ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The purpose of Management’s Discussion and Analysis of First Keystone Corporation, a bank holding company (the “Corporation”), and its wholly owned subsidiary, First Keystone Community Bank (the “Bank”), is to assist the reader in reviewing the financial information presented and should be read in conjunction with the consolidated financial statements and other financial data contained herein. Refer to Forward-Looking Statements on page 1 for detailed information.
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RESULTS OF OPERATIONS
Year Ended December 31, 2025 Versus Year Ended December 31, 2024
Net income increased to $6,152,000 for the year ended December 31, 2025, as compared to a net loss of $13,203,000 for the prior year, an increase of $19,355,000. The net loss in 2024 was primarily due to the Corporation recognizing a full goodwill impairment charge of $19,133,000 during the first quarter of 2024. Earnings per share, both basic and diluted, for 2025 was $0.99 as compared to $(2.14) in 2024. Dividends per share for 2025 and 2024 were $1.12. The Corporation’s return on average assets was 0.41% in 2025 and (0.93)% in 2024. Return on average equity increased to 5.60% in 2025 from (12.04)% in 2024. Total interest income in 2025 amounted to $77,199,000, an increase of $5,777,000 or 8.09% from 2024. The increase in interest income is due to increased interest and fees on loans related to growth in real estate loans. Total interest expense of $39,548,000 increased $405,000 or 1.03% from 2024. The majority of this increase is related to increases in interest paid to depositors to retain and grow deposit relationships offset by a decrease in expenses related to short-term borrowings mainly due to lower average balances of short-term borrowings held in 2025 versus 2024.
Selected financial data and performance ratios of the Corporation for the past five years are presented below in Table 1.
Table 1 — Selected Financial Data
(Dollars in thousands, except per share data)
For the Year Ended December 31,
SELECTED FINANCIAL DATA AT YEAR END:
Total assets
Total securities
Net loans
Total deposits
Total long-term borrowings
Total stockholders’ equity
SELECTED OPERATING DATA:
Interest income
Interest expense
Net interest income
Provision (credit) for credit losses
Net interest income after provision (credit) for credit losses
Non-interest income
Non-interest expense
Income before income tax expense
Income tax expense
Net income (loss)
PER SHARE DATA:
Net income (loss)
Dividends
PERFORMANCE RATIOS:
Return on average assets
Return on average equity
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Dividend payout
Average equity to average assets
Net interest income, as indicated below in Table 2, increased by $5,372,000 or 16.6% to $37,651,000 for the year ended December 31, 2025. The Corporation’s net interest income on a fully tax equivalent basis increased by $5,391,000, or 16.7% to $37,689,000 in 2025 as compared to $32,298,000 in 2024.
Table 2 — Reconciliation of Taxable Equivalent Net Interest Income
(Dollars in thousands)
Increase/(Decrease)
Amount
Interest Income
Interest Expense
Net Interest Income
Tax Equivalent Adjustment
Net Interest Income (fully tax equivalent)
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Table 3 — Average Balances, Rates and Interest Income and Expense
(Dollars in thousands)
Average
Yield/
Average
Yield/
Balance
Interest
Rate
Balance
Interest
Rate
Interest Earning Assets:
Loans:
Commercial, net 1,2,4
Real Estate 1,2
Consumer, net 4
Fees on Loans and fair value adjustment
Total Loans 5
Securities:
Taxable
Tax-Exempt 1,3
Total Securities
Restricted Investment in Bank Stocks
Interest-Bearing Deposits in Other Banks
Total Other Interest Earning Assets
Total Interest Earning Assets
Non-Interest Earning Assets:
Cash and Due From Banks
Allowance for Credit Losses
Premises and Equipment
Other Assets
Total Non-Interest Earning Assets
Total Assets
Interest Bearing Liabilities:
Savings, NOW, Money Markets and Interest Checking
Time Deposits
Securities Sold U/A to Repurchase
Short-Term Borrowings
Long-Term Borrowings
Subordinated Debentures
Total Interest Bearing Liabilities
Non-Interest Bearing Liabilities:
Demand Deposits
Other Liabilities
Stockholders’ Equity
Total Liabilities/Stockholders’ Equity
Net Interest Income Tax Equivalent
Net Interest Spread
Net Interest Margin
1 Tax-exempt income has been adjusted to a tax equivalent basis using an incremental rate of 21% and statutory interest expense disallowance.
2 Includes tax equivalent adjustments on tax-free municipal loans of $12,000 and $5,000 for years 2025 and 2024, respectively.
3 Includes tax equivalent adjustments on tax-free municipal securities of $26,000 and $13,000 for years 2025 and 2024, respectively.
4 Installment loans are stated net of unearned interest.
5 Average loan balances include non-accrual loans. Interest income on non-accrual loans is not included.
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NET INTEREST INCOME
The major source of operating income for the Corporation is net interest income. Net interest income is the difference between interest income on earning assets, such as loans and securities, and the interest expense on liabilities used to fund those assets, including deposits and other borrowings. The amount of interest income is dependent upon both the volume of earning assets and the level of interest rates. In addition, the volume of non-performing loans affects interest income. The amount of interest expense varies with the amount of funds needed to support earning assets, interest rates paid on deposits and borrowed funds, and finally, the level of non-interest bearing deposits.
Table 3 on the preceding page provides a summary of average outstanding balances of earning assets and interest bearing liabilities with the associated interest income and interest expense as well as average tax equivalent rates earned and paid as of year-end 2025 and 2024.
The yield on earning assets was 5.45% in 2025 and 5.30% in 2024. The rate paid on interest bearing liabilities was 3.42% in 2025 and 3.56% in 2024. This resulted in an increase in our net interest spread to 2.04% in 2025, as compared to 1.74% in 2024.
As Table 3 illustrates, net interest margin, which is interest income less interest expense divided by average earning assets, was 2.66% in 2025 as compared to 2.40% in 2024. Net interest margins are presented on a tax-equivalent basis. In 2025, the yield on earning assets increased by 0.15% and the rate paid on interest bearing liabilities decreased by 0.14%. The yield on loans increased from 5.55% in 2024 to 5.98% in 2025 mainly due to loans originating and repricing at higher interest rates during the latter part of 2024 and 2025. The securities portfolio yield decreased to 4.30% in 2025 as compared to 4.65% in 2024. The decrease was mainly the result of reduced yield on taxable securities which declined from 4.91% in 2024 to 4.51% in 2025 due to maturities and calls of securities that were reinvested at lower rates. The average rate paid on short-term borrowings decreased 0.24% from 4.96% in 2024 to 4.72% in 2025. The rate paid on savings, NOW, money market, and interest checking accounts decreased 0.35% from 2.41% to 2.06% and the average rate paid on time deposits decreased 0.13% from 4.22% to 4.09%. Interest income exempt from federal tax was $1,354,000 in 2025 and $1,352,000 in 2024. Tax-exempt income has been adjusted to a tax-equivalent basis using an incremental rate of 21%.
The increase in net interest margin at December 31, 2025 compared to December 31, 2024 was primarily due to increased yields on loans and decreased yields related to deposits and short-term borrowings in 2025, as compared to 2024. Fully tax equivalent net interest income increased by $5,391,000 or 16.7% to $37,689,000 at December 31, 2025 compared to $32,298,000 at December 31, 2024. During 2025, the Federal Reserve decreased the federal-funds rate by 0.75%, resulting in a target range of 3.50% - 3.75%. The Corporation could experience a decrease in net interest income if market rates remain static or increase, as the Corporation’s net interest income continues to be liability sensitive. To negate the potential impact of a decreasing net interest margin, the Corporation will continue to focus on attracting organic loan growth and core deposits such as checking, savings, and money market accounts, thereby further reducing its dependence on higher priced certificates of deposit and short-term borrowings. The Corporation is actively monitoring and restructuring its portfolios to become more asset sensitive, which will allow for better performance in a static or rates-up environment. As of December 31, 2025 the Corporation had a total of five fair value interest rate swaps, four with a combined notional amount of $96,646,000 hedging fixed-rate available-for-sale debt securities and one interest rate swap with a notional amount of $75,000,000, hedging a specified pool of the Bank’s fixed-rate loans. The Corporation also had a total of two cash flow interest rate swaps with a combined notional amount of $100,000,000 hedging specific short-term wholesale funding positions as of December 31, 2025. See Note 12 – Derivative Instruments and Hedging Activities on page 99 for further analysis. The Corporation will continue to evaluate the potential impact of short-term rate fluctuations in 2026, as well as the slope and position of the yield curve.
Table 4 sets forth changes in interest income and interest expense for the periods indicated for each category of interest earning assets and interest bearing liabilities. Information is provided on changes attributable to (i) changes in volume (changes in average volume multiplied by prior rate); (ii) changes in rate (changes in average rate multiplied by prior average volume); and, (iii) changes in rate and volume (changes in average volume multiplied by changes in average rate).
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In 2025, the increase in net interest income on a fully tax equivalent basis of $5,457,000 resulted from an increase in volume of $324,000 and an increase of $5,133,000 due to changes in rate.
Table 4 — Rate/Volume Analysis
(Dollars in thousands)
2025 COMPARED TO 2024
VOLUME
RATE
NET
Interest Income:
Loans, Net
Taxable Securities
Tax-Exempt Securities
Restricted Investment in Bank Stocks
Other
Total Interest Income
Interest Expense
Savings, NOW and Money Markets
Time Deposits
Securities Sold U/A to Repurchase
Short-Term Borrowings
Long-Term Borrowings
Subordinated Debentures
Total Interest Expense
Net Interest Income
The change in interest due to both volume and rate has been allocated to change due to volume and change due to rate in proportion to the absolute value of the change in each. Balances on non-accrual loans are included for computational purposes. Interest income on non-accrual loans is not included.
PROVISION FOR CREDIT LOSSES
For the year ended December 31, 2025, the provision for credit losses was $4,701,000 as compared to $1,640,000 for the year ended December 31, 2024. The increase in the provision for credit losses in 2025 as compared to 2024 resulted from the Corporation’s analysis of the current loan portfolio, including historic losses, past-due trends, current economic conditions, loan portfolio growth, and other relevant factors, along with specific, relationship-level credit events identified during the year ended December 31, 2025. Charge-off and recovery activity in the allowance for credit losses resulted in net charge-offs of $2,961,000 and $893,000 for the years ended December 31, 2025 and 2024, respectively. The increase in the provision for credit losses for the year ended December 31, 2025 was mainly the result of a charge-off of $2,000,000 on a commercial real estate loan, a charge-off of $500,000 on a commercial and industrial loan, and the movement to non-accrual of a significant hotel-related commercial real estate loan. The loan moved to non-accrual status was subsequently individually evaluated and a specific allocation of $973,000 was recorded based on the value of the underlying collateral. Aside from these discrete events, credit quality metrics within the remainder of the loan portfolio remained generally stable during the year ended December 31, 2025. See Analysis of Allowance for Credit table on page 39 for additional information.
The allowance for credit losses as a percentage of average loans outstanding was 0.98% as of December 31, 2025 and 0.83% as of December 31, 2024.
On a quarterly basis, management performs, and the Corporation’s Audit Committee and the Board of Directors review a detailed analysis of the adequacy of the allowance for credit losses. This analysis includes an evaluation of credit risk concentration, delinquency trends, past loss experience, current economic conditions, composition of the loan portfolio, classified loans and other relevant factors.
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The Corporation will continue to monitor its allowance for credit losses and make future adjustments to the allowance through the provision for credit losses as conditions warrant. Although the Corporation believes that the allowance for credit losses is adequate to provide for losses inherent in the loan portfolio, there can be no assurance that future losses will not exceed the estimated amounts or that additional provisions will not be required in the future.
The Corporation is subject to periodic regulatory examination by the Pennsylvania Department of Banking and Securities and the FDIC. As part of the examination, the regulators will assess the adequacy of the Corporation’s allowance for credit losses and may include factors not considered by the Corporation. In the event that a regulatory examination results in a conclusion that the Corporation’s allowance for credit losses is not adequate, the Corporation may be required to increase its provision for credit losses.
NON-INTEREST INCOME
Non-interest income is derived primarily from service charges and fees, ATM fees and debit card income, trust department revenue, increases in the cash surrender value of bank owned life insurance, gains on sales of mortgage loans and other miscellaneous income. In addition, net securities gains and losses also impact total non-interest income. Table 5 provides the yearly non-interest income by category, along with the amount, dollar changes, and percentage of change comparing the last two years.
Non-interest income through December 31, 2025 was $7,323,000, an increase of 9.3%, or $626,000, from 2024. The increase was mainly due to gains on life insurance proceeds received in 2025 related to a death benefit, more service charges and fee income in 2025 and higher net securities gains realized in 2025.
During 2025, net securities gains increased $119,000 to a net gain of $224,000. The increase was due to the Corporation recognizing $224,000 in net gains on held equity securities in 2025 vs recognizing $105,000 in net gains on held equity securities in 2024 due to improvement in the mark-to-market valuation on the Corporation’s held equity securities.
Gains on sales of mortgage loans amounted to a net gain of $143,000 in 2025 as compared to a net gain of $80,000 in 2024. The increase in net gains on sales of mortgage loans in 2025 was due to more individual loans sold at a higher average gain in 2025 vs 2024. The Corporation continues to service the majority of mortgages which are sold, through maturity of the loans. This servicing income provides an additional source of non-interest income on an ongoing basis.
ATM fees and debit card income increased by $33,000 or 1.5% in 2025 as compared to 2024 due to increased debit card interchange fees as the result of an increase in debit card transaction volume in 2025. Income related to a gain from life insurance proceeds related to a death benefit amounted to $255,000 for 2025 compared to 2024 when there were no gains realized in relation to life insurance proceeds.
Other income, consisting primarily of income from the sale of retail non-deposit investment products, safe deposit box rentals, and miscellaneous fees, increased $23,000, or 7.3% in 2025 as compared to 2024 as the Corporation recognized more income from retail investment activity in 2025.
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Table 5 — Non-Interest Income
(Dollars in thousands)
Increase/(Decrease)
Amount
Trust department
Service charges and fees
Increase in cash surrender value of life insurance
ATM fees and debit card income
Net gains (losses) on sales of mortgage loans
Gains from life insurance proceeds
Other
Subtotal
Net securities losses
Total
NON-INTEREST EXPENSE
Total non-interest expense amounted to $33,908,000, a decrease of $16,670,000, or 33.0% in 2025.
The significant decrease in total non-interest expense for the year ended December 31, 2025 was mainly the result of the full, one-time, goodwill impairment charge in the amount of $19,133,000 that was recorded during the first quarter of 2024. This was the result of goodwill impairment testing performed due to the decrease of the Company’s stock price during the first quarter of 2024 as a triggering event. The goodwill impairment has no impact on regulatory capital ratios, liquidity or the Company’s cash balances.
Aside from the one-time goodwill impairment charge recognized in 2024, expenses associated with employees (salaries and employee benefits) continue to be the largest non-interest expenditure. Salaries and employee benefits amounted to $17,879,000 or 52.7% of total non-interest expense in 2025 and $17,228,000 or 34.1% in 2024. Salaries and employee benefits increased $651,000, or 3.8% in 2025. The increase in 2025 was mainly due to increased costs associated with employee health insurance which were $454,000 higher in 2025 as compared to 2024.
Net occupancy, furniture and equipment and computer expense increased $510,000, or 11.7% in 2025 compared to 2024. The increase was mainly due to increased depreciation on furniture and equipment resulting from the replacement of the Corporation’s ATM fleet, an increase in disaster recovery expense as the Corporation put new disaster recovery systems in place in late 2024 and an increase in expense related to various new software systems that were implemented in 2025. Professional services decreased $6,000, or 0.4% in 2025 as compared to 2024.
Pennsylvania shares tax expense increased $49,000, or 4.6% in 2025 as compared to 2024. FDIC insurance expense increased $154,000, or 14.0% in 2025 as compared to 2024. FDIC insurance expense varies with changes in net asset size, risk ratings, and FDIC derived assessment rates.
ATM and debit card fees expense increased $205,000, or 20.4% in 2025 as compared to 2024. This increase was a result of higher electronic funds transfer expenses in 2025 as vendor relationship credits resulting from contract negotiations, applied against billings in 2024, were fully utilized and no longer available in 2025. Data processing fees increased $453,000, or 44.3% in 2025 as compared to 2024. The increase was the result of increased internet banking expenses and core system fees due to vendor relationship credits, applied in 2024, which were fully utilized and no longer available in 2025.
Advertising expense decreased $111,000, or 19.8% in 2025 as compared to 2024 as the result of the Corporation utilizing less television and radio advertising during 2025.
Other non-interest expense increased $558,000, or 15.9% in 2025 as compared to 2024. Other non-interest expense was higher in 2025 mainly as the result of a customer-related write-off of $307,000 during the first quarter of
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2025, increased promo and underwriting expenses of $76,000 related to loans, $72,000 in additional expenses related to non-accrual loans in 2025 including legal fees and force placed insurance, and increased postage expenses of $102,000 mainly due to increased marketing mailers sent to customers in 2025.
Table 6 — Non-Interest Expense
(Dollars in thousands)
Increase/(Decrease)
Amount
Salaries and employee benefits
Occupancy, net
Furniture and equipment
Computer expense
Professional services
Pennsylvania shares tax
FDIC Insurance
ATM and debit card fees
Data processing fees
Advertising
Goodwill impairment
Other
Total
Management of the Corporation believes that investors’ understanding of the Corporation’s performance is enhanced by disclosing non-GAAP financial measures without the effects of the impairment as a reasonable basis for comparison of the Corporation’s ongoing results of operations. These non-GAAP measures should not be considered a substitute for GAAP-basis measures and results. Our non-GAAP measures may not be comparable to non-GAAP
measures of other companies. The following Non-GAAP Reconciliation Schedule provides a reconciliation of these non-GAAP financial measures to the most closely analogous measure determined in accordance with GAAP.
NON-GAAP RECONCILIATION SCHEDULE
FIRST KEYSTONE AND SUBSIDIARY
Year Ended
Year Ended
(Dollars in thousands)
December 31,
December 31,
Net interest income after provision for credit losses
Total non-interest income
Total non-interest expense
Income tax (expense) benefit
Net income (loss)
Adjustments
Other expense:
Goodwill impairment
Income tax (expense) benefit
After tax adjustment to GAAP
Adjusted net income
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INCOME TAX EXPENSE
Income tax resulted in expense for the year ended December 31, 2025 of $213,000 as compared to income tax benefit of $45,000 for the year ended December 31, 2024. The effective income tax rate was 3.4% in 2025 and (0.3)% in 2024. The increase in the effective tax rate for 2025 was mainly due to higher overall operating income with minimal change to tax-exempt income. The Corporation recognized $840,000 of tax credits from low-income housing partnerships for the years ended December 31, 2025 and 2024, included in tax expense. The Corporation expects to carry forward $0 and $328,000 of low-income housing tax credits as of December 31, 2025 and December 31, 2024, respectively, which will begin to expire in the year 2045.
FINANCIAL CONDITION
GENERAL
Total assets increased to $1,530,977,000 at year-end 2025, an increase of 7.2% from year-end 2024.
Total cash and cash equivalents increased by $103,995,000 to $121,249,000 at December 31, 2025 from $17,254,000 at December 31, 2024. The increase was mainly the result of excess cash balances and excess cashflows from activity in the debt securities available-for-sale portfolio which were not reinvested during the year ended December 31, 2025.
Total debt securities available-for-sale increased $3,938,000 or 1.0% to $394,226,000 as of December 31, 2025. The increase was mainly due to $51,918,000 in securities purchased and an improvement of $10,313,000 in unrealized loss on securities, offset by $58,380,000 in maturities, paydowns, and calls completed during the same period.
Net loans decreased slightly in 2025 from $940,779,000 to $939,013,000 mainly due to higher balances of principal payments and paydowns which offset the new loan originations for the year.
As of December 31, 2025, total deposits amounted to $1,137,437,000, an increase of $91,557,000 or 8.8% from 2024. The increase is mainly due to a $135,733,000 increase in retail CDs offset by a $44,554,000 decrease in other retail deposits as the Corporation has experienced a shift from transactional deposits to term deposits.
Total short-term borrowings as of December 31, 2025 increased by $2,419,000 or 1.8% from 2024 mainly due to an increase of $3,913,000 in the balance of repurchase agreements, offset by a decrease of $1,494,000 in the balance of FHLB overnight borrowings. Balances of both FHLB long-term borrowings and subordinated debentures remained unchanged at December 31, 2025 versus December 31, 2024.
Total stockholders’ equity increased to $113,060,000 at December 31, 2025, an increase of $6,278,000, primarily due to an improvement of $6,177,000 in accumulated other comprehensive loss as a result of market value improvement in the current interest rate environment.
The Corporation continues to maintain and manage its asset growth. The Corporation’s strong equity capital position provides an opportunity to further leverage its asset growth.
SEGMENT REPORTING
Currently, management measures the performance and allocates the resources of the Corporation as a single segment.
EARNING ASSETS
Earning assets are defined as those assets that produce interest income. By maintaining a healthy asset utilization rate, i.e., the volume of earning assets as a percentage of total assets, the Corporation maximizes income. The earning asset ratio (average interest earning assets divided by average total assets) equaled 95.3% for 2025 compared to
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94.6% for 2024. This indicates that the management of earning assets is a priority and non-earning assets, primarily cash and due from banks, fixed assets and other assets, are maintained at minimal levels. The primary earning assets are securities and loans.
SECURITIES
The Corporation uses securities to not only generate interest and dividend revenue, but also to help manage interest rate risk and to provide liquidity to meet operating cash needs.
The securities portfolio consists of debt securities available-for-sale. No securities were established in a trading account. Debt securities available-for-sale increased $3,938,000 or 1.0% to $394,226,000 in 2025. At December 31, 2025, the net unrealized loss, net of the tax effect, on these securities was $16,320,000 and was included in stockholders’ equity as accumulated other comprehensive loss. Table 7 provides data on the fair value of the Corporation’s securities portfolio on the dates indicated. The vast majority of security purchases are allocated as available-for-sale. This provides the Corporation with increased flexibility should there be a need or desire to liquidate a security.
The securities portfolio includes, U.S. treasuries, U.S. government corporations and agencies, corporate debt obligations, mortgage-backed securities, asset-backed securities, and obligations of state and political subdivisions, both tax-exempt and taxable.
Debt securities available-for-sale may be sold as part of the overall asset and liability management process. Realized gains and losses are reflected in the results of operations on the Corporation’s Consolidated Statements of Income.
Table 7 — Securities
(Dollars in thousands)
Available-For-Sale
December 31, 2025
December 31, 2024
U.S. Treasury securities
U. S. Government corporations and agencies
Other mortgage-backed debt securities
Obligations of state and political subdivisions
Asset-backed securities
Corporate debt securities
Total
The amortized cost and fair value of securities, by contractual maturity, are shown below at December 31, 2025. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
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Table 8 — Securities Maturity Table
(Dollars in thousands)
December 31, 2025
Debt Securities Available-For-Sale
U.S. Government
Other
Obligations
Corporations &
Mortgage
of State
Asset
Corporate
U.S. Treasury
Agencies
Backed Debt
& Political
Backed
Debt
Securities
Obligations 1
Securities 1
Subdivisions
Securities
Securities
Within 1 Year:
Amortized cost
Fair value
1 - 5 Years:
Amortized cost
Fair value
5 - 10 Years:
Amortized cost
Fair value
After 10 Years:
Amortized cost
Fair value
Total:
Amortized cost
Fair value
1 Mortgage-backed and asset-backed securities are allocated for maturity reporting at their original maturity date.
Marketable equity securities consist of common stock investments in other commercial banks and bank holding companies. At December 31, 2025 and 2024, the Corporation had $1,810,000 and $1,587,000, respectively, in equity securities recorded at fair value, an increase of $223,000 or 14.1%.
LOANS
Total loans decreased to $946,661,000 as of December 31, 2025, compared to a balance of $946,826,000 as of December 31, 2024. Table 9 provides data relating to the composition of the Corporation’s loan portfolio on the dates indicated. Total loans decreased $165,000, or 0.02% in 2025 compared to an increase of $37,373,000, or 4.10% in 2024.
The Real Estate portfolio increased $3,012,000 or 0.4% from $850,656,000 at December 31, 2024 to $853,668,000 at December 31, 2025. The increase in the Real Estate portfolio for the year ended December 31, 2025 was mainly the result of $115,827,000 in new loan originations, which were offset by loan payoffs of $71,096,000 and a decrease of $41,679,000 in utilization of existing real estate lines of credit, along with regular principal payments and other typical fluctuations in the Real Estate portfolio. The Agricultural portfolio increased $48,000 or 5.1% from $936,000 at December 31, 2024 to $984,000 at December 31, 2025. The increase in the Agricultural portfolio for the year ended December 31, 2025 consisted of new loan originations in the amount of $30,000 and two loans totaling $219,000 that were reclassed from the Commercial and Industrial portfolio to the Agricultural portfolio during the year ended December 31, 2025, along with an increase of $12,000 in utilization of existing agricultural lines of credit, offset by loan payoffs of $64,000 along with regular principal payments and other typical fluctuations in the Agricultural portfolio. The Commercial and Industrial portfolio increased $218,000 or 0.3% from $66,706,000 at December 31, 2024 to $66,924,000 at December 31, 2025. The increase was attributable to $13,501,000 in new loan originations and an increase of $2,356,000 in utilization of existing commercial and industrial lines of credit, which were offset by loan payments of $6,179,000 and regular principal payments and other typical amortization in the Commercial and Industrial portfolio. The Consumer portfolio decreased $1,437,000 or 22.5% from $6,390,000 at December 31, 2024 to $4,953,000 at December 31, 2025. The decrease is mainly attributable to new loan originations of $1,771,000, offset by loan payoffs
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of $1,587,000, a decrease of $66,000 in utilization of existing consumer lines of credit, and regular principal payments. The State and Political Subdivisions portfolio decreased $2,006,000 or 9.1% from $22,138,000 at December 31, 2024 to $20,132,000 at December 31, 2025. The decrease is mainly the result of new loan originations totaling $3,309,000 and an increase of $105,000 in utilization of existing consumer lines of credit, offset by loan payoffs of $2,593,000 and regular principal payments on state and political subdivisions loans completed during the year ended December 31, 2025.
The Corporation continues to originate and sell certain long-term fixed rate residential mortgage loans, which conform to secondary market requirements, when the market pricing is favorable. The Corporation derives ongoing income from the servicing of mortgages sold in the secondary market. The Corporation continues its efforts to lend to creditworthy borrowers. Management believes the loan portfolio is well diversified.
All loan relationships in excess of $1,500,000 are reviewed internally and/or externally through a loan review process on an annual basis. Such review is based upon analysis of current financial statements of the borrower, co-borrowers/guarantors, payment history, and economic conditions.
Overall, the portfolio risk profile as measured by loan grade is considered low risk, as $917,870,000 or 96.9% of gross loans are graded Pass; $4,350,000 or 0.5% are graded Special Mention; $24,441,000 or 2.6% are graded Substandard; and $0 are graded Doubtful. The rating is intended to represent the best assessment of risk available at a given point in time, based upon a review of the borrower’s financial statements, credit analysis, payment history with the Bank, credit history and lender knowledge of the borrower. See Note 3 — Loans and Allowance for Credit Losses for risk grading tables.
Overall, non-pass grades increased to $28,791,000 at December 31, 2025, as compared to $27,834,000 at December 31, 2024. Real Estate non-pass grades increased $1,087,000 or 4.0% to $28,458,000 as of December 31, 2025 compared to $27,371,000 as of December 31, 2024. Commercial and Industrial non-pass grades decreased $147,000 or 32.2% to $310,000 as of December 31, 2025 compared to $457,000 as of December 31, 2024. Consumer non-pass grades increased $17,000 or 283.3% to $23,000 as of December 31, 2025 compared to $6,000 as of December 31, 2024. There were no Agricultural or State and Political Subdivision non-pass grades as of December 31, 2025 or December 31, 2024.
The Corporation continues to internally underwrite each of its loans to comply with prescribed policies and approval levels established by its Board of Directors.
The classes of the Corporation’s loan portfolio net of unearned discount and net deferred loan fees and costs are summarized in Table 9.
Table 9 — Loans
(Dollars in thousands)
December 31,
December 31,
Real Estate
Agricultural
Commercial and Industrial
Consumer
State and Political Subdivisions
Total Loans
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The Corporation’s maturity and interest rate sensitivity information related to the loan portfolio is summarized in Table 10.
Table 10 — Loan Maturity and Interest Sensitivity
Loans by Maturity
December 31, 2025
(Dollars in thousands)
One Year
After One Year
After
and Less
Through Five Years
Five Years
Total
Real Estate
Agricultural
Commercial and Industrial
Consumer
State and Political Subdivisions
Total
The above data represents the amount of loans receivable at December 31, 2025 which, based on remaining scheduled repayments of principal, are due in the periods indicated.
Loans by Repricing
December 31, 2025
(Dollars in thousands)
One Year
After One Year
After
and Less
Through Five Years
Five Years
Total
Real Estate
Agricultural
Commercial and Industrial
Consumer
State and Political Subdivisions
Total
Loans with a fixed interest rate
Loans with a variable interest rate
Total
The above data represents the amount of loans receivable at December 31, 2025 which are due or have the opportunity to reprice in the periods indicated, based on remaining scheduled repayments of principal for fixed rate loans or date of next repricing opportunity for variable rate loans. The fixed and variable portions of the amounts of loans receivable due or repricing in the periods indicated are also summarized above.
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses constitutes the amount available to absorb losses within the loan portfolio. As of December 31, 2025, the allowance for credit losses was $9,412,000 as compared to $7,672,000 as of December 31, 2024. The allowance for credit losses is established through a provision for credit losses charged to expenses. Loans are charged against the allowance for possible credit losses when management believes that the collectability of the principal is unlikely. The risk characteristics of the loan portfolio are managed through various control processes, including credit evaluations of individual borrowers, periodic reviews, and diversification by industry. Risk is further mitigated through the application of lending procedures such as the holding of adequate collateral and the establishment of contractual guarantees.
Management performs a quarterly analysis to determine the adequacy of the allowance for credit losses. The methodology in determining adequacy incorporates quantitative and qualitative allocations together with a risk/loss analysis on various segments of the portfolio according to an internal loan review process. This assessment results in an allocated allowance. Management maintains its loan review and loan classification standards consistent with those of its regulatory supervisory authority.
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Management considers, based upon its methodology, that the allowance for credit losses is adequate to cover foreseeable future losses. However, there can be no assurance that the allowance for credit losses will be adequate to cover significant losses, if any, that might be incurred in the future. On a quarterly basis, management evaluates the qualitative factors utilized in the calculation of the Corporation’s allowance for credit losses and various adjustments are made to these factors as deemed necessary at the time of evaluation. The following table summarizes the qualitative factor adjustments made during the year ended December 31, 2025.
Quarter Ended March 31, 2025:
Loan Segment
Qualitative Factor
Basis Point Increase (Decrease)
Loans secured by first liens
Delinquency Trends
Loans secured by owner occupied, non-farm, non-residential properties
Delinquency Trends
Loans secured by other non-farm, non-residential properties
Delinquency Trends
Commercial and industrial loans
Delinquency Trends
Other revolving credit plans
Delinquency Trends
Automobile loans
Delinquency Trends
Other revolving credit plans
Volume Trends
Obligations of states and political subdivisions
Volume Trends
Quarter Ended June 30, 2025:
Loan Segment
Qualitative Factor
Basis Point Increase (Decrease)
Loans secured by first liens
Delinquency Trends
Loans secured by multifamily properties
Delinquency Trends
Loans secured by owner occupied, non-farm, non-residential properties
Delinquency Trends
Loans secured by other non-farm, non-residential properties
Delinquency Trends
Other revolving credit plans
Delinquency Trends
Automobile loans
Delinquency Trends
Loans secured by multifamily properties
Volume Trends
Loans to finance agricultural production and other loans to farmers
Volume Trends
Other consumer loans
Volume Trends
Quarter Ended September 30, 2025:
Loan Segment
Qualitative Factor
Basis Point Increase (Decrease)
Loans secured by revolving, open-end 1-4 family residential properties
Delinquency Trends
Loans secured by first liens
Delinquency Trends
Loans secured by junior liens
Delinquency Trends
Loans secured by multifamily properties
Delinquency Trends
Loans secured by owner occupied, non-farm, non-residential properties
Delinquency Trends
Loans secured by other non-farm, non-residential properties
Delinquency Trends
Other revolving credit plans
Delinquency Trends
Commercial and industrial loans
Volume Trends
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Quarter Ended December 31, 2025:
Loan Segment
Qualitative Factor
Basis Point Increase (Decrease)
Loans secured by construction for land development and other land loans
Delinquency Trends
Loans secured by first liens
Delinquency Trends
Loans secured by junior liens
Delinquency Trends
Loans secured by owner occupied, non-farm, non-residential properties
Delinquency Trends
Commercial and industrial loans
Delinquency Trends
Other consumer loans
Delinquency Trends
Revolving, open-end, 1-4 family residential properties
Volume Trends
Loans secured by junior liens
Volume Trends
Commercial and industrial loans
Volume Trends
Other revolving credit plans
Volume Trends
Table 11 contains an analysis of the allowance for credit losses indicating charge-offs and recoveries by year. In 2025 and 2024, net charge-offs as a percentage of average loans amounted to 0.31% and 0.10% respectively. Net charge-offs amounted to $2,961,000 in 2025 and $893,000 in 2024. Net charge-offs were higher in 2025 than in 2024, mainly due to a charge-off of $2,000,000 completed on a loan granted to a real estate developer for the purpose of renovating the property into luxury residential rentals. Plans for renovations did not progress as anticipated and the borrower experienced difficulty in making payments as required, ultimately leading to the loan exceeding 90-days past due during the fourth quarter of 2025, at which point the loan was moved to non-accrual status and the charge-off was completed. Additionally, a charge-off in the amount of $500,000 was completed during the fourth quarter of 2025 on a fully drawn revolving commercial and industrial line of credit that was granted to a building contractor. It was determined that the pledged collateral did not support the loan balance and the borrower has become unresponsive to attempted communication from the Corporation regarding the repayment of the principal.
For the year ended December 31, 2025, the provision for credit losses resulted in a balance of $4,701,000 compared to $1,640,000 for the year ended December 31, 2024. The net effect of the provision and net charge-offs resulted in the year-end allowance for credit losses of $9,412,000 of which 93.88% was attributed to the Real Estate component, 0.02% was attributed to the Agricultural component, 4.80% was attributed to the Commercial and Industrial component, 0.79% was attributed to the Consumer component, and 0.51% was attributed to the State and Political Subdivisions component (refer to the activity in Note 3 — Loans and Allowance for Credit Losses on page 82.) The Corporation determined that the provision for credit losses made during 2025 was sufficient to maintain the allowance for credit losses at a level necessary for the probable losses inherent in the loan portfolio as of December 31, 2025.
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Table 11
Analysis of Allowance for Credit Losses
(Dollars in thousands)
December 31,
December 31,
As of and for the year ended:
Beginning Balance
Charge-offs:
Real Estate
Agricultural
Commercial and Industrial
Consumer
State and Political Subdivisions
Recoveries:
Real Estate
Agricultural
Commercial and Industrial
Consumer
State and Political Subdivisions
Net charge-offs
Provision charged to operations
Balance at end of period
Ratio of net charge-offs during the period to average loans outstanding during the period
Allowance for credit losses to average loans outstanding during the period
It is the policy of management and the Corporation’s Board of Directors to make a provision for both identified and unidentified losses inherent in its loan portfolio. A provision for credit losses is charged to operations based upon an evaluation of the potential losses in the loan portfolio. This evaluation takes into account such factors as portfolio concentrations, delinquency trends, trends of non-accrual and classified loans, economic conditions, and other relevant factors.
The loan review process, which is conducted quarterly, is an integral part of the Bank’s evaluation of the loan portfolio. A detailed quarterly analysis to determine the adequacy of the Corporation’s allowance for credit losses is reviewed by the Board of Directors.
With the Bank’s manageable level of net charge-offs and recoveries along with additions to the reserve from the provision out of operations, the allowance for credit losses as a percentage of average loans amounted to 0.98% in 2025 and 0.83% in 2024.
Table 12 sets forth the allocation of the Corporation’s allowance for credit losses by loan category and the percentage of loans in each category to the total allowance for credit losses at the dates indicated. The portion of the allowance for credit losses allocated to each loan category does not represent the total available for future losses that may occur within the loan category, since the total credit loss allowance is a valuation reserve applicable to the entire loan portfolio.
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Table 12
Allocation of Allowance for Credit Losses
(Dollars in thousands)
December 31, 2025
December 31, 2024
Real Estate
Agricultural
Commercial and Industrial
Consumer
State and Political Subdivisions
NON-PERFORMING ASSETS
Table 13 details the Corporation’s non-performing assets and individually evaluated loans as of the dates indicated. Generally, a loan is classified as non-accrual and the accrual of interest on such a loan is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on non-accrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against current period income. Foreclosed assets held for resale represent property acquired through foreclosure, or considered to be an in-substance foreclosure.
Total non-performing assets amounted to $16,919,000 as of December 31, 2025, as compared to $4,970,000 as of December 31, 2024. The economic growth for the fourth quarter of 2025 has remained relatively stagnant from the higher-than-expected growth in the first quarter of 2025. Consumer spending remains at high levels. The inflation rate was 2.7% as of December 31, 2025, compared inflation rates of 3.0%, 2.7%, and 2.4% as of September 30, 2025, June 30, 2025, and March 31, 2025, respectively. Inflation rates for all four quarters of 2025 were above the Federal Reserve Board’s desired rate of 2.0%. Inflation had been receding in the middle of 2024, but has seen a rise in 2025, as the currently imposed tariffs and threat of higher tariffs have pushed inflation higher. Additionally, mass layoffs from the federal government increased unemployment levels. Layoffs from large corporations from the public sector have also had an effect. Many economists and influential thinkers still believe that the economy is moving forward despite certain forecasts and predictors. The concern of a recession, although lessened in 2025, is still being discussed. The Federal Reserve is looking very cautiously at their next move, which will depend on which direction inflation and rates are trending. The war between Ukraine and Russia continues to deeply pierce the landscape of the world. The with Israel and Palestine is moving forward with the fire directive, and the world is watching to see if it holds. The new aggression with Venezuela and the continuing objective from Homeland Security, more specifically ICE agents, has fueled increased strife, , and on the economy. Values of new and used homes and automobiles have remained high. Although, there would seem to be a dynamic shift in the automobile industry where inventories are increasing and sales are , this may lead to a reduced profit margin. Interest rates have come down slightly but remain high and continue to borrowing. Consumer savings is dwindling, and credit balances are growing. Supply chains are back up and running in many areas. Labor continues to remain and . These forces have had a direct effect on the Corporation’s non-performing assets. The Corporation is closely monitoring all segments of its loan portfolio because of the current uncertain economic environment. Non-accrual loans totaled $16,773,000 as of December 31, 2025 as compared to $4,214,000 as of December 31, 2024. There were no assets held for resale as of December 31, 2025 or December 31, 2024. There was one loan past-due 90 days or more and still accruing interest as of December 31, 2025 which carried a balance of $146,000, compared to December 31, 2024 when there were six loans past-due 90 days or more and still accruing interest which carried an aggregate balance of $756,000. The loan past-due 90 days or more and still accruing interest as of December 31, 2025 was secured by residential real estate and was well secured and in the process of collection.
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Non-performing assets to total loans was 1.79% for December 31, 2025 and 0.52% for December 31, 2024. Non-performing assets to total assets was 1.11% for December 31, 2025 and 0.35% for December 31, 2024. The allowance for credit losses to total non-performing assets was 55.63% as of December 31, 2025 as compared to 154.37% as of December 31, 2024. Additional detail can be found in Table 13 – Non-Performing Assets and Individually Evaluated and the Non-Performing Assets table in Note 3 — Loans and Allowance for Credit Losses. Asset quality is a priority and the Corporation retains a full-time loan review officer to closely track and monitor overall loan quality, along with a full-time loan workout department to manage collection and liquidation efforts and engages an annual external loan review.
Performing substandard loans, which have not been designated for individual evaluation to determine expected credit losses, have characteristics that cause management to have doubts regarding the ability of the borrower to perform under present loan repayment terms and which may result in reporting these loans as non-performing loans in the future. Performing substandard loans not designated for individual evaluation amounted to $7,668,000 at December 31, 2025 and $20,080,000 at December 31, 2024.
Individually evaluated loans were $17,052,000 at December 31, 2025, compared to $4,523,000 at December 31, 2024. The largest individually evaluated loan relationship at December 31, 2025 consisted of a non-performing loan to a borrower engaged in the hotel operations business. The loan is secured by commercial real estate and carried a balance of $9,703,000 and a specific allocation of $973,000 as of December 31, 2025. The second largest individually evaluated loan relationship at December 31, 2025 consisted of a non-performing loan granted to a real estate developer for the purpose of renovating the property into luxury residential rentals. The loan is secured by commercial real estate and carried a balance of $2,443,000 as of December 31, 2025, net of $2,000,000 that had been charged off to date. The third largest individually evaluated loan relationship at December 31, 2025 consisted of a non-performing loan to a student housing holding company which is secured by commercial real estate. At December 31, 2025, the loan carried a balance of $1,603,000, net of $1,989,000 that had been charged off to date.
The Corporation determines the need for individual evaluation of loans based on its analysis of the cash flows or collateral estimated at fair value less cost to sell. For collateral dependent loans, the estimated appraisal or other qualitative adjustments and cost to sell percentages are determined based on the market area in which the real estate securing the loan is located, among other factors, and therefore, can differ from one loan to another. Of the $7,348,000 in individually evaluated loans at December 31, 2025, none were located outside the Corporation’s primary market area.
The post modification recorded investment of loans to borrowers experiencing financial difficulty was $12,671,000 at December 31, 2025, with $12,664,000 classified in the Real Estate portfolio and $7,000 classified in the Commercial and Industrial portfolio. The loan modifications for the year ended December 31, 2025 consisted of five payment modifications and one other modification was classified as “other.”. Four modifications of loans to borrowers experiencing financial difficulty were completed during the fourth quarter of 2025, one on a loan carrying a post modification recorded investment of $1,983,000 which allowed a full payment deferral period of three months, one on a loan carrying a post modification recorded investment of $7,000 which allowed interest-only payments for a period of six months, one on a loan carrying a post modification recorded investment of $9,716,000 for which the modification allowed taxes to be paid by the Corporation on behalf of the borrower and the amount appended on to the principal amount outstanding on the loan, and one on a loan carrying a post modification outstanding recorded investment of $529,000 for which the modification allowed interest-only payments for a period of six months. Two modifications of loans to borrowers experiencing financial difficulty were completed during the second quarter of 2025, one on a loan carrying a post modification recorded investment of $107,000 and one on a loan carrying a post modification recorded investment of $332,000, both of which allowed interest-only payments for periods of eleven and twelve months, respectively. Both loans were subsequently modified again during the fourth quarter of 2025 to allow an extension of interest-only payments on each loan for an additional four months. The post modification recorded investment of loans to borrowers experiencing financial was $10,183,000 as of December 31, 2024, with $10,009,000 classified in the Real Estate portfolio at $174,000 classified in the Commercial and Industrial portfolio. The loan modifications for the year ended December 31, 2024 consisted of four payment modifications. Two modifications of loans to borrowers experiencing financial were completed during the fourth quarter of 2024, one on a loan carrying a post modification recorded investment of $174,000 to extend the maturity date of the loan by six months and one on a loan carrying a post modification recorded investment of $434,000 to release a portion of the real estate securing the loan.
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One modification of a loan to a borrower experiencing financial difficulty was completed during the third quarter of 2024 to extend the maturity date of the loan by ten months. The loan carried a post modification recorded investment of $120,000. One modification of a loan to a borrower experiencing financial difficulty was completed during the first quarter of 2024 and allowed a period of interest-only payments of six months. The loan carried a post modification recorded investment of $9,455,000.
There were no unfunded commitments related to modified loans to borrowers experiencing financial difficulty as of December 31, 2025 or December 31, 2024. At December 31, 2025, there were two modifications of loans to borrowers experiencing financial difficulty that were not in compliance with the terms of their restructure, compared to December 31, 2024 when there were no modifications of loans to borrowers experiencing financial difficulty that were not in compliance with the terms of their restructure. Of the modifications of loans to borrowers experiencing financial difficulty that were completed during the twelve months preceding December 31, 2025, one loan carrying a post modification recorded investment of $107,000 experienced a payment default during the year ended December 31, 2025, but the loan was less than 30 days past due as of December 31, 2025. Of the modifications of loans to borrowers experiencing financial difficulty that were completed during the twelve months preceding December 31, 2024, two loans experienced payment defaults during the year ended December 31, 2024. One loan carrying a post modification recorded investment of $9,455,000 experienced a payment during the first quarter of 2024 and a loan carrying a post modification recorded investment of $120,000 experienced a payment during the fourth quarter of 2024. Both loans were paid current as of December 31, 2024.
The Corporation’s non-accrual loan valuation procedure for any loans greater than $250,000 requires an appraisal to be obtained and reviewed annually at year end, unless the Board of Directors waives such requirement for a specific loan, in favor of obtaining a Certificate of Inspection instead, defined as an internal evaluation completed by the Corporation. A quarterly collateral evaluation is performed which may include a site visit, property pictures and discussions with realtors and other similar business professionals to ascertain current values.
For non-accrual loans less than $250,000 upon classification and typically at year end, the Corporation completes a Certificate of Inspection, which includes the results of an onsite inspection, and may consider value indicators such as insured values, tax assessed values, recent sales comparisons and a review of the previous evaluations.
Improving loan quality is a priority. The Corporation actively works with borrowers to resolve credit problems and will continue its close monitoring efforts in 2026. Excluding the assets disclosed in Table 13 – Non-Performing Assets and Individually Evaluated Loans and the Non-Performing Assets table in Note 3 — Loans and Allowance for Credit Losses, management is not aware of any information about borrowers’ possible credit problems which cause serious doubt as to their ability to comply with present loan repayment terms.
In addition, regulatory authorities, as an integral part of their examinations, periodically review the allowance for possible loan losses. They may require additions to allowances based upon their judgments about information available to them at the time of examination.
The economic climate remains unstable. The war between Ukraine and Russia continues on into its fourth year and the Israeli conflict in the Gaza strip has moved to exploring yet another cease fire attempt. Inflationary pressures remain elevated and have seen a slight decline in the fourth quarter of 2025. This continues to create much debate, speculation, and concern regarding the appropriate actions to be taken to overcome the effects of monetary policy adjustments, tariffs, federal government shutdown, and continuing large federal layoffs that have transpired and may continue to transpire to affect the change. Intense political turmoil, commodity prices remaining high, gas prices fluctuating widely from week to week, small businesses closing, larger corporations cutting jobs, unprecedented weather conditions seen around the world, and the uncertainty of where the Federal Reserve may go from here in regard to rates have exacerbated the in the national and state economy. Experts at all levels continue to ascertain the intermediate or long-term effects of such issues. The Corporation may experience collecting payments on time from its borrowers, and certain types of loans may need to be modified, which could cause a rise in the level of individually evaluated loans, non-performing assets, charge-offs, and . Should such metrics increase, additions to the balance of the Corporation’s allowance for credit could be required. The extent of the impact of these stressors on the Corporation’s operational and financial performance will depend on certain developments
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including reactions to inflationary controls enacted, the labor force, the longevity of the wars, the ongoing political landscape, and the looming worldwide discord, and any after-effects of these factors. These factors may not immediately impact the Corporation’s operational and financial performance, as the effects of these factors may lag into the future. The Corporation is also susceptible to the impact of economic and fiscal policy factors that may evolve in the current economic environment.
A concentration of credit exists when the total amount of loans to borrowers, who are engaged in similar activities that are similarly impacted by economic or other conditions, exceed 10% of total loans. As of December 31, 2025 and 2024 management is of the opinion that there were no loan concentrations exceeding 10% of total loans.
Table 13
Non-Performing Assets and Individually Evaluated Loans
(Dollars in thousands)
December 31,
December 31,
Non-performing assets
Non-accrual loans
Foreclosed assets held for resale
Loans past-due 90 days or more and still accruing interest
Total non-performing assets
Individually evaluated loans
Non-accrual loans
Other Individually Evaluated loans
Total individually evaluated loans
Allocated allowance for credit losses
Net investment in individually evaluated loans
Individually evaluated loans with a valuation allowance
Individually evaluated loans without a valuation allowance
Total individually evaluated loans
Allocated valuation allowance as a percent of individually evaluated loans
Individually evaluated loans to total loans
Non-performing assets to total loans
Non-performing assets to total assets
Allowance for credit losses to individually evaluated loans
Allowance for credit losses to total non-performing assets
Real estate mortgages comprised 90.2% of the loan portfolio as of December 31, 2025 and 89.8% as of December 31 2024, respectively. Real estate mortgages consist of both loans secured by residential and commercial real estate. The Real Estate loan portfolio is well diversified in terms of borrowers, collateral, interest rates, and maturities. Also, the residential component of the Real Estate loan portfolio is largely comprised of fixed rate mortgages. The real estate loans are concentrated in the Corporation’s market area and are subject to risks associated with the local economy. The loans secured by commercial real estate typically reprice approximately every three to five years and are also concentrated in the Corporation’s market area. The Corporation’s loss exposure on its individually evaluated loans continues to be mitigated by collateral positions on these loans. The allocated allowance for credit losses associated with individually evaluated loans is generally computed based upon the related collateral value of the loans. The collateral values are determined by recent appraisals or Certificates of Inspection, but are generally discounted by management based on historical dispositions, changes in market conditions since the last valuation, and management’s expertise and knowledge of the borrower and the borrower’s business.
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DEPOSITS, OTHER BORROWED FUNDS AND SUBORDINATED DEBT
Consumer and commercial retail deposits are attracted primarily by the Corporation’s nineteen full service office locations and through its internet banking presence. The Corporation offers a broad selection of deposit products and continually evaluates its interest rates and fees on deposit products. The Corporation regularly reviews competing financial institutions’ interest rates, especially when establishing interest rates on certificates of deposit.
Deposits increased by $91,557,000, or 8.8% for the year ending December 31, 2025 as compared to December 31, 2024. The increase in deposits in 2025 can mainly be attributed to an increase of $135,733,000 in the balance of retail CDs resulting from new higher rate CD promotions offered throughout 2025.
The following schedule reflects the remaining maturities of time deposits and other time open deposits of $100,000 or more at December 31, 2025.
Table 14 – Remaining Maturities of Time Deposits and Other Time Open Deposits of $100,000 or More
(Dollars in thousands)
Time
Other Time Open
Deposits
Deposits
Less than or equal to 3 months
Over 3 months through 6 months
Over 6 months through 12 months
Over 12 months
Total borrowings were $242,845,000 as of December 31, 2025, compared to $240,426,000 at December 31, 2024. Short-term debt increased from $134,426,000 in 2024 to $136,845,000 as of December 31, 2025. Short-term borrowings are comprised of federal funds purchased, securities sold under agreements to repurchase, Federal Discount Window and short-term borrowings from FHLB. Short-term borrowings from FHLB are commonly used to offset balance sheet fluctuations. During 2025, long-term borrowings remained the same at $106,000,000.
In connection with FHLB borrowings, Federal Discount Window, and securities sold under agreements to repurchase, the Corporation maintains certain eligible assets as collateral.
The following table shows information about the Corporation’s short-term borrowings as of December 31, 2025 and 2024.
Table 15 — Short-Term Borrowings
(Dollars in thousands)
Maximum
Period End
Average
Month End
Average
Balance
Balance
Balance
Rate
Federal funds purchased
Securities sold under agreements to repurchase
Federal Discount Window
Federal Home Loan Bank
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(Dollars in thousands)
Maximum
Period End
Average
Month End
Average
Balance
Balance
Balance
Rate
Federal funds purchased
Securities sold under agreements to repurchase
Federal Discount Window
Federal Home Loan Bank
The rapid increase in interest rates throughout 2022 and 2023 created a significant earnings challenge for the industry. As liability costs outpaced asset yield growth, negative earnings was a plausible scenario shown in many models if no action was taken. Due to the stress this placed on the Corporation, an action plan strategy was put into effect in 2023 that included disciplined loan pricing, fair value and interest rate swaps/hedges and a leverage of the balance sheet consisting of securities and brokered CD purchases and long-term borrowings. This action plan strategy was the key part of the Corporation’s decision to utilize targeted long-term borrowings over high-rate short-term borrowings and the decision to take on more brokered CDs in 2023 and 2024, also entering into an additional hedge agreement against a specified pool of the Bank’s loans in 2024. As a continuation of this strategy, in 2025, the Corporation entered into an additional hedge agreement against a specified pool of the Bank’s securities with funding provided by short-term brokered CDs with a three-month maturity. The short-term brokered CDs matured during the third quarter of 2025 and replacement was not deemed necessary.
On December 10, 2020, the Corporation issued $25,000,000 aggregate principal amount of Subordinated Notes due December 31, 2030 (the “2020 Notes”). The 2020 Notes are intended to be treated as Tier 2 capital for regulatory capital purposes. The 2020 Notes bear a fixed interest rate of 4.375% per year for the first five years and then float based on a benchmark rate (as defined).
CAPITAL STRENGTH
Normal increases in capital are generated by net income, less cash dividends paid out. Also, the net unrealized gains or losses on debt securities available-for-sale and derivatives, net of taxes, referred to as accumulated other comprehensive (loss) income, may increase or decrease total equity capital. The total net increase in capital was $6,278,000 in 2025 after a decrease of $14,833,000 in 2024. The increase in equity capital in 2025 was due to an improvement in accumulated other comprehensive (loss) income amounting to $6,177,000 and issuance of new shares through the Corporation’s Dividend Reinvestment Program (“DRIP”) amounting to $922,000, offset by a decrease of $821,000 in retained earnings.
The Corporation had 231,611 shares of common stock as of December 31, 2025 and December 31, 2024, at a cost of $5,709,000, as treasury stock, authorized and issued but not outstanding.
Return on average equity (“ROE”) is computed by dividing net income by average stockholders’ equity. This ratio was 5.60% for 2025 and (12.04)% for 2024.
Adequate capitalization of banks and bank holding companies is required and monitored by regulatory authorities. Table 15 reflects risk-based capital ratios and the leverage ratio for the Bank. The Bank’s leverage ratio was 9.62% at December 31, 2025 and 10.24% December 31, 2024.
The Bank has consistently maintained regulatory capital ratios at or above the “well capitalized” standards. To be categorized as “well capitalized”, the Bank must maintain minimum tier 1 risk-based capital, common equity tier 1 risk based capital, total risk-based capital and tier 1 leverage ratios of 8.0%, 6.5%, 10.0% and 5.0%, respectively. For additional information on capital ratios, see Note 14 — Regulatory Matters. The risk-based capital calculation assigns various levels of risk to different categories of bank assets, requiring higher levels of capital for assets with more risk. Also measured in the risk-based capital ratio is credit risk exposure associated with off-balance sheet contracts and commitments.
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Table 16 — Capital Ratios
At December 31, 2025, the Bank met the definition of a “well-capitalized” institution under the regulatory framework for prompt corrective action and the minimum capital requirements under Basel III. The following table presents the Bank’s capital ratios as of December 31, 2025 and December 31, 2024:
Minimum Capital
December 31,
December 31,
Adequacy with
Capital Buffer
Tier 1 leverage ratio (to average assets)
Common Equity Tier 1 capital ratio (to risk-weighted assets)
Tier 1 risk-based capital ratio (to risk-weighted assets)
Total risk-based capital ratio
Under the final capital rules that became effective on January 1, 2015, there was a requirement for a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not maintain this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement was phased in over three years beginning in 2016. The capital buffer requirement effectively raises the minimum required common equity tier 1 capital ratio to 7.0%, the tier 1 capital ratio to 8.5%, and the total capital ratio to 10.5% on a fully phased-in basis on January 1, 2019. As of December 31, 2025, the Bank meets all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis.
The Corporation’s capital ratios are not materially different than those of the Bank.
LIQUIDITY MANAGEMENT
The Corporation’s objective is to maintain adequate liquidity to meet funding needs at a reasonable cost and provide contingency plans to meet unanticipated funding needs or a loss of funding sources, while minimizing interest rate risk. Adequate liquidity is needed to provide the funding requirements of depositors’ withdrawals, loan growth, and other operational needs.
Sources of liquidity are as follows:
Growth in the core deposit base;
Proceeds from sales or maturities of securities;
Payments received on loans and mortgage-backed and asset-backed securities;
Correspondent bank borrowings on various overnight credit lines, notes, etc., with various levels of capacity;
Securities sold under agreements to repurchase; and
Brokered CDs.
At December 31, 2025, the Corporation had $533,434,000 in available borrowing capacity at FHLB (inclusive of the outstanding balances of FHLB long-term notes, FHLB short-term borrowings and irrevocable standby letters of credit issued by FHLB); the maximum borrowing capacity at ACBB was $15,000,000 and the maximum borrowing capacity of the Federal Discount Window was $7,119,000.
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The Corporation enters into “Repurchase Agreements” in which it agrees to sell securities subject to an obligation to repurchase the same or similar securities. Because the agreement both entitles and obligates the Corporation to repurchase the assets, the Corporation may transfer legal control of the securities while still retaining effective control. As a result, the repurchase agreements are accounted for as collateralized financing agreements (secured borrowings) and act as an additional source of liquidity. Securities sold under agreements to repurchase were $36,845,000 at December 31, 2025.
Asset liquidity is provided by securities maturing in one year or less, other short-term investments, federal funds sold, and cash and due from banks. The liquidity is augmented by repayment of loans and cash flows from mortgage-backed and asset-backed securities. Liability liquidity is accomplished primarily by maintaining a core deposit base, acquired by attracting new deposits and retaining maturing and core deposits. Also, short-term borrowings provide funds to meet liquidity needs.
Net cash flows provided by operating activities were $11,163,000 and $8,645,000 as of December 31, 2025 and December 31, 2024, respectively. Net income amounted to $6,152,000 for the year ended December 31, 2025 compared to net loss of $13,203,000 for the year ended December 31, 2024. The provision for credit losses resulted in a balance of $4,701,000 for the year ended December 31, 2025 compared to $1,640,000 for the year ended December 31, 2024. Goodwill impairment amounted to $0 at December 31, 2025 compared to $19,133,000 at December 31, 2024. During the year ended December 31, 2025, net discount accretion on securities amounted to $86,000, compared to net premium amortization on securities of $273,000 for the year ended December 31, 2024. Net gains on sales of mortgage loans were $143,000 for the year ended December 31, 2025, compared to $80,000 for the year ended December 31, 2024. Originations of mortgage loans originated for resale exceeded proceeds (including gains) from sales of mortgage loans originated for resale by $272,000 and $446,000 for the years ended December 31, 2025 and 2024, respectively. Net securities gains were $224,000 for the year ended December 31, 2025, compared to $105,000 for the year ended December 31, 2024. Accrued interest receivable increased by $4,000 during the year ended December 31, 2025 and decreased by $208,000 during the year ended December 31, 2024. Accrued interest payable increased by $583,000 during the year ended December 31, 2025 and decreased by $671,000 during the year ended December 31, 2024. Other assets decreased by $584,000 during the year ended December 31, 2025 and increased by $808,000 during the year ended December 31, 2024. Other liabilities decreased by $906,000 and increased $1,721,000 during the years ended December 31, 2025 and 2024, respectively. Amortization of investment in low-income housing partnerships amounted to $819,000 for the years ended December 31, 2025 and 2024. Cash surrender value of bank owned life insurance increased by $666,000 during the year ended December 31, 2025 compared to an increase of $669,000 during the year ended December 31, 2024. A from bank owned life insurance proceeds was recognized during the year ended December 31, 2025 in relation to a death which amounted to $255,000, compared to the year ended December 31, 2024 when no were recognized in relation to bank owned life insurance proceeds.
Investing activities provided cash of $4,907,000 during the year ended December 31, 2025 and used cash of $33,158,000 during the year ended December 31, 2024. Net activity in the available-for-sale securities portfolio (including proceeds from sale, maturities, and redemptions, net against purchases) provided cash of $6,462,000 during the year ended December 31, 2025 and $4,419,000 during the year ended December 31, 2024. Net change in restricted investment in bank stocks provided cash of $40,000 during the year ended December 31, 2025 and $1,901,000 during the year ended December 31, 2024. Net cash used to originate loans amounted to $2,520,000 and $37,740,000 during the years ended December 31, 2025 and 2024, respectively. Proceeds from bank owned life insurance provided cash of $1,238,000 during the year ended December 31, 2025 compared to the year ended December 31, 2024 when there was no cash provided from bank-owned life insurance. Purchase of premises and equipment used cash of $313,000 and $1,728,000 during the years ended December 31, 2025 and 2024, respectively. Purchase of investment in real estate ventures used cash of $0 and $10,000 during the years ended December 31, 2025 and 2024, respectively.
Financing activities provided cash of $87,925,000 and $24,754,000 during the years ended December 31, 2025 and 2024, respectively. Deposits increased by $91,557,000 during the year ended December 31, 2025 and increased by $65,441,000 during the year ended December 31, 2024. Short-term borrowings increased by $2,419,000 during the year ended December 31, 2025 and decreased by $19,042,000 during the year ended December 31, 2024. Proceeds from long-term borrowings amounted to $0 for the year ended December 31, 2025, compared to $4,000,000 for the year ended December 31, 2024. Repayment of long-term borrowings used cash of $0 during the year ended December 31,
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2025 and $20,000,000 during the year ended December 31, 2024. Dividends paid amounted to $6,051,000 for the year ended December 31, 2025, compared to $5,645,000 for the year ended December 31, 2024.
Managing liquidity remains an important segment of asset/liability management. The overall liquidity position of the Corporation is maintained by an active asset/liability management committee. The Corporation believes that its core deposit base is stable even in periods of changing interest rates. Liquidity and funds management are governed by policies and measured on a monthly basis. These measurements indicate that liquidity generally remains stable and exceeds the Corporation’s minimum defined levels of adequacy. Other than the trends of continued competitive pressures and volatile interest rates, there are no known demands, commitments, events or uncertainties that will result in, or that are reasonably likely to result in, liquidity increasing or decreasing in any material way. Given our financial strength, we expect to be able to maintain adequate liquidity as we manage through the current environment, utilizing current funding options and possibly utilizing new options.
Table 17 represents scheduled maturities of the Corporation’s contractual obligations by time remaining until maturity as of December 31, 2025.
Table 17 — Contractual Obligations
(Dollars in thousands)
Less than
Over
December 31, 2025
1 Year
Years
Years
5 Years
Total
Time deposits
Securities sold under agreement to repurchase
Short-term borrowings
Long-term borrowings
Subordinated debentures
Operating lease obligations
Financing lease obligations
Off-Balance Sheet Arrangements
The Corporation is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and, to a lesser extent, standby letters of credit. At December 31, 2025, the Corporation had outstanding unfunded commitments to extend credit of $120,554,000 and outstanding standby letters of credit of $6,236,000. Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements. Please refer to Note 15 — Financial Instruments with Off-Balance Sheet Risk and Concentrations of Credit Risk for a discussion of the nature, business purpose, and importance of the Corporation’s off-balance sheet arrangements.
MARKET RISK
Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates and equity prices. The Corporation’s market risk is composed primarily of interest rate risk. The Corporation’s interest rate risk results from timing differences in the repricing of assets, liabilities, off-balance sheet instruments, and changes in relationships between rate indices and the potential exercise of explicit or embedded options.
Increases in the level of interest rates also may adversely affect the fair value of the Corporation’s securities and other earning assets. Generally, the fair value of fixed-rate instruments fluctuates inversely with changes in interest rates. As a result, increases in interest rates could result in decreases in the fair value of the Corporation’s interest-earning assets, which could adversely affect the Corporation’s results of operations if sold, or, in the case of interest-earning assets classified as available-for-sale, the Corporation’s stockholders’ equity, if retained. Under FASB Accounting
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Standards Codification (“ASC”) 320-10, Investments – Debt Securities , changes in the unrealized gains and losses, net of taxes, on debt securities classified as available-for-sale are reflected in the Corporation’s stockholders’ equity. The Corporation does not own any trading assets.
Asset/Liability Management
The principal objective of asset/liability management is to manage the sensitivity of the net interest margin to potential movements in interest rates and to enhance profitability through returns from managed levels of interest rate risk. The Corporation actively manages the interest rate sensitivity of its assets and liabilities. Table 18 presents an interest sensitivity analysis of assets and liabilities as of December 31, 2025. Several techniques are used for measuring interest rate sensitivity. Interest rate risk arises from the mismatches in the repricing of assets and liabilities within a given time period, referred to as a rate sensitivity gap. If more assets than liabilities mature or reprice within the time frame, the Corporation is asset sensitive. This position would contribute positively to net interest income in a rising rate environment. Conversely, if more liabilities mature or reprice, the Corporation is liability sensitive. This position would contribute positively to net interest income in a falling rate environment.
Limitations of interest rate sensitivity gap analysis as illustrated in Table 18 include: a) assets and liabilities which contractually reprice within the same period may not, in fact, reprice at the same time or to the same extent; b) changes in market interest rates do not affect all assets and liabilities to the same extent or at the same time, and c) interest rate sensitivity gaps reflect the Corporation’s position on a single day (December 31, 2025 in the case of the following schedule) while the Corporation continually adjusts its interest sensitivity throughout the year. The Corporation’s cumulative gap at one year indicates the Corporation is liability sensitive at December 31, 2025.
Table 18 — Interest Rate Sensitivity Analysis
(Dollars in thousands)
December 31, 2025
One
Beyond
Not Rate
Year
Years
5 Years
Sensitive
Total
Assets
Liabilities/Stockholders’ Equity
Interest Rate Sensitivity Gap
Cumulative Gap
Earnings at Risk
The Bank’s Asset/Liability Committee (“ALCO”) is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and limit exposure to interest rate risk. The guidelines established by ALCO are reviewed by the Corporation’s Board of Directors. The Corporation recognizes that more sophisticated tools exist for measuring the interest rate risk in the balance sheet beyond interest rate sensitivity gap. Although the Corporation continues to measure its interest rate sensitivity gap, the Corporation utilizes additional modeling for interest rate risk in the overall balance sheet. Earnings at risk and economic values at risk are analyzed.
Earnings simulation modeling addresses earnings at risk and net present value estimation addresses economic value at risk. While each of these interest rate risk measurements has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk to the Corporation.
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Earnings Simulation Modeling
The Corporation’s net income is affected by changes in the level of interest rates. Net income is also subject to changes in the shape of the yield curve. For example, a flattening of the yield curve would result in a decline in earnings due to the compression of earning asset yields and increased liability rates, while a steepening would result in increased earnings as earning asset and liability yields widen.
Earnings simulation modeling is the primary mechanism used in assessing the impact of changes in interest rates on net interest income. The model reflects management’s assumptions related to asset yields and rates paid on liabilities, deposit sensitivity, size and composition of the balance sheet. The assumptions are based on what management believes at that time to be the most likely interest rate environment. Earnings at risk is the change in net interest income from a base case scenario under various scenarios of rate shock increases and decreases in the interest rate earnings simulation model.
Table 19 presents an analysis of the changes in net interest income and net present value of the balance sheet resulting from various immediate shock increases or decreases in the level of interest rates, such as two percentage points (200 basis points) in the level of interest rates. The calculated estimates of change in net interest income and net present value of the balance sheet are compared to current limits approved by ALCO and the Board of Directors. The earnings simulation model projects net interest income would increase 2.36%, 4.14% and 5.72% in the 100, 200 and 300 basis point increasing rate scenarios presented. In addition, the earnings simulation model projects net interest income would decrease 5.61%, 11.90%, and 17.39% in the 100, 200, and 300 basis point decreasing rate scenarios, respectively. All of these forecasts are within the Corporation’s one year policy guidelines.
The analysis and model used to quantify the sensitivity of net interest income becomes less reliable in a decreasing rate scenario given the current interest rate environment with federal funds trading in the 350-375 basis point range and many deposit accounts still lagging at markedly lower rates. Results of the decreasing basis point declining scenarios are affected by the fact that many of the Corporation’s interest-bearing liabilities are at rates below 1% and therefore likely may not decline 100 or more basis points. However, the Corporation’s interest-sensitive assets are able to decline by these amounts. For the years ended December 31, 2025 and 2024, the cost of interest-bearing liabilities averaged 3.42% and 3.56%, respectively, and the yield on average interest-earning assets, on a fully taxable equivalent basis, averaged 5.45% and 5.30%, respectively.
Net Present Value Estimation
The net present value measures economic value at risk and is used for helping to determine levels of risk at a point in time present in the balance sheet that might not be taken into account in the earnings simulation model. The net present value of the balance sheet is defined as the discounted present value of asset cash flows minus the discounted present value of liability cash flows. At December 31, 2025, net present value is projected to decrease 3.19%, 7.19%, and 11.69% in the 100, 200 and 300 basis point immediate increase scenarios, respectively. Additionally, the 100, 200 and 300 basis point immediate decreases in rates are estimated to affect net present value with an increase of 1.36% in the 100 basis point immediate decrease scenario and decreases of 0.80% and 7.46% in the 200 and 300 basis point immediate decrease scenarios, respectively. All scenarios presented are within the Corporation’s policy limits.
The computation of the effects of hypothetical interest rate changes are based on many assumptions. They should not be relied upon solely as being indicative of actual results, since the computations do not account for actions management could undertake in response to changes in interest rates.
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Table 19 — Effect of Change in Interest Rates
December 31, 2025
Projected Change
Effect on Net Interest Income
1-Year Net Interest Income Simulation Projection
+300 bp Shock vs. Stable Rate
+200 bp Shock vs. Stable Rate
+100 bp Shock vs. Stable Rate
Flat rate
‒100 bp Shock vs. Stable Rate
‒200 bp Shock vs. Stable Rate
‒300 bp Shock vs. Stable Rate
Effect on Net Present Value of Balance Sheet
Static Net Present Value Change
+300 bp Shock vs. Stable Rate
+200 bp Shock vs. Stable Rate
+100 bp Shock vs. Stable Rate
Flat rate
‒100 bp Shock vs. Stable Rate
‒200 bp Shock vs. Stable Rate
‒300 bp Shock vs. Stable Rate
Table 20 shows the quarterly results of operations for the Corporation for the years ended December 31, 2025 and 2024:
Table 20 — Quarterly Results of Operations (Unaudited)
(Dollars in thousands, except per share data)
Three Months Ended
March 31
June 30
September 30
December 31
Interest income
Interest expense
Net interest income
Provision (credit) for credit losses
Non-interest income
Non-interest expense
Income before income tax expense (benefit)
Income tax expense (benefit)
Net income
Basic and diluted earnings per share
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(Dollars in thousands, except per share data)
Three Months Ended
March 31
June 30
September 30
December 31
Interest income
Interest expense
Net interest income
Provision for credit losses
Non-interest income
Non-interest expense
(Loss) income before income tax (benefit) expense
Income tax (benefit) expense
Net (loss) income
Basic and diluted (losses) earnings per share
Critical Accounting Estimates
The Corporation has chosen accounting policies that it believes are appropriate to accurately and fairly report its operating results and financial position, and the Corporation has applied those policies in a consistent manner.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America require that the Corporation make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates and assumptions are based on historical or other factors believed to be reasonable under the circumstances. The Corporation evaluates these estimates and assumptions on an ongoing basis and may retain outside consultants, lawyers and actuaries to assist in its evaluation. These estimates, assumptions and judgments are based on information available as of the date of the consolidated financial statements; accordingly, as this information changes, the consolidated financial statements could reflect different estimates, assumptions and judgments.
The Corporation considers three accounting policies to be critical because they involve the most significant judgments and estimates used in preparation of its consolidated financial statements. The three policies are the determination of allowance for credit losses, the determination of fair value of financial instruments, and the valuation of deferred tax assets.
Allowance for Credit Losses. The allowance for credit losses represents management’s estimate of losses arising from borrowers’ inability to make loan payments as required. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to specific expectations for the future economic environment, the Corporation’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may impact the borrower’s ability to repay (including the timing of future payments), the estimated value of any underlying collateral (if the loan is collateral dependent), the composition of the portfolio, and other relevant factors.
The evaluation of the allowance for credit losses is inherently subjective as it requires material estimates based upon management’s judgment regarding the projected credit losses over the contractual lifetime of the loans. The Corporation utilizes the Weighted Average Remaining Maturity (“WARM”) method to calculate the allowance for credit losses which utilizes an average annual charge-off rate containing loss content over several vintages. The average annual charge-off rate is used as a foundation for estimating the credit loss content for loans segmented by homogeneous pools (consistent with the segmentation of the FDIC Bank Call Report), determining a historical charge-off rate for each pool/segment. The methodology used to determine the allowance for credit losses also includes a qualitative component which adjusts loss estimates upward or downward, considering information not already captured in the loss estimation process. See “Allowance for Credit Losses – Loans” under Note 1 – Summary of Significant Accounting Policies for more information.
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Fair Value of Financial Instruments. A fair value hierarchy for valuation inputs is established by the fair value measurement and disclosure guidance and grants highest priority to unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities (Level 1). The next priority in the hierarchy is given to quoted prices in markets that are not active or inputs that are observable either directly or indirectly for substantially the full term of the asset or liability (Level 2). Lowest priority is given to prices or valuation techniques that require inputs that are both significant to the fair value measurement and are unobservable or supported by little to no market activity (Level 3).
Determining fair value measurement for financial instruments may require significant judgment by management in the application of valuation techniques and observable market inputs. The Corporation measures the fair value of certain financial instruments on a recurring basis, which include its available-for-sale investment portfolio and derivative instruments. Measurements related to available-for-sale investments and derivative instruments are primarily based on observable inputs such as interest rates, yield curves, and credit spreads and the majority of the instruments are classified as Level 2 of the fair value hierarchy. While the measurements used to determine fair value for available-for-sale investments and derivative instruments do not involve unobservable inputs, changes in market conditions could impact fair values.
Particularly for items that fall under Level 3 of the valuation hierarchy, management judgment is a key component in the determination of fair value, as the valuation techniques for these instruments rely on internal assessments and evaluations completed by management. See Note 17 – Fair Value Measurements for additional information.
Valuation of Deferred Tax Assets. Deferred income tax expense may result from changes in deferred tax assets and liabilities between periods. If it is more likely than not that some portion or all of a deferred tax asset will not be realized, deferred tax assets are reduced by a valuation allowance based on the weight of the evidence available at the time the analysis is performed. Deferred tax assets can only be recognized to the extent that it is probable that future taxable income will be available against which the unused tax credits can be applied; therefore, management’s judgment is required to assess the probability that such probable future taxable income will be available. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers facts, circumstances, and information available at the reporting date and is subject to management’s judgment. See “Income Taxes” under Note 1 – Summary of Significant Accounting Policies for more information.
