UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

x

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

 

For the quarterly period ended June 30, 2016

 

or

 

¨

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

For the transition period from _______________ to _________________________.

 

Commission file number: 000-16084

 

CITIZENS & NORTHERN CORPORATION

(Exact name of Registrant as specified in its charter)

 

PENNSYLVANIA	23-2451943
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

 

90-92 MAIN STREET, WELLSBORO, PA 16901

(Address of principal executive offices) (Zip code)

 

570-724-3411

(Registrant's telephone number including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

 

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.

Common Stock ($1.00 par value)

12,068,583 Shares Outstanding on August 1, 2016

 

 

CITIZENS & NORTHERN CORPORATION

 

Index

 

Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets (Unaudited) – June 30, 2016 and December 31, 2015	Page 3
Consolidated Statements of Income (Unaudited) – Three-month and  Six-month Periods Ended June 30, 2016 and 2015	Page 4
Consolidated Statements of Comprehensive Income (Unaudited) - Three-month and Six-month Periods Ended June 30, 2016 and 2015	Page 5
Consolidated Statements of Cash Flows (Unaudited) – Six Months Ended June 30, 2016 and 2015	Page 6
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) - Six Months Ended June 30, 2016 and 2015	Page 7
Notes to Unaudited Consolidated Financial Statements	Pages 8 – 39
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	Pages 40 – 58
Item 3. Quantitative and Qualitative Disclosures About Market Risk	Pages 59 – 61
Item 4. Controls and Procedures	Page 61
Part II. Other Information	Pages 62 – 63
Signatures	Page 64
Exhibit 10.1. Restricted Stock Agreement
Exhibit 31.1. Rule 13a-14(a)/15d-14(a) Certification - Chief Executive Officer
Exhibit 31.2. Rule 13a-14(a)/15d-14(a) Certification - Chief Financial Officer
Exhibit 32. Section 1350 Certifications

 

 

ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share and Per Share Data) (Unaudited)		June 30,				December 31,
		2016				2015
ASSETS
Cash and due from banks:
Noninterest-bearing		$	14,567			$	14,710
Interest-bearing			12,869				21,351
Total cash and due from banks			27,436				36,061
Available-for-sale securities, at fair value			417,205				420,290
Loans held for sale			381				280
Loans receivable			727,842				704,880
Allowance for loan losses			(7,929	)			(7,889	)
Loans, net			719,913				696,991
Bank-owned life insurance			19,511				20,764
Accrued interest receivable			3,837				3,768
Bank premises and equipment, net			15,339				15,406
Foreclosed assets held for sale			2,052				1,260
Deferred tax asset, net			425				3,115
Intangible asset - Core deposit intangibles			24				30
Intangible asset - Goodwill			11,942				11,942
Other assets			12,953				13,510
TOTAL ASSETS		$	1,231,018			$	1,223,417
LIABILITIES
Deposits:
Noninterest-bearing		$	215,004			$	211,041
Interest-bearing			752,947				724,574
Total deposits			967,951				935,615
Short-term borrowings			25,702				53,496
Long-term borrowings			38,615				38,767
Accrued interest and other liabilities			8,220				8,052
TOTAL LIABILITIES			1,040,488				1,035,930
STOCKHOLDERS' EQUITY
Preferred stock, $1,000 par value; authorized 30,000 shares; $1,000 liquidation preference per share; no shares issued at June 30, 2016 and December 31, 2015			0				0
Common stock, par value $1.00 per share; authorized 20,000,000 shares in 2016 and 2015; issued 12,655,171 at June 30, 2016 and December 31, 2015; outstanding 12,070,195 at June 30, 2016 and 12,180,623 December 31, 2015			12,655				12,655
Paid-in capital			71,391				71,654
Retained earnings			110,677				109,454
Treasury stock, at cost; 584,976 shares at June 30, 2016 and 474,548 shares at December 31, 2015			(11,087	)			(8,804	)
Sub-total			183,636				184,959
Accumulated other comprehensive income:
Unrealized gain on available-for-sale securities			6,849				2,493
Defined benefit plans gain			45				35
Total accumulated other comprehensive income			6,894				2,528
TOTAL STOCKHOLDERS' EQUITY			190,530				187,487
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY		$	1,231,018			$	1,223,417

 

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

 

 

Consolidated Statements of Income		3 Months Ended								6 Months Ended
(In Thousands Except Per Share Data) (Unaudited)		June 30,				June 30,				June 30,				June 30,
		2016				2015				2016				2015
INTEREST INCOME
Interest and fees on loans		$	8,086			$	7,753			$	16,060			$	15,462
Interest on balances with depository institutions			36				25				60				51
Interest on loans to political subdivisions			452				391				900				740
Interest on mortgages held for sale			8				3				14				5
Income from available-for-sale securities:
Taxable			1,490				1,934				3,045				3,908
Tax-exempt			847				1,013				1,743				2,029
Dividends			5				67				39				154
Total interest and dividend income			10,924				11,186				21,861				22,349
INTEREST EXPENSE
Interest on deposits			522				479				1,001				965
Interest on short-term borrowings			41				5				103				6
Interest on long-term borrowings			362				692				725				1,418
Total interest expense			925				1,176				1,829				2,389
Net interest income			9,999				10,010				20,032				19,960
Provision for loan losses			318				221				686				224
Net interest income after provision for loan losses			9,681				9,789				19,346				19,736
OTHER INCOME
Service charges on deposit accounts			1,164				1,305				2,302				2,327
Service charges and fees			123				123				217				236
Trust and financial management revenue			1,251				1,241				2,395				2,355
Brokerage revenue			180				206				353				425
Insurance commissions, fees and premiums			27				23				48				63
Interchange revenue from debit card transactions			487				500				950				974
Net gains from sale of loans			295				183				463				330
Decrease in fair value of servicing rights			(108	)			(33	)			(179	)			(150	)
Increase in cash surrender value of life insurance			93				102				189				199
Other operating income			394				312				858				759
Sub-total			3,906				3,962				7,596				7,518
Realized gains on available-for-sale securities, net			122				932				505				1,006
Total other income			4,028				4,894				8,101				8,524
OTHER EXPENSES
Salaries and wages			3,913				3,603				7,800				7,090
Pensions and other employee benefits			1,002				935				2,439				2,320
Occupancy expense, net			560				640				1,169				1,362
Furniture and equipment expense			439				467				866				921
FDIC Assessments			155				148				297				299
Pennsylvania shares tax			323				317				645				635
Professional fees			282				140				571				296
Automated teller machine and interchange expense			267				255				516				501
Software subscriptions			251				211				492				408
Loss on prepayment of debt			0				910				0				910
Other operating expense			1,343				1,248				2,812				2,665
Total other expenses			8,535				8,874				17,607				17,407
Income before income tax provision			5,174				5,809				9,840				10,853
Income tax provision			1,303				1,452				2,396				2,681
NET INCOME		$	3,871			$	4,357			$	7,444			$	8,172
NET INCOME PER SHARE - BASIC		$	0.32			$	0.36			$	0.61			$	0.67
NET INCOME PER SHARE - DILUTED		$	0.32			$	0.36			$	0.61			$	0.67

 

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

 

 

Consolidated Statements of Comprehensive Income		3 Months Ended								Six Months Ended
(In Thousands)		June 30,								June 30,
		2016				2015				2016				2015
Net income		$	3,871			$	4,357			$	7,444			$	8,172
Unrealized gains (losses) on available-for-sale securities:
Unrealized holding gains (losses) on available-for-sale securities			2,431				(4,572	)			7,205				(847	)
Reclassification adjustment for gains realized in income			(122	)			(932	)			(505	)			(1,006	)
Other comprehensive gain (loss) on available-for-sale securities			2,309				(5,504	)			6,700				(1,853	)
Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses included in accumulated other comprehensive gain (loss)			0				0				26				(100	)
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost			(5	)			(5	)			(10	)			(8	)
Other comprehensive (loss) gain on unfunded retirement obligations			(5	)			(5	)			16				(108	)
Other comprehensive income (loss) before income tax			2,304				(5,509	)			6,716				(1,961	)
Income tax related to other comprehensive income (loss)			(806	)			1,929				(2,350	)			687
Net other comprehensive income (loss)			1,498				(3,580	)			4,366				(1,274	)
Comprehensive income		$	5,369			$	777			$	11,810			$	6,898

 

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

 

 

CONSOLIDATED STATEMENTS OF CASH FLOWS		6 Months Ended
(In Thousands) (Unaudited)		June 30,				June 30,
		2016				2015
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	7,444			$	8,172
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses			686				224
Realized gains on available-for-sale securities, net			(505	)			(1,006	)
Loss on prepayment of debt			0				910
Realized loss (gain) on foreclosed assets			67				(61	)
Depreciation expense			787				958
Accretion and amortization on securities, net			660				791
Accretion and amortization on loans and deposits, net			(8	)			(10	)
Decrease in fair value of servicing rights			179				150
Increase in cash surrender value of life insurance			(189	)			(199	)
Stock-based compensation			325				307
Amortization of core deposit intangibles			6				11
Deferred income taxes			340				424
Gains on sales of loans, net			(463	)			(330	)
Origination of loans for sale			(12,698	)			(10,029	)
Proceeds from sales of loans			12,953				10,089
Increase in accrued interest receivable and other assets			(708	)			(1,225	)
(Decrease) increase in accrued interest payable and other liabilities			(296	)			681
Net Cash Provided by Operating Activities			8,580				9,857
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of certificates of deposit			100				0
Purchase of certificates of deposit			(340	)			0
Proceeds from sales of available-for-sale securities			19,387				11,255
Proceeds from calls and maturities of available-for-sale securities			37,009				41,777
Purchase of available-for-sale securities			(46,766	)			(35,200	)
Redemption of Federal Home Loan Bank of Pittsburgh stock			2,642				2,042
Purchase of Federal Home Loan Bank of Pittsburgh stock			(1,600	)			(2,960	)
Net increase in loans			(24,751	)			(34,153	)
Proceeds from bank owned life insurance			1,442				1,442
Purchase of premises and equipment			(720	)			(539	)
Return of principal on limited liability entity investments			82				99
Proceeds from sale of foreclosed assets			292				657
Net Cash Used in Investing Activities			(13,223	)			(15,580	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits			32,336				10,460
Net (decrease) increase in short-term borrowings			(27,794	)			14,269
Repayments of long-term borrowings			(152	)			(11,054	)
Purchase of treasury stock			(3,723	)			(3,415	)
Sale of treasury stock			100				378
Tax benefit from compensation plans			88				78
Common dividends paid			(5,557	)			(5,635	)
Net Cash (Used in) Provided by Financing Activities			(4,702	)			5,081
DECREASE IN CASH AND CASH EQUIVALENTS			(9,345	)			(642	)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR			33,313				31,619
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	23,968			$	30,977
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Accrued purchase of certificates of deposit		$	480			$	0
Assets acquired through foreclosure of real estate loans		$	1,151			$	630
Interest paid		$	1,826			$	2,404
Income taxes paid		$	1,485			$	1,645

 

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

 

 

Consolidated Statements of Changes in Stockholders' Equity
(In Thousands Except Share and Per Share Data)
(Unaudited)																						Accumulated
																						Other
		Common				Treasury				Common				Paid-in				Retained				Comprehensive				Treasury
		Shares				Shares				Stock				Capital				Earnings				Income				Stock				Total
Six Months Ended June 30, 2016
Balance, December 31, 2015			12,655,171				474,548			$	12,655			$	71,654			$	109,454			$	2,528			$	(8,804	)		$	187,487
Net income																			7,444												7,444
Other comprehensive income, net																							4,366								4,366
Cash dividends declared on common stock, $0.52 per share																			(6,298	)											(6,298	)
Shares issued for dividend reinvestment plan							(36,771	)							48												693				741
Treasury stock purchased							187,075																				(3,723	)			(3,723	)
Shares issued from treasury for exercise of stock options							(5,556	)							(9	)											109				100
Restricted stock granted							(35,427	)							(658	)											658				0
Forfeiture of restricted stock							1,107								20												(20	)			0
Stock-based compensation expense															325																325
Tax effect of stock option exercises															(1	)															(1	)
Tax benefit from dividends on restricted stock															12																12
Tax benefit from employee benefit plan																			77												77
Balance, June 30, 2016			12,655,171				584,976			$	12,655			$	71,391			$	110,677			$	6,894			$	(11,087	)		$	190,530
Six Months Ended June 30, 2015
Balance, December 31, 2014			12,655,171				375,191			$	12,655			$	71,541			$	105,550			$	5,360			$	(6,744	)		$	188,362
Net income																			8,172												8,172
Other comprehensive loss, net																							(1,274	)							(1,274	)
Cash dividends declared on common stock, $0.52 per share																			(6,373	)											(6,373	)
Shares issued for dividend reinvestment plan							(37,758	)							25												713				738
Treasury stock purchased							176,000																				(3,415	)			(3,415	)
Shares issued from treasury for exercise of stock options							(22,235	)							(26	)											404				378
Restricted stock granted							(34,800	)							(627	)											627				0
Forfeiture of restricted stock							1,943								33												(33	)			0
Stock-based compensation expense															307																307
Tax effect of stock option exercises															(6	)															(6	)
Tax benefit from dividends on restricted stock															11																11
Tax benefit from employee benefit plan																			73												73
Balance, June 30, 2015			12,655,171				458,341			$	12,655			$	71,258			$	107,422			$	4,086			$	(8,448	)		$	186,973

 

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

 

 

Notes to Unaudited Consolidated Financial Statements

 

1. BASIS OF INTERIM PRESENTATION

 

The consolidated financial information included herein, with the exception of the consolidated balance sheet dated December 31, 2015, is unaudited. Such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations, comprehensive income, cash flows and changes in stockholders’ equity for the interim periods; however, the information does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for a complete set of financial statements. Certain 2015 information has been reclassified for consistency with the 2016 presentation.

 

Operating results reported for the three-month and six-month periods ended June 30, 2016 might not be indicative of the results for the year ending December 31, 2016. The Corporation evaluates subsequent events through the date of filing with the Securities and Exchange Commission.

 

2. PER SHARE DATA

 

Net income per share is based on the weighted-average number of shares of common stock outstanding. The following data show the amounts used in computing basic and diluted net income per share. As shown in the table that follows, diluted earnings per share is computed using weighted average common shares outstanding, plus weighted-average common shares available from the exercise of all dilutive stock options, less the number of shares that could be repurchased with the proceeds of stock option exercises based on the average share price of the Corporation's common stock during the period.

 

						Weighted-
						Average				Earnings
		Net				Common				Per
		Income				Shares				Share
Six Months Ended June 30, 2016
Earnings per share – basic		$	7,444,000				12,108,743			$	0.61
Dilutive effect of potential common stock arising from stock options:
Exercise of outstanding stock options							197,817
Hypothetical share repurchase at $20.11							(176,659	)
Earnings per share – diluted		$	7,444,000				12,129,901			$	0.61
Six Months Ended June 30, 2015
Earnings per share – basic		$	8,172,000				12,233,964			$	0.67
Dilutive effect of potential common stock arising from stock options:
Exercise of outstanding stock options							218,115
Hypothetical share repurchase at $19.97							(196,407	)
Earnings per share – diluted		$	8,172,000				12,255,672			$	0.67

 

 

						Weighted-
						Average				Earnings
		Net				Common				Per
		Income				Shares				Share
Three Months Ended June 30, 2016
Earnings per share – basic		$	3,871,000				12,062,376			$	0.32
Dilutive effect of potential common stock arising from stock options:
Exercise of outstanding stock options							196,646
Hypothetical share repurchase at $20.17							(175,106	)
Earnings per share – diluted		$	3,871,000				12,083,916			$	0.32
Three Months Ended June 30, 2015
Earnings per share – basic		$	4,357,000				12,199,996			$	0.36
Dilutive effect of potential common stock arising from stock options:
Exercise of outstanding stock options							205,024
Hypothetical share repurchase at $20.15							(182,494	)
Earnings per share – diluted		$	4,357,000				12,222,526			$	0.36

 

Stock options that were anti-dilutive were excluded from net income per share calculations. Weighted-average common shares available from anti-dilutive instruments totaled 47,224 shares in the six-month period ended June 30, 2016, 75,539 shares in the six-month period ended June 30, 2015, 47,139 shares in the second quarter 2016 and 47,974 shares in the second quarter 2015.

 

3. COMPREHENSIVE INCOME

 

Comprehensive income is the total of (1) net income, and (2) all other changes in equity from non-stockholder sources, which are referred to as other comprehensive income. The components of other comprehensive income, and the related tax effects, are as follows:

 

(In Thousands)		Before-Tax				Income Tax				Net-of-Tax
		Amount				Effect				Amount
Six Months Ended June 30, 2016
Unrealized gains on available-for-sale securities:
Unrealized holding gains on available-for-sale securities		$	7,205			$	(2,521	)		$	4,684
Reclassification adjustment for (gains) realized in income			(505	)			177				(328	)
Other comprehensive income on available-for-sale securities			6,700				(2,344	)			4,356
Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses included in other comprehensive income			26				(9	)			17
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost			(10	)			3				(7	)
Other comprehensive income on unfunded retirement obligations			16				(6	)			10
Total other comprehensive income		$	6,716			$	(2,350	)		$	4,366

 

 

(In Thousands)		Before-Tax				Income Tax				Net-of-Tax
		Amount				Effect				Amount
Six Months Ended June 30, 2015
Unrealized losses on available-for-sale securities:
Unrealized holding losses on available-for-sale securities		$	(847	)		$	297			$	(550	)
Reclassification adjustment for (gains) realized in income			(1,006	)			352				(654	)
Other comprehensive loss on available-for-sale securities			(1,853	)			649				(1,204	)
Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses included in other comprehensive income			(100	)			35				(65	)
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost			(8	)			3				(5	)
Other comprehensive loss on unfunded retirement obligations			(108	)			38				(70	)
Total other comprehensive loss		$	(1,961	)		$	687			$	(1,274	)

 

(In Thousands)		Before-Tax				Income Tax				Net-of-Tax
		Amount				Effect				Amount
Three Months Ended June 30, 2016
Unrealized gains on available-for-sale securities:
Unrealized holding gains on available-for-sale securities		$	2,431			$	(850	)		$	1,581
Reclassification adjustment for (gains) realized in income			(122	)			43				(79	)
Other comprehensive income on available-for-sale securities			2,309				(807	)			1,502
Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses included in other comprehensive income			0				0				0
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost			(5	)			1				(4	)
Other comprehensive loss on unfunded retirement obligations			(5	)			1				(4	)
Total other comprehensive income		$	2,304			$	(806	)		$	1,498

 

(In Thousands)		Before-Tax				Income Tax				Net-of-Tax
		Amount				Effect				Amount
Three Months Ended June 30, 2015
Unrealized losses on available-for-sale securities:
Unrealized holding losses on available-for-sale securities		$	(4,572	)		$	1,601			$	(2,971	)
Reclassification adjustment for (gains) realized in income			(932	)			326				(606	)
Other comprehensive loss on available-for-sale securities			(5,504	)			1,927				(3,577	)
Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses included in other comprehensive income			0				0				0
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost			(5	)			2				(3	)
Other comprehensive loss on unfunded retirement obligations			(5	)			2				(3	)
Total other comprehensive loss		$	(5,509	)		$	1,929			$	(3,580	)

 

 

Changes in the components of accumulated other comprehensive income are as follows and are presented net of tax:

 

(In Thousands)						Unfunded				Accumulated
		Unrealized				Pension and				Other
		Holding Gains				Postretirement				Comprehensive
		on Securities				Obligations				Income
Six Months Ended June 30, 2016
Balance, beginning of period		$	2,493			$	35			$	2,528
Other comprehensive income before reclassifications			4,684				17				4,701
Amounts reclassified from accumulated other comprehensive income			(328	)			(7	)			(335	)
Other comprehensive income			4,356				10				4,366
Balance, end of period		$	6,849			$	45			$	6,894
Six Months Ended June 30, 2015
Balance, beginning of period		$	5,281			$	79			$	5,360
Other comprehensive loss before reclassifications			(550	)			(65	)			(615	)
Amounts reclassified from accumulated other comprehensive income			(654	)			(5	)			(659	)
Other comprehensive loss			(1,204	)			(70	)			(1,274	)
Balance, end of period		$	4,077			$	9			$	4,086
Three Months Ended June 30, 2016
Balance, beginning of period		$	5,347			$	49			$	5,396
Other comprehensive income before reclassifications			1,581				0				1,581
Amounts reclassified from accumulated other comprehensive income			(79	)			(4	)			(83	)
Other comprehensive income			1,502				(4	)			1,498
Balance, end of period		$	6,849			$	45			$	6,894
Three Months Ended June 30, 2015
Balance, beginning of period		$	7,654			$	12			$	7,666
Other comprehensive loss before reclassifications			(2,971	)			0				(2,971	)
Amounts reclassified from accumulated other comprehensive income			(606	)			(3	)			(609	)
Other comprehensive loss			(3,577	)			(3	)			(3,580	)
Balance, end of period		$	4,077			$	9			$	4,086

 

Items reclassified out of each component of other comprehensive income are as follows:

 

For the Six Months Ended June 30, 2016
(In Thousands)
		Reclassified from
Details about Accumulated Other		Accumulated Other				Affected Line Item in the Consolidated
Comprehensive Income Components		Comprehensive Income				Statements of Income
Unrealized gains and losses on available-for-sale securities		$	(505	)		Realized gains on available-for-sale securities, net
			177			Income tax provision
			(328	)		Net of tax
Amortization of defined benefit pension and postretirement items:
Prior service cost			(15	)		Pensions and other employee benefits
Actuarial loss			5			Pensions and other employee benefits
			(10	)		Total before tax
			3			Income tax provision
			(7	)		Net of tax
Total reclassifications for the period		$	(335	)

 

 

For the Six Months Ended June 30, 2015
(In Thousands)
		Reclassified from
Details about Accumulated Other		Accumulated Other				Affected Line Item in the Consolidated
Comprehensive Income Components		Comprehensive Income				Statements of Income
Unrealized gains and losses on available-for-sale securities		$	(1,006	)		Realized gains on available-for-sale securities, net
			352			Income tax provision
			(654	)		Net of tax
Amortization of defined benefit pension and postretirement items:
Prior service cost			(15	)		Pensions and other employee benefits
Actuarial loss			7			Pensions and other employee benefits
			(8	)		Total before tax
			3			Income tax provision
			(5	)		Net of tax
Total reclassifications for the period		$	(659	)

 

For the Three Months Ended June 30, 2016
(In Thousands)
		Reclassified from
Details about Accumulated Other		Accumulated Other				Affected Line Item in the Consolidated
Comprehensive Income Components		Comprehensive Income				Statements of Income
Unrealized gains and losses on available-for-sale securities		$	(122	)		Realized gains on available-for-sale securities, net
			43			Income tax provision
			(79	)		Net of tax
Amortization of defined benefit pension and postretirement items:
Prior service cost			(7	)		Pensions and other employee benefits
Actuarial loss			2			Pensions and other employee benefits
			(5	)		Total before tax
			1			Income tax provision
			(4	)		Net of tax
Total reclassifications for the period		$	(83	)

 

For the Three Months Ended June 30, 2015
(In Thousands)
		Reclassified from
Details about Accumulated Other		Accumulated Other				Affected Line Item in the Consolidated
Comprehensive Income Components		Comprehensive Income				Statements of Income
Unrealized gains and losses on available-for-sale securities		$	(932	)		Realized gains on available-for-sale securities, net
			326			Income tax provision
			(606	)		Net of tax
Amortization of defined benefit pension and postretirement items:
Prior service cost			(8	)		Pensions and other employee benefits
Actuarial loss			3			Pensions and other employee benefits
			(5	)		Total before tax
			2			Income tax provision
			(3	)		Net of tax
Total reclassifications for the period		$	(609	)

 

 

4. CASH AND DUE FROM BANKS

 

Cash and due from banks at June 30, 2016 and December 31, 2015 include the following:

 

(In thousands)		June 30,				Dec. 31,
		2016				2015
Cash and cash equivalents		$	23,968			$	33,313
Certificates of deposit			3,468				2,748
Total cash and due from banks		$	27,436			$	36,061

 

Certificates of deposit are issues by U.S. banks with original maturities greater than three months. Each certificate of deposit is fully FDIC-insured. The Corporation maintains cash and cash equivalents with certain financial institutions in excess of the FDIC insurance limit.

 

The Corporation is required to maintain reserves against deposit liabilities in the form of cash and balances with the Federal Reserve Bank of Philadelphia. The reserves are based on deposit levels, account activity, and other services provided by the Federal Reserve Bank. Required reserves were $12,532,000 at June 30, 2016 and $15,327,000 at December 31, 2015.

 

5. FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS

 

The Corporation measures certain assets at fair value. Fair value is defined as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date. FASB ASC topic 820, “Fair Value Measurements and Disclosures” establishes a framework for measuring fair value that includes a hierarchy used to classify the inputs used in measuring fair value. The hierarchy prioritizes the inputs used in determining valuations into three levels. The level in the fair value hierarchy within which the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement. The levels of the fair value hierarchy are as follows:

 

Level 1 – Fair value is based on unadjusted quoted prices in active markets that are accessible to the Corporation for identical assets. These generally provide the most reliable evidence and are used to measure fair value whenever available.

 

Level 2 – Fair value is based on significant inputs, other than Level 1 inputs, that are observable either directly or indirectly for substantially the full term of the asset through corroboration with observable market data. Level 2 inputs include quoted market prices in active markets for similar assets, quoted market prices in markets that are not active for identical or similar assets and other observable inputs.

 

Level 3 – Fair value is based on significant unobservable inputs. Examples of valuation methodologies that would result in Level 3 classification include option pricing models, discounted cash flows and other similar techniques.

 

The Corporation monitors and evaluates available data relating to fair value measurements on an ongoing basis and recognizes transfers among the levels of the fair value hierarchy as of the date of an event or change in circumstances that affects the valuation method chosen. Examples of such changes may include the market for a particular asset becoming active or inactive, changes in the availability of quoted prices, or changes in the availability of other market data.

 

 

At June 30, 2016 and December 31, 2015, assets measured at fair value and the valuation methods used are as follows:

 

						June 30, 2016
		Quoted Prices				Other
		in Active				Observable				Unobservable				Total
		Markets				Inputs				Inputs				Fair
(In Thousands)		(Level 1)				(Level 2)				(Level 3)				Value
Recurring fair value measurements
AVAILABLE-FOR-SALE SECURITIES:
Obligations of U.S. Government agencies		$	0			$	9,781			$	0			$	9,781
Obligations of states and political subdivisions:
Tax-exempt			0				116,056				0				116,056
Taxable			0				35,132				0				35,132
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities			0				65,407				0				65,407
Residential collateralized mortgage obligations			0				177,980				0				177,980
Commercial mortgage-backed securities			0				11,239				0				11,239
Collateralized debt obligations			0				1				0				1
Total debt securities			0				415,596				0				415,596
Marketable equity securities			1,609				0				0				1,609
Total available-for-sale securities			1,609				415,596				0				417,205
Servicing rights			0				0				1,224				1,224
Total recurring fair value measurements		$	1,609			$	415,596			$	1,224			$	418,429
Nonrecurring fair value measurements
Impaired loans with a valuation allowance		$	0			$	0			$	1,275			$	1,275
Valuation allowance			0				0				(253	)			(253	)
Impaired loans, net			0				0				1,022				1,022
Foreclosed assets held for sale			0				0				2,052				2,052
Total nonrecurring fair value measurements		$	0			$	0			$	3,074			$	3,074

 

 

						December 31, 2015
		Quoted Prices				Other
		in Active				Observable				Unobservable				Total
		Markets				Inputs				Inputs				Fair
(In Thousands)		(Level 1)				(Level 2)				(Level 3)				Value
Recurring fair value measurements
AVAILABLE-FOR-SALE SECURITIES:
Obligations of U.S. Government agencies		$	0			$	10,483			$	0			$	10,483
Obligations of states and political subdivisions:
Tax-exempt			0				107,757				0				107,757
Taxable			0				34,597				0				34,597
Mortgage-backed securities			0				73,343				0				73,343
Collateralized mortgage obligations, Issued by U.S. Government agencies			0				191,715				0				191,715
Collateralized debt obligations			0				9				0				9
Total debt securities			0				417,904				0				417,904
Marketable equity securities			2,386				0				0				2,386
Total available-for-sale securities			2,386				417,904				0				420,290
Servicing rights			0				0				1,296				1,296
Total recurring fair value measurements		$	2,386			$	417,904			$	1,296			$	421,586
Nonrecurring fair value measurements
Impaired loans with a valuation allowance		$	0			$	0			$	1,933			$	1,933
Valuation allowance			0				0				(820	)			(820	)
Impaired loans, net			0				0				1,113				1,113
Foreclosed assets held for sale			0				0				1,260				1,260
Total nonrecurring fair value measurements		$	0			$	0			$	2,373			$	2,373

 

Management’s evaluation and selection of valuation techniques and the unobservable inputs used in determining the fair values of assets valued using Level 3 methodologies include sensitive assumptions. Other market participants might use substantially different assumptions, which could result in calculations of fair values that would be substantially different than the amount calculated by management.

 

At June 30, 2016 and December 31, 2015, quantitative information regarding significant techniques and inputs used for assets measured on a recurring basis using unobservable inputs (Level 3 methodologies) are as follows:

 

		Fair Value at
		6/30/16				Valuation		Unobservable						Method or Value As of
Asset		(In Thousands)				Technique		Input(s)						6/30/16
Servicing rights		$	1,224			Discounted cash flow		Discount rate			10.00	%		Rate used through modeling period
								Loan prepayment speeds			181.00	%		Weighted-average PSA
								Servicing fees			0.25	%		of loan balances
											4.00	%		of payments are late
											5.00	%		late fees assessed
										$	1.94			Miscellaneous fees per account per month
								Servicing costs		$	6.00			Monthly servicing cost per account
										$	24.00			Additional monthly servicing cost per loan on loans more than 30 days delinquent
											1.50	%		of loans more than 30 days delinquent
											3.00	%		annual increase in servicing costs

 

 

		Fair Value at
		12/31/15				Valuation		Unobservable						Method or Value As of
Asset		(In Thousands)				Technique		Input(s)						12/31/15
Servicing rights		$	1,296			Discounted cash flow		Discount rate			10.00	%		Rate used through modeling period
								Loan prepayment speeds			146.00	%		Weighted-average PSA
								Servicing fees			0.25	%		of loan balances
											4.00	%		of payments are late
											5.00	%		late fees assessed
										$	1.94			Miscellaneous fees per account per month
								Servicing costs		$	6.00			Monthly servicing cost per account
										$	24.00			Additional monthly servicing cost per loan on loans more than 30 days delinquent
											1.50	%		of loans more than 30 days delinquent
											3.00	%		annual increase in servicing costs

 

The fair value of servicing rights is affected by expected future interest rates. Increases (decreases) in future expected interest rates tend to increase (decrease) the fair value of the Corporation’s servicing rights because of changes in expected prepayment behavior by the borrowers on the underlying loans.

 

Following is a reconciliation of activity for Level 3 assets measured at fair value on a recurring basis:

 

(In Thousands)		Three Months Ended								Six Months Ended
		June 30, 2016				June 30, 2015				June 30, 2016				June 30, 2015
Servicing rights balance, beginning of period		$	1,261			$	1,195			$	1,296			$	1,281
Issuances of servicing rights			71				47				107				78
Unrealized losses included in earnings			(108	)			(33	)			(179	)			(150	)
Servicing rights balance, end of period		$	1,224			$	1,209			$	1,224			$	1,209

 

Loans are classified as impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Foreclosed assets held for sale consist of real estate acquired by foreclosure. For impaired commercial loans secured by real estate and foreclosed assets held for sale, estimated fair values are determined primarily using values from third-party appraisals. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.

 

At June 30, 2016 and December 31, 2015, quantitative information regarding significant techniques and inputs used for nonrecurring fair value measurements using unobservable inputs (Level 3 methodologies) are as follows:

 

(In Thousands, Except																		Value at
Percentages)						Valuation												6/30/16
		Balance at				Allowance at				Fair Value at				Valuation		Unobservable		(Weighted
Asset		6/30/16				6/30/16				6/30/16				Technique		Inputs		Average)
Impaired loans:
Commercial:
Commercial loans secured by real estate		$	413			$	125			$	288			Sales comparison		Discount to appraised value			44	%
Commercial and industrial			354				77				277			Sales comparison		Discount to appraised value			54	%
Loans secured by farmland			508				51				457			Sales comparison		Discount to appraised value			55	%
Total impaired loans		$	1,275			$	253			$	1,022
Foreclosed assets held for sale - real estate:
Residential (1-4 family)		$	1,005			$	0			$	1,005			Sales comparison		Discount to appraised value			34	%
Land			1,047				0				1,047			Sales comparison		Discount to appraised value			39	%
Total foreclosed assets held for sale		$	2,052			$	0			$	2,052

 

 

(In Thousands, Except																		Value at
Percentages)						Valuation												12/31/15
		Balance at				Allowance at				Fair Value at				Valuation		Unobservable		(Weighted
Asset		12/31/15				12/31/15				12/31/15				Technique		Inputs		Average)
Impaired loans:
Residential mortgage loans - first liens		$	42			$	1			$	41			Sales comparison		Discount to appraised value			31	%
Commercial:
Commercial loans secured by
real estate			317				97				220			Sales comparison		Discount to appraised value			46	%
Commercial and industrial			75				75				0			Sales comparison		Discount to appraised value			31	%
Loans secured by farmland			512				52				460			Sales comparison		Discount to appraised value			49	%
Multi-family (5 or more) residential			987				595				392			Sales comparison		Discount to appraised value			41	%
Total impaired loans		$	1,933			$	820			$	1,113
Foreclosed assets held for sale -real estate:
Residential (1-4 family)		$	556			$	0			$	556			Sales comparison		Discount to appraised value			32	%
Land			704				0				704			Sales comparison		Discount to appraised value			29	%
Total foreclosed assets held for sale		$	1,260			$	0			$	1,260

 

Certain of the Corporation’s financial instruments are not measured at fair value in the consolidated financial statements. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from disclosure requirements. Therefore, the aggregate fair value amounts presented may not represent the underlying fair value of the Corporation.

 

The Corporation used the following methods and assumptions in estimating fair value disclosures for financial instruments:

 

CASH AND CASH EQUIVALENTS - The carrying amounts of cash and short-term instruments approximate fair values.

 

CERTIFICATES OF DEPOSIT - Fair values for certificates of deposit, included in cash and due from banks in the consolidated balance sheet, are based on quoted market prices for certificates of similar remaining maturities.

 

SECURITIES - Fair values for securities, excluding restricted equity securities, are based on quoted market prices or other methods as described above. The carrying value of restricted equity securities approximates fair value based on applicable redemption provisions.

 

LOANS HELD FOR SALE - Fair values of loans held for sale are determined based on applicable sale prices available under the Federal Home Loan Banks’ MPF Xtra and MPF Original programs.

 

LOANS - Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, commercial real estate, residential mortgage and other consumer. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories. The fair value of performing loans is calculated by discounting contractual cash flows, adjusted for estimated prepayments based on historical experience, using estimated market discount rates that reflect the credit and interest rate risk inherent in the loans. Fair value of nonperforming loans is based on recent appraisals or estimates prepared by the Corporation’s lending officers.

 

SERVICING RIGHTS - The fair value of servicing rights, included in other assets in the consolidated balance sheet, is determined through a discounted cash flow valuation. Significant inputs include expected net servicing income, the discount rate and the expected prepayment speeds of the underlying loans.

 

 

DEPOSITS - The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, money market and interest checking accounts, is (by definition) equal to the amount payable on demand at June 30, 2016 and December 31, 2015. The fair value of time deposits, such as certificates of deposit and Individual Retirement Accounts, is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered

for deposits of similar remaining maturities. The fair value estimates of deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market, commonly referred to as the core deposit intangible.

 

BORROWED FUNDS - The fair value of borrowings is estimated using discounted cash flow analyses based on rates currently available to the Corporation for similar types of borrowing arrangements.

 

ACCRUED INTEREST - The carrying amounts of accrued interest receivable and payable approximate fair values.

 

OFF-BALANCE SHEET COMMITMENTS - The Corporation has commitments to extend credit and has issued standby letters of credit. Standby letters of credit are conditional guarantees of performance by a customer to a third party. Estimates of the fair value of these off-balance sheet items were not made because of the short-term nature of these arrangements and the credit standing of the counterparties.

 

The estimated fair values, and related carrying amounts, of the Corporation’s financial instruments are as follows:

 

(In Thousands)		Valuation		June 30, 2016								December 31, 2015
		Method(s)		Carrying				Fair				Carrying				Fair
		Used		Amount				Value				Amount				Value
Financial assets:
Cash and cash equivalents		Level 1		$	23,968			$	23,968			$	33,313			$	33,313
Certificates of deposit		Level 2			3,468				3,500				2,748				2,752
Available-for-sale securities		See Above			417,205				417,205				420,290				420,290
Restricted equity securities (included in Other Assets)		Level 2			3,615				3,615				4,657				4,657
Loans held for sale		Level 2			381				381				280				280
Loans, net		Level 3			719,913				720,987				696,991				685,552
Accrued interest receivable		Level 2			3,837				3,837				3,768				3,768
Servicing rights		Level 3			1,224				1,224				1,296				1,296
Financial liabilities:
Deposits with no stated maturity		Level 2			737,817				737,817				713,931				713,931
Time deposits		Level 2			230,134				230,555				221,684				221,891
Short-term borrowings		Level 2			25,702				25,615				53,496				53,398
Long-term borrowings		Level 2			38,615				40,017				38,767				40,166
Accrued interest payable		Level 2			73				73				70				70

 

 

6. SECURITIES

 

Amortized cost and fair value of available-for-sale securities at June 30, 2016 and December 31, 2015 are summarized as follows:

 

						June 30, 2016
						Gross				Gross
						Unrealized				Unrealized
		Amortized				Holding				Holding				Fair
(In Thousands)		Cost				Gains				Losses				Value
Obligations of U.S. Government agencies		$	9,664			$	117			$	0			$	9,781
Obligations of states and political subdivisions:
Tax-exempt			110,702				5,374				(20	)			116,056
Taxable			34,015				1,117				0				35,132
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities			64,108				1,299				0				65,407
Residential collateralized mortgage obligations			175,889				2,354				(263	)			177,980
Commercial mortgage-backed securities			11,120				119				0				11,239
Collateralized debt obligations			1				0				0				1
Total debt securities			405,499				10,380				(283	)			415,596
Marketable equity securities			1,171				438				0				1,609
Total		$	406,670			$	10,818			$	(283	)		$	417,205

 

						December 31, 2015
						Gross				Gross
						Unrealized				Unrealized
		Amortized				Holding				Holding				Fair
(In Thousands)		Cost				Gains				Losses				Value
Obligations of U.S. Government agencies		$	10,663			$	12			$	(192	)		$	10,483
Obligations of states and political subdivisions:
Tax-exempt			103,414				4,365				(22	)			107,757
Taxable			34,317				381				(101	)			34,597
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities			73,227				486				(370	)			73,343
Residential collateralized mortgage obligations			193,145				623				(2,053	)			191,715
Collateralized debt obligations:			9				0				0				9
Total debt securities			414,775				5,867				(2,738	)			417,904
Marketable equity securities			1,680				706				0				2,386
Total		$	416,455			$	6,573			$	(2,738	)		$	420,290

 

 

The following table presents gross unrealized losses and fair value of available-for-sale securities with unrealized loss positions that are not deemed to be other-than-temporarily impaired, aggregated by length of time that individual securities have been in a continuous unrealized loss position at June 30, 2016 and December 31, 2015:

 

June 30, 2016		Less Than 12 Months								12 Months or More								Total
(In Thousands)		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
Obligations of states and political subdivisions, Tax-exempt		$	2,875			$	(6	)		$	1,002			$	(14	)		$	3,877			$	(20	)
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies,
Residential collateralized mortgage obligations			2,773				(73	)			25,995				(190	)			28,768				(263	)
Total temporarily impaired available-for-sale securities		$	5,648			$	(79	)		$	26,997			$	(204	)		$	32,645			$	(283	)

 

December 31, 2015		Less Than 12 Months								12 Months or More								Total
(In Thousands)		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
Obligations of U.S. Government agencies		$	0			$	0			$	7,850			$	(192	)		$	7,850			$	(192	)
Obligations of states and political subdivisions:
Tax-exempt			5,200				(19	)			216				(3	)			5,416				(22	)
Taxable			10,605				(60	)			2,910				(41	)			13,515				(101	)
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored Agencies:
Residential pass-through securities			38,764				(295	)			3,503				(75	)			42,267				(370	)
Residential collateralized mortgage obligations			88,355				(648	)			49,273				(1,405	)			137,628				(2,053	)
Total temporarily impaired available-for-sale securities		$	142,924			$	(1,022	)		$	63,752			$	(1,716	)		$	206,676			$	(2,738	)

 

Gross realized gains and losses from available-for-sale securities were as follows:

 

(In Thousands)		3 Months Ended								6 Months Ended
		June 30,				June 30,				June 30,				June 30,
		2016				2015				2016				2015
Gross realized gains from sales		$	123			$	932			$	506			$	1,006
Gross realized losses from sales			(1	)			0				(1	)			0
Net realized gains		$	122			$	932			$	505			$	1,006

 

 

The amortized cost and fair value of available-for-sale debt securities by contractual maturity are shown in the following table as of June 30, 2016. Actual maturities may differ from contractual maturities because counterparties may have the right to call or prepay obligations with or without call or prepayment penalties.

 

		Amortized				Fair
(In Thousands)		Cost				Value
Due in one year or less		$	11,792			$	11,899
Due from one year through five years			73,657				76,144
Due from five years through ten years			44,270				46,349
Due after ten years			24,663				26,578
Sub-total			154,382				160,970
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities			64,108				65,407
Residential collateralized mortgage obligations			175,889				177,980
Commercial mortgage-backed securities			11,120				11,239
Total		$	405,499			$	415,596

 

The Corporation’s mortgage-backed securities have stated maturities that may differ from actual maturities due to borrowers’ ability to prepay obligations. Cash flows from such investments are dependent upon the performance of the underlying mortgage loans and are generally influenced by the level of interest rates. In the table above, mortgage-backed securities and collateralized mortgage obligations are shown in one period.

 

Investment securities carried at $203,791,000 at June 30, 2016 and $228,616,000 at December 31, 2015 were pledged as collateral for public deposits, trusts and certain other deposits as provided by law. See Note 8 for information concerning securities pledged to secure borrowing arrangements.

 

Management evaluates securities for other-than-temporary impairment (OTTI) at least on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether the Corporation intends to sell the security or more likely than not will be required to sell the security before its anticipated recovery.

 

A summary of information management considered in evaluating debt and equity securities for OTTI at June 30, 2016 is provided below.

 

Debt Securities

 

At June 30, 2016, management performed an assessment for possible OTTI of the Corporation’s debt securities on an issue-by-issue basis, relying on information obtained from various sources, including publicly available financial data, ratings by external agencies, brokers and other sources. The extent of individual analysis applied to each security depended on the size of the Corporation’s investment, as well as management’s perception of the credit risk associated with each security. Based on the results of the assessment, management believes impairment of debt securities at June 30, 2016 to be temporary.

 

Equity Securities

 

The Corporation’s marketable equity securities at June 30, 2016 and December 31, 2015 consisted exclusively of stocks of banking companies. At June 30, 2016, the Corporation held no stocks with an unrealized loss.

 

The Corporation realized gains from sales of bank stocks totaling $28,000 in the three-month period ended June 30, 2016 and $277,000 during the first six months of 2016. Realized gains from sales of bank stocks totaled $476,000 in the three-month and six-month periods ended June 30, 2015.

 

 

C&N Bank is a member of the Federal Home Loan Bank of Pittsburgh (FHLB-Pittsburgh), which is one of 11 regional Federal Home Loan Banks. As a member, C&N Bank is required to purchase and maintain stock in FHLB-Pittsburgh. There is no active market for FHLB-Pittsburgh stock, and it must ordinarily be redeemed by FHLB-Pittsburgh in order to be liquidated. C&N Bank’s investment in FHLB-Pittsburgh stock, included in Other Assets in the consolidated balance sheet, was $3,485,000 at June 30, 2016 and $4,527,000 at December 31, 2015. The Corporation evaluated its holding of FHLB-Pittsburgh stock for impairment and deemed the stock to not be impaired at June 30, 2016 and December 31, 2015. In making this determination, management concluded that recovery of total outstanding par value, which equals the carrying value, is expected. The decision was based on review of financial information that FHLB-Pittsburgh has made publicly available.

 

7. LOANS

 

The loans receivable portfolio is segmented into residential mortgage, commercial and consumer loans. Loans outstanding at June 30, 2016 and December 31, 2015 are summarized by segment, and by classes within each segment, as follows:

 

Summary of Loans by Type
(In Thousands)		June 30,				Dec. 31,
		2016				2015
Residential mortgage:
Residential mortgage loans - first liens		$	315,191			$	304,783
Residential mortgage loans - junior liens			22,159				21,146
Home equity lines of credit			39,054				39,040
1-4 Family residential construction			22,241				21,121
Total residential mortgage			398,645				386,090
Commercial:
Commercial loans secured by real estate			153,070				154,779
Commercial and industrial			82,390				75,196
Political subdivisions			41,026				40,007
Commercial construction and land			9,193				5,122
Loans secured by farmland			6,615				7,019
Multi-family (5 or more) residential			8,173				9,188
Agricultural loans			4,692				4,671
Other commercial loans			11,904				12,152
Total commercial			317,063				308,134
Consumer			12,134				10,656
Total			727,842				704,880
Less: allowance for loan losses			(7,929	)			(7,889	)
Loans, net		$	719,913			$	696,991

 

The Corporation grants loans to individuals as well as commercial and tax-exempt entities. Commercial, residential and personal loans are made to customers geographically concentrated in the Pennsylvania and New York counties that comprise the market serviced by Citizens & Northern Bank. Although the Corporation has a diversified loan portfolio, a significant portion of its debtors’ ability to honor their contracts is dependent on the local economic conditions within the region. There is no concentration of loans to borrowers engaged in similar businesses or activities that exceed 10% of total loans at either June 30, 2016 or December 31, 2015.

 

The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and recorded as a reduction of the investment in loans. The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Corporation’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available. In the process of evaluating the loan portfolio, management also considers the Corporation’s exposure to losses from unfunded loan commitments. As of June 30, 2016 and December 31, 2015, management determined that no allowance for credit losses related to unfunded loan commitments was required.

 

 

Transactions within the allowance for loan losses, summarized by segment and class, for the three-month and six-month periods ended June 30, 2016 and 2015 were as follows:

 

Three Months Ended June 30, 2016		March 31,																June 30,
(In Thousands)		2016 Balance				Charge-offs				Recoveries				Provision (Credit)				2016 Balance
Allowance for Loan Losses:
Residential mortgage:
Residential mortgage loans - first liens		$	2,722			$	(42	)		$	0			$	150			$	2,830
Residential mortgage loans - junior liens			228				0				0				11				239
Home equity lines of credit			351				0				0				8				359
1-4 Family residential construction			200				0				0				22				222
Total residential mortgage			3,501				(42	)			0				191				3,650
Commercial:
Commercial loans secured by real estate			2,027				0				1				55				2,083
Commercial and industrial			976				0				0				62				1,038
Commercial construction and land			84				0				0				21				105
Loans secured by farmland			108				0				0				(5	)			103
Multi-family (5 or more) residential			256				0				0				(8	)			248
Agricultural loans			44				0				0				3				47
Other commercial loans			112				0				0				7				119
Total commercial			3,607				0				1				135				3,743
Consumer			126				(21	)			12				21				138
Unallocated			427				0				0				(29	)			398
Total Allowance for Loan Losses		$	7,661			$	(63	)		$	13			$	318			$	7,929

 

Three Months Ended June 30, 2015		March 31,																June 30,
(In Thousands)		2015 Balance				Charge-offs				Recoveries				Provision (Credit)				2015 Balance
Allowance for Loan Losses:
Residential mortgage:
Residential mortgage loans - first liens		$	2,774			$	(58	)		$	0			$	59			$	2,775
Residential mortgage loans - junior liens			200				0				0				10				210
Home equity lines of credit			322				0				0				22				344
1-4 Family residential construction			207				0				0				50				257
Total residential mortgage			3,503				(58	)			0				141				3,586
Commercial:
Commercial loans secured by real estate			1,736				0				0				(44	)			1,692
Commercial and industrial			684				0				3				113				800
Commercial construction and land			286				0				0				10				296
Loans secured by farmland			159				0				0				(4	)			155
Multi-family (5 or more) residential			81				0				0				(1	)			80
Agricultural loans			29				0				0				11				40
Other commercial loans			123				0				0				(3	)			120
Total commercial			3,098				0				3				82				3,183
Consumer			139				(19	)			19				(4	)			135
Unallocated			394				0				0				2				396
Total Allowance for Loan Losses		$	7,134			$	(77	)		$	22			$	221			$	7,300

 

 

Six Months Ended June 30, 2016		Dec. 31,																June 30,
(In Thousands)		2015 Balance				Charge-offs				Recoveries				Provision (Credit)				2016 Balance
Allowance for Loan Losses:
Residential mortgage:
Residential mortgage loans - first liens		$	2,645			$	(42	)		$	0			$	227			$	2,830
Residential mortgage loans - junior liens			219				0				0				20				239
Home equity lines of credit			347				0				0				12				359
1-4 Family residential construction			207				0				0				15				222
Total residential mortgage			3,418				(42	)			0				274				3,650
Commercial:
Commercial loans secured by real estate			1,939				0				2				142				2,083
Commercial and industrial			981				0				1				56				1,038
Commercial construction and land			58				0				0				47				105
Loans secured by farmland			106				0				0				(3	)			103
Multi-family (5 or more) residential			675				(595	)			0				168				248
Agricultural loans			45				0				0				2				47
Other commercial loans			118				0				0				1				119
Total commercial			3,922				(595	)			3				413				3,743
Consumer			122				(39	)			27				28				138
Unallocated			427				0				0				(29	)			398
Total Allowance for Loan Losses		$	7,889			$	(676	)		$	30			$	686			$	7,929

 

Six Months Ended June 30, 2015		Dec. 31,																June 30,
(In Thousands)		2014 Balance				Charge-offs				Recoveries				Provision (Credit)				2015 Balance
Allowance for Loan Losses:
Residential mortgage:
Residential mortgage loans - first liens		$	2,941			$	(137	)		$	1			$	(30	)		$	2,775
Residential mortgage loans - junior liens			176				0				0				34				210
Home equity lines of credit			322				0				0				22				344
1-4 Family residential construction			214				0				0				43				257
Total residential mortgage			3,653				(137	)			1				69				3,586
Commercial:
Commercial loans secured by real estate			1,758				(115	)			0				49				1,692
Commercial and industrial			688				(10	)			4				118				800
Commercial construction and land			283				0				0				13				296
Loans secured by farmland			165				0				0				(10	)			155
Multi-family (5 or more) residential			87				0				0				(7	)			80
Agricultural loans			31				0				0				9				40
Other commercial loans			131				0				0				(11	)			120
Total commercial			3,143				(125	)			4				161				3,183
Consumer			145				(37	)			34				(7	)			135
Unallocated			395				0				0				1				396
Total Allowance for Loan Losses		$	7,336			$	(299	)		$	39			$	224			$	7,300

 

 

In the evaluation of the loan portfolio, management determines two major components for the allowance for loan losses – (1) a specific component based on an assessment of certain larger relationships, mainly commercial purpose loans, on a loan-by-loan basis; and (2) a general component for the remainder of the portfolio based on a collective evaluation of pools of loans with similar risk characteristics. The general component is assigned to each pool of loans based on both historical net charge-off experience, and an evaluation of certain qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the above methodologies for estimating specific and general losses in the portfolio.

 

In determining the larger loan relationships for detailed assessment under the specific allowance component, the Corporation uses an internal risk rating system. Under the risk rating system, the Corporation classifies problem or potential problem loans as “Special Mention,” “Substandard,” or “Doubtful” on the basis of currently existing facts, conditions and values. Substandard loans include those characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected. Loans classified as Doubtful have all the weaknesses inherent in those classified as Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans that do not currently expose the Corporation to sufficient risk to warrant classification as Substandard or Doubtful, but possess weaknesses that deserve management’s close attention, are deemed to be Special Mention. Risk ratings are updated any time that conditions or the situation warrants. Loans not classified are included in the “Pass” column in the table below.

 

The following tables summarize the aggregate credit quality classification of outstanding loans by risk rating as of June 30, 2016 and December 31, 2015:

 

June 30, 2016
(In Thousands)						Special
		Pass				Mention				Substandard				Doubtful				Total
Residential Mortgage:
Residential mortgage loans - first liens		$	304,713			$	562			$	9,852			$	64			$	315,191
Residential mortgage loans - junior liens			21,591				154				414				0				22,159
Home equity lines of credit			38,030				423				601				0				39,054
1-4 Family residential construction			22,225				16				0				0				22,241
Total residential mortgage			386,559				1,155				10,867				64				398,645
Commercial:
Commercial loans secured by real estate			135,738				5,941				11,391				0				153,070
Commercial and Industrial			77,197				3,509				1,558				126				82,390
Political subdivisions			41,026				0				0				0				41,026
Commercial construction and land			9,096				60				37				0				9,193
Loans secured by farmland			4,911				169				1,517				18				6,615
Multi-family (5 or more) residential			7,538				0				635				0				8,173
Agricultural loans			3,862				817				13				0				4,692
Other commercial loans			11,828				0				76				0				11,904
Total commercial			291,196				10,496				15,227				144				317,063
Consumer			11,922				1				211				0				12,134
Totals		$	689,677			$	11,652			$	26,305			$	208			$	727,842

 

 

December 31, 2015
(In Thousands)						Special
		Pass				Mention				Substandard				Doubtful				Total
Residential Mortgage:
Residential mortgage loans - first liens		$	295,302			$	407			$	9,007			$	67			$	304,783
Residential mortgage loans - junior liens			20,558				185				403				0				21,146
Home equity lines of credit			38,071				543				426				0				39,040
1-4 Family residential construction			21,104				17				0				0				21,121
Total residential mortgage			375,035				1,152				9,836				67				386,090
Commercial:
Commercial loans secured by real estate			140,381				5,862				8,536				0				154,779
Commercial and Industrial			71,225				2,106				1,737				128				75,196
Political subdivisions			40,007				0				0				0				40,007
Commercial construction and land			4,957				60				105				0				5,122
Loans secured by farmland			5,084				483				1,432				20				7,019
Multi-family (5 or more) residential			7,943				0				1,245				0				9,188
Agricultural loans			4,655				0				16				0				4,671
Other commercial loans			12,073				0				79				0				12,152
Total commercial			286,325				8,511				13,150				148				308,134
Consumer			10,490				21				145				0				10,656
Totals		$	671,850			$	9,684			$	23,131			$	215			$	704,880

 

The general component of the allowance for loan losses covers pools of loans including commercial loans not considered individually impaired, as well as smaller balance homogeneous classes of loans, such as residential real estate, home equity lines of credit and other consumer loans. Accordingly, the Corporation generally does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are subject to a restructuring agreement. The pools of loans are evaluated for loss exposure based upon three-year average historical net charge-off rates for each loan class, adjusted for qualitative factors. Qualitative risk factors (described in the following paragraph) are evaluated for the impact on each of the three segments (residential mortgage, commercial and consumer) within the loan portfolio. Each qualitative factor is assigned a value to reflect improving, stable or declining conditions based on management’s judgment using relevant information available at the time of the evaluation. The adjustment for qualitative factors is applied as an increase or decrease to the three-year average net charge-off rate to each loan class within each segment.

 

The qualitative factors used in the general component calculations are designed to address credit risk characteristics associated with each segment. The Corporation’s credit risk associated with all of the segments is significantly impacted by these factors, which include economic conditions within its market area, the Corporation’s lending policies, changes or trends in the portfolio, risk profile, competition, regulatory requirements and other factors. Further, the residential mortgage segment is significantly affected by the values of residential real estate that provide collateral for the loans. The majority of the Corporation’s commercial segment loans (approximately 56% at June 30, 2016) is secured by real estate, and accordingly, the Corporation’s risk for the commercial segment is significantly affected by commercial real estate values. The consumer segment includes a wide mix of loans for different purposes, primarily secured loans, including loans secured by motor vehicles, manufactured housing and other types of collateral.

 

Loans are classified as impaired, when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial loans, by the fair value of the collateral (if the loan is collateral dependent), by future cash flows discounted at the loan’s effective rate or by the loan’s observable market price.

 

 

The scope of loans evaluated individually for impairment include all loan relationships greater than $200,000 for which there is at least one extension of credit graded Special Mention, Substandard or Doubtful. Also, all loans classified as troubled debt restructurings (discussed in more detail below) and all loan relationships less than $200,000 in the aggregate, but with an estimated loss of $100,000 or more, are individually evaluated for impairment. Loans that are individually evaluated for impairment, but which are not determined to be impaired, are combined with all remaining loans that are not reviewed on a specific basis, and such loans are included within larger pools of loans based on similar risk and loss characteristics for purposes of determining the general component of the allowance. The loans that have been individually evaluated, but which have not been determined to be impaired, are included in the “Collectively Evaluated” column in the tables summarizing the allowance and associated loan balances as of June 30, 2016 and December 31, 2015.

 

The following tables present a summary of loan balances and the related allowance for loan losses summarized by portfolio segment and class for each impairment method used as of June 30, 2016 and December 31, 2015:

 

June 30, 2016		Loans:												Allowance for Loan Losses:
(In Thousands)
		Individually				Collectively								Individually				Collectively
		Evaluated				Evaluated				Totals				Evaluated				Evaluated				Totals
Residential mortgage:
Residential mortgage loans - first liens		$	824			$	314,367			$	315,191			$	0			$	2,830			$	2,830
Residential mortgage loans - junior liens			71				22,088				22,159				0				239				239
Home equity lines of credit			0				39,054				39,054				0				359				359
1-4 Family residential construction			0				22,241				22,241				0				222				222
Total residential mortgage			895				397,750				398,645				0				3,650				3,650
Commercial:
Commercial loans secured by real estate			5,856				147,214				153,070				125				1,958				2,083
Commercial and industrial			766				81,624				82,390				77				961				1,038
Political subdivisions			0				41,026				41,026				0				0				0
Commercial construction and land			0				9,193				9,193				0				105				105
Loans secured by farmland			1,408				5,207				6,615				51				52				103
Multi-family (5 or more) residential			392				7,781				8,173				0				248				248
Agricultural loans			13				4,679				4,692				0				47				47
Other commercial loans			0				11,904				11,904				0				119				119
Total commercial			8,435				308,628				317,063				253				3,490				3,743
Consumer			0				12,134				12,134				0				138				138
Unallocated																							398
Total		$	9,330			$	718,512			$	727,842			$	253			$	7,278			$	7,929

 

 

December 31, 2015		Loans:												Allowance for Loan Losses:
(In Thousands)
		Individually				Collectively								Individually				Collectively
		Evaluated				Evaluated				Totals				Evaluated				Evaluated				Totals
Residential mortgage:
Residential mortgage loans - first liens		$	884			$	303,899			$	304,783			$	1			$	2,644			$	2,645
Residential mortgage loans - junior liens			74				21,072				21,146				0				219				219
Home equity lines of credit			0				39,040				39,040				0				347				347
1-4 Family residential construction			0				21,121				21,121				0				207				207
Total residential mortgage			958				385,132				386,090				1				3,417				3,418
Commercial:
Commercial loans secured by real estate			6,262				148,517				154,779				97				1,842				1,939
Commercial and industrial			324				74,872				75,196				75				906				981
Political subdivisions			0				40,007				40,007				0				0				0
Commercial construction and land			0				5,122				5,122				0				58				58
Loans secured by farmland			1,427				5,592				7,019				52				54				106
Multi-family (5 or more) residential			987				8,201				9,188				595				80				675
Agricultural loans			16				4,655				4,671				0				45				45
Other commercial loans			0				12,152				12,152				0				118				118
Total commercial			9,016				299,118				308,134				819				3,103				3,922
Consumer			0				10,656				10,656				0				122				122
Unallocated																							427
Total		$	9,974			$	694,906			$	704,880			$	820			$	6,642			$	7,889

 

Summary information related to impaired loans at June 30, 2016 and December 31, 2015 is as follows:

 

(In Thousands)		June 30, 2016												December 31, 2015
		Unpaid												Unpaid
		Principal				Recorded				Related				Principal				Recorded				Related
		Balance				Investment				Allowance				Balance				Investment				Allowance
With no related allowance recorded:
Residential mortgage loans - first liens		$	824			$	824			$	0			$	842			$	842			$	0
Residential mortgage loans - junior liens			71				71				0				74				74				0
Commercial loans secured by real estate			7,127				5,443				0				7,580				5,945				0
Commercial and industrial			412				412				0				249				249				0
Loans secured by farmland			900				900				0				915				915				0
Multi-family (5 or more) residential			987				392				0				0				0				0
Agricultural loans			13				13				0				16				16				0
Total with no related allowance recorded			10,334				8,055				0				9,676				8,041				0
With a related allowance recorded:
Residential mortgage loans - first liens			0				0				0				42				42				1
Commercial loans secured by real estate			413				413				125				317				317				97
Commercial and industrial			354				354				77				75				75				75
Loans secured by farmland			508				508				51				512				512				52
Multi-family (5 or more) residential			0				0				0				987				987				595
Total with a related allowance recorded			1,275				1,275				253				1,933				1,933				820
Total		$	11,609			$	9,330			$	253			$	11,609			$	9,974			$	820

 

 

The average balance of impaired loans and interest income recognized on impaired loans is as follows:

 

																		Interest Income Recognized on
		Average Investment in Impaired Loans																Impaired Loans on a Cash Basis
(In Thousands)		3 Months Ended								6 Months Ended								3 Months Ended								6 Months Ended
		June 30,								June 30,								June 30,								June 30,
		2016				2015				2016				2015				2016				2015				2016				2015
Residential mortgage:
Residential mortgage loans - first lien		$	833			$	3,701			$	847			$	3,819			$	12			$	20			$	22			$	58
Residential mortgage loans - junior lien			71				66				72				57				1				1				2				2
Total residential mortgage			904				3,767				919				3,876				13				21				24				60
Commercial:
Commercial loans secured by real estate			5,892				6,286				6,026				6,437				81				90				191				203
Commercial and industrial			754				423				661				513				7				5				10				12
Commercial construction and land			0				41				0				58				0				0				0				0
Loans secured by farmland			1,413				1,447				1,418				1,468				17				26				38				52
Multi-family (5 or more) residential			490				0				590				0				0				0				0				0
Agricultural loans			15				46				15				23				0				2				1				2
Total commercial			8,564				8,243				8,710				8,499				105				123				240				269
Consumer			18				0				15				0				0				0				0				0
Total		$	9,486			$	12,010			$	9,644			$	12,375			$	118			$	144			$	264			$	329

 

Loans are placed on nonaccrual status for all classes of loans when, in the opinion of management, collection of interest is doubtful. Any unpaid interest previously accrued on those loans is reversed from income. Interest income is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on loans for which the risk of further loss is greater than remote are applied as a reduction of the loan principal balance. Interest income on other nonaccrual loans, including impaired loans, is recognized only to the extent of interest payments received. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectability of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans receivable is determined based on contractual due dates for loan payments. Also, the amortization of deferred loan fees is discontinued when a loan is placed on nonaccrual status.

 

The breakdown by portfolio segment and class of nonaccrual loans and loans past due ninety days or more and still accruing is as follows:

 

(In Thousands)		June 30, 2016								December 31, 2015
		Past Due								Past Due
		90+ Days and								90+ Days and
		Accruing				Nonaccrual				Accruing				Nonaccrual
Residential mortgage:
Residential mortgage loans - first liens		$	3,663			$	2,739			$	2,381			$	3,044
Residential mortgage loans - junior liens			44				0				79				0
Home equity lines of credit			285				12				130				0
Total residential mortgage			3,992				2,751				2,590				3,044
Commercial:
Commercial loans secured by real estate			135				5,592				503				5,730
Commercial and industrial			313				310				65				313
Loans secured by farmland			102				1,408				0				1,427
Multi-family (5 or more) residential			0				392				0				987
Agricultural loans			76				13				0				16
Total commercial			626				7,715				568				8,473
Consumer			36				38				71				0
Totals		$	4,654			$	10,504			$	3,229			$	11,517

 

 

The amounts shown in the table immediately above include loans classified as troubled debt restructurings (described in more detail below), if such loans are past due ninety days or more or nonaccrual.

 

The table below presents a summary of the contractual aging of loans as of June 30, 2016 and December 31, 2015:

 

		As of June 30, 2016																As of December 31, 2015
		Current &																Current &
(In Thousands)		Past Due				Past Due				Past Due								Past Due				Past Due				Past Due
		Less than				30-89				90+								Less than				30-89				90+
		30 Days				Days				Days				Total				30 Days				Days				Days				Total
Residential mortgage:
Residential mortgage loans - first liens		$	306,697			$	3,852			$	4,642			$	315,191			$	294,703			$	6,156			$	3,924			$	304,783
Residential mortgage loans - junior liens			21,826				289				44				22,159				20,816				251				79				21,146
Home equity lines of credit			38,527				242				285				39,054				38,581				329				130				39,040
1-4 Family residential construction			22,241				0				0				22,241				21,121				0				0				21,121
Total residential mortgage			389,291				4,383				4,971				398,645				375,221				6,736				4,133				386,090
Commercial:
Commercial loans secured by real estate			149,599				2,762				709				153,070				153,427				108				1,244				154,779
Commercial and industrial			81,927				139				324				82,390				75,002				118				76				75,196
Political subdivisions			41,026				0				0				41,026				40,007				0				0				40,007
Commercial construction and land			9,193				0				0				9,193				5,018				104				0				5,122
Loans secured by farmland			5,413				284				918				6,615				5,970				223				826				7,019
Multi-family (5 or more) residential			7,713				68				392				8,173				8,201				0				987				9,188
Agricultural loans			4,560				43				89				4,692				4,642				13				16				4,671
Other commercial loans			11,904				0				0				11,904				12,152				0				0				12,152
Total commercial			311,335				3,296				2,432				317,063				304,419				566				3,149				308,134
Consumer			11,979				81				74				12,134				10,537				48				71				10,656
Totals		$	712,605			$	7,760			$	7,477			$	727,842			$	690,177			$	7,350			$	7,353			$	704,880

 

Nonaccrual loans are included in the contractual aging in the immediately preceding table. A summary of the contractual aging of nonaccrual loans at June 30, 2016 and December 31, 2015 is as follows:

 

		Current &
(In Thousands)		Past Due				Past Due				Past Due
		Less than				30-89				90+
		30 Days				Days				Days				Total
June 30, 2016 Nonaccrual Totals		$	6,866			$	815			$	2,823			$	10,504
December 31, 2015 Nonaccrual Totals		$	7,100			$	293			$	4,124			$	11,517

 

Loans whose terms are modified are classified as Troubled Debt Restructurings (TDRs) if the Corporation grants such borrowers concessions, and it is deemed that those borrowers are experiencing financial difficulty. Loans classified as TDRs are designated as impaired. The outstanding balance of loans subject to TDRs, as well as contractual aging information at June 30, 2016 and December 31, 2015 is as follows:

 

		Current &
(In Thousands)		Past Due				Past Due				Past Due
		Less than				30-89				90+
		30 Days				Days				Days				Nonaccrual				Total
June 30, 2016 Totals		$	989			$	58			$	81			$	5,021			$	6,149
December 31, 2015 Totals		$	1,186			$	0			$	81			$	5,097			$	6,364

 

 

The TDR that occurred during the three-month period ended June 30, 2016 is as follows:

 

Three Months Ended June 30, 2016

Pre-

Post-

(Balances in Thousands)

Modification

Modification

Number

Outstanding

Outstanding

of

Recorded

Recorded

Contracts

Investment

Investment

Commercial,

Commercial and industrial

1

$

102

$

102

 

There were no TDRs that occurred during the three-month period ended June 30, 2015.

 

The TDR in the three-month period ended June 30, 2016 resulted from an extension of a final maturity date and a lowered interest rate. There was a $30,000 allowance for loan losses on this loan at June 30, 2016 as compared to no allowance for loan losses on the loan prior to the second quarter 2016.

 

TDRs that occurred during the six-month periods ended June 30, 2016 and 2015 were as follows:

 

Six Months Ended June 30, 2016

Pre-

Post-

(Balances in Thousands)

Modification

Modification

Number

Outstanding

Outstanding

of

Recorded

Recorded

Contracts

Investment

Investment

Commercial,

Commercial and industrial

2

$

107

$

107

 

Six Months Ended June 30, 2015

Pre-

Post-

(Balances in Thousands)

Modification

Modification

Number

Outstanding

Outstanding

of

Recorded

Recorded

Contracts

Investment

Investment

Residential mortgage:

Residential mortgage loans - first liens

1

$

56

$

56

Residential mortgage loans - junior liens

1

32

32

Consumer

1

30

30

 

The TDRs in the six-month period ended June 30, 2016 included an extension of a final maturity date and a lowered interest rate on one contract and an extension of a final maturity date on one contract. There was a $30,000 allowance for loan losses on the commercial and industrial loan that included an extension of a final maturity date and a lowered interest rate at June 30, 2016 as compared to no allowance for loan losses on the loan at December 31, 2015. There was no allowance for loan losses at June 30, 2016 on the other commercial and industrial loan (TDR), and no change in the allowance for loan losses resulting from that TDR in the six-month period ended June 30, 2016.

 

The TDRs in the six-month period ended June 30, 2015 included an extended maturity date and a reduction in interest rate on a residential mortgage – first lien, a lowered interest rate and reduced payment amount on a residential mortgage – junior lien and a lowered interest rate and reduced payment amount on the consumer loan. There was no allowance for loan losses on these loans at June 30, 2015, and no change in the allowance for loan losses resulting from these TDRs.

 

In the three-month period ended June 30, 2016, defaults on loans for which modifications considered to be TDRs were entered into within the previous 12 months were as follows:

 

		Number
		of				Recorded
		Contracts				Investment
Three Months Ended June 30, 2016
(Balances in Thousands)
Residential mortgage:
Residential mortgage loans - first liens			1			$	242
Residential mortgage loans - junior liens			1				30
Consumer			1				28

 

 

There were no defaults on loans for which modification considered to be TDRs were entered into within the previous 12 months in the three-month period ended June 30, 2015.

 

In the six-month period ended June 30, 2016, the events of default in the table listed above resulted from a borrower’s failure to pay in a timely manner after reduced payment amounts for six months expired on the Residential mortgage – first lien and a borrower’s failure to pay in a timely manner after lowered interest rates and reduced payment amounts on the Residential mortgage – junior lien and on the Consumer loan. There was no allowance for loan losses recorded on these loans at June 30, 2016.

 

In the six-month periods ended June 30, 2016 and 2015, defaults on loans for which modifications considered to be TDRs were entered into within the previous 12 months were as follows:

 

		Number
		of				Recorded
		Contracts				Investment
Six Months Ended June 30, 2016
(Balances in Thousands)
Residential mortgage:
Residential mortgage loans - first liens			2			$	273
Residential mortgage loans - junior liens			1				30
Commercial,
Commercial and industrial			1				5
Consumer			1				28

 

		Number
		of				Recorded
		Contracts				Investment
Six Months Ended June 30, 2015
(Balances in Thousands)
Residential mortgage,
Residential mortgage loans - first liens			2			$	115
Commercial:
Commercial loans secured by real estate			1				407
Commercial construction and land			1				25

 

In the six-month period ended June 30, 2016, the events of default in the table listed above resulted from the borrowers’ failure to make timely payments under the following circumstances: (1) for one customer relationship included in the Residential first lien mortgage class, timely payment was missed after payment amounts were reduced for six months; (2) for the other customer relationship in the Residential first lien mortgage class, payment was missed after the monthly payment amount was reduced for six months; (3) for the customer relationships in the Residential junior lien mortgage class and the consumer class, timely payments were missed after interest rates and payment amounts were reduced on both loans; and (4) for the Commercial and industrial loan, the borrower failed to pay off the loan at the extended maturity date.

 

In the six-month period ended June 30, 2015, the events of default in the table listed above resulted from the borrowers’ failure to make timely payments under the following circumstances: (1) for one customer relationship included in the Residential first lien mortgage class, payment was missed after the interest rate and monthly payment amount had been reduced; (2) for the other customer relationship included in the Residential first lien class, monthly payments were missed after reducing the monthly payments to interest only payments; (3) for the Commercial loan secured by real estate, monthly payments were missed after reducing the monthly payments to interest only; and (4) for the Commercial construction and land loan, monthly payments were missed after extending the term of maturity. There were no allowances for loan losses recorded on these loans at June 30, 2015.

 

 

The carrying amount of foreclosed residential real estate properties held as a result of obtaining physical possession (included in Foreclosed assets held for sale in the unaudited Consolidated Balance Sheet) is as follows:

 

(In Thousands)		June 30,				Dec. 31,
		2016				2015
Foreclosed residential real estate		$	1,005			$	556

 

The recorded investment of consumer mortgage loans secured by residential real properties for which formal foreclosure proceedings were in process is as follows:

 

(In Thousands)		June 30,				Dec. 31,
		2016				2015
Residential real estate in process of foreclosure		$	1,598			$	1,173

 

8. BORROWED FUNDS

 

Short-term borrowings include the following:

 

(In Thousands)		June 30,				Dec. 31,
		2016				2015
FHLB-Pittsburgh borrowings		$	20,041			$	48,581
Customer repurchase agreements			5,661				4,915
Total short-term borrowings		$	25,702			$	53,496

 

Short-term borrowings from FHLB-Pittsburgh are as follows:

 

(In Thousands)		June 30,				Dec. 31
		2016				2015
Overnight borrowing		$	7,500			$	23,500
Other short-term advances			12,541				25,081
Total short-term FHLB-Pittsburgh borrowings		$	20,041			$	48,581

 

The FHLB-Pittsburgh loan facilities are collateralized by qualifying loans secured by real estate with a book value totaling $454,935,000 at June 30, 2016 and $450,883,000 at December 31, 2015. Also, the FHLB-Pittsburgh loan facilities require the Corporation to invest in established amounts of FHLB-Pittsburgh stock. The carrying values of the Corporation’s holdings of FHLB-Pittsburgh stock (included in Other Assets) were $3,485,000 at June 30, 2016 and $4,527,000 at December 31, 2015.

 

At June 30, 2016, short-term borrowings from the FHLB-Pittsburgh include 6 advances of approximately $2,090,000 each, maturing monthly throughout the remainder of the year ending December 31, 2016, with a weighted average interest rate of 0.99% and rates ranging from 0.92% to 1.052%. In the first six months 2016, the Corporation repaid six advances of approximately $2,090,000 each, with a weighted average rate of 0.72%.

 

The Corporation engages in repurchase agreements with certain commercial customers. These agreements provide that the Corporation sells specified investment securities to the customers on an overnight basis and repurchases them on the following business day. The weighted average interest rate paid by the Corporation on customer repurchase agreements was 0.10% at June 30, 2016 and December 31, 2015. The carrying value of the underlying securities was $17,218,000 at June 30, 2016 and $12,613,000 at December 31, 2015.

 

 

Long-term borrowings are as follows:

 

(In Thousands)		June 30,				Dec. 31,
		2016				2015
FHLB-Pittsburgh borrowings		$	11,615			$	11,767
Repurchase agreement			27,000				27,000
Total long-term borrowings		$	38,615			$	38,767

 

Long-term borrowings from FHLB-Pittsburgh are as follows:

 

(In Thousands)		June 30,				Dec. 31,
		2016				2015
Loan maturing in 2016 with a rate of 6.86%		$	32			$	57
Loan maturing in 2017 with a rate of 6.83%			7				10
Loan maturing in 2017 with a rate of 3.81%			10,000				10,000
Loan maturing in 2020 with a rate of 4.79%			734				821
Loan maturing in 2025 with a rate of 4.91%			842				879
Total long-term FHLB-Pittsburgh borrowings		$	11,615			$	11,767

 

The repurchase agreement included in long-term borrowings has an interest rate of 3.595% and an effective maturity date in December 2017.

 

The “Repurchase Date,” as defined in the Master Repurchase Agreement between the Corporation and the broker-dealer, occurs quarterly on or about the 20^th of each March, June, September and December until the “Final Repurchase Date” (as defined) on December 20, 2017. The Corporation pays interest, and the borrowing is putable by the issuer, on each Repurchase Date. The Final Repurchase Date is the effective maturity date of the borrowing.

 

Securities sold under repurchase agreements were delivered to the broker-dealer who is the counter-party to the transactions. The broker-dealer may have sold, loaned or otherwise disposed of such securities to other parties in the normal course of their operations, and has agreed to resell to the Corporation substantially identical securities at the maturities of the agreements. The Master Repurchase Agreement provides that the Agreement constitutes a “netting contract,” as defined; however, the Corporation and the broker-dealer have no other obligations to one another and accordingly, no netting has occurred.

 

The carrying value of the underlying securities was $36,117,000 at June 30, 2016 and $33,780,000 at December 31, 2015, detailed in the following table:

 

(In Thousands)		June 30,				Dec. 31,
		2016				2015
Mortgage-backed securities		$	20,116			$	15,772
Collateralized mortgage obligations, Issued by U.S. Government agencies			16,001				18,008
Total		$	36,117			$	33,780

 

Two of the more significant risks associated with the repurchase agreement with the broker-dealer are as follows:

·

The borrowings are putable at quarterly intervals by the issuer. Accordingly, if interest rates were to rise to a sufficient level, the issuer would be expected to require the Corporation to pay off the borrowing. In this circumstance, the Corporation would be required to obtain a new borrowing at a higher interest rate than the existing repurchase agreement or utilize cash from other sources to pay off the borrowing. If sales of available-for-sale securities were used to generate cash to pay off the borrowing, the value of such securities would be expected to have fallen, which could result in the Corporation recognizing a loss.

 

·

As principal pay-downs of mortgage backed securities and CMOs occur, the Corporation must have available, unencumbered assets or purchase a sufficient amount of assets with credit quality suitable to the broker-dealer to replace the amounts being paid off. Since pre-payments of mortgages typically increase as interest rates fall, the Corporation may be required to purchase additional assets at times when market rates are lower than the rates paid on the borrowing.

 

 

The Corporation manages these risks by maintaining sufficient available assets of acceptable credit quality, as well as maintaining other borrowing facilities, to meet ongoing collateral maintenance requirements or pay off the borrowing if required. In particular, the Corporation had unused borrowing capacity available from the FHLB-Pittsburgh of $294,373,000 at June 30, 2016.

 

9. DEFINED BENEFIT PLANS

 

The Corporation sponsors a defined benefit health care plan that provides postretirement medical benefits and life insurance to employees who meet certain age and length of service requirements. Full-time employees no longer accrue service time toward the Corporation-subsidized portion of the medical benefits. This plan contains a cost-sharing feature, which causes participants to pay for all future increases in costs related to benefit coverage. Accordingly, actuarial assumptions related to health care cost trend rates do not significantly affect the liability balance at June 30, 2016 and December 31, 2015, and are not expected to significantly affect the Corporation's future expenses. The Corporation uses a December 31 measurement date for the postretirement plan.

 

In an acquisition in 2007, the Corporation assumed the Citizens Trust Company Retirement Plan, a defined benefit pension plan. This plan covers certain employees who were employed by Citizens Trust Company on December 31, 2002, when the plan was amended to discontinue admittance of any future participant and to freeze benefit accruals. Information related to the Citizens Trust Company Retirement Plan has been included in the tables that follow. The Corporation uses a December 31 measurement date for this plan.

 

The components of net periodic benefit costs from these defined benefit plans are as follows:

 

Defined Benefit Plans
(In Thousands)		Pension								Postretirement
		Six Months Ended								Six Months Ended
		June 30,								June 30,
		2016				2015				2016				2015
Service cost		$	0			$	0			$	18			$	19
Interest cost			13				18				31				28
Expected return on plan assets			(13	)			(23	)			0				0
Amortization of prior service cost			0				0				(15	)			(15	)
Recognized net actuarial loss			5				7				0				0
Net periodic benefit cost		$	5			$	2			$	34			$	32

 

(In Thousands)		Pension								Postretirement
		Three Months Ended								Three Months Ended
		June 30,								June 30,
		2016				2015				2016				2015
Service cost		$	0			$	0			$	9			$	9
Interest cost			6				9				15				15
Expected return on plan assets			(6	)			(12	)			0				0
Amortization of prior service cost			0				0				(7	)			(8	)
Recognized net actuarial loss			2				3				0				0
Net periodic benefit cost		$	2			$	0			$	17			$	16

 

In the first six months of 2016, the Corporation funded postretirement contributions totaling $31,000, with estimated annual postretirement contributions of $68,000 expected in 2016 for the full year. Based upon the related actuarial reports, no defined benefit pension contributions are required in 2016, though the Corporation may make discretionary contributions.

 

10. STOCK-BASED COMPENSATION PLANS

 

The Corporation has a Stock Incentive Plan for a selected group of officers and an Independent Directors Stock Incentive Plan. In the three-month periods ended March 31, 2016 and 2015, the Corporation issued restricted stock under each of the Plans.

 

 

In the first quarter 2016, the Corporation awarded a total of 34,199 shares of restricted stock under the Stock Incentive and Independent Directors Stock Incentive Plans. Restricted stock awards in the first quarter 2016 included the following: (1) a total of 17,289 shares to employees, vesting over a three-year term, with vesting contingent upon the Corporation meeting an annual return on average equity (“ROAE”) performance ratio, as defined; (2) a total of 10,304 shares to employees, vesting over a three-year term, with vesting dependent on satisfactory performance; and (3) a total of 6,606 shares under the Independent Directors Incentive Plan, vesting over a term of one year.

 

In the second quarter 2016, the Corporation awarded a total of 1,228 shares of restricted stock under the Independent Directors Stock Incentive Plan. The restricted stock was awarded to two new directors, with each award vesting over a term of one year.

 

In the first quarter 2015, a total of 34,800 shares of restricted stock were awarded under the Plans. Restricted stock awards in 2015 included the following: (1) a total of 20,298 shares to employees, vesting over a four-year term, with vesting contingent upon the Corporation meeting an annual ROAE performance ratio, as defined; (2) a total of 2,198 shares to employees, vesting over a four-year term, with vesting dependent on satisfactory performance; (3) an award to the Chief Executive Officer of 5,174 shares, vesting over a three-year term, with vesting dependent on satisfactory performance; and (4) a total of 7,130 shares under the Independent Directors Incentive Plan, vesting over a term of one year.

 

Compensation cost related to restricted stock is recognized based on the market price of the stock at the grant date over the vesting period. Management has estimated restricted stock expense in the first six months of 2016 based on an assumption that the ROAE target for 2016 will be met.

 

Total stock-based compensation expense is as follows:

 

(In Thousands)		3 Months Ended								6 Months Ended
		June 30,				June 30,				June 30,				June 30,
		2016				2015				2016				2015
Restricted stock		$	163			$	157			$	325			$	307

 

11. INCOME TAXES

 

The net deferred tax asset at June 30, 2016 and December 31, 2015 represents the following temporary difference components:

 

		June 30,				December 31,
(In Thousands)		2016				2015
Deferred tax assets:
Net realized losses on securities		$	36			$	69
Allowance for loan losses			2,775				2,761
Other deferred tax assets			2,359				2,634
Total deferred tax assets			5,170				5,464
Deferred tax liabilities:
Unrealized holding gains on securities			3,686				1,342
Defined benefit plans - ASC 835			25				19
Bank premises and equipment			916				869
Core deposit intangibles			8				11
Other deferred tax liabilities			110				108
Total deferred tax liabilities			4,745				2,349
Deferred tax asset, net		$	425			$	3,115

 

 

The provision for income tax for the three-month and six month periods ended June 30, 2016 and 2015 is based on the Corporation’s estimate of the effective tax rate expected to be applicable for the full year. The effective tax rates for the Corporation are as follows:

 

		Three Months Ended								Six Months Ended
(In thousands)		June 30,								June 30,
		2016				2015				2016				2015
Income before income tax provision		$	5,174			$	5,809			$	9,840			$	10,853
Income tax provision			1,303				1,452				2,396				2,681
Effective tax rate			25.18	%			25.00	%			24.35	%			24.70	%

 

The effective tax rate for each period presented differs from the statutory rate of 35% principally because of the effects of tax-exempt interest income.

 

The Corporation has investments in three limited partnerships that manage affordable housing projects that have qualified for the federal low-income housing tax credit. The Corporation’s expected return from these investments is based on the receipt of tax credits and tax benefits from deductions of operating losses. The Corporation uses the effective yield method to account for these investments, with the benefits recognized as a reduction of the provision for income taxes. For two of the three limited partnership investments, the tax credits have been received in full in prior years, and the Corporation has fully realized the benefits of the credits and amortized its initial investments in the partnerships. The most recent affordable housing project was completed in 2013, and the Corporation received tax credits in 2013, 2014 and 2015 and expects to continue to receive tax credits annually through 2022. The carrying amount of the Corporation’s investment is $762,000 at June 30, 2016 and $812,000 at December 31, 2015 (included in Other Assets in the consolidated balance sheets). For the year ending December 31, 2016, the estimated amount of tax credits and other tax benefits to be received is $158,000 and the estimated amount to be recognized as a reduction of the provision for income taxes is $76,000. For the year ended December 31, 2015, tax credits and other tax benefits totaled $158,000 and the amount recognized as a reduction of the provision for income taxes for 2015 was $80,000. The total reduction in the provision for income taxes resulting from this investment is $19,000 in the second quarter 2016, and $38,000 for the six months ended June 30, 2016, and $20,000 in the second quarter 2015, and $41,000 for the six months ended June 30, 2015.

 

The Corporation has no unrecognized tax benefits, nor pending examination issues related to tax positions taken in preparation of its income tax returns. With limited exceptions, the Corporation is no longer subject to examination by the Internal Revenue Service for years prior to 2012.

 

12. CONTINGENCIES

 

In the normal course of business, the Corporation may be subject to pending and threatened lawsuits in which claims for monetary damages could be asserted. In management’s opinion, the Corporation’s financial position and results of operations would not be materially affected by the outcome of such pending legal proceedings.

 

13. RECENT ACCOUNTING PRONOUNCEMENTS

 

The FASB issues Accounting Standards Updates (ASUs) to the FASB Accounting Standards Codification (ASC). This section provides a summary description of recent ASUs that have significant implications (elected or required) within the consolidated financial statements, or that management expects may have a significant impact on financial statements issued in the near future.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which provides a principles-based framework for revenue recognition that supersedes virtually all previously issued revenue recognition guidance under U.S. GAAP. Additionally, the ASU requires improved disclosures to help users of financial statements better understand the nature, amount, timing, and uncertainty of revenue that is recognized. The core principle of the five-step revenue recognition framework is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In April 2016, the FASB issued ASU 2016-10, which provides clarifying information related to identifying performance obligations and licensing. In May 2016, the FASB issued ASU 2016-12, which provides clarifying guidance in a few narrow areas and adds some practical expedients to the guidance. In August 2015 the FASB issued ASU 2015-14, which deferred the effective date of the revenue recognition standard by a year, making it applicable for the Corporation in the first quarter 2018 and for the annual period ending December 31, 2018. The amendments should be applied either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the amendments recognized at the date of initial application. The Corporation is in the process of evaluating the potential impact of adopting the amendments, including determining which transition method to apply.

 

 

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities. This makes significant changes in U.S. GAAP related to certain aspects of recognition, measurement, presentation and disclosure of financial instruments. The changes provided for in this Update that are applicable to the Corporation are as follows: (1) require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; however, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer; (2) for equity investments without readily determinable fair values, require a qualitative assessment to identify impairment, and if a qualitative assessment indicates that impairment exists, requiring an entity to measure the investment at fair value; (3) eliminate the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (4) require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (5) require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments (at March 31, 2016 and December 31, 2015, the Corporation has no liabilities for which the fair value measurement option has been elected); (6) require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (7) clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The amendments in this Update will become effective for the Corporation for annual and interim periods beginning in the first quarter 2018. With limited exceptions, early adoption of the amendments in this Update is not permitted. Amendments are to be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values should be applied prospectively.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases. Specifically, a lessee should recognize on the balance sheet a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee would be permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and liabilities. Topic 842 would not significantly change the recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee from current U.S. GAAP; however, the principal change from current GAAP is that lease assets and liabilities arising from operating leases would be recognized on the balance sheet. Topic 842 provides several other changes or clarifications to existing GAAP, and will require qualitative disclosures, along with quantitative disclosures, so that financial statement users can understand more about the nature of an entity’s leasing activities. In transition, Topic 842 provides that lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach, including optional practical expedients. An entity that elects to apply the practical expedients will, in effect, continue to account for leases that commence before the effective date in accordance with previous GAAP unless the lease is modified, except that lessees will be required to recognize a right-of-use asset and a lease liability for all operating leases at each reporting date based on the present value of the remaining minimum rental payments that were tracked and disclosed under previous GAAP. Topic 842 will become effective for the Corporation for annual and interim periods beginning in the first quarter 2019.

 

In March 2016, the FASB issued ASU No. 2016-07, Investments – Equity Method and Joint Ventures. This ASU eliminates the requirement that when an investment qualifies for the equity method as a result of an increase in the level of ownership interest or influence, an investor must adjust the investment, results of operations and retained earnings retroactively as if the equity method had been in effect during all previous periods the investment had been held. The ASU requires the equity method investor to add the cost of acquiring an additional interest in the investee to the basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for the equity method. The ASU further requires that an entity that has an available-for-sale equity security that becomes qualified for the equity method recognize through earnings the unrealized gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method. The amendments in this Update are effective for the Corporation for annual and interim periods beginning in the first quarter 2017, with earlier application permitted. The amendments should be applied prospectively upon their effective date.

 

 

In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation. This ASU changes several aspects of accounting for share-based payment transactions, and includes some changes that apply only to nonpublic companies. This Update includes amendments that currently apply, or may apply in the future, to the Corporation related to the following: (1) accounting for the difference between the deduction for tax purposes and the amount of compensation cost recognized for financial reporting purposes; (2) classification of excess tax benefits on the statement of cash flows; (3) accounting for forfeitures; (4) accounting for awards partially settled in cash in excess of the employer’s minimum statutory tax withholding requirements; and (5) classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax-withholding purposes. The amendments in this Update are effective for the Corporation for annual and interim periods beginning in the first quarter 2017, with earlier adoption permitted. The ASU provides separate transition provisions for each of the amendments. The Corporation is in the process of evaluating the potential impact of adopting the amendments.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326). This ASU will result in significant changes in the Corporation’s accounting for credit losses related to loans receivable and investment securities. A summary of significant provisions of this ASU is as follows:

 

·

The ASU requires that a financial asset (or a group of financial assets) measured at amortized cost basis be presented, net of a valuation allowance for credit losses, at an amount expected to be collected on the financial asset(s), and that the income statement include the measurement of credit losses for newly recognized financial assets as well as changes in expected losses on previously recognized financial assets. The provisions of this ASU require measurement of expected credit losses based on relevant information including past events, historical experience, current conditions, and reasonable and supportive forecasts that affect the collectability of the asset. The provisions of this ASU differ from current U.S. GAAP in that current U.S. GAAP generally delays recognition of the full amount of credit losses until the loss is probable of occurring.

 

·

The amendments in the Update retain many of the disclosure requirements related to credit quality in current U.S. GAAP, updated to reflect the change from an incurred loss methodology to an expected credit loss methodology. In addition, the Update requires that disclosure of credit quality indicators in relation to the amortized cost of financing receivables, a current requirement, be further disaggregated by year of origination.

 

·

This ASU requires that credit losses on available-for-sale debt securities be presented as an allowance rather than as a write-down, and limits the amount of the allowance for credit losses to the amount by which the fair value is below amortized cost. For purchased available-for-sale securities with a more-than-insignificant amount of credit deterioration since origination, the ASU requires an allowance be determined in a manner similar to other available-for-sale debt securities; however, the initial allowance would be added to the purchase price, with only subsequent changes in the allowance recorded in credit loss expense, and interest income recognized at the effective rate excluding the discount embedded in the purchase price related to estimated credit losses at acquisition.

 

·

This ASU will be effective for the Corporation for interim and annual periods beginning in the first quarter of 2020. Earlier adoption is permitted beginning in the first quarter of 2019. The entity will record the effect of implementing this ASU through a cumulative-effect adjustment through retained earnings as of the beginning of the reporting period in which Topic 326 is effective. The Corporation is in the early stages of evaluating the potential impact of adopting this amendment.

 

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Certain statements in this section and elsewhere in this quarterly report on Form 10-Q are forward-looking statements. Citizens & Northern Corporation and its wholly-owned subsidiaries (collectively, the Corporation) intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995. Forward-looking statements, which are not historical facts, are based on certain assumptions and describe future plans, business objectives and expectations, and are generally identifiable by the use of words such as, "should", “likely”, "expect", “plan”, "anticipate", “target”, “forecast”, and “goal”. These forward-looking statements are subject to risks and uncertainties that are difficult to predict, may be beyond management’s control and could cause results to differ materially from those expressed or implied by such forward-looking statements. Factors which could have a material, adverse impact on the operations and future prospects of the Corporation include, but are not limited to, the following:

 

·

changes in monetary and fiscal policies of the Federal Reserve Board and the U. S. Government, particularly related to changes in interest rates

·

changes in general economic conditions

·

legislative or regulatory changes

·

downturn in demand for loan, deposit and other financial services in the Corporation’s market area

·

increased competition from other banks and non-bank providers of financial services

·

technological changes and increased technology-related costs

·

changes in accounting principles, or the application of generally accepted accounting principles.

 

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.

 

EARNINGS OVERVIEW

 

Second quarter 2016 net income was $0.32 per basic and diluted share, as compared to $0.29 in the first quarter 2016 and $0.36 in the second quarter 2015. For the six months ended June 30, 2016, net income per basic and diluted share was $0.61 as compared to $0.67 per basic and diluted share for the first six months of 2015. The return on average assets for the first six months of 2016 was 1.22%, and the return on average equity was 7.94%.

 

Some of the more significant fluctuations in revenues and expenses between the three-month period ended June 30, 2016 and the corresponding period in 2015 were as follows:

 

·

Net interest income was lower by $11,000, or 0.1%, in the second quarter 2016 as compared to the second quarter 2015. The net interest margin for the second quarter 2016 was 0.07% higher than in the second quarter 2015 due to a lower cost of borrowed funds and a more favorable mix of earning assets. The average balance of total borrowed funds was $61,874,000 at an average interest rate of 2.62% in the second quarter 2016, down from average borrowings of $78,396,000 at an average interest rate of 3.57% in the second quarter 2015. The reduction in amount and average rate on borrowed funds reflects the impact of prepayments in the second and fourth quarters of 2015 of a long-term borrowing with an interest rate of 4.265%. Average total loans outstanding were higher by $70.7 million (11.0%) in the second quarter 2016 as compared to the second quarter 2015, while average total available-for-sale securities were lower by $99.9 million. The average balance of earning assets fell $26.5 million, reflecting a reduction in funding available for investment, as average total deposits decreased $12.5 million (1.3%).

 

·

The second quarter 2016 provision for loan losses was $97,000 higher than the comparative second quarter 2015 amount. The provision in the second quarter 2016 included the impact of increasing the allowance for loan losses for the effects of loan growth and slight increases in qualitative factor percentages used in determining the collectively evaluated portion of the allowance.

 

·

Noninterest revenue in the second quarter 2016 was lower by $56,000 (1.4%) than the second quarter 2015 amount. Service charges on deposit accounts were $141,000 (10.8%) lower, reflecting a reduced volume of consumer overdrafts, and the fair value of mortgage servicing rights decreased $108,000 in the second quarter 2016 compared to a $33,000 decrease in the second quarter 2015. Net gains from sales of loans in the second quarter 2016 exceeded the corresponding second quarter 2015 amount by $112,000, or 61.2%, reflecting higher volume of sales. Other operating income was $82,000 higher in the second quarter 2016 as compared to the second quarter 2015, including increases in dividend income from Federal Home Loan Bank of Pittsburgh stock and in revenue from redemption of tax credits.

 

 

·

Realized gains from securities totaled $122,000 in the second quarter 2016. In comparison, in the second quarter 2015, C&N generated gains from sales of securities totaling $932,000, and also incurred a loss from prepayment of borrowings totaling $910,000. In the second quarter 2015, C&N prepaid principal of $10 million on a long-term borrowing (repurchase agreement) with an interest rate of 4.265%.

 

·

Noninterest expenses, excluding loss on prepayment of borrowings, in the second quarter 2016 exceeded the second quarter 2015 amount by $571,000 (7.2%). Salaries and wages expense increased $310,000 (8.6%), reflecting an increase in number of employees, including new positions established for lending, lending support, information technology, training, human resources and marketing functions. Professional fees expense increased $142,000 in the second quarter 2016 over the second quarter 2015 amount, including increases related to employee sales and service training, information technology, marketing and outsourced commercial loan credit review.

 

Some of the more significant fluctuations in revenues and expenses between the six-month period ended June 30, 2016 and the corresponding period in 2015 were as follows:

 

·

For the first six months of 2016, net interest income was $72,000, or 0.4%, higher than the comparable total for the first six months of 2015. Consistent with the trends described above, the net interest margin was 0.08% higher than the margin for the first six months of 2015, reflecting a lower cost of borrowed funds resulting from prepayment in 2015 of a long-term borrowing and a more favorable mix of earning assets. The average balance of total borrowed funds was $68,141,000 at an average interest rate of 2.44% for the first six months of 2016, down from average borrowings of $78,715,000 at an average interest rate of 3.65% in the first six months of 2015. Average total loans outstanding were higher by $73.9 million (11.7%) in the first six months of 2016 as compared to the first six months of 2015, while average total available-for-sale securities were lower by $97.2 million. The average balance of earning assets fell $25.1 million, reflecting a reduction in funding available for investment, as average total deposits decreased $17.0 million (1.7%).

 

·

The provision for loan losses for the six months ended June 30, 2016 exceeded the corresponding amount for the first six months of 2015 by $462,000. The provision in 2016 included the impact of increasing the allowance for loan losses for the effects of loan growth and slight increases in net charge-off experience and qualitative factors used in determining the collectively evaluated portion of the allowance. In comparison, the provision in 2015 also reflected the effects of loan growth, but the qualitative factors used in determining a portion of the collectively determined allowance for loan allowances were slightly decreased during the period.

 

·

Noninterest revenue increased $78,000 (1.0%) in the first six months of 2016 as compared to the total for the first six months of 2015. Net gains from sales of loans increased $133,000, or 40.3%, reflecting higher volume of sales. Other operating income increased $99,000, mainly due to an increase in revenue from redemption of tax credits. Brokerage revenue decreased $72,000, as the volume of sales of annuities declined.

 

·

In the first six months of 2016, realized gains from securities totaled $505,000, including gains from sales of bank stocks of $277,000. In the first six months of 2015, C&N generated gains from sales of securities totaling $1,006,000, including gains from sales of bank stocks of $476,000, and also incurred the loss from prepayment of a borrowing described above of $910,000.

 

·

Noninterest expenses, excluding loss on prepayment of borrowings, in the first six months of 2016 exceeded the amount for the first six months of 2015 by $1,110,000 (6.7%). Salaries and wages expense increased $710,000 (10.0%). As described above, several new positions were established in the latter portion of 2015 and early 2016. Professional fees expense increased $275,000, including increases related to employee sales and service training, information technology, marketing and outsourced commercial loan credit review.

 

More detailed information concerning fluctuations in the Corporation’s earnings results and other financial information are provided in other sections of Management’s Discussion and Analysis.

 

 

TABLE I - QUARTERLY FINANCIAL DATA
(In Thousands) (Unaudited)		For the Three Months Ended:
		June 30,				Mar. 31,				Dec. 31,				Sept. 30,				June 30,				Mar. 31,
		2016				2016				2015				2015				2015				2015
Interest income		$	10,924			$	10,937			$	11,036			$	11,134			$	11,186			$	11,163
Interest expense			925				904				1,087				1,126				1,176				1,213
Net interest income			9,999				10,033				9,949				10,008				10,010				9,950
Provision for loan losses			318				368				319				302				221				3
Net interest income after provision for loan losses			9,681				9,665				9,630				9,706				9,789				9,947
Other income			3,906				3,690				3,999				3,961				3,962				3,556
Net gains on available-for-sale securities			122				383				1,776				79				932				74
Loss on prepayment of borrowings			0				0				1,663				0				910				0
Other expenses			8,535				9,072				8,416				8,117				7,964				8,533
Income before income tax provision			5,174				4,666				5,326				5,629				5,809				5,044
Income tax provision			1,303				1,093				1,261				1,395				1,452				1,229
Net income		$	3,871			$	3,573			$	4,065			$	4,234			$	4,357			$	3,815
Net income per share – basic		$	0.32			$	0.29			$	0.33			$	0.35			$	0.36			$	0.31
Net income per share – diluted		$	0.32			$	0.29			$	0.33			$	0.35			$	0.36			$	0.31

 

CRITICAL ACCOUNTING POLICIES

 

The presentation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect many of the reported amounts and disclosures. Actual results could differ from these estimates.

 

A material estimate that is particularly susceptible to significant change is the determination of the allowance for loan losses. Management believes the allowance for loan losses is adequate and reasonable. Analytical information related to the Corporation’s aggregate loans and the related allowance for loan losses is summarized by loan segment and classes of loans in Note 7 to the unaudited consolidated financial statements. Additional discussion of the Corporation’s allowance for loan losses is provided in a separate section later in Management’s Discussion and Analysis. Given the very subjective nature of identifying and valuing loan losses, it is likely that well-informed individuals could make materially different assumptions, and could, therefore calculate a materially different allowance value. While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.

 

Another material estimate is the calculation of fair values of the Corporation’s debt securities. For most of the Corporation’s debt securities, the Corporation receives estimated fair values of debt securities from an independent valuation service, or from brokers. In developing fair values, the valuation service and the brokers use estimates of cash flows, based on historical performance of similar instruments in similar interest rate environments. Based on experience, management is aware that estimated fair values of debt securities tend to vary among brokers and other valuation services.

 

As described in Note 6 to the unaudited consolidated financial statements, management evaluates securities for other-than-temporary impairment (OTTI). In making that evaluation, consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether the Corporation intends to sell the security or more likely than not will be required to sell the security before its anticipated recovery. Management’s assessments of the likelihood and potential for recovery in value of securities are subjective and based on sensitive assumptions.

 

NET INTEREST INCOME

 

The Corporation’s primary source of operating income is net interest income, which is equal to the difference between the amounts of interest income and interest expense. Tables II, III and IV include information regarding the Corporation’s net interest income for the three-month and six-month periods ended June 30, 2016 and June 30, 2015. In each of these tables, the amounts of interest income earned on tax-exempt securities and loans have been adjusted to a fully taxable-equivalent basis. Accordingly, the net interest income amounts reflected in these tables exceed the amounts presented in the consolidated financial statements. The discussion that follows is based on amounts in the related Tables.

 

 

Six-Month Periods Ended June 30, 2016 and 2015

 

For the six-month periods, fully taxable equivalent net interest income was $21,428,000 in 2016, $11,000 (0.1%) higher than in 2015. Interest income was $549,000 lower in 2016 as compared to 2015; however, interest expense was lower by $560,000 in comparing the same periods. As presented in Table III, the Net Interest Margin was 3.79% in 2016 as compared to 3.71% in 2015, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) was 3.66% in 2016 as compared to 3.55% in 2015.

 

INTEREST INCOME AND EARNING ASSETS

 

Interest income totaled $23,257,000 in 2016, a decrease of 2.3% from 2015. Interest and fees on loans receivable increased $844,000, or 5.1%. The average balance of gross loans receivable increased $73,894,000, or 11.7%, to $706,759,000 in 2016 from $632,865,000 in 2015. The Corporation experienced significant growth in both commercial and mortgage loans outstanding. Growth in commercial loans included an increase of approximately $25 million in the average outstanding balance of participation loans in the first six months of 2016 as compared to the first six months of 2015. The Corporation’s average rate of return on loans receivable declined to 4.96% in 2016 from 5.29% in 2015 as average interest rates on new loans are lower, reflecting recent market conditions.

 

As indicated in Table III, average available-for-sale securities (at amortized cost) totaled $408,773,000 in 2016, a decrease of $97,180,000 (19.2%) from 2015. The net decrease in the Corporation’s available-for-sale securities portfolio consisted of decreases in all categories of securities with the exception of commercial mortgage-backed securities. The Corporation’s yield on securities was slightly lower in 2016 than in 2015, primarily because of lower market interest rates. The average rate of return on available-for-sale securities was 2.83% in 2016 and 2.85% in 2015.

 

INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES

 

Interest expense fell $560,000, or 23.4%, to $1,829,000 in 2016 from $2,389,000 in 2015. Table III shows that the overall cost of funds on interest-bearing liabilities fell to 0.45% in 2016 from 0.58% in 2015.

 

Total average deposits (interest-bearing and noninterest-bearing) decreased 1.7%, to $956,602,000 in 2016 from $973,631,000 in 2015. Decreases in the average balances of demand deposits, certificates of deposit and Individual Retirement Accounts were partially offset by increases in interest checking, money market accounts and savings accounts.

 

Total average borrowed funds decreased $10,574,000 to $68,141,000 in 2016 from $78,715,000 in 2015. The average rate on borrowed funds was 2.44% in 2016 compared to 3.65% in 2015, reflecting a $32,418,000 reduction in the average balance of higher-rate, long-term borrowings resulting from prepayment in the second and fourth quarters of 2015 of a long-term repurchase agreement borrowing with an interest rate of 4.265%. The average balance of short-term borrowings increased $21,844,000 in 2016 over 2015, as average overnight borrowings were higher in 2016 and the Corporation funded the pay-off of the long-term repurchase agreement with a series of short-term advances from the FHLB-Pittsburgh.

 

Three-Month Periods Ended June 30, 2016 and 2015

 

For the three-month periods, fully taxable equivalent net interest income was $10,684,000 in 2016, which was $65,000 (0.6%) lower than in 2015. Interest income was $316,000 lower in 2016 as compared to 2015, while interest expense was lower by $251,000 in comparing the same periods. As presented in Table III, the Net Interest Margin was 3.76% in 2016 as compared to 3.69% in 2015, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) was 3.63% in 2016 as compared to 3.53% in 2015.

 

Interest income totaled $11,609,000 in 2016, a decrease of $316,000 (2.6%) from 2015. Interest and fees from loans receivable increased $426,000, or 5.1%, in 2016 as compared to 2015, while income from available-for-sale securities decreased $758,000 (21.4%). As indicated in Table III, for the three-month periods, the average balance of gross loans receivable increased 11.0% to $711,882,000 in 2016 from $641,214,000 in 2015. The average rate of return on loans was 4.96% in 2016, down from 5.22% in 2015. Total average available-for-sale securities (at amortized cost) in 2016 decreased to $406,260,000 from $506,126,000 in 2015. The average rate of return on available-for-sale securities was 2.76% for 2016, down from 2.81% in 2015.

 

For the three-month periods, interest expense fell $251,000, or 21.3%, to $925,000 in 2016 from $1,176,000 in 2015. Total average deposits (interest-bearing and noninterest-bearing) amounted to $968,605,000 in the second quarter 2016, a decrease of $12,547,000 (1.3%) from the second quarter 2015 total. Total average borrowed funds decreased to

 

 

$61,874,000 in the second quarter 2016 from $78,396,000 in the second quarter 2015, while the average rate on borrowed funds fell to 2.62% in the second quarter 2016 from 3.57% in the second quarter 2015. The net change in average borrowed funds included an increase of $14,040,000 in short-term borrowings and a decrease of $30,562,000 in long-term borrowings. In total, the average interest rate on interest-bearing liabilities was 0.46% in the second quarter 2016 as compared to 0.56% in the second quarter 2015. The reduction in average rate on interest-bearing liabilities in 2016 was mainly caused by the pay-off (prepayment) of the higher-cost borrowing in 2015, as described above.

 

TABLE II - ANALYSIS OF INTEREST INCOME AND EXPENSE

 

		Three Months Ended												Six Months Ended
		June 30,								Increase/				June 30,								Increase/
(In Thousands)		2016				2015				(Decrease)				2016				2015				(Decrease)
INTEREST INCOME
Available-for-sale securities:
Taxable		$	1,495			$	2,001			$	(506	)		$	3,084			$	4,062			$	(978	)
Tax-exempt			1,294				1,546				(252	)			2,664				3,097				(433	)
Total available-for-sale securities			2,789				3,547				(758	)			5,748				7,159				(1,411	)
Interest-bearing due from banks			36				25				11				60				51				9
Loans held for sale			8				3				5				14				5				9
Loans receivable:
Taxable			8,086				7,753				333				16,060				15,462				598
Tax-exempt			690				597				93				1,375				1,129				246
Total loans receivable			8,776				8,350				426				17,435				16,591				844
Total Interest Income			11,609				11,925				(316	)			23,257				23,806				(549	)
INTEREST EXPENSE
Interest-bearing deposits:
Interest checking			74				54				20				132				109				23
Money market			86				73				13				165				145				20
Savings			33				33				0				65				64				1
Certificates of deposit			220				205				15				422				420				2
Individual Retirement Accounts			109				114				(5	)			217				227				(10	)
Other time deposits			0				0				0				0				0				0
Total interest-bearing deposits			522				479				43				1,001				965				36
Borrowed funds:
Short-term			41				5				36				103				6				97
Long-term			362				692				(330	)			725				1,418				(693	)
Total borrowed funds			403				697				(294	)			828				1,424				(596	)
Total Interest Expense			925				1,176				(251	)			1,829				2,389				(560	)
Net Interest Income		$	10,684			$	10,749			$	(65	)		$	21,428			$	21,417			$	11

 

Note: Interest income from tax-exempt securities and loans has been adjusted to a fully tax-equivalent basis, using the Corporation’s marginal federal income tax rate of 35%.

 

 

TABLE III - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES

(Dollars in Thousands)

 

		3 Months								3 Months								6 Months								6 Months
		Ended				Rate of				Ended				Rate of				Ended				Rate of				Ended				Rate of
		6/30/2016				Return/				6/30/2015				Return/				6/30/2016				Return/				6/30/2015				Return/
		Average				Cost of				Average				Cost of				Average				Cost of				Average				Cost of
		Balance				Funds %				Balance				Funds %				Balance				Funds %				Balance				Funds %
EARNING ASSETS
Available-for-sale securities, at amortized cost:
Taxable		$	297,608				2.02	%		$	389,705				2.06	%		$	301,744				2.06	%		$	388,909				2.11	%
Tax-exempt			108,652				4.79	%			116,421				5.33	%			107,029				5.01	%			117,044				5.34	%
Total available-for-sale securities			406,260				2.76	%			506,126				2.81	%			408,773				2.83	%			505,953				2.85	%
Interest-bearing due from banks			24,250				0.60	%			21,970				0.46	%			22,299				0.54	%			24,468				0.42	%
Loans held for sale			540				5.96	%			145				8.30	%			496				5.68	%			117				8.62	%
Loans receivable:
Taxable			650,213				5.00	%			592,188				5.25	%			645,586				5.00	%			587,370				5.31	%
Tax-exempt			61,669				4.50	%			49,026				4.88	%			61,173				4.52	%			45,495				5.00	%
Total loans receivable			711,882				4.96	%			641,214				5.22	%			706,759				4.96	%			632,865				5.29	%
Total Earning Assets			1,142,932				4.09	%			1,169,455				4.09	%			1,138,327				4.11	%			1,163,403				4.13	%
Cash			16,522								17,072								16,055								16,602
Unrealized gain/loss on securities			7,737								10,260								7,396								10,442
Allowance for loan losses			(7,756	)							(7,226	)							(7,844	)							(7,308	)
Bank premises and equipment			15,390								16,095								15,424								16,173
Intangible Asset - Core Deposit Intangible			25								44								27								47
Intangible Asset - Goodwill			11,942								11,942								11,942								11,942
Other assets			38,938								38,065								38,734								37,603
Total Assets		$	1,225,730							$	1,255,707							$	1,220,061							$	1,248,904
INTEREST-BEARING LIABILITIES
Interest-bearing deposits:
Interest checking		$	196,918				0.15	%		$	199,373				0.11	%		$	196,030				0.14	%		$	195,560				0.11	%
Money market			200,896				0.17	%			196,537				0.15	%			196,205				0.17	%			195,690				0.15	%
Savings			132,353				0.10	%			128,879				0.10	%			131,178				0.10	%			128,369				0.10	%
Certificates of deposit			117,825				0.75	%			122,634				0.67	%			115,618				0.73	%			122,322				0.69	%
Individual Retirement Accounts			104,030				0.42	%			111,765				0.41	%			104,796				0.42	%			112,780				0.41	%
Other time deposits			1,140				0.00	%			1,125				0.00	%			972				0.00	%			965				0.00	%
Total interest-bearing deposits			753,162				0.28	%			760,313				0.25	%			744,799				0.27	%			755,686				0.26	%
Borrowed funds:
Short-term			23,225				0.71	%			9,185				0.22	%			29,454				0.70	%			7,610				0.16	%
Long-term			38,649				3.77	%			69,211				4.01	%			38,687				3.77	%			71,105				4.02	%
Total borrowed funds			61,874				2.62	%			78,396				3.57	%			68,141				2.44	%			78,715				3.65	%
Total Interest-bearing Liabilities			815,036				0.46	%			838,709				0.56	%			812,940				0.45	%			834,401				0.58	%
Demand deposits			215,443								220,839								211,803								217,945
Other liabilities			8,304								7,756								7,841								7,937
Total Liabilities			1,038,783								1,067,304								1,032,584								1,060,283
Stockholders' equity, excluding other comprehensive income/loss			181,882								181,683								182,629								181,813
Other comprehensive income/loss			5,065								6,720								4,848								6,808
Total Stockholders' Equity			186,947								188,403								187,477								188,621
Total Liabilities and Stockholders' Equity		$	1,225,730							$	1,255,707							$	1,220,061							$	1,248,904
Interest Rate Spread							3.63	%							3.53	%							3.66	%							3.55	%
Net Interest Income/Earning Assets							3.76	%							3.69	%							3.79	%							3.71	%
Total Deposits (Interest-bearing and Demand)		$	968,605							$	981,152							$	956,602							$	973,631

 

(1) Annualized rates of return on tax-exempt securities and loans are presented on a fully taxable-equivalent basis, using the Corporation’s marginal federal income tax rate of 35%.

(2) Nonaccrual loans have been included with loans for the purpose of analyzing net interest earnings.

(3) Rates of return on earning assets and costs of funds are presented on an annualized basis.

 

 

TABLE IV - ANALYSIS OF VOLUME AND RATE CHANGES

 

(In Thousands)		3 Months Ended 6/30/16 vs. 6/30/15												6 Months Ended 6/30/16 vs. 6/30/15
		Change in				Change in				Total				Change in				Change in				Total
		Volume				Rate				Change				Volume				Rate				Change
EARNING ASSETS
Available-for-sale securities:
Taxable		$	(469	)		$	(37	)		$	(506	)		$	(883	)		$	(95	)		$	(978	)
Tax-exempt			(101	)			(151	)			(252	)			(251	)			(182	)			(433	)
Total available-for-sale securities			(570	)			(188	)			(758	)			(1,134	)			(277	)			(1,411	)
Interest-bearing due from banks			2				9				11				(5	)			14				9
Loans held for sale			7				(2	)			5				12				(3	)			9
Loans receivable:
Taxable			721				(388	)			333				1,508				(910	)			598
Tax-exempt			142				(49	)			93				363				(117	)			246
Total loans receivable			863				(437	)			426				1,871				(1,027	)			844
Total Interest Income			302				(618	)			(316	)			744				(1,293	)			(549	)
INTEREST-BEARING LIABILITIES
Interest-bearing deposits:
Interest checking			(1	)			21				20				0				23				23
Money market			1				12				13				0				20				20
Savings			0				0				0				1				0				1
Certificates of deposit			(9	)			24				15				(23	)			25				2
Individual Retirement Accounts			(9	)			4				(5	)			(16	)			6				(10	)
Other time deposits			0				0				0				0				0				0
Total interest-bearing deposits			(18	)			61				43				(38	)			74				36
Borrowed funds:
Short-term			21				15				36				43				54				97
Long-term			(290	)			(40	)			(330	)			(609	)			(84	)			(693	)
Total borrowed funds			(269	)			(25	)			(294	)			(566	)			(30	)			(596	)
Total Interest Expense			(287	)			36				(251	)			(604	)			44				(560	)
Net Interest Income		$	589			$	(654	)		$	(65	)		$	1,348			$	(1,337	)		$	11

 

(1) Changes in income on tax-exempt securities and loans are presented on a fully tax-equivalent basis, using the Corporation’s marginal federal income tax rate of 35%.

 

(2) The change in interest due to both volume and rates has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amount of the change in each.

 

 

TABLE V - COMPARISON OF NONINTEREST INCOME

(In Thousands)

 

		6 Months Ended
		June 30,								$				%
		2016				2015				Change				Change
Service charges on deposit accounts		$	2,302			$	2,327			$	(25	)			(1.1	)
Service charges and fees			217				236				(19	)			(8.1	)
Trust and financial management revenue			2,395				2,355				40				1.7
Brokerage revenue			353				425				(72	)			(16.9	)
Insurance commissions, fees and premiums			48				63				(15	)			(23.8	)
Interchange revenue from debit card transactions			950				974				(24	)			(2.5	)
Net gains from sales of loans			463				330				133				40.3
Decrease in fair value of servicing rights			(179	)			(150	)			(29	)			19.3
Increase in cash surrender value of life insurance			189				199				(10	)			(5.0	)
Other operating income			858				759				99				13.0
Total other operating income before realized gains on available-for-sale securities, net		$	7,596			$	7,518			$	78				1.0

 

Table V excludes realized gains on available-for-sale securities, which are discussed in the “Earnings Overview” section of Management’s Discussion and Analysis. Total noninterest income shown in Table V increased $78,000 or 1.0%, in the first six months of 2016 as compared to the first six months of 2015. The most significant variances include the following:

 

·

Net gains on the sale of loans increased $133,000 reflecting a higher volume of residential mortgage sales. The Corporation originates and sells some of its residential mortgage production under the Mortgage Partnership Finance Program, administered by the Federal Home Loan Banks of Chicago and Pittsburgh.

 

·

Other operating income increased $99,000, mainly due to an increase of $91,000 in revenue from the redemption of tax credits.

 

·

Brokerage revenue decreased $72,000, as the volume of sales of annuities decreased. Brokerage revenue was also impacted by decreases in market values of underlying assets for a portion of the first six months of 2016.

 

TABLE VI - COMPARISON OF NONINTEREST INCOME

(In Thousands)

 

		3 Months Ended
		June 30,								$				%
		2016				2015				Change				Change
Service charges on deposit accounts		$	1,164			$	1,305			$	(141	)			(10.8	)
Service charges and fees			123				123				0				0.0
Trust and financial management revenue			1,251				1,241				10				0.8
Brokerage revenue			180				206				(26	)			(12.6	)
Insurance commissions, fees and premiums			27				23				4				17.4
Interchange revenue from debit card transactions			487				500				(13	)			(2.6	)
Net gains from sales of loans			295				183				112				61.2
Decrease in fair value of servicing rights			(108	)			(33	)			(75	)			227.3
Increase in cash surrender value of life insurance			93				102				(9	)			(8.8	)
Other operating income			394				312				82				26.3
Total other operating income before realized gains on available-for-sale securities, net		$	3,906			$	3,962			$	(56	)			(1.4	)

 

Table VI excludes realized gains on available-for-sale securities, which are discussed in the “Earnings Overview” section of Management’s Discussion and Analysis. Total noninterest income shown in Table VI decreased $56,000 or 1.4%, in the three months ended June 30, 2016 as compared to the three months ended June 30, 2015. The most significant variances include the following:

 

 

·

Service charges on deposit accounts decreased $141,000, or 10.8%, primarily as a result of a lower volume of consumer overdrafts.

 

·

Fair value of mortgage servicing rights decreased $108,000 in the second quarter 2016, primarily from changes in prepayment assumptions driven by market expectations of lower interest rates. In comparison, the fair value of mortgage servicing rights decreased $33,000 in the second quarter 2015.

 

·

Net gains from the sales of loans increased $112,000 in 2016 (61.2%) reflecting a higher volume of sales of residential mortgages.

 

·

Other operating income increased $82,000 in 2016, with increases in several categories, most significantly dividends received on Federal Home Loan Bank of Pittsburgh stock and revenue from redemption of tax credits.

 

TABLE VII - COMPARISON OF NONINTEREST EXPENSE

(In Thousands)

 

		Six Months Ended
		June 30,								$				%
		2016				2015				Change				Change
Salaries and wages		$	7,800			$	7,090			$	710				10.0
Pensions and other employee benefits			2,439				2,320				119				5.1
Occupancy expense, net			1,169				1,362				(193	)			(14.2	)
Furniture and equipment expense			866				921				(55	)			(6.0	)
FDIC Assessments			297				299				(2	)			(0.7	)
Pennsylvania shares tax			645				635				10				1.6
Professional fees			571				296				275				92.9
Automated teller machine and interchange expense			516				501				15				3.0
Software subscriptions			492				408				84				20.6
Loss on prepayment of borrowings			0				910				(910	)			(100.0	)
Other operating expense			2,812				2,665				147				5.5
Total Other Expense		$	17,607			$	17,407			$	200				1.1

 

As shown in Table VII, total noninterest expense increased $200,000 or 1.1% in the first six months of 2016 as compared to the first six months of 2015. Excluding the $910,000 loss on prepayment of debt in 2015, total noninterest expense increased $1,110,000, or 6.7%. Other significant variances include the following:

 

·

Salaries and wages expense increased $710,000 (10.0%), reflecting an increase in number of employees and the effects of a significant portion of 2016 employee annual performance evaluations and merit increases occurring in the first six months of 2016. The average number of full-time equivalent employees was 286 in 2016, up from 277 in 2015, including new positions established for lending, lending support, information technology, training and marketing functions.

 

·

Professional fees expense increased $275,000 (92.9%) in the first six months 2016 over the first six months of 2015 amount, including increases related to employee sales and service training, information technology, marketing and outsourced commercial loan credit review.

 

·

Other operating expense increased $147,000 (5.5%) in the first six months of 2016 over the first six months of 2015, including an increase in charitable donations of $75,000 and a $57,000 increase in education and training related expenses.

 

·

Pensions and other employee benefits increased $119,000 (5.1%) in the first six months of 2016 over the first six months of 2015 as a result of increased healthcare claims on the Corporation’s partially self-insured plan as well as increases in other benefits attributable to having more personnel.

 

·

Software subscriptions and updates increased $84,000 (20.6%) in the first six months of 2016 over the first six months 2015 as a result of enhancements and new applications initiated in 2015 and continuing into 2016.

 

 

·

Occupancy expense in the first six months of 2016 was $193,000 (14.2%) lower than the total for the first six months of 2015, primarily as a result of lower depreciation expense and lower winter-related expenses such as snow removal and fuel costs.

 

TABLE VIII - COMPARISON OF NONINTEREST EXPENSE

(In Thousands)

 

		Three Months Ended
		June 30,								$				%
		2016				2015				Change				Change
Salaries and wages		$	3,913			$	3,603			$	310				8.6
Pensions and other employee benefits			1,002				935				67				7.2
Occupancy expense, net			560				640				(80	)			(12.5	)
Furniture and equipment expense			439				467				(28	)			(6.0	)
FDIC Assessments			155				148				7				4.7
Pennsylvania shares tax			323				317				6				1.9
Professional fees			282				140				142				101.4
Automated teller machine and interchange expense			267				255				12				4.7
Software subscriptions			251				211				40				19.0
Loss on prepayment of borrowings			0				910				(910	)			(100.0	)
Other operating expense			1,343				1,248				95				7.6
Total Other Expense		$	8,535			$	8,874			$	(339	)			(3.8	)

 

As shown in Table VIII, total noninterest expense decreased $339,000 or 3.8% in the three months ended June 30, 2016 as compared to the same period of 2015. Excluding the $910,000 loss on prepayment of debt in 2015, total noninterest expense increased $571,000, or 7.2%.Significant variances include the following:

 

·

Salaries and wages expense increased $310,000 (8.6%), reflecting an increase in number of employees. The average number of full-time equivalent employees was 286 in the second quarter 2016, up from 278 in the second quarter 2015, including new positions established for lending, lending support, information technology, training and marketing functions.

 

·

Professional fees expense increased $142,000 (101.4%) in the three months June 30, 2016 over the same period in 2015, including increases related to employee sales and service training, information technology, marketing and outsourced commercial loan credit review.

 

·

Other operating expense increased $95,000 (7.6%) in the three months ended June 30, 2016 over the same period in 2015, including a $28,000 increase in education and training related expenses and a $26,000 increase in expenses related to other real estate.

 

·

Pensions and other employee benefits increased $67,000 (7.2%) in the three months ended June 30, 2016 over the same period in 2015 as a result of increased healthcare claims and increases in other benefits attributable to having more personnel.

 

·

Software subscriptions and updates increased $40,000 (19.0%) in the three months ended June 30, 2016 over the same period in 2015 as a result of enhancements and new applications initiated in 2015 and continuing into 2016.

 

·

Occupancy expense in the three months ended June 30, 2016 was $80,000 (12.5%) lower than in the same period in 2015, primarily as a result of lower depreciation and utility costs.

 

 

FINANCIAL CONDITION

 

Gross loans outstanding (excluding mortgage loans held for sale) were $727,842,000 at June 30, 2016, up 3.3% from $704,880,000 at December 31, 2015 and up 9.6% from $663,818,000 at June 30, 2015. The total outstanding balances of residential mortgage segment loans at June 30, 2016 increased $12,555,000 (3.3%) as compared to December 31, 2015 and increased $23,374,000 (6.2%) as compared to June 30, 2015. The total outstanding balances of commercial segment loans at June 30, 2016 increased $8,929,000 (2.9%) as compared to December 31, 2015 and increased $63,168,000 (13.9%) as compared to June 30, 2015. These increases in loans outstanding included significant increases in commercial participation loans and commercial real estate secured loans. Participation loans represent portions of larger commercial transactions for which other institutions are the “lead banks”. Although not the lead bank, the Corporation conducts detailed underwriting and monitoring of participation loan opportunities. Participation loans are included in the “Commercial and industrial,” “Commercial loans secured by real estate” and “Political subdivisions” classes in the loan tables presented in this Form 10-Q. Total participation loans outstanding amounted to $35,940,000 at June 30, 2016, up from $33,059,000 at December 31, 2015 and up significantly from $10,354,000 at June 30, 2015. At June 30, 2016, the balance of participation loans outstanding includes $7,320,000 to a business based in the Corporation’s market area, $10,000,000 to an entity located outside of the Corporation’s market area and $11,089,000 from participations in loans originated through the Corporation’s membership in a network that originates loans throughout the U.S. The Corporation’s participation loans originated through the network consist of loans to businesses that are larger than the Corporation’s typical commercial customer base. The loans originated through the network are considered “leveraged loans,” meaning the businesses typically have minimal tangible book equity and the extent of collateral available is limited, though the businesses have demonstrated strong cash flow performance in their recent histories.

 

Other significant changes in the average balances of the Corporation’s earning assets and interest-bearing liabilities are described in the “Net Interest Income” section of Management’s Discussion and Analysis. Other significant balance sheet items, including the allowance for loan losses and stockholders’ equity, are discussed in separate sections of Management’s Discussion and Analysis.

 

Management does not expect capital expenditures to have a material, detrimental effect on the Corporation’s financial condition in 2016.

 

Since 2009, the Corporation has originated and sold residential mortgage loans to the secondary market through the MPF Xtra program administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Residential mortgages originated and sold through the MPF Xtra program consist primarily of conforming, prime loans sold to the Federal National Mortgage Association (Fannie Mae), a government agency. In 2014, the Corporation began to originate and sell residential mortgage loans to the secondary market through the MPF Original program, which is also administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Residential mortgages originated and sold through the MPF Original program consist primarily of conforming, prime loans sold to the Federal Home Loan Bank of Pittsburgh. For loans sold under the Original program, the Corporation provides a credit enhancement whereby the Corporation would assume credit losses in excess of a defined First Loss Account (“FLA”) balance, up to specified amounts. The FLA is funded by the Federal Home Loan Bank of Pittsburgh based on a percentage of the outstanding balance of loans sold. At June 30, 2016, the Corporation has recorded an allowance in the amount of $155,000 for credit losses on loans sold under the MPF Original Program which is included in “Accrued interest and other liabilities” in the accompanying balance sheet. There was no allowance recorded at December 31, 2015. The Corporation does not provide a credit enhancement for loans sold through the Xtra program.

 

For loan sales originated under the MPF Xtra and Original programs, the Corporation provides customary representations and warranties to investors that specify, among other things, that the loans have been underwritten to the standards established by the investor. The Corporation may be required to repurchase a loan and reimburse a portion of fees received, or reimburse the investor for a credit loss incurred on a loan, if it is determined that the representations and warranties have not been met. Such repurchases or reimbursements generally result from an underwriting or documentation deficiency. At June 30, 2016, the total outstanding balance of loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $1,939,000, and the corresponding total outstanding balance repurchased at December 31, 2015 was $1,968,000.

 

At June 30, 2016, outstanding balances of loans sold and serviced through the two programs totaled $156,417,000, including loans sold through the MPF Xtra program of $120,225,000 and loans sold through the Original program of $36,192,000. At December 31, 2015, outstanding balances of loans sold and serviced through the two programs totaled $152,448,000, including loans sold through the MPF Xtra program of $125,571,000 and loans sold through the Original program of $26,877,000. Based on the fairly limited volume of required repurchases to date, no allowance had been established for representation and warranty exposures as of June 30, 2016 and December 31, 2015.

 

 

PROVISION AND ALLOWANCE FOR LOAN LOSSES

 

The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction of the investment in loans. Note 7 to the unaudited consolidated financial statements provides an overview of the process management uses for evaluating and determining the allowance for loan losses.

 

While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.

 

The allowance for loan losses was $7,929,000 at June 30, 2016, up slightly from $7,889,000 at December 31, 2015. As shown in Table X, the specific allowance on impaired loans totaled $253,000 at June 30, 2016, which was $567,000 lower than the total specific allowance at December 31, 2015 primarily as a result of a $595,000 partial charge-off on one commercial loan. Table X also shows the collectively determined component of the allowance for commercial loans was $387,000 higher at June 30, 2016 than at December 31, 2015, reflecting the effects of growth in outstanding loans and increases in the average net charge-offs experience and qualitative factors used to estimate the required allowance. The collectively determined component of the allowance for residential mortgages was $233,000 higher at June 30, 2016 than at December 31, 2015, reflecting growth in outstanding loans and the use of slightly higher qualitative factors to estimate the required allowance.

 

The provision (credit) for loan losses by segment in the three-month and six-month period ended June 30, 2016 and 2015 is as follows:

 

(In Thousands)		3 Months Ended								6 Months Ended
		June 30,				June 30,				June 30,				June 30,
		2016				2015				2016				2015
Residential mortgage		$	191			$	141			$	274			$	69
Commercial			135				82				413				161
Consumer			21				(4	)			28				(7	)
Unallocated			(29	)			2				(29	)			1
Total		$	318			$	221			$	686			$	224

 

The increases in the provision for loan losses for the second quarter and first six months of 2016 as compared to the corresponding periods of 2015 reflect, in part, increases in the collectively determined allowance for loan losses resulting from growth in outstanding loans and from slight increases in qualitative factors used to estimate the required allowance. In 2016, the provision for the commercial segment also includes the effects of an increase in average net charge-offs as a percentage of outstanding loans (based on historical experience over the previous thirty-six months) used to estimate a portion of the collectively determined allowance.

 

Table XI presents information related to past due and impaired loans, and loans that have been modified under terms that are considered troubled debt restructurings (TDRs). Table XI shows total impaired loans of $9,330,000 at June 30, 2016, down $644,000 from the corresponding amount at December 31, 2015 of $9,974,000. As also shown in Table XI, loans classified as TDRs totaled $6,149,000 at June 30, 2016 down slightly from $6,364,000 at December 31, 2015, and nonaccrual loans totaled $10,504,000 at June 30, 2016 as compared to $11,517,000 at December 31, 2015.

 

The outstanding balances of impaired loans without a valuation allowance, nonaccrual loans and nonperforming TDRs at June 30, 2016, include an outstanding balance of $4,925,000 from loans to one commercial entity. In 2014, the Corporation entered into a forbearance agreement with this commercial borrower which included a reduction in monthly payment amounts over a fifteen-month period. At the end of the fifteen-month period, the monthly payment amounts would revert to the original amounts, unless the forbearance agreement was extended or the payment requirements otherwise modified. The forbearance agreement has been extended for two additional twelve-month periods, most recently in July 2016. The Corporation recorded a charge-off of $1,486,000 in the second quarter 2014 as a result of these modifications, as the payment amounts based on the forbearance agreement are not sufficient to fully amortize the contractual amount of principal outstanding on the loans. The borrower has made all required payments on the loans in accordance with the terms of the forbearance agreement, as extended.

 

 

As also shown in Table XI total loans past due 90 days or more and still accruing interest increased to $4,654,000 at June 30, 2016 from $3,229,000 at December 31, 2015. This category includes first lien residential mortgages with a total outstanding balance of $3,663,000 at June 30, 2016. The Corporation reviews the status of loans past due 90 days or more each quarter to determine if it is appropriate to continue to accrue interest, and has determined the loans included in this category are well secured and that ultimate collection of all principal and interest is probable.

 

Each period presented in Table XI includes a few large commercial relationships that have required significant monitoring and workout efforts. As a result, a limited number of relationships may significantly impact the total amount of allowance required on impaired loans, and may significantly impact the amount of total charge-offs reported in any one period.

 

Management believes it has been conservative in its decisions concerning identification of impaired loans, estimates of loss, and nonaccrual status; however, the actual losses realized from these relationships could vary materially from the allowances calculated as of June 30, 2016. Management continues to closely monitor its commercial loan relationships for possible credit losses, and will adjust its estimates of loss and decisions concerning nonaccrual status, if appropriate.

 

Tables IX through XII present historical data related to loans and the allowance for loan losses.

 

TABLE IX - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES

(In Thousands)

 

		6 Months Ended
		June 30,				June 30,				Years Ended December 31,
		2016				2015				2015				2014				2013				2012				2011
Balance, beginning of year		$	7,889			$	7,336			$	7,336			$	8,663			$	6,857			$	7,705			$	9,107
Charge-offs:
Residential mortgage			(42	)			(137	)			(217	)			(327	)			(95	)			(552	)			(100	)
Commercial			(595	)			(125	)			(251	)			(1,715	)			(459	)			(498	)			(1,189	)
Consumer			(39	)			(37	)			(94	)			(97	)			(117	)			(171	)			(157	)
Total charge-offs			(676	)			(299	)			(562	)			(2,139	)			(671	)			(1,221	)			(1,446	)
Recoveries:
Residential mortgage			0				1				1				25				24				18				3
Commercial			3				4				214				264				348				8				255
Consumer			27				34				55				47				58				59				71
Total recoveries			30				39				270				336				430				85				329
Net charge-offs			(646	)			(260	)			(292	)			(1,803	)			(241	)			(1,136	)			(1,117	)
Provision (credit) for loan losses			686				224				845				476				2,047				288				(285	)
Balance, end of period		$	7,929			$	7,300			$	7,889			$	7,336			$	8,663			$	6,857			$	7,705
Net charge-offs as a % of average loans			0.09	%			0.04	%			0.04	%			0.29	%			0.04	%			0.16	%			0.16	%

 

 

TABLE X - COMPONENTS OF THE ALLOWANCE FOR LOAN LOSSES

(In Thousands)

		June 30,				As of December 31,
		2016				2015				2014				2013				2012				2011
ASC 310 - Impaired loans		$	253			$	820			$	769			$	2,333			$	623			$	1,126
ASC 450 - Collective segments:
Commercial			3,490				3,103				2,732				2,583				2,594				2,811
Residential mortgage			3,650				3,417				3,295				3,156				3,011				3,130
Consumer			138				122				145				193				188				204
Unallocated			398				427				395				398				441				434
Total Allowance		$	7,929			$	7,889			$	7,336			$	8,663			$	6,857			$	7,705

 

The above allocation is based on estimates and subjective judgments and is not necessarily indicative of the specific amounts or loan categories in which losses may occur.

 

TABLE XI - PAST DUE AND IMPAIRED LOANS, NONPERFORMING ASSETS AND TROUBLED DEBT RESTRUCTURINGS (TDRs)

(In Thousands)		As of
		June 30,				As of December 31,
		2016				2015				2014				2013				2012				2011
Impaired loans with a valuation allowance		$	1,275			$	1,933			$	3,241			$	9,889			$	2,710			$	3,433
Impaired loans without a valuation allowance			8,055				8,041				9,075				6,432				4,719				4,431
Total impaired loans		$	9,330			$	9,974			$	12,316			$	16,321			$	7,429			$	7,864
Total loans past due 30-89 days and still accruing		$	6,945			$	7,057			$	7,121			$	8,305			$	7,756			$	7,898
Nonperforming assets:
Total nonaccrual loans		$	10,504			$	11,517			$	12,610			$	14,934			$	7,353			$	7,197
Total loans past due 90 days or more and still accruing			4,654				3,229				2,843				3,131				2,311				1,267
Total nonperforming loans			15,158				14,746				15,453				18,065				9,664				8,464
Foreclosed assets held for sale (real estate)			2,052				1,260				1,189				892				879				1,235
Total nonperforming assets		$	17,210			$	16,006			$	16,642			$	18,957			$	10,543			$	9,699
Loans subject to troubled debt restructurings (TDRs):
Performing		$	1,047			$	1,186			$	1,807			$	3,267			$	906			$	1,064
Nonperforming			5,102				5,178				5,388				908				1,155				2,413
Total TDRs		$	6,149			$	6,364			$	7,195			$	4,175			$	2,061			$	3,477
Total nonperforming loans as a % of loans			2.08	%			2.09	%			2.45	%			2.80	%			1.41	%			1.19	%
Total nonperforming assets as a % of assets			1.40	%			1.31	%			1.34	%			1.53	%			0.82	%			0.73	%
Allowance for loan losses as a % of total loans			1.09	%			1.12	%			1.16	%			1.34	%			1.00	%			1.09	%
Allowance for loan losses as a % of nonperforming loans			52.31	%			53.50	%			47.47	%			47.95	%			70.95	%			91.03	%

 

 

TABLE XII - SUMMARY OF LOANS BY TYPE

Summary of Loans by Type

(In Thousands)		June 30,				As of December 31,
		2016				2015				2014				2013				2012				2011
Residential mortgage:
Residential mortgage loans - first liens		$	315,191			$	304,783			$	291,882			$	299,831			$	311,627			$	331,015
Residential mortgage loans - junior liens			22,159				21,146				21,166				23,040				26,748				28,851
Home equity lines of credit			39,054				39,040				36,629				34,530				33,017				30,037
1-4 Family residential construction			22,241				21,121				16,739				13,909				12,842				9,959
Total residential mortgage			398,645				386,090				366,416				371,310				384,234				399,862
Commercial:
Commercial loans secured by real estate			153,070				154,779				145,878				147,215				158,413				156,388
Commercial and industrial			82,390				75,196				50,157				42,387				48,442				57,191
Political subdivisions			41,026				40,007				17,534				16,291				31,789				37,620
Commercial construction and land			9,193				5,122				6,938				17,003				28,200				23,518
Loans secured by farmland			6,615				7,019				7,916				10,468				11,403				10,949
Multi-family (5 or more) residential			8,173				9,188				8,917				10,985				6,745				6,583
Agricultural loans			4,692				4,671				3,221				3,251				3,053				2,987
Other commercial loans			11,904				12,152				13,334				14,631				362				552
Total commercial			317,063				308,134				253,895				262,231				288,407				295,788
Consumer			12,134				10,656				10,234				10,762				11,269				12,665
Total			727,842				704,880				630,545				644,303				683,910				708,315
Less: allowance for loan losses			(7,929	)			(7,889	)			(7,336	)			(8,663	)			(6,857	)			(7,705	)
Loans, net		$	719,913			$	696,991			$	623,209			$	635,640			$	677,053			$	700,610

 

LIQUIDITY

 

Liquidity is the ability to quickly raise cash at a reasonable cost. An adequate liquidity position permits the Corporation to pay creditors, compensate for unforeseen deposit fluctuations and fund unexpected loan demand. At June 30, 2016, the Corporation maintained overnight interest-bearing deposits with the Federal Reserve Bank of Philadelphia and other correspondent banks totaling $9,401,000.

 

The Corporation maintains overnight borrowing facilities with several correspondent banks that provide a source of day-to-day liquidity. Also, the Corporation maintains borrowing facilities with the Federal Home Loan Bank of Pittsburgh, secured by various mortgage loans.

 

The Corporation has a line of credit with the Federal Reserve Bank of Philadelphia’s Discount Window. Management intends to use this line of credit as a contingency funding source. As collateral for the line, the Corporation has pledged available-for-sale securities with a carrying value of $19,031,000 at June 30, 2016.

 

The Corporation’s outstanding, available, and total credit facilities at June 30, 2016 and December 31, 2015 are as follows:

 

		Outstanding								Available								Total Credit
(In Thousands)		June 30,				Dec. 31,				June 30,				Dec. 31,				June 30,				Dec. 31,
		2016				2015				2016				2015				2016				2015
Federal Home Loan Bank of Pittsburgh		$	31,656			$	60,348			$	294,372			$	262,361			$	326,028			$	322,709
Federal Reserve Bank Discount Window			0				0				17,285				19,606				17,285				19,606
Other correspondent banks			0				0				45,000				45,000				45,000				45,000
Total credit facilities		$	31,656			$	60,348			$	356,657			$	326,967			$	388,313			$	387,315

 

At June 30, 2016, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowings of $7,500,000, short-term borrowings of $12,541,000, and long-term borrowings with a total amount of $11,615,000. At December 31, 2015, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowings of $23,500,000, short-term borrowings of $25,081,000, and long-term borrowings with a total amount of $11,767,000. Additional information regarding borrowed funds is included in Note 8 of the unaudited consolidated financial statements.

 

 

Additionally, the Corporation uses repurchase agreements placed with brokers to borrow funds secured by investment assets and “RepoSweep” arrangements to borrow funds from commercial banking customers on an overnight basis. If required to raise cash in an emergency situation, the Corporation could sell available-for-sale securities to meet its obligations. At June 30, 2016, the carrying value of available-for-sale securities in excess of amounts required to meet pledging or repurchase agreement obligations was $224,393,000.

 

Management believes the Corporation is well-positioned to meet its short-term and long-term obligations.

 

STOCKHOLDERS’ EQUITY AND CAPITAL ADEQUACY

 

The Corporation and C&N Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Details concerning capital ratios at June 30, 2016 and December 31, 2015 are presented below. Management believes, as of June 30, 2016 and December 31, 2015, that the Corporation and C&N Bank meet all capital adequacy requirements to which they are subject and maintain capital conservation buffers (described in more detail in the “New Capital Rule” section below) that allow the Corporation and C&N Bank to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. Further, as reflected in the table below, the Corporation’s and C&N Bank’s capital ratios at June 30, 2016 and December 31, 2015 exceed the Corporation’s policy threshold levels.

 

(Dollars in Thousands)																										Minimum To Be Well
										Minimum								Minimum To Maintain								Capitalized Under								Minimum To Meet
										Capital								Capital Conservation								Prompt Corrective								the Corporation's
		Actual								Requirement								Buffer at Reporting Date								Action Provisions								Policy Thresholds
			Amount				Ratio				Amount				Ratio				Amount				Ratio				Amount				Ratio				Amount				Ratio
June 30, 2016:
Total capital to risk-weighted assets:
Consolidated		$	179,810				23.47	%		$	61,279				8	%		$	66,067				³8.625%			$	76,599				³10	%		$	80,429				³10.5	%
C&N Bank			159,919				21.01	%			60,903				8	%			65,661				³8.625%				76,128				³10	%			79,935				³10.5	%
Tier 1 capital to risk-weighted assets:
Consolidated			171,684				22.41	%			30,640				6	%			50,747				³6.625%				61,279				³8	%			65,109				³8.5	%
C&N Bank			151,990				19.96	%			30,451				6	%			50,435				³6.625%				60,903				³8	%			64,709				³8.5	%
Common equity tier 1 capital to risk-weighted assets:
Consolidated			171,684				22.41	%			30,640				4.5	%			39,257				³5.125%				49,789				³6.5	%			53,619				³7	%
C&N Bank			151,990				19.96	%			30,451				4.5	%			39,016				³5.125%				49,483				³6.5	%			53,290				³7	%
Tier 1 capital to average assets:
Consolidated			171,684				14.19	%			48,391				4	%			N/A				N/A				60,489				³5	%			60,489				³5	%
C&N Bank			151,990				12.72	%			47,786				4	%			N/A				N/A				59,732				³5	%			59,732				³5	%
December 31, 2015:
Total capital to risk-weighted assets:
Consolidated		$	181,216				24.40	%		$	59,424				8	%			N/A				N/A			$	74,281				³10	%		$	77,995				³10.5	%
C&N Bank			161,187				21.83	%			59,058				8	%			N/A				N/A				73,823				³10	%			77,514				³10.5	%
Tier 1 capital to risk-weighted assets:
Consolidated			173,009				23.29	%			29,712				6	%			N/A				N/A				59,424				³8	%			63,139				³8.5	%
C&N Bank			153,298				20.77	%			29,529				6	%			N/A				N/A				59,058				³8	%			62,749				³8.5	%
Common equity tier 1 capital to risk-weighted assets:
Consolidated			173,009				23.29	%			29,712				4.5	%			N/A				N/A				48,282				³6.5	%			51,996				³7	%
C&N Bank			153,298				20.77	%			29,529				4.5	%			N/A				N/A				47,985				³6.5	%			51,676				³7	%
Tier 1 capital to average assets:
Consolidated			173,009				14.31	%			48,355				4	%			N/A				N/A				60,444				³5	%			60,444				³5	%
C&N Bank			153,298				12.81	%			47,861				4	%			N/A				N/A				59,826				³5	%			59,826				³5	%

 

 

Management expects the Corporation and C&N Bank to maintain capital levels that exceed the regulatory standards for well-capitalized institutions and the applicable capital conservation buffers for the next 12 months and for the foreseeable future.

 

Future dividend payments will depend upon maintenance of a strong financial condition, future earnings and capital and regulatory requirements. As described in more detail in the section below titled “New Capital Rule," the Corporation and C&N Bank are subject to restrictions on the amount of dividends that may be paid without approval of banking regulatory authorities.

 

NEW CAPITAL RULE

 

In July 2013, the federal regulatory authorities issued a new capital rule based, in part, on revisions developed by the Basel Committee on Banking Supervision to the Basel capital framework (Basel III). The Corporation and C&N Bank became subject to the new rule effective January 1, 2015. Generally, the new rule implemented higher minimum capital requirements, revised the definition of regulatory capital components and related calculations, added a new common equity tier 1 capital ratio, implemented a new capital conservation buffer, increased the risk weighting for past due loans and provided a transition period for several aspects of the new rule.

 

The current (new) capital rule provides that, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of common equity tier 1 capital above its minimum risk-based capital requirements. The buffer is measured relative to risk-weighted assets. Phase-in of the capital conservation buffer requirements began January 1, 2016. The transition schedule for new ratios, including the capital conservation buffer, is as follows:

 

		As of January 1:
		2015				2016				2017				2018				2019
Minimum common equity tier 1 capital ratio			4.5	%			4.5	%			4.5	%			4.5	%			4.5	%
Common equity tier 1 capital conservation buffer			N/A				0.625	%			1.25	%			1.875	%			2.5	%
Minimum common equity tier 1 capital ratio plus capital conservation buffer			4.5	%			5.125	%			5.75	%			6.375	%			7.0	%
Phase-in of most deductions from common equity tier 1 capital			40	%			60	%			80	%			100	%			100	%
Minimum tier 1 capital ratio			6.0	%			6.0	%			6.0	%			6.0	%			6.0	%
Minimum tier 1 capital ratio plus capital conservation buffer			N/A				6.625	%			7.25	%			7.875	%			8.5	%
Minimum total capital ratio			8.0	%			8.0	%			8.0	%			8.0	%			8.0	%
Minimum total capital ratio plus capital conservation buffer			N/A				8.625	%			9.25	%			9.875	%			10.5	%

 

As fully phased in, a banking organization with a buffer greater than 2.5% would not be subject to additional limits on dividend payments or discretionary bonus payments; however, a banking organization with a buffer less than 2.5% would be subject to increasingly stringent limitations as the buffer approaches zero. The new rule also prohibits a banking organization from making dividend payments or discretionary bonus payments if its eligible retained income is negative in that quarter and its capital conservation buffer ratio was less than 2.5% as of the beginning of that quarter. Eligible net income is defined as net income for the four calendar quarters preceding the current calendar quarter, net of any distributions and associated tax effects not already reflected in net income. A summary of payout restrictions based on the capital conservation buffer is as follows:

 

 

Capital Conservation Buffer		Maximum Payout
(as a % of risk-weighted assets)		(as a % of eligible retained income)
Greater than 2.5%			No payout limitation applies
≤2.5% and >1.875%			60	%
≤1.875% and >1.25%			40	%
≤1.25% and >0.625%			20	%
≤0.625%			0	%

 

At June 30, 2016, the Corporation’s Capital Conservation Buffer, determined based on the minimum total capital ratio, was 15.47%. C&N Bank’s Capital Conservation Buffer (also determined based on the minimum total capital ratio) was 13.01%.

 

The Corporation’s total stockholders’ equity is affected by fluctuations in the fair values of available-for-sale securities. The difference between amortized cost and fair value of available-for-sale securities, net of deferred income tax, is included in Accumulated Other Comprehensive Income within stockholders’ equity. The balance in Accumulated Other Comprehensive Income related to unrealized gains on available-for-sale securities, net of deferred income tax, amounted to $6,849,000 at June 30, 2016 and $2,493,000 at December 31, 2015. Changes in accumulated other comprehensive income are excluded from earnings and directly increase or decrease stockholders’ equity. If available-for-sale securities are deemed to be other-than-temporarily impaired, unrealized losses are recorded as a charge against earnings, and amortized cost for the affected securities is reduced. Note 6 to the unaudited consolidated financial statements provides additional information concerning management’s evaluation of available-for-sale securities for other-than-temporary impairment at June 30, 2016.

 

Stockholders’ equity is also affected by the underfunded or overfunded status of defined benefit pension and postretirement plans. The balance in Accumulated Other Comprehensive Income related to defined benefit plans, net of deferred income tax, was $45,000 at June 30, 2016 and $35,000 at December 31, 2015.

 

COMPREHENSIVE INCOME

 

Comprehensive Income is the total of (1) net income, and (2) all other changes in equity from non-stockholder sources, which are referred to as Other Comprehensive Income. Changes in the components of Accumulated Other Comprehensive Income (Loss) are included in Other Comprehensive Income, and for the Corporation, consist of changes in unrealized gains or losses on available-for-sale securities and changes in underfunded or overfunded defined benefit plans. Fluctuations in interest rates significantly affect fair values of available-for-sale securities, and accordingly have an effect on Other Comprehensive Income (Loss) in each period.

 

Comprehensive Income totaled $5,369,000 for the three months ended June 30, 2016 as compared to $777,000 in the second quarter 2015. For the three months ended June 30, 2016, Comprehensive Income included: (1) Net Income of $3,871,000, which was $486,000 lower than in the second quarter 2015; (2) Other Comprehensive Income from an increase in net unrealized gains on available-for-sale securities of $1,502,000 as compared to Other Comprehensive Loss of ($3,577,000) from a decrease in net unrealized gains on available-for-sale securities in the second quarter 2015; and (3) Other Comprehensive Loss from defined benefit plans of ($4,000) for the second quarter 2016 and ($3,000) for the second quarter 2015.

 

Comprehensive Income totaled $11,810,000 for the six months ended June 30, 2016 as compared to $6,898,000 for the six months ended June 30, 2015. In the six months ended June 30, 2016, Comprehensive Income included: (1) Net Income of $7,444,000, which was $728,000 lower than in the first six months of 2015; (2) Other Comprehensive Income from an increase in net unrealized gains on available-for-sale securities, net of deferred income tax, of $4,356,000 as compared to Other Comprehensive Loss of ($1,204,000) in the first six months of 2015; and (3) Other Comprehensive Income from defined benefit plans of $10,000 as compared to Other Comprehensive Loss of ($70,000) in the first six months of 2015.

 

INCOME TAXES

 

The effective income tax rate ranged from 24.35% to 25.18% of pre-tax income for the three-month and six-month periods ended June 30, 2016 and 2015. The provision for income tax for interim periods is based on the Corporation’s estimate of the effective tax rate expected to be applicable for the full year. The Corporation’s effective tax rates differ from the statutory rate of 35% principally because of the effects of tax-exempt interest income.

 

 

The Corporation recognizes deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax basis of assets and liabilities. At June 30, 2016, the net deferred tax asset was $425,000, down from $3,115,000 at December 31, 2015. The most significant change in temporary difference components was an increase of $2,344,000 in the deferred tax liability associated with unrealized gains on available-for-sale securities.

 

The Corporation regularly reviews deferred tax assets for recoverability based on history of earnings, expectations for future earnings and expected timing of reversals of temporary differences. Realization of deferred tax assets ultimately depends on the existence of sufficient taxable income, including taxable income in prior carryback years, as well as future taxable income. Management believes the recorded net deferred tax asset at June 30, 2016 is fully realizable; however, if management determines the Corporation will be unable to realize all or part of the net deferred tax asset, the Corporation would adjust the deferred tax asset, which would negatively impact earnings.

 

Additional information related to income taxes is presented in Note 11 to the unaudited, consolidated financial statements.

 

INFLATION

 

The Corporation is significantly affected by the Federal Reserve Board’s efforts to control inflation through changes in short-term interest rates. Beginning in September 2007, in response to concerns about weakness in the U.S. economy, the Federal Reserve lowered the fed funds target rate numerous times; in December 2008, it established a target range of 0% to 0.25%, which it maintained through mid-December 2015. On December 16, 2015, the Federal Reserve raised their target for the federal funds rate to 0.25% to 0.50%. This decision was based on data available that suggested economic activity had been expanding at a moderate pace. This included an increase in household spending, business fixed investments increasing, and an improvement in labor market conditions. Also, throughout this period, the Federal Reserve has injected massive amounts of liquidity into the nation’s monetary system through a variety of programs. The Federal Reserve has purchased large amounts of securities in an effort to keep interest rates low and stimulate economic growth. Beginning in late 2013, the Federal Reserve began reducing the amount of securities purchased under its asset purchase program and then ended the program in October 2014, though still reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and continued to roll over maturing Treasury securities at auction. The Federal Reserve maintained their commitment to this policy in their June 15, 2016 statement and anticipates doing so until normalization of the level of the federal funds rate is well under way.

 

Despite the current low short-term rate environment, inflation statistics indicate that the overall rate of inflation is unlikely to significantly affect the Corporation’s operations within the near future. Although management cannot predict future changes in the rates of inflation, management monitors the impact of economic trends, including any indicators of inflationary pressures, in managing interest rate and other financial risks.

 

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

MARKET RISK

 

Market risk is the risk of loss arising from adverse changes in market rates and prices of the Corporation’s financial instruments. In addition to the effects of interest rates, the market prices of the Corporation’s debt securities within the available-for-sale securities portfolio are affected by fluctuations in the risk premiums (amounts of spread over risk-free rates) demanded by investors. Management attempts to limit the risk that economic conditions would force the Corporation to sell securities for realized losses by maintaining a strong capital position (discussed in the “Stockholders’ Equity and Capital Adequacy” section of Management’s Discussion and Analysis) and ample sources of liquidity (discussed in the “Liquidity” section of Management’s Discussion and Analysis).

 

The Corporation’s two major categories of market risk are interest rate risk and equity securities risk, which are discussed in the following sections.

 

INTEREST RATE RISK

 

Business risk arising from changes in interest rates is an inherent factor in operating a bank. The Corporation’s assets are predominantly long-term, fixed-rate loans and debt securities. Funding for these assets comes principally from shorter-term deposits and borrowed funds. Accordingly, there is an inherent risk of lower future earnings or decline in fair value of the Corporation’s financial instruments when interest rates change.

 

The Corporation uses a simulation model to calculate the potential effects of interest rate fluctuations on net interest income and the market value of portfolio equity. For purposes of these calculations, the market value of portfolio equity includes the fair values of financial instruments, such as securities, loans, deposits and borrowed funds, and the book values of nonfinancial assets and liabilities, such as premises and equipment and accrued expenses. The model measures and projects the amount of potential changes in net interest income, and calculates the discounted present value of anticipated cash flows of financial instruments, assuming an immediate increase or decrease in interest rates. Management ordinarily runs a variety of scenarios within a range of plus or minus 100-400 basis points of current rates.

 

The model makes estimates, at each level of interest rate change, regarding cash flows from principal repayments on loans and mortgage-backed securities and call activity on other investment securities. Actual results could vary significantly from these estimates, which could result in significant differences in the calculations of projected changes in net interest income and market value of portfolio equity. Also, the model does not make estimates related to changes in the composition of the deposit portfolio that could occur due to rate competition, and the table does not necessarily reflect changes that management would make to realign the portfolio as a result of changes in interest rates.

 

The Corporation’s Board of Directors has established policy guidelines for acceptable levels of interest rate risk, based on an immediate increase or decrease in interest rates. The policy limits acceptable fluctuations in net interest income from the baseline (flat rates) one-year scenario and variances in the market value of portfolio equity from the baseline values based on current rates.

 

Table XIII, which follows this discussion, is based on the results of calculations performed using the simulation model as of April 30, 2016 and December 31, 2015. The table shows that as of the respective dates, the changes in net interest income and changes in market value were within the policy limits in all scenarios.

 

 

TABLE XIII - THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES

 

April 30, 2016 Data
(In Thousands)		Period Ending April 30, 2017
Basis Point		Interest				Interest				Net Interest				NII				NII
Change in Rates		Income				Expense				Income (NII)				% Change				Risk Limit
+400		$	51,989			$	21,581			$	30,408				-17.8	%			25.0	%
+300			49,254				16,936				32,318				-12.6	%			20.0	%
+200			46,486				12,380				34,106				-7.8	%			15.0	%
+100			43,641				8,020				35,621				-3.7	%			10.0	%
0			40,711				3,713				36,998				0.0	%			0.0	%
-100			38,093				3,194				34,899				-5.7	%			10.0	%
-200			36,860				3,192				33,668				-9.0	%			15.0	%
-300			36,402				3,192				33,210				-10.2	%			20.0	%
-400			36,269				3,192				33,077				-10.6	%			25.0	%

 

		Market Value of Portfolio Equity at April 30, 2016
		Present				Present				Present
Basis Point		Value				Value				Value
Change in Rates		Equity				% Change				Risk Limit
+400		$	176,279				-21.4	%			50.0	%
+300			186,707				-16.7	%			45.0	%
+200			198,706				-11.4	%			35.0	%
+100			210,669				-6.0	%			25.0	%
0			224,161				0.0	%			0.0	%
-100			222,397				-0.8	%			25.0	%
-200			229,441				2.4	%			35.0	%
-300			263,537				17.6	%			45.0	%
-400			295,145				31.7	%			50.0	%

 

December 31, 2015 Data
(In Thousands)						Period Ending December 31, 2016
Basis Point		Interest				Interest				Net Interest				NII				NII
Change in Rates		Income				Expense				Income (NII)				% Change				Risk Limit
+400		$	52,181			$	21,985			$	30,196				-20.8	%			25.0	%
+300			49,687				17,282				32,405				-15.0	%			20.0	%
+200			47,136				12,659				34,477				-9.6	%			15.0	%
+100			44,546				8,109				36,437				-4.4	%			10.0	%
0			41,835				3,715				38,120				0.0	%			0.0	%
-100			39,116				3,171				35,945				-5.7	%			10.0	%
-200			37,417				3,168				34,249				-10.2	%			15.0	%
-300			36,838				3,168				33,670				-11.7	%			20.0	%
-400			36,689				3,168				33,521				-12.1	%			25.0	%

 

		Market Value of Portfolio Equity at December 31, 2016
		Present				Present				Present
Basis Point		Value				Value				Value
Change in Rates		Equity				% Change				Risk Limit
+400		$	167,741				-24.4	%			50.0	%
+300			179,772				-18.9	%			45.0	%
+200			193,823				-12.6	%			35.0	%
+100			207,803				-6.3	%			25.0	%
0			221,750				0.0	%			0.0	%
-100			223,517				0.8	%			25.0	%
-200			225,185				1.5	%			35.0	%
-300			250,353				12.9	%			45.0	%
-400			286,210				29.1	%			50.0	%

 

 

EQUITY SECURITIES RISK

 

The Corporation’s equity securities portfolio consists of investments in stocks of banks and bank holding companies. Investments in bank stocks are subject to risk factors that affect the banking industry in general, including credit risk, competition from non-bank entities, interest rate risk and other factors, which could result in a decline in market prices. Also, losses could occur in individual stocks held by the Corporation because of specific circumstances related to each bank.

 

Equity securities held as of June 30, 2016 and December 31, 2015 are presented in Table XIV. Table XIV presents quantitative data concerning the effects of a decline in fair value of the Corporation’s equity securities of 10% or 20%. The data in Table XIV does not reflect the effects of any appreciation in value that may occur, nor does it present the Corporation’s maximum exposure to loss on equity securities, which would be 100% of their fair value as of June 30, 2016.

 

TABLE XIV - EQUITY SECURITIES RISK
(In Thousands)
		June 30,				Dec. 31,
		2016				2015
Cost		$	1,171			$	1,680
Fair Value			1,609				2,386
Hypothetical 10% Decline In Market Value			(161	)			(239	)
Hypothetical 20% Decline In Market Value			(322	)			(477	)

 

ITEM 4. CONTROLS AND PROCEDURES

 

The Corporation’s management, under the supervision of and with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, has carried out an evaluation of the design and effectiveness of the Corporation’s disclosure controls and procedures as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Securities Exchange Act of 1934 as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Corporation’s disclosure controls and procedures are effective to ensure that all material information required to be disclosed in reports the Corporation files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.

 

There were no significant changes in the Corporation’s internal control over financial reporting that occurred during the period covered by this report that have materially affected, or that are reasonably likely to affect, our internal control over financial reporting.

 

 

PART II – OTHER INFORMATION

 

Item 1.

Legal Proceedings

 

The Corporation and C&N Bank are involved in various legal proceedings incidental to their business. Management believes the aggregate liability, if any, resulting from such pending and threatened legal proceedings will not have a material, adverse effect on the Corporation’s financial condition or results of operations.

 

Item 1A.

Risk Factors

 

There have been no material changes from the risk factors previously disclosed in Item 1A of the Corporation’s Form 10-K filed February 18, 2016.

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

Issuer Purchases of Equity Securities

 

The following table sets forth a summary of the purchases by the Corporation, on the open market, of its equity securities during the second quarter 2016:

 

Period		Total Number of Shares Purchased				Average Price Paid per Share				Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs				Maximum Number of Shares that May Yet be Purchased Under the Plans or Programs
April 1 - 30, 2016			32,950			$	19.82				622,500				600,000
May 1 - 31, 2016			0			$	0				0				600,000
June 1 - 30, 2016			0			$	0				0				600,000

 

Notes to Table:

 

1.

Effective July 17, 2014, the Corporation established a treasury stock repurchase program authorizing repurchase of up to 622,500 shares of the Corporation’s common stock, or approximately 5% of the Corporation’s issued and outstanding shares at July 16, 2014. As permitted by securities laws and other legal requirements and subject to market conditions and other factors, purchases under the program could be made from time to time in the open market at prevailing prices, or through privately negotiated transactions.

 

In April 2016, the Corporation repurchased the remainder of the shares authorized under the program. In total, 622,500 shares were repurchased for a total cost of $12,140,000, at an average price of $19.50 per share.

 

2.

Effective April 21, 2016, the Corporation’s Board of Directors approved a new treasury stock repurchase program. Under the newly approved stock repurchase program, the Corporation is authorized to repurchase up to 600,000 shares of the Corporation's common stock or slightly less than 5% of the Corporation's issued and outstanding shares at April 19, 2016. Consistent with the previous program, the Board of Directors’ April 21, 2016 authorization provides that: (1) the new treasury stock repurchase program shall be effective when publicly announced and shall continue thereafter until suspended or terminated by the Board of Directors, in its sole discretion; and (2) all shares of common stock repurchased pursuant to the new program shall be held as treasury shares and be available for use and reissuance for purposes as and when determined by the Board of Directors including, without limitation, pursuant to the Corporation’s Dividend Reinvestment and Stock Purchase Plan and its equity compensation program. To date, no purchases have been made under this repurchase program.

 

Item 3.

Defaults Upon Senior Securities

 

None

 

Item 4.

Mine Safety Disclosures

 

Not applicable

 

 

Item 5.

Other Information

 

None

 

Item 6.

Exhibits

 

2.	Plan of acquisition, reorganization, arrangement, liquidation or succession	Not applicable
3.	(i) Articles of Incorporation	Incorporated by reference to Exhibit 3.1 of the Corporation's Form 8-K filed September 21, 2009
3.	(ii) By-laws	Incorporated by reference to Exhibit 3.1 of the Corporation's Form 8-K filed April 19, 2013
4.	Instruments defining the rights of Security holders, including indentures	Not applicable
10.	Material contracts:
	10.1 Form of Restricted Stock agreement dated May 3, 2016 between the Corporation and Independent Directors Terry L. Lehman and Frank G. Pellegrino pursuant to the Citizens & Northern Corporation Independent Directors Stock Incentive Plan	Filed herewith
11.	Statement re: computation of per share earnings	Information concerning the computation of earnings per share is provided in Note 2 to the unaudited consolidated financial statements, which is included in Part I,  Item 1 of Form 10-Q
15.	Letter re: unaudited interim information	Not applicable
18.	Letter re: change in accounting principles	Not applicable
19.	Report furnished to security holders	Not applicable
22.	Published report regarding matters submitted to vote of security holders	Not applicable
23.	Consents of experts and counsel	Not applicable
24.	Power of attorney	Not applicable
31.	Rule 13a-14(a)/15d-14(a) certifications:
	31.1 Certification of Chief Executive Officer	Filed herewith
	31.2 Certification of Chief Financial Officer	Filed herewith
32.	Section 1350 certifications	Filed herewith
99.	Additional exhibits	Not applicable
100.	XBRL-related documents	Not applicable
101.	Interactive data file	Filed herewith

 

 

SIGNATURES

 

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

 

	CITIZENS & NORTHERN CORPORATION
August 4, 2016	By:/s/ J. Bradley Scovill
Date	President and Chief Executive Officer
August 4, 2016	By: /s/ Mark A. Hughes
Date	Treasurer and Chief Financial Officer