FRAF 10-Q Quarter ended March 31, 2017



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)



Part I - FINANCIAL INFORMATION



 Item 1

Financial Statements



Consolidated Balance Sheets as of March 3 1 , 201 7 and December 31, 201 6 (unaudited)

1



Consolidated Statements of Income for the Three Months ended March 3 1 , 201 7

2



and 201 6 (unaudited)



Consolidated Statements of Comprehensive Income for the Three M onths ended

3



March 3 1 , 201 7 and 201 6 (unaudited)



Consolidated Statements of Changes in Shareholders’ Equity for the Three Months

3



ended March 3 1 , 201 7 and 201 6 (unaudited)



Consolidated Statements of Cash Flows for the Three Months ended March 3 1 , 201 7

4



and 201 6 (unaudited)



Notes to Consolidated Financial Statements (unaudited)

5



 Item 2

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

26

 Item 3

Quantitative and Qualitative Disclosures about Market Risk

44

 Item 4

Controls and Procedures

44



Part II - OTHER INFORMATION



 Item 1

Legal Proceedings

45

 Item 1A

Risk Factors

45

 Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

45

 Item 3

Defaults Upon Senior Securities

45

 Item 4

Mine Safety Disclosures

45

 Item 5

Other Information

45

 Item 6

Exhibits

46

 SIGNATURE PAGE

47

EXHIBITS





(Dollars in thousands, except share and per share data)(unaudited)

March 31

December 31



2017

2016

Assets

Cash and due from banks

$

$

Interest-bearing deposits in other banks

Total cash and cash equivalents

Investment securities available for sale, at fair value

Restricted stock

Loans held for sale

Loans

Allowance for loan losses

Net Loans

Premises and equipment, net

Bank owned life insurance

Goodwill

Other real estate owned

Deferred tax asset, net

Other assets

Total assets

$

$



Liabilities

Deposits

Noninterest-bearing checking

$

$

Money management, savings and interest checking

Time

Total Deposits

Short-term borrowings

-

Other liabilities

Total liabilities



Shareholders' equity

Common stock, $1 par value per share, 15,000,000 shares authorized with

4,688,349 shares issued and 4,325,425 shares outstanding at March 31, 2017 and

4,688,349 shares issued and 4,316,836 shares outstanding at December 31, 2016

Capital stock without par value, 5,000,000 shares authorized with no

shares issued and outstanding

-

-

Additional paid-in capital

Retained earnings

Accumulated other comprehensive loss

Treasury stock, 362,924 shares at March 31, 2017 and 371,513 shares at

December 31, 2016, at cost

Total shareholders' equity

Total liabilities and shareholders' equity

$

$



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





For the Three Months Ended

(Dollars in thousands, except per share data) (unaudited)

March 31



2017

2016

Interest income

Loans, including fees

$

$

Interest and dividends on investments:

Taxable interest

Tax exempt interest

Dividend income

Deposits and obligations of other banks

Total interest income



Interest expense

Deposits

Short-term borrowings

Total interest expense

Net interest income

Provision for loan losses

Net interest income after provision for loan losses



Noninterest income

Investment and trust services fees

Loan service charges

Deposit service charges and fees

Other service charges and fees

Debit card income

Increase in cash surrender value of life insurance

Net (loss) gain on sale of other real estate owned

-

OTTI losses on debt securities

-

Securities gains, net

Other

Total noninterest income



Noninterest expense

Salaries and employee benefits

Occupancy, net

Furniture and equipment

Advertising

Legal and professional

Data processing

Pennsylvania bank shares tax

FDIC insurance

ATM/debit card processing

Foreclosed real estate

Telecommunications

Other

Total noninterest expense

Income before federal income tax expense

Federal income tax expense

Net income

$

$



Per share

Basic earnings per share

$

$

Diluted earnings per share

$

$

Cash dividends declared

$

$





For the Three Months Ended



March 31

(Dollars in thousands) (unaudited)

2017

2016

Net Income

$

$



Securities:

Unrealized gains arising during the period

Reclassification adjustment for net (gains) losses and OTTI included in net income (1)

Net unrealized gains

Tax effect

Net of tax amount



Total other comprehensive income



Total Comprehensive Income

$

$





Reclassification adjustment / Statement line item

Tax  expense (benefit)

(1) Securities / securities (gains) losses and OTTI losses, net

$

$

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







Accumulated



Additional

Other



Common

Paid-in

Retained

Comprehensive

Treasury

(Dollars in thousands, except per share data) (unaudited)

Stock

Capital

Earnings

Loss

Stock

Total

Balance at December 31, 2015

$

$

$

$

$

$

Net income

-

-

-

-

Other comprehensive income

-

-

-

-

Cash dividends declared, $0.19 per share

-

-

-

-

Treasury shares issued under stock option plans, 183 shares

-

-

-

Common stock issued under dividend reinvestment plan, 14,158 shares

-

-

-

Stock option compensation expense

-

-

-

-

Balance at March 31, 2016

$

$

$

$

$

$



Balance at December 31, 2016

$

$

$

$

$

$

Net income

-

-

-

-

Other comprehensive income

-

-

-

-

Cash dividends declared, $.21 per share

-

-

-

-

Treasury shares issued under employee stock purchase plan, 1,126 shares

-

-

-

Treasury shares issued under dividend reinvestment plan, 7,463 shares

-

-

-

Stock option compensation expense

-

-

-

-

Balance at March 31, 2017

$

$

$

$

$

$



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







Three Months Ended March 31



2017

2016

(Dollars in thousands) (unaudited)

Cash flows from operating activities

Net income

$

$

Adjustments to reconcile net income to net cash provided by operating activities:

Depreciation and amortization

Net amortization of loans and investment securities

Amortization and net change in mortgage servicing rights valuation

Provision for loan losses

Gain on sales of securities

Impairment write-down on securities recognized in earnings

-

Loans originated for sale

Proceeds from sale of loans

Write-down of other real estate owned

-

Write-down on premises and equipment

Net loss (gain) on sale or disposal of other real estate/other repossessed assets

-

Increase in cash surrender value of life insurance

Stock option compensation

Decrease in other assets

Increase (decrease) in other liabilities

Net cash provided by operating activities



Cash flows from investing activities

Proceeds from sales and calls of investment securities available for sale

Proceeds from maturities and pay-downs of securities available for sale

Purchase of investment securities available for sale

-

Net decrease in restricted stock

Net increase in loans

Capital expenditures

Proceeds from surrender of life insurance policy

-

Proceeds from sale of other real estate

Net cash provided by (used in) investing activities



Cash flows from financing activities

Net increase in demand deposits, interest-bearing checking, and savings accounts

Net decrease in time deposits

Net decrease in short-term borrowings

-

Dividends paid

Treasury shares issued under employee stock purchase plan

Treasury shares issued under dividend reinvestment plan

Net cash (used) provided by financing activities



Increase in cash and cash equivalents

Cash and cash equivalents as of January 1

Cash and cash equivalents as of March 31

$

$



Supplemental Disclosures of Cash Flow Information

Cash paid during the year for:

Interest on deposits and other borrowed funds

$

$

Income taxes

$

$



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





For the Three Months Ended



March 31

(Dollars and shares in thousands, except per share data)

2017

2016

Weighted average shares outstanding (basic)

Impact of common stock equivalents

Weighted average shares outstanding (diluted)

Anti-dilutive options excluded from calculation

Net income

$

$

Basic earnings per share

$

$

Diluted earnings per share

$

$



Standard

Description

Effective Date

Effect on the financial statements or other significant matters



ASU 2016-15, Statements of Cash Flow (Topic 320): Classification of Certain Cash Receipts and Cash Payments

The standard clarifies how certain cash receipts and cash payments are presented and classified in the statement of cash flows.  The amendments are intended to reduce diversity in practice.  The standard contains additional guidance clarifying when an entity should separate cash receipts and cash payments and classify them into more than one class of cash flows (including when reasonable judgement is required to estimate and allocate cash flows) versus when an entity should classify the aggregate amount into one class of cash flows on the basis of predominance.

January 1, 2018

We do not expect this guidance will have an effect on the Corporation's consolidated financial statements.



ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments

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 (“gross up approach”) to determine the initial amortized cost basis.  The subsequent account for PCD financial assets is the same expected loss model described above.

January 1, 2020

We have formed an implementation team led by Risk Management that also includes other lines of business and functions within the Corporation.  The team is working on developing models that can meet the requirements of the new guidance. The Corporation believes 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.



ASU 2014-09, Revenue from Contracts with Customers (Topic 606)

The amendments in this Update (ASU 2014-09) establish a comprehensive revenue recognition standard. The revenue standard’s core principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. To accomplish this objective, the standard requires five basic steps: (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. Three basic transition methods are available – full retrospective, retrospective with certain practical expedients, and a cumulative effect approach.

January 1, 2018

The majority of our revenue comes from net interest income, and is explicitly out of scope of the guidance.  The contracts in noninterest income that are in scope of the guidance are primarily related to service charges and fees on deposit accounts, investment and trust income and other service charges and fees.  We are analyzing the contracts in scope to determine if our current accounting will change.



ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities

The standard amends the guidance on the classification and measurement of financial instruments.  Some of the amendments include the following: 1) requires equity investments to be measured at fair value with changes in fair value recognized in net income; 2) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; 3) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; and 4) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value; among others.

January 1, 2018

We do not expect this guidance will have a material effect on the Corporation's consolidated financial statements.  We do not have a significant number of AFS equity securities.  Additionally we do not have financial liabilities accounted for under the fair value option.  The adoption of this guidance is not expected to be material.



ASU 2016-02, Leases (Topic 842)

From the lessee’s perspective, the new standard established a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months.  Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for a lessees.  From the lessor’s perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating.  A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee.  If risks and rewards are conveyed without the transfer of control, the lease is treated as financing.  If the lessor doesn’t convey risks and rewards or control, an operating lease results.

January 1, 2019

The Corporation currently has real estate and equipment leases that it classifies as operating leases that are not recognized on the balance sheet.  Under the new standard, these leases will move onto the balance sheet.  The Corporation is currently gathering data and reviewing methods of implementing the standard, but due to the number of lease agreements in effect, the Corporation believes the new standard will not have a material effect on its consolidated financial statements.



ASU 2017-04, Goodwill (Topic 350)

This guidance, amon g other things, removes step 2 of the goodwill impairment test thus eliminating the need to determine the fair value of individual assets and liabilities of the reporting unit.  Upon adoption of this standard, goodwill impairment will be the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of goodwill.  This may result in more or less impairment being recognized than under the current guidance.

January 1, 2020

We do not currently expect this guidance to have a material effect on the Corporation's consolidated financial statements based upon the most recent goodwill impairment analysis.



ASU 2016-09, Stock Compensation (Topic 718): Improvements to Employee Share-based Payment Accounting

The standard requires entities to recognize the income tax effects of share-based awards in the income statement when the awards vest or are settled (i.e. the additional paid-in capital pools will be eliminated).  The guidance on employers' accounting for an employee's use of shares to satisfy the employer's statutory income tax withholding obligation and for forfeitures is changing.  The standard also provides an entity the option to make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures when they occur.

January 1, 2017

We adopted the standard during the first quarter of 2017.  Due to the type of stock compensation plans used by the Corporation, there was no effect on the Corporation's consolidated financial statements.



ASU 2017-09, Premium Amortization on Purchased Callable Debt Securities

The standard shortens the amortization period for premiums on purchased callable debt securities to the earliest call date, rather than amortizing over the full contractual term.  The standard does change the standard for securities held at a discount.  The amendments require companies to reset the effective yield using the payment terms of the debt security if the call option is not exercised on the earliest call date.  If the security has additional future called dates, any excess of the amortized cost basis over the amount repayable by the issuer at the next call date should be amortized to the next call date.

January 1, 2017

We adopted the standard during the first quarter of 2017, and there was no effect on the Corporation's consolidated financial statements.



ASU 2017-07, Employee Benefits Plan (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost

This standard requires an employer to report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period.  The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations.  The amendments in this update also allow only the service cost component to be eligible for capitalization when applicable.

January 1, 2018

We do not expect this standard will have an effect on the Corporation's consolidated financial statements.







March 31

December 31



2017

2016

(Dollars in thousands)

Net unrealized gains (losses) on securities

$

$

Tax effect

Net of tax amount



Accumulated pension adjustment

Tax effect

Net of tax amount



Total accumulated other comprehensive loss

$

$





(Dollars in thousands)

Gross

Gross



Amortized

unrealized

unrealized

Fair

March 31, 2017

cost

gains

losses

value

Equity securities

$

$

$

-

$

U.S. Government and Agency securities

Municipal securities

Trust preferred securities

-

Agency mortgage-backed securities

Private-label mortgage-backed securities

Asset-backed securities

-



$

$

$

$





(Dollars in thousands)

Gross

Gross



Amortized

unrealized

unrealized

Fair

December 31, 2016

cost

gains

losses

value

Equity securities

$

$

$

-

$

U.S. Government and Agency securities

Municipal securities

Trust preferred securities

-

Agency mortgage-backed securities

Private-label mortgage-backed securities

Asset-backed securities

-



$

$

$

$









(Dollars in thousands)

Amortized cost

Fair value

Due in one year or less

$

$

Due after one year through five years

Due after five years through ten years

Due after ten years



Mortgage-backed securities



$

$





For the Three Months Ended



March 31

(Dollars in thousands)

2017

2016

Gross gains realized

$

$

Gross losses realized

-

-

Conversion gain

-

-

Net gains realized

$

$



(Dollars in thousands)

Deal Name

Maturity

Single Issuer or Pooled

Class

Amortized Cost

Fair Value

Gross Unrealized Gain (Loss)

Lowest Credit Rating Assigned



BankAmerica Cap III

1/15/2027

Single

Preferred Stock

$

$

$

BB+

Wachovia Cap Trust II

1/15/2027

Single

Preferred Stock

BBB

Huntington Cap Trust

2/1/2027

Single

Preferred Stock

BB

Corestates Captl Tr II

2/15/2027

Single

Preferred Stock

BBB+

Huntington Cap Trust II

6/15/2028

Single

Preferred Stock

BB

Chase Cap VI JPM

8/1/2028

Single

Preferred Stock

BBB-

Fleet Cap Tr V

12/18/2028

Single

Preferred Stock

BB+



$

$

$





(Dollars in thousands)

Gross

Cumulative



Origination

Amortized

Fair

Unrealized

Collateral

Lowest Credit

Credit

OTTI

Description

Date

Cost

Value

Gain (Loss)

Type

Rating Assigned

Support %

Charges

MALT 2004-6 7A1

6/1/2004

$

$

$

ALT A

CCC

$

-

RALI 2005-QS2 A1

2/1/2005

ALT A

CC

RALI 2006-QS4 A2

4/1/2006

ALT A

D

-

GSR 2006-5F 2A1

5/1/2006

Prime

D

-

RALI 2006-QS8 A1

7/28/2006

ALT A

D

-



$

$

$

$







March 31, 2017



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 securities

$

$

$

$