external loan review consultant to assist with internal loan review with a goal of reviewing 80% of commercial loans each year. The FDIC defines certain supervisory loan-to-value lending limits. The Bank’s internal loan–to-value limits are all equal to or have a lower loan-to-value limit than the supervisory limits. However, in certain instances, the Bank may make a loan that exceeds the supervisory loan-to-value limit. At September, 2021, the Bank had loans of $20.6 million (2.0% of gross loans) that exceeded the supervisory limit, compared to 2.3% at year-end 2020. Potential problem loans, defined as watch list loans less loans on nonaccrual or past due more than 90 days totaled $49.9 million at September 30, 2021 compared to $53.2 million at December 31, 2020.

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Loan quality, as measured by nonperforming loans is nearly unchanged during the first nine months of 2021 with $8.7 million of nonperforming loans and a nonperforming loan ratio of .85%

The following table presents a summary of nonperforming assets as of:

September 30, December 31,
(Dollars in thousands) 2021 2020
Nonaccrual loans
Residential Real Estate 1-4 Family
First liens $ 41 $ 41
Junior liens and lines of credit 38 10
Total 79 51
Residential real estate - construction 426 512
Commercial real estate 8,027 8,033
Commercial 100 108
Total nonaccrual loans 8,632 8,704
Loans past due 90 days or more and still accruing
Residential Real Estate 1-4 Family
First liens — 26
Junior liens and lines of credit — —
Total — 26
Commercial real estate — —
Consumer 3 12
Total loans past due 90 days or more and still accruing 3 38
Total nonperforming loans 8,635 8,742
Other real estate owned — —
Total nonperforming assets $ 8,635 $ 8,742
Nonperforming loans to total gross loans 0.85% 0.87%
Nonperforming assets to total assets 0.50% 0.57%
Allowance for loan losses to nonperforming loans 177.95% 192.05%

The following table identifies the most significant loans in nonaccrual status. These two nonaccrual loans account for 80% of the total nonaccrual balance.

(Dollars in thousands)
ALL Nonaccrual TDR Collateral
Balance Reserve Date Status Collateral Location Value (1)
Credit 1 $ 1,203 $ — Mar-12 Y 1st and 2nd liens on commercial real estate, residential real estate and business assets PA $ 2,807
Credit 2 5,687 1,308 Sep-20 N 1st and 2nd liens on commercial real estate (hotel) and all related business assets PA $ 4,379
$ 6,890 $ 1,308
(1) Includes any estimated discount on appraised value and cost to sell.

In addition to monitoring nonaccrual loans, the Bank also closely monitors impaired loans and troubled debt restructurings (TDR). A loan is considered to be impaired when, based on current information and events, it is probable that the Bank will be unable to collect all interest and principal payments due according to the originally contracted terms of the loan agreement. Nonaccrual loans (excluding consumer purpose loans) and TDR loans are considered impaired.

A loan is considered a troubled debt restructuring if the creditor (the Bank), for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. These concessions may include lowering the rate, extending the maturity, re-amortization of the payment, or a combination of multiple concessions. The Bank reviews all loans rated 6-OAEM or worse when it is providing a loan restructure, modification or new credit facility to determine if the action is a TDR. If a TDR loan is placed on nonaccrual status, it remains on nonaccrual status for at least six months to ensure performance.

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In accordance with financial accounting standards, TDR loans are always considered impaired until they are paid off or in certain circumstances, refinanced. However, an impaired TDR loan can be a performing loan. Impaired loans totaled $6.3 million compared to $11.0 million at year-end 2020. TDR loans not performing in accordance with the modified terms were $1.3 million at quarter-end.

At September 30, 2021 the Bank had no loans modified under the March 22, 2020 Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus or Section 4013 of the CARES Act.

Paycheck Protection Program. In March 2020, Congress passed the CARES Act to provide economic relief to small businesses and consumers affect by the COVID-19 pandemic. Included in this Act was the Paycheck Protection Program (PPP) administered by the Small Business Administration (SBA). The PPP loans are 100 percent guaranteed by the SBA and have a maturity of two-years or five-years with a fixed interest rate of 1% for the life of the loan. Borrowers of PPP loans do not have to make payments on the loan during the SBA defined deferral period, and then the loans will fully amortize for the remainder of the two- or five-year terms. At September 30, 2021 the Bank held $21.7 million in PPP loans with a 5-year maturity.

The SBA paid originating banks a processing fee ranging from 1% to 5% of the loan, depending on the loan balance for PPP funding. The Bank recognizes these fees in interest income over the contractual life (two or five years) of the loan. As PPP loans are granted forgiveness by the SBA, fee recognition will accelerate. At September 30, 2021, the Bank had $821 thousand of PPP fees remaining to be recognized. The PPP loans are 100% guaranteed by the SBA, thereby presenting no credit risk to the Bank once the SBA guarantee is fulfilled, if necessary.

Allowance for Loan Losses:

Management monitors loan performance on a monthly basis and performs a quarterly evaluation of the adequacy of the allowance for loan losses. The ALL is determined by segmenting the loan portfolio based on the loan’s collateral. When calculating the ALL, consideration is given to a variety of factors in establishing this estimate including, but not limited to, current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, historical charge-offs, the adequacy of the underlying collateral (if collateral dependent) and other relevant factors. The Bank begins enhanced monitoring of all loans rated 6-OAEM, or worse, and obtains a new appraisal or asset valuation for any placed on nonaccrual and rated 7-Substandard or worse. Management, at its discretion, may determine that additional adjustments to the appraisal or valuation are required. Valuation adjustments will be made as necessary based on factors, including, but not limited to; the economy, deferred maintenance, industry, type of property/equipment, age of the appraisal, etc. and the knowledge Management has about a particular situation. In addition, the cost to sell or liquidate the collateral is also estimated and deducted from the valuation in order to determine the net realizable value to the Bank. When determining the allowance for loan losses, certain factors involved in the evaluation are inherently subjective and require material estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans. Management monitors the adequacy of the allowance for loan losses on an ongoing basis and reports its adequacy quarterly to the Board Enterprise Risk Management Committee of the Board of Directors. Management believes that the allowance for loan losses at September 30, 2021 is adequate.

The analysis for determining the ALL is consistent with guidance set forth in generally accepted accounting principles (GAAP) and the Interagency Policy Statement on the Allowance for Loan and Lease Losses. The analysis has three components; specific, general and unallocated. The specific component addresses specific reserves established for impaired loans. A loan is considered to be impaired when, based on current information and events, it is probable that the Bank will be unable to collect all interest and principal payments due according to the originally contracted terms of the loan agreement. Collateral values discounted for market conditions and selling costs are used to establish specific allocations for impaired loans. However, it is possible that as a result of the credit analysis, a specific reserve is not required for an impaired loan. Commercial loans with a balance less than $250 thousand, and all consumer purpose loans are not included in the specific reserve analysis as impaired loans but are added to the general allocation pool. These loans totaled $289 thousand and Management does not believe excluding these loans from the specific reserve analysis presents any additional risk. Loans that are evaluated for a specific reserve, but not needing a specific reserve are not added back to the general allocation pool. There was a $1.3 million specific reserve established for one impaired loan at September 30, 2021 compared to $228 thousand at year-end 2020 on the same loan.

The general allocation component addresses the reserves established for pools of homogenous loans. The general component includes a quantitative and qualitative analysis. When calculating the general allocation, the Bank segregates its loan portfolio into the following segments based primarily on the type of supporting collateral: residential real estate, commercial, industrial or agricultural real estate; commercial and industrial (C&I non-real estate), and consumer. Each segment may be further segregated by type of collateral, lien position, or owner/nonowner occupied properties. The quantitative analysis uses the Bank’s twenty quarter rolling historical loan loss experience as determined for each loan

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segment to determine a loss factor applicable to each loan segment. PPP loans, because of the SBA guarantee, are excluded from the quantitative analysis. The allowance established as a result of the quantitative analysis was $2.5 million compared to $3.6 million at year-end 2020. The decrease in the quantitative allowance was due primarily to a decrease in the twenty-quarter rolling historical loss rate used in the calculation.

The qualitative analysis utilizes a risk matrix that incorporates four primary risk factors: economic conditions, delinquency, classified loans, and level of risk, and assigns a risk score (as measured in basis points) to each factor. The economic condition factor is primarily based on unemployment rates. The delinquency factor considers the level of past due loans and charge-offs. The classified loan factor considers the internal credit risk score of the portfolio. The level of risk factor considers operational factors such as: loan volume, management, loan review process, credit concentrations, competition, and legal and regulatory issues. The risk score (as measured in basis points) for each of the four risk factors is minimal, low, moderate, high or very high and is determined independently for commercial loans, residential mortgage loans and consumer loans. The qualitative allowance declined to $11.0 million at September 30, 2021 from $12.1 million at year-end 2020. PPP loans, because of the SBA guarantee, were excluded from the qualitative analysis.

The unallocated component is maintained to cover uncertainties that could affect Management’s estimate of probable loss. The unallocated component of the ALL reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. The unallocated allowance was $551 thousand at September 30, 2021.

Real estate appraisals and collateral valuations are an important part of the Bank’s process for determining potential loss on collateral dependent loans and thereby have a direct effect on the determination of loan reserves, charge-offs and the calculation of the allowance for loan losses. As long as the loan remains a performing loan, no further updates to appraisals are required. If a loan or relationship migrates to nonaccrual and a risk rating of 7-Substandard or worse, an evaluation for impairment status is made based on the current information available at the time of downgrade and a new appraisal or collateral valuation is obtained. We believe this practice complies with the regulatory guidance.

In determining the allowance for loan losses, Management, at its discretion, may determine that additional adjustments to the fair value obtained from an appraisal or collateral valuation are required. Adjustments will be made as necessary based on factors, including, but not limited to the economy, deferred maintenance, industry, type of property or equipment etc., and the knowledge Management has about a particular situation. In addition, the cost to sell or liquidate the collateral is also estimated and deducted from the valuation in order to determine the net realizable value to the Bank. If an appraisal is not available, Management may make its best estimate of the real value of the collateral or use last known market value and apply appropriate discounts.  If an adjustment is made to the collateral valuation, this will be documented with appropriate support and reported to the Loan Management Committee.

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The following table shows, by loan segment, the activity in the ALL, the amount of allowance established in each category and the loans that were evaluated for the ALL under a specific reserve (individually) and those that were evaluated under a general reserve (collectively) as of September 30, 2021.

Residential Real Estate 1-4 Family
First Junior Liens & Commercial
(Dollars in thousands) Liens Lines of Credit Construction Real Estate Commercial Consumer Unallocated Total
ALL at June 30, 2021 $ 459 $ 220 $ 349 $ 7,878 $ 5,309 $ 102 $ 738 $ 15,055
Charge-offs — — — — (3) (126) — (129)
Recoveries — — — — 436 4 — 440
Provision 33 25 18 810 (856) 157 (187) —
ALL at September 30, 2021 $ 492 $ 245 $ 367 $ 8,688 $ 4,886 $ 137 $ 551 $ 15,366
ALL at December 31, 2020 $ 555 $ 226 $ 294 $ 9,163 $ 5,679 $ 97 $ 775 $ 16,789
Charge-offs — — (28) (13) (11) (162) — (214)
Recoveries — 170 — 1 497 23 — 691
Provision (63) (151) 101 (463) (1,279) 179 (224) (1,900)
ALL at September 30, 2021 $ 492 $ 245 $ 367 $ 8,688 $ 4,886 $ 137 $ 551 $ 15,366
ALL at June 30, 2020 $ 580 $ 197 $ 242 $ 8,837 $ 5,845 $ 105 $ 749 $ 16,555
Charge-offs - — — — — (28) — (28)
Recoveries - — — — 243 6 — 249
Provision (2) 14 17 372 (52) 11 15 375
ALL at September 30, 2020 $ 578 $ 211 $ 259 $ 9,209 $ 6,036 $ 94 $ 764 $ 17,151
ALL at December 31, 2019 $ 416 $ 119 $ 187 $ 6,607 $ 4,021 $ 84 $ 532 $ 11,966
Charge-offs - — — — (365) (87) — (452)
Recoveries 4 — — — 267 16 — 287
Provision 158 92 72 2,602 2,113 81 232 5,350
ALL at September 30, 2020 $ 578 $ 211 $ 259 $ 9,209 $ 6,036 $ 94 $ 764 $ 17,151
Residential Real Estate 1-4 Family
--- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- ---
First Junior Liens & Commercial
(Dollars in thousands) Liens Lines of Credit Construction Real Estate Commercial Consumer Unallocated Total
September 30, 2021
Loans evaluated for ALL:
Individually $ 659 $ — $ 426 $ 11,371 $ — $ — $ — $ 12,456
Collectively 133,620 70,222 21,652 515,721 257,693 6,804 — 1,005,712
Total $ 134,279 $ 70,222 $ 22,078 $ 527,092 $ 257,693 $ 6,804 $ — $ 1,018,168
ALL established for <br>‎  loans evaluated:
Individually $ — $ — $ — $ 1,308 $ — $ — $ — $ 1,308
Collectively 492 245 367 7,380 4,886 137 551 14,058
ALL at September 30, 2021 $ 492 $ 245 $ 367 $ 8,688 $ 4,886 $ 137 $ 551 $ 15,366
December 31, 2020
Loans evaluated for ALL:
Individually $ 637 $ — $ 512 $ 16,104 $ — $ — $ — $ 17,253
Collectively 136,587 65,360 15,797 487,873 281,257 5,577 — 992,451
Total $ 137,224 $ 65,360 $ 16,309 $ 503,977 $ 281,257 $ 5,577 $ — $ 1,009,704
ALL established for <br>‎  loans evaluated:
Individually $ — $ — $ — $ 228 $ — $ — $ — $ 228
Collectively 555 226 294 8,935 5,679 97 775 16,561
ALL at December 31, 2020 $ 555 $ 226 $ 294 $ 9,163 $ 5,679 $ 97 $ 775 $ 16,789

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The allocation of the allowance for loan losses is based on estimates and is not intended to imply limitations on the usage of the allowance. The entire allowance is available to absorb any losses without regard to the category in which the loan is classified.

The following table shows the ALL and charge-off ratios for the periods ended:

Nine Months Ended Year Ended Nine Months Ended
September 30, 2021 December 31, 2020 September 30, 2020
Net charge-offs (recoveries)/average loans* -0.06% -0.02% 0.02%
Allowance for loan losses as a % of loans 1.51% 1.66% 1.68%
Net (recoveries) charge-offs $ (477) $ (198) $ 165
* Annualized

Deposits:

Total deposits increased $189.7 million during the first nine months of 2021 to $1.544 billion. Noninterest-bearing deposits increased $52.7 million (primarily in small business and municipal deposits) and interest-bearing checking and savings deposits increased $142.7 million, while time deposits decreased $5.7 million. Interest-bearing checking increased by $79.5 million in retail and commercial deposits, while the Bank’s Money Management increased $56.6 million. Based on current information known to Management, the increases seem to stem from government stimulus payments to consumers, businesses and municipalities, lower spending as economic activity slowed during the pandemic and a sense of security offered by bank deposits in uncertain economic times. The decrease in time deposits is primarily in retail accounts.

As of September 30, 2021, the Bank had deposits of $244.3 million placed in the IntraFi Network deposit program ($178.8 million in interest-bearing checking and $65.5 million in money management) and $4.1 million in reciprocal time deposits in the CDARS program included in time deposits. These programs allow the Bank to offer full FDIC coverage to large depositors, but with the convenience to the customer of only having to deal with one bank. The Bank solicits these deposits from within its market and it believes they present no greater risk than any other local deposit. Only reciprocal deposits that exceed 20% of liabilities are considered brokered deposits. At September 30, 2021, the Bank’s reciprocal deposits were 16.0% of total liabilities compared to 12.9% at year-end 2020.

The following table presents a summary of deposits for the periods ended:

September 30, December 31, Change
(Dollars in thousands) 2021 2020 Amount %
Noninterest-bearing checking $ 311,770 $ 259,060 $ 52,710 20.3
Interest-bearing checking 488,634 409,178 79,456 19.4
Money management 557,661 501,017 56,644 11.3
Savings 115,786 109,153 6,633 6.1
Total interest-bearing checking and savings 1,162,081 1,019,348 142,733 14.0
Time deposits 70,444 76,165 (5,721) (7.5)
Total deposits $ 1,544,295 $ 1,354,573 $ 189,722 14.0
Overdrawn deposit accounts reclassified as loans $ 114 $ 86

Borrowings:

On August 4, 2020, the Corporation completed the sale of a subordinated debt note offering. The Corporation sold $15.0 million of subordinated debt notes with a maturity date of September 1, 2030. These notes are noncallable for 5 years and carry a fixed interest rate of 5% per year for 5 years and then convert to floating rate of SOFR plus 4.93% per year for the remainder of the term. The notes can be redeemed at par beginning 5 years prior to maturity. The Corporation also sold $5.0 million of subordinated debt notes with a maturity date of September 1, 2035. These notes are noncallable for 10 years and carry a fixed interest rate of 5.25% per year for 10 years and then convert to floating rate of SOFR plus 4.92% per year for the remainder of the term. The notes can be redeemed at par beginning 5 years prior to maturity. The notes are structured to qualify as Tier 2 capital for the Corporation and any funds it invests in the Bank qualify as Tier 1 capital at the Bank. The Corporation paid an issuance fee of 2% of the total issue that will be amortized to the call date of each issue on a pro-rata basis. The proceeds are intended to be used for general corporate purposes.

Shareholders’ Equity:

Total shareholders’ equity increased $7.7 million to $152.8 million from December 31, 2020, due primarily to an increase of $11.9 million in retained earnings during 2021 partially offset by a decrease of $5.4 million in accumulated

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other comprehensive income (AOCI) as the fair value of the investment portfolio declined during the year. The Corporation’s net earnings of $16.0 million were partially offset by cash dividends of $4.1 million. The Corporation’s Dividend Reinvestment Plan (DRIP) added $1.3 million in new capital from optional cash contributions and $721 thousand from the reinvestment of quarterly dividends. The Corporation’s dividend payout ratio was 25.72% for the first nine months of 2021.

As part of its quarterly dividend decision, the Corporation considers current and future income projections, dividend yield, payout ratio, and current and future capital ratios. For the third quarter of 2021, the Corporation paid a $0.32 per share dividend, compared to $0.31 paid in the second quarter of 2021. On October 15, 2021, the Board of Directors declared a $0.32 per share regular quarterly dividend for the fourth quarter of 2021, which will be paid on November 24, 2021.

On December 17, 2020, the Board of Directors authorized the 2020 Repurchase Plan for the repurchase of up to 150,000 shares of the Corporation’s $1.00 par value common stock at market prices in open market or privately negotiated transactions beginning December 18, 2020 and expiring on December 18, 2021. The Corporation repurchased 35,718 shares through September 30, 2021. The Corporation is monitoring the market and intends to repurchase shares when and if the opportunity arises in accordance with applicable law, regulations and plan authorizations.

Capital adequacy for the Bank is currently defined by regulatory agencies through the use of several minimum required ratios. The capital ratios to be considered “well capitalized” are: (1) Common Equity Tier 1 (CET1) of 6.5%, (2) Tier 1 Leverage of 5%, (3) Tier 1 Risk-Based Capital of 8%, and (4) Total Risk-Based Capital of 10%. In addition, a capital conservation buffer of 2.50% is applicable to all of the capital ratios except for the Tier 1 Leverage ratio. The capital conservation buffer is equal to the lowest value of the three applicable capital ratios less the regulatory minimum for each respective capital measurement. The Bank’s capital conservation buffer at September 30, 2021 was 8.23% compared to the regulatory buffer of 2.50%. Compliance with the capital conservation buffer is required in order to avoid limitations to certain capital distributions and is in addition to the minimum required capital requirements. As of March 31, 2021, the Bank was “well capitalized”.

In 2019, the Community Bank Leverage Ratio (CBLR) was approved by federal banking agencies as an optional capital measure available to Qualifying Community Banking Organizations (QCBO). If a bank qualifies as a QCBO and maintains a CBLR of 9% or greater, the bank would be considered “well-capitalized” for regulatory capital purposes and exempt from complying with the risk-based capital rule described above. The CBLR rule took effect January 1, 2020 and banks could opt-in through an election in the first quarter 2020 regulatory filing. The Bank met the criteria of a QCBO but did not opt-in to the CBLR.

The consolidated asset limit on small bank holding companies is $3 billion and a company with assets under that limit is not subject to the consolidated capital rules but may file reports that include capital amounts and ratios. The Corporation has elected to file those reports.

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The following table summarizes the regulatory capital requirements and results as of September 30, 2021 and December 31, 2020 for the Corporation and the Bank:

Regulatory Ratios
Adequately Well
September 30, December 31, Capitalized Capitalized
(Dollars in thousands) 2021 2020 Minimum Minimum
Common Equity Tier 1 Risk-based Capital Ratio (1)
Franklin Financial Services Corporation 14.91% 14.32% N/A N/A
Farmers & Merchants Trust Company 14.97% 14.07% 4.50% 6.50%
Tier 1 Risk-based Capital Ratio (2)
Franklin Financial Services Corporation 14.91% 14.32% N/A N/A
Farmers & Merchants Trust Company 14.97% 14.07% 6.00% 8.00%
Total Risk-based Capital Ratio (3)
Franklin Financial Services Corporation 18.16% 17.69% N/A N/A
Farmers & Merchants Trust Company 16.23% 15.33% 8.00% 10.00%
Tier 1 Leverage Ratio (4)
Franklin Financial Services Corporation 8.53% 8.69% N/A N/A
Farmers & Merchants Trust Company 8.57% 8.54% 4.00% 5.00%
(1) Common equity Tier 1 capital/ total risk-weighted assets (2) Tier 1 capital / total risk-weighted assets
(3) Total risk-based capital / total risk-weighted assets, (4) Tier 1 capital / average quarterly assets

Economy

The Corporation’s primary market area includes Franklin, Fulton, Cumberland and Huntingdon Counties, Pennsylvania. This area is diverse in demographic and economic makeup. County populations range from a low of approximately 15,000 in Fulton County to over 250,000 in Cumberland County. Unemployment in the Bank’s market area ranged from 5.2% in Cumberland County to 7.2% in Huntingdon County, as of the end of July. The market area has a diverse economic base and local industries include warehousing, truck & rail shipping centers, light and heavy manufacturers, healthcare, higher education institutions, farming and agriculture, and a varied service sector. The Corporation’s primary market area is located in South Central PA and provides easy access to the major metropolitan markets on the east coast via trucking and rail transportation. Because of this, warehousing and distribution companies continue to find the area attractive. The local economy is not overly dependent on any one industry or business and Management believes that the Bank’s primary market area continues to be well suited for growth.

Impact of Inflation

The impact of inflation upon financial institutions such as the Corporation differs from its effect upon other commercial enterprises. Unlike many companies, the assets and liabilities of the Corporation are financial in nature. As such, interest rates and changes in interest rates may have a more significant effect on the Corporation’s financial results than on other types of industries. Because of this, the Corporation watches the actions of the Federal Reserve Open Market Committee (FOMC) as it makes decisions about interest rate changes and how such changes affect market rates and the Corporation. Although inflation (and inflation expectations) may affect the interest rate environment, it is not possible to measure with any precision the effect of inflation on the Corporation.

Liquidity

The Corporation must meet the financial needs of the customers that it serves, while providing a satisfactory return on the shareholders’ investment. In order to accomplish this, the Corporation must maintain sufficient liquidity in order to respond quickly to the changing level of funds required for both loan and deposit activity. The goal of liquidity management is to meet the ongoing cash flow requirements of depositors who want to withdraw funds and of borrowers who request loan disbursements. The Bank regularly reviews it liquidity position by measuring its projected net cash flows (in and out) at a 30 and 90-day interval. The Bank stresses the measurements by assuming a level of deposit out-flows that have not historically been realized. In addition to this forecast, other funding sources are reviewed as a method to provide emergency funding if necessary. The objective of this measurement is to identify the amount of cash that could

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be raised quickly without the need to liquidate assets. The Bank also stresses its liquidity position utilizing different longer-term scenarios. The varying degrees of stress create pressure on deposit flows in its local market, reduce access to wholesale funding and limit access of funds available through brokered deposit channels. In addition to stressing cash flow, specific liquidity risk indicators are monitored to help identify risk areas. This analysis helps identify and quantify the potential cash surplus/deficit over a variety of time horizons to ensure the Bank has adequate funding resources. Assumptions used for liquidity stress testing are subjective. Should an evolving liquidity situation or business cycle present new data, potential assumption changes will be considered. The Bank believes it can meet all anticipated liquidity demands.

Historically, the Corporation has satisfied its liquidity needs from earnings, repayment of loans and amortizing investment securities, maturing investment securities, loan` sales, deposit growth and its ability to access existing lines of credit. All investment securities are classified as available for sale; therefore, securities that are unencumbered (approximately $395 million fair value) as collateral for borrowings are an additional source of readily available liquidity, either by selling the security or, more preferably, to provide collateral for additional borrowing. The Bank also has access to other wholesale funding via the brokered CD market.

The FHLB system has always been a major funding source for the Bank. There are no current indicators that lead the Bank to believe the FHLB would discontinue its lending function or restrict the Bank’s ability to borrow. If either of these events would occur, it would have a negative effect on the Bank, and it is unlikely that the Bank could replace the level of FHLB funding in a short time. The Bank has established credit at the Federal Reserve Discount Window and at correspondent banks.

The following table shows the Bank’s available liquidity at September 30, 2021.

(Dollars in thousands)
Liquidity Source Capacity Outstanding Available
Federal Home Loan Bank $ 351,422 $ — $ 351,422
Federal Reserve Bank Discount Window 26,423 — 26,423
Correspondent Banks 56,000 — 56,000
Total $ 433,845 $ — $ 433,845

Off Balance Sheet Commitments

The Corporation’s financial statements do not reflect various commitments that are made in the normal course of business, which may involve some liquidity risk. These commitments consist mainly of unfunded loans and letters of credit made under the same standards as on-balance sheet instruments. Because these instruments have fixed maturity dates, and because many of them will expire without being drawn upon, they do not generally present any significant liquidity risk to the Corporation. Unused commitments and standby letters of credit totaled $413.3 million and $380.3 million, respectively, at September 30, 2021 and December 31, 2020. In the second quarter of 2018, the Bank established a $2.4 million allowance against letters of credit issued in connection with a commercial borrower that declared bankruptcy. In the first quarter of 2020, the Bank reversed $250 thousand of this reserve as one letter of credit was cancelled. In the second quarter of 2021, the Bank reversed $636 thousand of this reserve as a second letter of credit was cancelled. At September 30, 2021, this reserve was $1.5 million.

The Corporation has entered into various contractual obligations to make future payments. These obligations include time deposits, long-term debt, operating leases, deferred compensation and pension payments. These amounts have not changed materially from those reported in the Corporation’s 2020 Annual Report on Form 10-K.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

There were no material changes in the Corporation’s exposure to market risk during the nine months ended September 30, 2021. For more information on market risk refer to the Corporation’s 2020 Annual Report on Form 10-K.

Item 4. Controls and Procedures

Evaluation of Controls and Procedures

The Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon the

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evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer concluded that as of September 30, 2021, the Corporation’s disclosure controls and procedures are effective. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in the Corporation’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. There were no changes in the Corporation’s internal control over financial reporting during the quarterly period ended September 30, 2021, that have materially affected, or are reasonably likely to materially affect, the internal control over financial reporting.

The management of the Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. The Corporation’s internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

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Part II – OTHER INFORMATION

Item 1. Legal Proceedings

The nature of the Corporation’s business generates a certain amount of litigation in the ordinary course of business.

In management’s opinion, there are no other proceedings pending to which the Corporation is a party or to which its property is subject which, if determined adversely to the Corporation, would be material. No material proceedings are pending or are known to be threatened or contemplated against us by any governmental authorities.

Item 1A. Risk Factors

There were no material changes in the Corporation’s risk factors during the three and nine months ended September 30, 2021. For more information, refer to the Corporation’s 2020 Annual Report on Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On December 17, 2020, the Board of Directors authorized the 2020 Repurchase Plan for the repurchase of up to 150,000 shares of the Corporation’s $1.00 par value common stock at market prices in open market or privately negotiated transactions beginning December 18, 2020 and expiring on December 17, 2021. The following table presents the activity under this plan during the third quarter of 2021.

(Dollars in thousands, except per share)
Period Number of<br>‎Shares Purchased as Part of Publicly Announced Program Weighted<br>‎Average<br>‎Price Paid<br>‎per Share Dollar Amount of<br>‎Shares Purchased<br>‎as Part of Publicly<br>‎Announced Program ‎Shares Yet<br>‎To Be Purchased<br>‎Under Program
July 2021 10,049 32.01 $ 321,716 116,796
August 2021 345 31.84 10,985 116,451
September 2021 1,695 31.83 53,947 114,756
12,089 $ 386,648

Item 3. Defaults by the Company on its Senior Securities

None

Item 4. Mine Safety Disclosures

Not Applicable

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Item 5. Other Information

None

Item 6.   Exhibits

Exhibits

3.1 Amended and Restated Articles of Incorporation of the Corporation (Filed as Exhibit 3.1 to Quarterly Report on Form 10-Q for the quarter ended June 30, 2020 and incorporated herein by reference).
3.2 Bylaws of the Corporation. (Filed on Form 8-K, as Exhibit 99 with the commission on July 9, 2021 and incorporated herein by reference.)
31.1 Rule 13a – 14(a)/15d-14(a) Certifications – Principal Executive Officer
31.2 Rule 13a – 14(a)/15d-14(a) Certifications – Principal Financial Officer
32.1 Section 1350 Certifications – Principal Executive Officer
32.2 Section 1350 Certifications – Principal Financial Officer
101 Interactive Data File (XBRL)
104 Cover Page Interactive Data File (the cover page XBRL tags are imbedded in the XBRL document)

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FRANKLIN FINANCIAL SERVICES CORPORATION

and SUBSIDIARIES

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Franklin Financial Services Corporation

November 8, 2021 /s/ Timothy G. Henry
Timothy G. Henry
Chief Executive Office and President
(Principal Executive Officer)
November 8, 2021 /s/ Mark R. Hollar
Mark R. Hollar
Treasurer and Chief Financial Officer
(Principal Financial and Accounting Officer) 
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		Exhibit 311

Exhibit 31.1

Rule 13a-14(a)/15d-14(a) Certifications



I, Timothy G.  Henry, certify that: | 1. | I have reviewed this quarterly report on Form 10-Q of Franklin Financial Services Corporation; | | --- | --- |  | 2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; | | --- | --- |  | 3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; | | --- | --- |  | 4. | The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: | | --- | --- |  | a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; | | --- | --- |  | b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; | | --- | --- |  | c) | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and | | --- | --- | | d) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting and | | --- | --- |  | 5. | The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors: | | --- | --- | 

a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and



b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.





Date:  November 8, 2021



/s/ Timothy G.  Henry

Timothy G.  Henry

President and Chief Executive Officer

		Exhibit 312

Exhibit 31.2

Rule 13a-14(a)/15d-14(a) Certifications



I, Mark R. Hollar, certify that:

 | 1. | I have reviewed this quarterly report on Form 10-Q of Franklin Financial Services Corporation; | | --- | --- |  | 2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; | | --- | --- |  | 3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this  report; | | --- | --- |  | 4. | The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: | | --- | --- |  | a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; | | --- | --- |  | b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; | | --- | --- |  | c) | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and | | --- | --- | | d) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting and | | --- | --- |  | 5. | The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors: | | --- | --- | 

a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and



b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.





Date:  November 8, 2021



/s/ Mark R. Hollar

Mark R. Hollar

Treasurer and Chief Financial Officer



		Exhibit 321

Exhibit 32.1

Certification Pursuant to 18 U.S.C. Section 1350,

As Adopted Pursuant to Section 906 of the Sarbanes–Oxley Act of 2002



In connection with the Quarterly Report of Franklin Financial Services Corporation (the “Corporation”) on Form 10-Q, for the period ending September  30, 2021, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Timothy G.  Henry, Chief Executive Officer of the Corporation, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes–Oxley Act of 2002 that: | (1) | The report fully complies with the requirements of Section 13(a) or 15(d) of the Securities and Exchange Act of 1934; and | | --- | --- | | (2) | The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. | | --- | --- | 

/s/ Timothy G.  Henry

Timothy G.  Henry

President and Chief Executive Officer

November 8, 2021



		Exhibit 322

Exhibit 32.2

Certification Pursuant to 18 U.S.C. Sections 1350,

As Adopted Pursuant to Section 906 of the Sarbanes–Oxley Act of 2002



In connection with the Quarterly Report of Franklin Financial Services Corporation (the “Corporation”) on Form 10-Q for the period ending September  30, 2021 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Mark R. Hollar, Chief Financial Officer of the Corporation, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes–Oxley Act of 2002 that: | (1) | The report fully complies with the requirements of Section 13(a) or 15(d) of the Securities and Exchange Act of 1934; and | | --- | --- | | (2) | The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. | | --- | --- | 

/s/ Mark R. Hollar

Mark R. Hollar

Chief Financial Officer

November 8, 2021



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