CITIZENS FINANCIAL SERVICES INC - Quarter Report: 2020 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10‑Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2020

[ ] 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 0‑13222

CITIZENS FINANCIAL SERVICES, INC.

(Exact name of registrant as specified in its charter)

PENNSYLVANIA 23‑2265045

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

15 South Main Street

Mansfield, Pennsylvania 16933

(Address of principal executive offices)(Zip Code)

Registrant's telephone number, including area code: (570) 662‑2121

N/A

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

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


Title of Each Class		Trading Symbol(s)		Name of Each Exchange on Which Registered

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes __X__ No_____

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

Large accelerated filer ____ Accelerated filer _X__

Non-accelerated filer ____ Smaller reporting company _X__

Emerging growth company ____

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes____ No __X__

The number of outstanding shares of the Registrant’s Common Stock, as of April 30, 2020, was 3,879,378.

Citizens Financial Services, Inc.

Form 10-Q

INDEX

		PAGE
Part I	FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited):
	Consolidated Balance Sheet as of March 31, 2020 and December 31, 2019	1
	Consolidated Statement of Income for the Three months Ended March 31, 2020 and 2019	2
	Consolidated Statement of Comprehensive Income for the Three months ended March 31, 2020 and 2019	3
	Consolidated Statement of Changes in Stockholders’ Equity for the Three months ended March 31, 2020 and 2019	4
	Consolidated Statement of Cash Flows for the Three months ended March 31, 2020 and 2019	5
	Notes to Consolidated Financial Statements	6-28
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	29-48
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	48
Item 4.	Controls and Procedures	48

Part II	OTHER INFORMATION
Item 1.	Legal Proceedings	48
Item 1A.	Risk Factors	49-50
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	51
Item 3.	Defaults Upon Senior Securities	51
Item 4.	Mine Safety Disclosures	51
Item 5.	Other Information	51
Item 6.	Exhibits	51-52
	Signatures	53

CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED BALANCE SHEET
(UNAUDITED)

	March 31,			December 31,
(in thousands except share data)	2020			2019
ASSETS:
Cash and due from banks:
Noninterest-bearing	$	20,663		$	17,727
Interest-bearing		858			793
Total cash and cash equivalents		21,521			18,520
Interest bearing time deposits with other banks		14,506			14,256
Equity securities		649			701
Available-for-sale securities		257,788			240,706
Loans held for sale		2,006			815

Loans (net of allowance for loan losses:
2020, $14,247 and 2019, $13,845)		1,079,473			1,101,724

Premises and equipment		16,222			15,933
Accrued interest receivable		4,587			4,555
Goodwill		23,296			23,296
Bank owned life insurance		28,284			28,128
Other intangibles		1,294			1,346
Other assets		15,103			16,359

TOTAL ASSETS	$	1,464,729		$	1,466,339

LIABILITIES:
Deposits:
Noninterest-bearing	$	204,489		$	203,793
Interest-bearing		1,000,661			1,007,325
Total deposits		1,205,150			1,211,118
Borrowed funds		83,563			85,117
Accrued interest payable		906			1,088
Other liabilities		15,187			14,242
TOTAL LIABILITIES		1,304,806			1,311,565
STOCKHOLDERS' EQUITY:
Preferred Stock
$1.00 par value; authorized 3,000,000 shares at March 31, 2020 and
December 31, 2019; none issued in 2020 or 2019		-			-
Common stock
$1.00 par value; authorized 25,000,000 shares at March 31, 2020 and December 31, 2019;
issued 3,938,668 at March 31, 2020 and December 31, 2019		3,939			3,939
Additional paid-in capital		55,129			55,089
Retained earnings		113,374			110,800
Accumulated other comprehensive income (loss)		2,918			(629	)
Treasury stock, at cost: 432,659 shares at March 31, 2020
and 413,607 shares at December 31, 2019		(15,437	)		(14,425	)
TOTAL STOCKHOLDERS' EQUITY		159,923			154,774
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY	$	1,464,729		$	1,466,339

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

CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
	Three Months Ended
	March 31,
(in thousands, except share and per share data)	2020			2019
INTEREST INCOME:
Interest and fees on loans	$	13,638		$	13,314
Interest-bearing deposits with banks		95			104
Investment securities:
Taxable		1,107			1,108
Nontaxable		389			357
Dividends		110			134
TOTAL INTEREST INCOME		15,339			15,017
INTEREST EXPENSE:
Deposits		1,987			2,314
Borrowed funds		462			788
TOTAL INTEREST EXPENSE		2,449			3,102
NET INTEREST INCOME		12,890			11,915
Provision for loan losses		400			400
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES		12,490			11,515
NON-INTEREST INCOME:
Service charges		1,081			1,099
Trust		198			232
Brokerage and insurance		340			293
Gains on loans sold		167			99
Equity security (losses) gains, net		(254	)		11
Earnings on bank owned life insurance		156			151
Other		163			148
TOTAL NON-INTEREST INCOME		1,851			2,033
NON-INTEREST EXPENSES:
Salaries and employee benefits		5,414			5,029
Occupancy		526			592
Furniture and equipment		131			155
Professional fees		325			442
FDIC insurance		71			111
Pennsylvania shares tax		275			275
Amortization of intangibles		50			66
Merger and acquisition		376			-
Software expenses		247			227
ORE expenses		32			107
Other		1,474			1,318
TOTAL NON-INTEREST EXPENSES		8,921			8,322
Income before provision for income taxes		5,420			5,226
Provision for income taxes		889			821
NET INCOME	$	4,531		$	4,405

PER COMMON SHARE DATA:
Net Income – Basic	$	1.29		$	1.25
Net Income – Diluted	$	1.29		$	1.25

Number of shares used in computation – basic		3,515,500			3,528,466
Number of shares used in computation – diluted		3,515,500			3,528,466

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

CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(UNAUDITED)
	Three Months Ended
	March 31,
(in thousands)				2020				2019
Net income				$	4,531			$	4,405
Other comprehensive income (loss):
Change in unrealized gains (losses) on available
for sale securities		4,334				1,328
Income tax effect		(910	)			(280	)
Change in unrecognized pension cost		156				61
Income tax effect		(33	)			(13	)
Other comprehensive income (loss), net of tax					3,547				1,096
Comprehensive income				$	8,078			$	5,501

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

CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
											Accumulated
					Additional						Other
	Common Stock				Paid-in			Retained			Comprehensive			Treasury
(in thousands, except share data)	Shares		Amount		Capital			Earnings			Income (Loss)			Stock			Total
Balance, December 31, 2019		3,938,668	$	3,939	$	55,089		$	110,800		$	(629	)	$	(14,425	)	$	154,774
Comprehensive income:
Net income									4,531									4,531
Net other comprehensive income (loss)												3,547						3,547
Purchase of treasury stock (23,412 shares)															(1,279	)		(1,279	)
Restricted stock, executive and Board of Director awards (204 shares)						1									12			13
Restricted stock vesting						40												40
Cash dividend reinvestment paid from treasury stock (4,156 shares)						(1	)		-						255			254
Cash dividends, $0.55 per share									(1,957	)								(1,957	)
Balance, March 31, 2020		3,938,668	$	3,939	$	55,129		$	113,374		$	2,918		$	(15,437	)	$	159,923

Balance, December 31, 2018		3,904,212	$	3,904	$	53,099		$	99,727		$	(3,921	)	$	(13,580	)	$	139,229
Comprehensive income:
Net income									4,405									4,405
Net other comprehensive income (loss)												1,096						1,096
Purchase of treasury stock (5,762 shares)															(330	)		(330	)
Restricted stock vesting						3												3
Cash dividends, $0.441 per share									(1,558	)								(1,558	)
Balance, March 31, 2019		3,904,212	$	3,904	$	53,102		$	102,574		$	(2,825	)	$	(13,910	)	$	142,845

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

CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)	Three Months Ended
	March 31,
(in thousands)	2020			2019
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	4,531		$	4,405
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses		400			400
Depreciation and amortization		150			183
Amortization and accretion of investment securities		120			175
Deferred income taxes		(284	)		464
Equity securities losses (gains), net		254			(11	)
Earnings on bank owned life insurance		(156	)		(151	)
Originations of loans held for sale		(7,043	)		(3,880	)
Proceeds from sales of loans held for sale		5,973			4,885
Realized gains on loans sold		(167	)		(99	)
Increase in accrued interest receivable		(32	)		(317	)
(Decrease) increase in accrued interest payable		(182	)		16
Other, net		1,169			(1,313	)
Net cash provided by operating activities		4,733			4,757
CASH FLOWS FROM INVESTING ACTIVITIES:
Available-for-sale securities:
Proceeds from maturity and principal repayments		29,045			10,581
Purchase of securities		(41,915	)		(12,855	)
Purchase of equity securities		(202	)		-
Purchase of interest bearing time deposits with other banks		(250	)		-
Proceeds from redemption of regulatory stock		3,300			2,580
Purchase of regulatory stock		(2,798	)		(2,782	)
Net decrease (increase) in loans		22,003			(12,908	)
Purchase of premises and equipment		(507	)		(105	)
Proceeds from sale of premises and equipment		-			1
Proceeds from sale of foreclosed assets held for sale		350			89
Net cash provided by (used in) investing activities		9,026			(15,399	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits		(5,968	)		(3,502	)
Proceeds from long-term borrowings		5,000			5,000
Repayments of long-term borrowings		-			(2,589	)
Net (decrease) increase in short-term borrowed funds		(6,554	)		14,658
Purchase of treasury and restricted stock		(1,279	)		(330	)
Dividends paid		(1,957	)		(1,558	)
Net cash (used in) provided by financing activities		(10,758	)		11,679
Net increase in cash and cash equivalents		3,001			1,037
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		18,520			16,797
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	21,521		$	17,834

Supplemental Disclosures of Cash Flow Information:
Interest paid	$	2,631		$	3,086
Income taxes paid	$	-		$	-
Loans transferred to foreclosed property	$	-		$	3,805
Right of use asset and liability	$	-		$	1,454

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

CITIZENS FINANCIAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 - Basis of Presentation

Citizens Financial Services, Inc. (individually and collectively with its direct and indirect subsidiaries, the “Company”) is a Pennsylvania corporation and the holding company of its wholly owned subsidiary, First Citizens Community Bank (the “Bank”), and of the Bank’s wholly owned subsidiaries, First Citizens Insurance Agency, Inc. (“First Citizens Insurance”) and 1^st Realty of PA LLC (“Realty”). The Bank is the wholly owned subsidiary of CZFS Acquisition Company, LLC, which is a wholly owned subsidiary of the Company. Realty was formed in March of 2019 to manage and sell properties acquired by the Bank in the settlement of a bankruptcy filing with a commercial customer.

The accompanying consolidated financial statements have been prepared pursuant to rules and regulations of the Securities and Exchange Commission (“SEC”) and in conformity with U.S. generally accepted accounting principles. Because this report is based on an interim period, certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted. Certain of the prior year amounts have been reclassified to conform with the current year presentation. Such reclassifications had no effect on net income or stockholders’ equity. All material inter‑company balances and transactions have been eliminated in consolidation.

In the opinion of management of the Company, the accompanying interim financial statements at March 31, 2020 and for the periods ended March 31, 2020 and 2019 include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the financial condition and the results of operations at the dates and for the periods presented. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and of revenues and expenses for the period covered by the Consolidated Income Statement. The financial performance reported for the Company for the three month period ended March 31, 2020 is not necessarily indicative of the results to be expected for the full year. This information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

Note 2 – Revenue Recognition

In accordance with ASC 606, Management determined that the primary sources of revenue emanating from interest and dividend income on loans and investments along with noninterest revenue resulting from investment security gains, loan servicing, gains on loans sold and earnings on bank owned life insurances are not within the scope of ASC 606. These sources of revenue cumulatively comprise 90.0% and 89.8% of the total revenue of the Company for the three months ended March 31, 2020 and 2019, respectively. The main types of noninterest income within the scope of the standard are as follows:

•

Service charges on deposit accounts – The Company has contracts with its deposit customers where fees are charged if certain parameters are not met. These agreements can be cancelled at any time by either the Company or the deposit customer. Revenue from these transactions is recognized on a monthly basis as the Company has an unconditional right to the fee consideration. The Company also has transaction fees related to specific transactions or activities resulting from a customer request or activity that include overdraft fees, online banking fees, interchange fees, ATM fees and other transaction fees. All of these fees are attributable to specific performance obligations of the Company where the revenue is recognized at a defined point in time upon the completion of the requested service/transaction.

•

Trust fees – Typical contracts for trust services are based on a fixed percentage of the assets earned ratably over a defined period and billed on a monthly basis. Fees charged to customers’ accounts are recognized as revenue over the period during which the Company fulfills its performance obligation under the contract (i.e., holding client asset in a managed fiduciary trust account). For these accounts, the performance obligation of the Company is typically satisfied by holding and managing the customer’s assets over time. Other fees related to specific customer requests are attributable to specific performance obligations of the Company where the revenue is recognized at a defined point in time, upon completion of the requested service/transaction.

•

Gains and losses on sale of other real estate owned – Gains and losses are recognized at the completion of the property sale when the buyer obtains control of the real estate and all of the performance obligations of the Company have been satisfied. Evidence of the buyer obtaining control of the asset include transfer of the property title, physical possession of the asset, and the buyer obtaining control of the risks and rewards related to the asset. In situations where the Company agrees to provide financing to facilitate the sale, additional analysis is performed to ensure that the contract for sale identifies the buyer and seller, the asset to be transferred, payment terms, and that the contract has a true commercial substance and that collection of amounts due from the buyer are reasonable. In situations where financing terms are not reflective of current market terms, the transaction price is discounted impacting the gain/loss and the carrying value of the asset.

•

Brokerage and insurance – Fees includes commissions from the sales of investments and insurance products recognized on a trade date basis as the performance obligation is satisfied at the point in time in which the trade is processed. Additional fees are based on a percentage of the market value of customer accounts and billed on a monthly or quarterly basis. The Company’s performance obligation under the contracts with certain customers is generally satisfied through the passage of time as the Company monitors and manages the assets in the customer’s portfolio and is not dependent on certain return or performance level of the customer’s portfolio. Fees for these services are billed monthly and are recorded as revenue at the end of the month for which the wealth management service has been performed. Other performance obligations (such as the delivery of account statements to customers) are generally considered immaterial to the overall transaction price.

The following table depicts the disaggregation of revenue derived from contracts with customers to depict the nature, amount, timing, and uncertainty of revenue and cash flows for the three months ended March 31, 2020 and 2019 (in thousands). All revenue in the table below relates to goods and services transferred at a point in time.

	Three Months Ended
	March 31,
Revenue stream	2020		2019
Service charges on deposit accounts
Overdraft fees	$	359		358
Statement fees		56		51
Interchange revenue		522		540
ATM income		83		91
Other service charges		61		59
Total Service Charges		1,081		1,099
Trust		198		232
Brokerage and insurance		340		293
Other		107		111
Total	$	1,726	$	1,735

Note 3 - Earnings per Share

The following table sets forth the computation of earnings per share.

	Three Months Ended
	March 31,
	2020		2019
Net income applicable to common stock	$	4,531,000	$	4,405,000

Basic earnings per share computation
Weighted average common shares outstanding		3,515,500		3,528,466
Earnings per share – basic	$	1.29	$	1.25

Diluted earnings per share computation
Weighted average common shares outstanding for basic earnings per share		3,515,500		3,528,466
Add: Dilutive effects of restricted stock		-		-
Weighted average common shares outstanding for dilutive earnings per share		3,515,500		3,528,466
Earnings per share – diluted	$	1.29	$	1.25

For the three months ended March 31, 2020 and 2019, there were 7,564 and 6,705 shares, respectively, related to the restricted stock plan that were excluded from the diluted earnings per share calculations since they were anti-dilutive. These anti-dilutive shares had per share prices ranging from $52.44-$62.93 for the three month period ended March 31, 2020 and per share prices ranging from $47.81-$62.93 for the three month period ended March 31, 2019.

Note 4 – Investments

The amortized cost, gross unrealized gains and losses, and fair value of investment securities at March 31, 2020 and December 31, 2019 were as follows (in thousands):

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
March 31, 2020	Cost		Gains		Losses			Value
Available-for-sale securities:
U.S. agency securities	$	74,681	$	2,869	$	(40	)	$	77,510
U.S. treasury securities		27,406		907		-			28,313
Obligations of state and
political subdivisions		73,276		1,650		(148	)		74,778
Corporate obligations		3,250		97		-			3,347
Mortgage-backed securities in
government sponsored entities		71,942		1,919		(21	)		73,840
Total available-for-sale securities	$	250,555	$	7,442	$	(209	)	$	257,788

December 31, 2019
Available-for-sale securities:
U.S. agency securities	$	83,410	$	1,523	$	(70	)	$	84,863
U.S. treasury securities		27,394		267		-			27,661
Obligations of state and
political subdivisions		60,667		865		(77	)		61,455
Corporate obligations		3,250		78		-			3,328
Mortgage-backed securities in
government sponsored entities		63,086		468		(155	)		63,399
Total available-for-sale securities	$	237,807	$	3,201	$	(302	)	$	240,706

The following table shows the Company’s gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time, which individual securities have been in a continuous unrealized loss position, at March 31, 2020 and December 31, 2019 (in thousands). As of March 31, 2020, the Company owned 29 securities whose fair value was less than their cost basis.

	Less than Twelve Months					Twelve Months or Greater					Total
			Gross					Gross					Gross
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
March 31, 2020	Value		Losses			Value		Losses			Value		Losses
U.S. agency securities	$	3,765	$	(40	)	$	-	$	-		$	3,765	$	(40	)
Obligations of state and
political subdivisions		13,631		(148	)		-		-			13,631		(148	)
Mortgage-backed securities in
government sponsored entities		3,870		(6	)		3,886		(15	)		7,756		(21	)
Total securities	$	21,266	$	(194	)	$	3,886	$	(15	)	$	25,152	$	(209	)


December 31, 2019
U.S. agency securities	$	14,587	$	(63	)	$	13,094	$	(7	)	$	27,681	$	(70	)
Obligations of states and
political subdivisions		7,508		(75	)		1,507		(2	)		9,015		(77	)
Mortgage-backed securities in
government sponsored entities		27,737		(97	)		9,559		(58	)		37,296		(155	)
Total securities	$	49,832	$	(235	)	$	24,160	$	(67	)	$	73,992	$	(302	)

As of March 31, 2020 and December 31, 2019, the Company’s investment securities portfolio contained unrealized losses on agency securities issued or backed by the full faith and credit of the United States government or are generally viewed as having the implied guarantee of the U.S. government, obligations of states and political subdivisions and mortgage backed securities issued by government sponsored entities. For fixed maturity investments management considers whether the present value of cash flows expected to be collected are less than the security’s amortized cost basis (the difference defined as the credit loss), the magnitude and duration of the decline, the reasons underlying the decline and the Company’s intent to sell the security or whether it is more likely than not that the Company would be required to sell the security before its anticipated recovery in market value, to determine whether the loss in value is other than temporary. Once a decline in value is determined to be other than temporary, if the Company does not intend to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of the security’s amortized cost basis, the charge to earnings is limited to the amount of credit loss. Any remaining difference between fair value and amortized cost (the difference defined as the non-credit portion) is recognized in other comprehensive income, net of applicable taxes. Otherwise, the entire difference between fair value and amortized cost is charged to earnings. The Company has concluded that any impairment of its investment securities portfolio outlined in the above table is not other than temporary and is the result of interest rate changes, sector credit rating changes, or issuer-specific rating changes that are not expected to result in the non-collection of principal and interest during the period.

There were no sales of available for sale securities during the three months ended March 31, 2020 and 2019.

The following table presents the net gains on the Company’s equity investments recognized in earnings during the three month periods ended March 31, 2020 and 2019, and the portion of unrealized gains for the period that relates to equity investments held at March 31, 2020 and 2019 (in thousands):

	Three Months Ended
	March 31,
Equity Securities	2020			2019
Net (losses) gains recognized in equity securities during the period	$	(254	)	$	11
Less: Net gains realized on the sale of equity securities during the period		-			-
Net unrealized (losses) gains	$	(254	)	$	11

Investment securities with an approximate carrying value of $203.1 million and $209.1 million at March 31, 2020 and December 31, 2019, respectively, were pledged to secure public funds, certain other deposits and borrowing lines.

Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The amortized cost and fair value of debt securities (excludes equity securities) at March 31, 2020, by contractual maturity, are shown below (in thousands):

	Amortized
	Cost		Fair Value
Available-for-sale debt securities:
Due in one year or less	$	17,816	$	17,979
Due after one year through five years		71,725		75,025
Due after five years through ten years		49,897		51,081
Due after ten years		111,117		113,703
Total	$	250,555	$	257,788

Note 5 – Loans

The Company grants loans primarily to customers throughout north central, central and south central Pennsylvania and the southern tier of New York. The recently completed MidCoast acquisition has expanded our lending market into Wilmington and Dover, Delaware. Although the Company had a diversified loan portfolio at March 31, 2020 and December 31, 2019, a substantial portion of its debtors’ ability to honor their contracts is dependent on the economic conditions within these regions. The following table summarizes the primary segments of the loan portfolio and how those segments are analyzed within the allowance for loan losses as of March 31, 2020 and December 31, 2019 (in thousands):

March 31, 2020	Total Loans		Individually evaluated for impairment		Loans acquired with deteriorated credit quality (PCI)		Collectively evaluated for impairment
Real estate loans:
Residential	$	216,179	$	1,220	$	23	$	214,936
Commercial		338,490		11,480		1,195		325,815
Agricultural		300,606		3,893		-		296,713
Construction		17,926		-		-		17,926
Consumer		9,533		3		-		9,530
Other commercial loans		71,038		1,842		30		69,166
Other agricultural loans		46,170		1,293		-		44,877
State and political subdivision loans		93,778		-		-		93,778
Total		1,093,720		19,731		1,248		1,072,741
Less: allowance for loan losses		14,247		753		-		13,494
Net loans	$	1,079,473	$	18,978	$	1,248	$	1,059,247

December 31 , 2019
Real estate loans:
Residential	$	217,088	$	1,166	$	23	$	215,899
Commercial		342,023		11,537		1,210		329,276
Agricultural		311,464		3,782		-		307,682
Construction		15,519		-		-		15,519
Consumer		9,947		4		-		9,943
Other commercial loans		69,970		1,902		49		68,019
Other agricultural loans		55,112		1,281		-		53,831
State and political subdivision loans		94,446		-		-		94,446
Total		1,115,569		19,672		1,282		1,094,615
Less: allowance for loan losses		13,845		735		-		13,110
Net loans	$	1,101,724	$	18,937	$	1,282	$	1,081,505

Upon acquisition, the Company evaluates whether an acquired loan is within the scope of ASC 310-30, Receivables-Loans and Debt Securities Acquired with Deteriorated Credit Quality. PCI, defined above, loans are loans that have evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. The fair value of PCI loans, on the acquisition date, was determined, primarily based on the fair value of the loans’ collateral. The carrying value of PCI loans was $1,248,000 and $1,282,000 at March 31, 2020 and December 31, 2019, respectively. The carrying value of the PCI loans was determined by projected discounted contractual cash flows.

Changes in the accretable yield for PCI loans were as follows for the three months ended March 31, 2020 and 2019, respectively (in thousands):

	Three months ended
	March 31
	2020			2019
Balance at beginning of period	$	89		$	104
Accretion		(1	)		(2	)
Balance at end of period	$	88		$	102

The following table presents additional information regarding loans acquired with specific evidence of deterioration in credit quality under ASC 310-30 (in thousands):

	March 31, 2020		December 31, 2019
Outstanding balance	$	4,057	$	4,072
Carrying amount		1,248		1,282

The segments of the Company’s loan portfolio are disaggregated into classes to a level that allows management to monitor risk and performance. Residential real estate mortgages consist primarily of 15 to 30 year first mortgages on residential real estate, while residential real estate home equity loans are consumer purpose installment loans or lines of credit with terms of 15 years or less secured by a mortgage which is often a second lien on residential real estate. Commercial real estate loans are business purpose loans secured by a mortgage on commercial real estate. Agricultural real estate loans are loans secured by a mortgage on real estate used in agriculture production. Construction real estate loans are loans secured by residential, commercial or agricultural real estate used during the construction phase of residential, commercial or agricultural projects. Consumer loans are typically unsecured or primarily secured by assets other than real estate and overdraft lines of credit are typically secured by customer deposit accounts. Other commercial loans are loans for commercial purposes primarily secured by non-real estate collateral. Other agricultural loans are loans for agricultural purposes primarily secured by non-real estate collateral. State and political subdivision loans are loans to state and local municipalities for capital and operating expenses or tax free loans used to finance commercial development.

Management considers other commercial loans, other agricultural loans, state and political subdivision loans, commercial real estate loans and agricultural real estate loans which are 90 days or more past due to be impaired. Management will also consider a loan impaired based on other factors it becomes aware of, including the customer’s results of operations and cash flows or if the loan is modified in a troubled debt restructuring. In addition, certain residential mortgages, home equity and consumer loans that are cross collateralized with commercial relationships that are determined to be impaired may also be classified as impaired. Impaired loans are analyzed to determine if it is probable that all amounts will not be collected according to the contractual terms of the loan agreement. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allocation of the allowance for loan losses or a charge-off to the allowance for loan losses.

The following table includes the recorded investment and unpaid principal balances for impaired loan receivables by class, excluding PCI loans, with the associated allowance amount, if applicable (in thousands):

			Recorded		Recorded
	Unpaid		Investment		Investment		Total
	Principal		With No		With		Recorded		Related
March 31, 2020	Balance		Allowance		Allowance		Investment		Allowance
Real estate loans:
Mortgages	$	1,282	$	776	$	300	$	1,076	$	20
Home Equity		166		80		64		144		11
Commercial		12,000		10,668		812		11,480		335
Agricultural		4,046		1,549		2,344		3,893		86
Consumer		3		3		-		3		-
Other commercial loans		2,459		1,499		343		1,842		148
Other agricultural loans		1,381		129		1,164		1,293		153
Total	$	21,337	$	14,704	$	5,027	$	19,731	$	753

			Recorded		Recorded
	Unpaid		Investment		Investment		Total
	Principal		With No		With		Recorded		Related
December 31, 2019	Balance		Allowance		Allowance		Investment		Allowance
Real estate loans:
Mortgages	$	1,212	$	794	$	223	$	1,017	$	20
Home Equity		170		83		66		149		12
Commercial		12,070		10,723		814		11,537		251
Agricultural		3,900		1,580		2,202		3,782		151
Consumer		4		4		-		4		-
Other commercial loans		2,517		1,555		347		1,902		147
Other agricultural loans		1,347		126		1,155		1,281		154
Total	$	21,220	$	14,865	$	4,807	$	19,672	$	735

The following tables includes the average balance of impaired loan receivables by class and the income recognized on these receivables for the three month periods ended March 31, 2020 and 2019(in thousands):

	For the Three Months Ended
	March 31, 2020						March 31, 2019
					Interest						Interest
	Average		Interest		Income		Average		Interest		Income
	Recorded		Income		Recognized		Recorded		Income		Recognized
	Investment		Recognized		Cash Basis		Investment		Recognized		Cash Basis
Real estate loans:
Mortgages	$	1,031	$	5	$	-	$	1,103	$	4	$	-
Home Equity		146		2		-		85		1		-
Commercial		11,486		104		2		12,548		119		6
Agricultural		3,777		21		-		5,575		32		-
Consumer		3		-		-		-		-		-
Other commercial loans		1,839		1		-		2,137		1		-
Other agricultural loans		1,276		2		-		1,431		2		-
Total	$	19,558	$	135	$	2	$	22,879	$	159	$	6

Credit Quality Information

For commercial real estate, agricultural real estate, construction, other commercial, other agricultural and state and political subdivision loans, management uses a nine grade internal risk rating system to monitor and assess credit quality. The first five categories are considered not criticized and are aggregated as “Pass” rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The definitions of each rating are defined below:

•	Pass (Grades 1-5) – These loans are to customers with credit quality ranging from an acceptable to very high quality and are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral.

•	Special Mention (Grade 6) – This loan grade is in accordance with regulatory guidance and includes loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected.

•	Substandard (Grade 7) – This loan grade is in accordance with regulatory guidance and includes loans that have a well-defined weakness based on objective evidence and be characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

•	Doubtful (Grade 8) – This loan grade is in accordance with regulatory guidance and includes loans that have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, based on existing circumstances.

•	Loss (Grade 9) – This loan grade is in accordance with regulatory guidance and includes loans that are considered uncollectible, or of such value that continuance as an asset is not warranted.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay the loan as agreed, the Company’s loan rating process includes several layers of internal and external oversight. The Company’s loan officers are responsible for the timely and accurate risk rating of the loans in each of their portfolios at origination and on an ongoing basis under the supervision of management. All commercial, agricultural and state and political relationships over $500,000 are reviewed annually to ensure the appropriateness of the loan grade. In addition, the Company engages an external consultant on at least an annual basis to: 1) review a minimum of 50% of the dollar volume of the commercial, agricultural and municipal loan portfolios on an annual basis, 2) review a sample of new loans originated for over $1.0 million in the last year, 3) review a sample of borrowers with commitments greater than or equal to $1.0 million, 4) review selected loan relationships over $750,000 which are over 30 days past due or classified Special Mention, Substandard, Doubtful, or Loss, and 5) such other loans which management or the consultant deems appropriate.

The following tables represent credit exposures by internally assigned grades as of March 31, 2020 and December 31, 2019 (in thousands):

March 31, 2020	Pass		Special Mention		Substandard		Doubtful		Loss		Ending Balance
Real estate loans:
Commercial	$	326,415	$	4,256	$	7,780	$	39	$	-	$	338,490
Agricultural		276,091		14,648		9,867		-		-		300,606
Construction		17,926		-		-		-		-		17,926
Other commercial loans		68,042		986		1,948		62		-		71,038
Other agricultural loans		42,917		1,030		2,223		-		-		46,170
State and political
subdivision loans		93,369		-		409		-		-		93,778
Total	$	824,760	$	20,920	$	22,227	$	101	$	-	$	868,008

December 31, 2019	Pass		Special Mention		Substandard		Doubtful		Loss		Ending Balance
Real estate loans:
Commercial	$	329,831	$	4,305	$	7,848	$	39	$	-	$	342,023
Agricultural		287,044		14,261		10,159		-		-		311,464
Construction		15,519		-		-		-		-		15,519
Other commercial loans		66,880		984		2,042		64		-		69,970
Other agricultural loans		51,711		1,077		2,324		-		-		55,112
State and political
subdivision loans		93,993		-		453		-		-		94,446
Total	$	844,978	$	20,627	$	22,826	$	103	$	-	$	888,534

For residential real estate mortgages, home equity and consumer loans, credit quality is monitored based on whether the loan is performing or non-performing, which is typically based on the aging status of the loan and payment activity, unless a specific action, such as bankruptcy, repossession, death or significant delay in payment occurs to raise awareness of a possible credit event. Non-performing loans include those loans that are considered nonaccrual, described in more detail below, and all loans past due 90 or more days and still accruing. The following table presents the recorded investment in those loan classes based on payment activity as of March 31, 2020 and December 31, 2019 (in thousands):

March 31, 2020	Performing		Non-performing		PCI		Total
Real estate loans:
Mortgages	$	156,630	$	915	$	23	$	157,568
Home Equity		58,555		56		-		58,611
Consumer		9,514		19		-		9,533
Total	$	224,699	$	990	$	23	$	225,712

December 31, 2019	Performing		Non-performing		PCI		Total
Real estate loans:
Mortgages	$	156,151	$	904	$	23	$	157,078
Home Equity		59,950		60		-		60,010
Consumer		9,939		8		-		9,947
Total	$	226,040	$	972	$	23	$	227,035

Aging Analysis of Past Due Loan Receivables

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following table includes an aging analysis of the recorded investment of past due loan receivables as of March 31, 2020 and December 31, 2019 (in thousands):

													Total		90 Days or
	30-59 Days		60-89 Days		90 Days		Total Past						Loan		Greater and
March 31, 2020	Past Due		Past Due		Or Greater		Due		Current		PCI		Receivables		Accruing
Real estate loans:
Mortgages	$	559	$	212	$	345	$	1,116	$	156,429	$	23	$	157,568	$	-
Home Equity		165		89		53		307		58,304		-		58,611		-
Commercial		2,044		350		3,905		6,299		330,996		1,195		338,490		55
Agricultural		201		-		413		614		299,992		-		300,606		98
Construction		-		-		-		-		17,926		-		17,926		-
Consumer		115		25		19		159		9,374		-		9,533		11
Other commercial loans		63		77		1,715		1,855		69,153		30		71,038		-
Other agricultural loans		50		-		20		70		46,100		-		46,170		-
State and political
subdivision loans		-		-		-		-		93,778		-		93,778		-
Total	$	3,197	$	753	$	6,470	$	10,420	$	1,082,052	$	1,248	$	1,093,720	$	164

Loans considered non-accrual	$	786	$	5	$	6,306	$	7,097	$	4,205	$	-	$	11,302
Loans still accruing		2,411		748		164		3,323		1,077,847		1,248		1,082,418
Total	$	3,197	$	753	$	6,470	$	10,420	$	1,082,052	$	1,248	$	1,093,720

													Total		90 Days or
	30-59 Days		60-89 Days		90 Days		Total Past						Loan		Greater and
December 31, 2019	Past Due		Past Due		Or Greater		Due		Current		PCI		Receivables		Accruing
Real estate loans:
Mortgages	$	581	$	57	$	319	$	957	$	156,098	$	23	$	157,078	$	1
Home Equity		334		11		56		401		59,609		-		60,010		1
Commercial		750		573		3,720		5,043		335,770		1,210		342,023		-
Agricultural		118		-		785		903		310,561		-		311,464		299
Construction		-		-		-		-		15,519		-		15,519		-
Consumer		113		10		8		131		9,816		-		9,947		2
Other commercial loans		217		71		1,946		2,234		67,687		49		69,970		184
Other agricultural loans		29		32		-		61		55,051		-		55,112		-
State and political
subdivision loans		-		-		-		-		94,446		-		94,446		-
Total	$	2,142	$	754	$	6,834	$	9,730	$	1,104,557	$	1,282	$	1,115,569	$	487

Loans considered non-accrual	$	90	$	95	$	6,347	$	6,532	$	5,004	$	-	$	11,536
Loans still accruing		2,052		659		487		3,198		1,099,553		1,282		1,104,033
Total	$	2,142	$	754	$	6,834	$	9,730	$	1,104,557	$	1,282	$	1,115,569

Nonaccrual Loans

Loans are considered for non-accrual status upon reaching 90 days delinquency, although the Company may be receiving partial payments of interest and partial repayments of principal on such loans, or if full payment of principal and interest is not expected. Additionally, if management is made aware of other information including bankruptcy, repossession, death, or legal proceedings, the loan may be placed on non-accrual status. If a loan is 90 days or more past due and is well secured and in the process of collection, it may still be considered accruing.

The following table reflects the loan receivables, excluding PCI loans, on non-accrual status as of March 31, 2020 and December 31, 2019, respectively. The balances are presented by class of loan receivable (in thousands):

	March 31, 2020		December 31, 2019
Real estate loans:
Mortgages	$	915	$	903
Home Equity		56		59
Commercial		5,038		5,080
Agricultural		2,464		2,578
Consumer		8		6
Other commercial loans		1,786		1,837
Other agricultural loans		1,035		1,073
	$	11,302	$	11,536

Troubled Debt Restructurings

In situations where, for economic or legal reasons related to a borrower's financial difficulties, management may grant a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the related loan is classified as a Troubled Debt Restructuring (TDR). Management strives to identify borrowers in financial difficulty early and work with them to structure more affordable terms before their loan reaches nonaccrual status. These restructured terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where borrowers are granted new terms that provide for a reduction of interest or principal, or both, management measures any impairment on the restructuring by calculating the present value of the revised loan terms and comparing this balance to the Company’s investment in the loan prior to the restructuring. As these loans are individually evaluated, they are excluded from pooled portfolios when calculating the allowance for loan and lease losses and a separate allocation within the allowance for loan and lease losses is provided. Management continually evaluates loans that are considered TDRs, including payment history under the modified loan terms, the borrower’s ability to continue to repay the loan based on continued evaluation of their operating results and cash flows from operations. As of March 31, 2020 and December 31, 2019, included within the allowance for loan losses are reserves of $273,000 and $345,000 respectively, that are associated with loans modified as TDRs.

Loan modifications that are considered TDRs completed during the three months ended March 31, 2020 and 2019 were as follows (dollars in thousands):

	For the Three Months Ended March 31, 2020
	Number of contracts				Pre-modification Outstanding Recorded Investment				Post-Modification Outstanding Recorded Investment
	Interest Modification		Term Modification		Interest Modification		Term Modification		Interest Modification		Term Modification

Real estate loans:
Agricultural		-		1	$	-	$	150	$	-	$	150
Total		-		1	$	-	$	150	$	-	$	150

	For the Three Months Ended March 31, 2019
	Number of contracts				Pre-modification Outstanding Recorded Investment				Post-Modification Outstanding Recorded Investment
	Interest Modification		Term Modification		Interest Modification		Term Modification		Interest Modification		Term Modification
Real estate loans:
Commercial		-		1	$	-	$	548	$	-	$	548
Total		-		1	$	-	$	548	$	-	$	548

Recidivism, or the borrower defaulting on its obligation pursuant to a modified loan, results in the loan once again becoming a non-accrual loan. Recidivism on modified loans occurs at a notably higher rate than do defaults on new origination loans, so modified loans present a higher risk of loss than do new origination loans. The following table presents the recorded investment in loans that were modified as TDRs during each 12-month period prior to the current reporting periods, which began January 1, 2020 and 2019 (3 month periods), respectively, and that subsequently defaulted during these reporting periods (dollars in thousands):

	For the Three Months Ended
	March 31, 2020				March 31, 2019
	Number of contracts		Recorded investment		Number of contracts		Recorded investment
Other agricultural loans		-	$	-		1	$	124
Total recidivism		-	$	-		1	$	124

Allowance for Loan Losses

The following table segregates the allowance for loan losses (ALLL) into the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of March 31, 2020 and December 31, 2019, respectively (in thousands):

	March 31, 2020						December 31, 2019
	Individually evaluated for impairment		Collectively evaluated for impairment		Total		Individually evaluated for impairment		Collectively evaluated for impairment		Total
Real estate loans:
Residential	$	31	$	1,123	$	1,154	$	32	$	1,082	$	1,114
Commercial		335		4,394		4,729		251		4,298		4,549
Agricultural		86		4,792		4,878		151		4,871		5,022
Construction		-		56		56		-		43		43
Consumer		-		117		117		-		112		112
Other commercial loans		148		1,149		1,297		147		1,108		1,255
Other agricultural loans		153		682		835		154		807		961
State and political
subdivision loans		-		558		558		-		536		536
Unallocated		-		623		623		-		253		253
Total	$	753	$	13,494	$	14,247	$	735	$	13,110	$	13,845

The following tables roll forward the balance of the ALLL by portfolio segment for the three months ended March 31, 2020 and 2019, respectively (in thousands):

	For the three months ended March 31, 2020
	Balance at December 31, 2019		Charge-offs			Recoveries		Provision			Balance at March 31, 2020
Real estate loans:
Residential	$	1,114	$	-		$	-	$	40		$	1,154
Commercial		4,549		(1	)		1		180			4,729
Agricultural		5,022		-			-		(144	)		4,878
Construction		43		-			-		13			56
Consumer		112		(8	)		8		5			117
Other commercial loans		1,255		-			2		40			1,297
Other agricultural loans		961		-			-		(126	)		835
State and political
subdivision loans		536		-			-		22			558
Unallocated		253		-			-		370			623
Total	$	13,845	$	(9	)	$	11	$	400		$	14,247

	For the three months ended March 31, 2019
	Balance at December 31, 2018		Charge-offs			Recoveries		Provision			Balance at March 31, 2019
Real estate loans:
Residential	$	1,105	$	-		$	-	$	(16	)	$	1,089
Commercial		4,115		(200	)		-		215			4,130
Agricultural		4,264		-					128			4,392
Construction		58		-			-		(26	)		32
Consumer		120		(14	)		11		7			124
Other commercial loans		1,354		-			3		(74	)		1,283
Other agricultural loans		752		-			-		4			756
State and political
subdivision loans		762		-			-		(197	)		565
Unallocated		354		-			-		359			713
Total	$	12,884	$	(214	)	$	14	$	400		$	13,084

The Company allocates the ALLL based on the factors described below, which conform to the Company’s loan classification policy and credit quality measurements. In reviewing risk within the Company’s loan portfolio, management has determined there to be several different risk categories within the loan portfolio. The ALLL consists of amounts applicable to: (i) residential real estate loans; (ii) residential real estate home equity loans; (iii) commercial real estate loans; (iv) agricultural real estate loans; (v) real estate construction loans; (vi) other commercial and agricultural loans; (vii) consumer loans; (viii) other agricultural loans and (ix) state and political subdivision loans. Factors considered in this process include general loan terms, collateral, and availability of historical data to support the analysis. Historical loss percentages are calculated and used as the basis for calculating allowance allocations. Certain qualitative factors are evaluated to determine additional inherent risks in the loan portfolio, which are not necessarily reflected in the historical loss percentages. These factors are then added to the historical allocation percentage to get the adjusted factor to be applied to non-classified loans. The following qualitative factors are analyzed:

•	Level of and trends in delinquencies and impaired/classified loans

◾	Change in volume and severity of past due loans

◾	Volume of non-accrual loans

◾	Volume and severity of classified, adversely or graded loans;

•	Level of and trends in charge-offs and recoveries;

•	Trends in volume, terms and nature of the loan portfolio;

•	Effects of any changes in risk selection and underwriting standards and any other changes in lending and recovery policies, procedures and practices;

•	Changes in the quality of the Company’s loan review system;

•	Experience, ability and depth of lending management and other relevant staff;

•	National, state, regional and local economic trends and business conditions

◾	General economic conditions

◾	Unemployment rates

◾	Inflation rate/ Consumer Price Index

◾	Changes in values of underlying collateral for collateral-dependent loans;

•	Industry conditions including the effects of external factors such as competition, legal, and regulatory requirements on the level of estimated credit losses;

•	Existence and effect of any credit concentrations, and changes in the level of such concentrations; and

•	Any change in the level of board oversight.

The Company analyzes its loan portfolio at least each quarter to determine the adequacy of its ALLL.

Loans determined to be TDRs are impaired and for purposes of estimating the ALLL must be individually evaluated for impairment. In calculating the impairment, the Company calculates the present value utilizing an analysis of discounted cash flows. If the present value calculated is below the recorded investment of the loan, impairment is recognized by a charge to the provision for loan and lease losses and a credit to the ALLL.

For the three months ended March 31, 2020, the allowance for all categories was increased due to a general deterioration in economic activity and unemployment as a result of the Covid-19 pandemic. In addition, commercial real estate was increased due to an increase in past due loans. The decrease in the provision for agricultural real estate loans and other agricultural loans is due to the decrease in outstanding loans in these loan portfolios as of March 31, 2020 compared to December 31, 2019.

For the three months ended March 31, 2019, the allowance for commercial real estate was decreased in general reserves due to a decrease in the amount of non-accrual, classified and past due loans, which was offset by an specific reserves. This was represented as an increase in the provision. The allowance for agricultural real estate loans was increased in general reserves as a result of higher loan balances, an increase in the amount of loans classified as non-accrual and past due. The result of this was represented as an increase in the provision. The allowance for other commercial loans was decreased as a result of a decrease in specific reserves and a decrease in the volume of classified loans. The result of these changes was represented as a decrease in the provision. The allowance for state and political subdivision was decreased as a result a decrease in the volume of classified loans. The result of this change was represented as a decrease in the provision.

Foreclosed Assets Held For Sale

Foreclosed assets acquired in settlement of loans are carried at fair value, less estimated costs to sell, and are included in other assets on the Consolidated Balance Sheet. As of March 31, 2020 and December 31, 2019, included within other assets are $3,056,000 and $3,404,000, respectively, of foreclosed assets. As of March 31, 2020, included within the foreclosed assets are $167,000 of consumer residential mortgages that were foreclosed on or received via a deed in lieu transaction prior to the period end. As of March 31, 2020, the Company had initiated formal foreclosure proceedings on $743,000 of consumer residential mortgages, which had not yet been transferred into foreclosed assets.

Note 6 – Goodwill and Other Intangible Assets

The following table provides the gross carrying value and accumulated amortization of intangible assets as of March 31, 2020 and December 31, 2019 (in thousands):

	March 31, 2020							December 31, 2019
	Gross carrying value		Accumulated amortization			Net carrying value		Gross carrying value		Accumulated amortization			Net carrying value
Amortized intangible assets (1):
Mortgage servicing rights (MSRs)	$	1,764	$	(1,125	)	$	639	$	1,718	$	(1,077	)	$	641
Core deposit intangibles		1,786		(1,131	)		655		1,786		(1,081	)		705
Covenant not to compete		125		(125	)		-		125		(125	)		-
Total amortized intangible assets	$	3,675	$	(2,381	)	$	1,294	$	3,629	$	(2,283	)	$	1,346
Unamortized intangible assets:
Goodwill	$	23,296						$	23,296

The following table provides the current year and estimated future amortization expense for amortized intangible assets for the next five years (in thousands). We based our projections of amortization expense shown below on existing asset balances at March 31, 2020. Future amortization expense may vary from these projections:

	MSRs		Core deposit intangibles		Covenant not to compete		Total
Three months ended March 31, 2020 (actual)	$	48	$	50	$	-	$	98
Three months ended March 31, 2019 (actual)		48		58		8		114
Estimate for year ending December 31,
Remaining 2020		138		147		-		285
2021		141		165		-		306
2022		108		133		-		241
2023		80		100		-		180
2024		57		68		-		125
Thereafter		115		42		-		157
Total	$	639	$	655	$	-	$	1,294

Note 7 - Employee Benefit Plans

For additional detailed disclosure on the Company's pension and employee benefits plans, please refer to Note 11 of the Company's Consolidated Financial Statements included in the 2019 Annual Report on Form 10-K.

Noncontributory Defined Benefit Pension Plan

The Bank sponsors a trusteed noncontributory defined benefit pension plan (“Pension Plan”) covering substantially all employees and officers hired prior to January 1, 2007. Additionally, the Bank assumed the noncontributory defined benefit pension plan of the First National Bank of Fredericksburg (FNB) when FNB was acquired in December 2015. The FNB plan was closed and all assets were distributed in the fourth quarter of 2019. The Bank’s funding policy is to make annual contributions, if needed, based upon the funding formula developed by the plans’ actuary. Any employee with a hire date of January 1, 2007 or later is not eligible to participate in the Pension Plan.

In lieu of the Pension Plan, employees with a hire date of January 1, 2007 or later are eligible to receive, after meeting certain length of service requirements, an annual discretionary 401(k) plan contribution from the Bank equal to a percentage of an employee’s base compensation. The contribution amount, if any, is placed in a separate account within the 401(k) plan and is subject to a vesting requirement.

For employees who are eligible to participate in the Pension Plan, the Pension Plan requires benefits to be paid to eligible employees based primarily upon age and compensation rates during employment. Upon retirement or other termination of employment, employees can elect either an annuity benefit or a lump sum distribution of vested benefits in the Pension Plan.

The following sets forth the components of net periodic benefit costs of the Pension Plan and the line item on the Consolidated Statement of Income where such amounts are included, for the three months ended March 31, 2020 and 2019, respectively (in thousands):

	Three Months Ended
	March 31,
	2020			2019
Service cost	$	83		$	89
Interest cost		87			139
Expected return on plan assets		(225	)		(205	)
Net amortization and deferral		62			61
Net periodic benefit cost	$	7		$	84

The Bank does not expect to contribute to the Pension Plan during 2020.

Restricted Stock Plan

The Company maintains a Restricted Stock Plan (the “Plan”) whereby employees and non-employee corporate directors are eligible to receive awards of restricted stock based upon performance related requirements. Awards granted under the Plan are in the form of the Company’s common stock and are subject to certain vesting requirements including continuous employment or service with the Company. In April of 2016, the Company’s shareholders authorized a total of 150,000 shares of the Company’s common stock to be made available under the Plan. As of March 31, 2020, 129,211 shares remain available to be issued under the Plan. The Plan assists the Company in attracting, retaining and motivating employees to make substantial contributions to the success of the Company and to increase the emphasis on the use of equity as a key component of compensation.

The following table details the vesting, awarding and forfeiting of restricted shares during the three months ended March 31, 2020:

	Three months
				Weighted
	Unvested			Average
	Shares			Market Price
Outstanding, beginning of period		10,877		$	60.11
Granted		-			-
Forfeited		-			-
Vested		(680	)		(59.85	)
Outstanding, end of period		10,197		$	60.12

Compensation expense related to restricted stock is recognized, based on the market price of the stock at the grant date, over the vesting period. Compensation expense related to restricted stock was $82,000 and $67,000 for the three months ended March 31, 2020 and 2019, respectively. At March 31, 2020, the total compensation cost related to nonvested awards that had not yet been recognized was $613,000, which is expected to be recognized over the next three years.

Note 8 – Accumulated Comprehensive Income Loss

The following tables present the changes in accumulated other comprehensive loss by component, net of tax, for the three months ended March 31, 2020 and 2019 (in thousands):

	Three months ended March 31, 2020
	Unrealized gain (loss) on available for sale securities (a)		Defined Benefit Pension Items (a)			Total
Balance as of December 31, 2019	$	2,290	$	(2,919	)	$	(629	)
Other comprehensive income (loss) before reclassifications (net of tax)		3,424		-			3,424
Amounts reclassified from accumulated other
comprehensive income (loss) (net of tax)		-		123			123
Net current period other comprehensive income (loss)		3,424		123			3,547
Balance as of March 31, 2020	$	5,714	$	(2,796	)	$	2,918

	Three months ended March 31, 2019
	Unrealized gain (loss) on available for sale securities (a)			Defined Benefit Pension Items (a)			Total
Balance as of December 31, 2018	$	(973	)	$	(2,948	)	$	(3,921	)
Other comprehensive income (loss) before reclassifications (net of tax)		1,048			-			1,048
Amounts reclassified from accumulated other
comprehensive income (loss) (net of tax)		-			48			48
Net current period other comprehensive income (loss)		1,048			48			1,096
Balance as of March 31, 2019	$	75		$	(2,900	)	$	(2,825	)

(a) Amounts in parentheses indicate debits

The following table presents the significant amounts reclassified out of each component of accumulated other comprehensive income for the three months ended March 31, 2020 and 2019 (in thousands):

Details about accumulated other comprehensive income (loss)	Amount reclassified from accumulated comprehensive income (loss) (a)						Affected line item in the Consolidated Statement of Income
	Three Months Ended March 31, 2020
	2020			2019
Defined benefit pension items
	$	(156	)	$	(61	)	Other expenses
		33			13		Provision for income taxes
	$	(123	)	$	(48	)	Net of tax
Total reclassifications	$	(123	)	$	(48	)

(a) Amounts in parentheses indicate debits

Note 9 – Fair Value Measurements

The Company has established a hierarchal disclosure framework associated with the level of pricing observability utilized in measuring assets and liabilities at fair value. The three broad levels defined by this hierarchy are as follows:

Level I:

Quoted prices are available in active markets for identical assets or liabilities as of the reported date.

Level II:	Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but traded less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed.

Level III:	Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality, the Company's creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. Our valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company’s monthly and/or quarterly valuation process.

Assets and Liabilities Required to be Measured at Fair Value on a Recurring Basis

The fair values of equity securities and securities available for sale are determined by quoted prices in active markets, when available, and classified as Level I. If quoted market prices are not available, the fair value is determined by a matrix pricing, which is a mathematical technique, widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities and classified as Level II. The fair values consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

The following tables present the assets and liabilities reported on the Consolidated Balance Sheet at their fair value on a recurring basis as of March 31, 2020 and December 31, 2019 by level within the fair value hierarchy (in thousands). Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

March 31, 2020	Level I		Level II		Level III		Total
Fair value measurements on a recurring basis:
Assets
Equity securities	$	649	$	-	$	-	$	649
Available for sale securities:
U.S. Agency securities		-		77,510		-		77,510
U.S. Treasury securities		28,313		-		-		28,313
Obligations of state and
political subdivisions		-		74,778		-		74,778
Corporate obligations		-		3,347		-		3,347
Mortgage-backed securities in
government sponsored entities		-		73,840		-		73,840

December 31, 2019	Level I		Level II		Level III		Total
Fair value measurements on a recurring basis:
Assets
Equity securities	$	701	$	-	$	-	$	701
Available for sale securities:
U.S. Agency securities		-		84,863		-		84,863
U.S. Treasuries securities		27,661		-		-		27,661
Obligations of state and
political subdivisions		-		61,455		-		61,455
Corporate obligations		-		3,328		-		3,328
Mortgage-backed securities in
government sponsored entities		-		63,399		-		63,399

Assets and Liabilities Required to be Measured and Reported at Fair Value on a Nonrecurring Basis

Assets measured at fair value on a nonrecurring basis as of March 31, 2020 and December 31, 2019 are included in the table below (in thousands):

March 31, 2020	Level I		Level II		Level III		Total
Impaired Loans	$	-	$	-	$	4,178	$	4,178
Other real estate owned		-		-		2,951		2,951

December 31, 2019	Level I		Level II		Level III		Total
Impaired Loans	$	-	$	-	$	3,860	$	3,860
Other real estate owned		-		-		3,299		3,299

•

Impaired Loans - The Company has measured impairment on impaired loans generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties. In some cases, management may adjust the appraised value due to the age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed. Additionally, management makes estimates about expected costs to sell the property which are also included in the net realizable value. If the fair value of the collateral dependent loan is less than the carrying amount of the loan a specific reserve for the loan is made in the allowance for loan losses or a charge-off is taken to reduce the loan to the fair value of the collateral (less estimated selling costs) and the loan is included in the table above as a Level III measurement. If the fair value of the collateral exceeds the carrying amount of the loan, then the loan is not included in the table above as it is not currently being carried at its fair value. The fair values above excluded estimated selling costs of $459,000 and $424,000 at March 31, 2020 and December 31, 2019, respectively.

•

Other Real Estate Owned (OREO) – OREO is carried at the lower of cost or fair value, less estimated costs to sell, which is measured at the date of foreclosure. If the fair value of the collateral exceeds the carrying amount of the loan, no charge-off or adjustment is necessary, the loan is not considered to be carried at fair value, and is therefore not included in the table above. If the fair value of the collateral is less than the carrying amount of the loan, management will charge the loan down to its estimated realizable value. The fair value of OREO is based on the appraised value of the property, which is generally unadjusted by management and is based on comparable sales for similar properties in the same geographic region as the subject property, and is included in the above table as a Level II measurement. In some cases, management may adjust the appraised value due to the age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed. In these cases, the loans are categorized in the above table as a Level III measurement since these adjustments are considered to be unobservable inputs. Income and expenses from operations and further declines in the fair value of the collateral subsequent to foreclosure are included in net expenses from OREO.

The following table provides a listing of the significant unobservable inputs used in the fair value measurement process for items valued utilizing Level III techniques (dollars in thousands).

March 31, 2020	Fair Value		Valuation Technique(s)	Unobservable input	Range			Weighted average
Impaired Loans	$	4,178	Appraised Collateral Values	Discount for time since appraisal		0-100	%		15.54	%
				Selling costs		5%-10	%		9.34	%
				Holding period	0 - 12 months			11.93 months

Other real estate owned		2,951	Appraised Collateral Values	Discount for time since appraisal		5-33	%		16.27	%

Deceber 31, 2020	Fair Value		Valuation Technique(s)	Unobservable input	Range			Weighted average
Impaired Loans	$	3,860	Appraised Collateral Values	Discount for time since appraisal		0-100	%		19.22	%
				Selling costs		5%-10	%		9.26	%
				Holding period	6- 12 months			11.76 months

Other real estate owned		3,299	Appraised Collateral Values	Discount for time since appraisal		5-43	%		16.37	%

Financial Instruments Not Required to be Measured or Reported at Fair Value

The carrying amount and fair value of the Company’s financial instruments that are not required to be measured or reported at fair value on a recurring basis are as follows (in thousands):

	Carrying
March 31, 2020	Amount		Fair Value		Level I		Level II		Level III
Financial assets:
Interest bearing time deposits with other banks	$	14,506	$	14,962	$	-	$	-	$	14,962
Loans held for sale		2,006		2,006		-		-		2,006
Net loans		1,079,473		1,073,943		-		-		1,073,943

Financial liabilities:
Deposits		1,205,150		1,209,221		946,724		-		262,497
Borrowed funds		83,563		84,101		-		-		84,101

	Carrying
December 31, 2019	Amount		Fair Value		Level I		Level II		Level III
Financial assets:
Interest bearing time deposits with other banks	$	14,256	$	14,635	$	-	$	-	$	14,635
Loans held for sale		815		815		-		-		815
Net loans		1,101,724		1,091,006		-		-		1,091,006

Financial liabilities:
Deposits		1,211,118		1,211,200		938,387		-		272,813
Borrowed funds		85,117		84,581		-		-		84,581

The carrying amounts for cash and due from banks, bank owned life insurance, regulatory stock, accrued interest receivable and payable approximate fair value and are considered Level I measurements.

Note 10 – Acquisition of MidCoast Community Bancorp, Inc.

On April 17, 2020, Citizens Financial Services, Inc. (Company) and its wholly owned subsidiary, First Citizens Community Bank (Bank), and MidCoast Community Bancorp, Inc. (MidCoast), and its wholly owned subsidiary, MidCoast Community Bank (“MC Bank”) completed the merger agreed to in 2019, pursuant to which MidCoast merged with and into a wholly-owned acquisition subsidiary of the Company, with the acquisition subsidiary as the surviving corporation. Concurrent with the merger, MC Bank merged with and into the Bank, with the Bank as the surviving institution.

Each outstanding share of MidCoast common stock was converted into $6.50 in cash or 0.1065 shares of the Company’s common stock. The merger resulted in 25% of the outstanding shares of MidCoast common stock (including for this purpose, dissenters’ shares) paid in cash and the remainder was paid in the Company’s common stock.

The senior management of the Company and the Bank remained the same following the merger.

Note 11 – Recent Accounting Pronouncements

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments, which changes the impairment model for most financial assets. This Update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The underlying premise of the Update is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset. The income statement will be effected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted for annual and interim periods beginning after December 15, 2018. With certain exceptions, transition to the new requirements will be through a cumulative effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is adopted. In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). This Update defers the effective date of ASU 2016-13 for SEC filers that are eligible to be smaller reporting companies, non-SEC filers, and all other companies to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. We expect to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements. In that regard, we have formed a cross-functional working group. The working group is comprised of individuals from various functional areas including credit, loan origination and finance. We are currently working through our implementation plan which includes assessment and documentation of processes, internal controls and data sources; model development and documentation; and system configuration, among other things. We are also in the process of implementing a third-party vendor solution to assist us in the application of the ASU 2016-13. The adoption of the ASU 2016-13 could result in an increase in the allowance for loan losses as a result of changing from an “incurred loss” model, which encompasses allowances for current known and inherent losses within the portfolio, to an “expected loss” model, which encompasses allowances for losses expected to be incurred over the life of the portfolio. While we are currently unable to reasonably estimate the impact of adopting ASU 2016-13, we expect that the impact of adoption will be significantly influenced by the composition, characteristics and quality of our loan portfolio as well as the prevailing economic conditions and forecasts as of the adoption date.

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. To simplify the subsequent measurement of goodwill, the FASB eliminated Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, under the amendments in this Update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting units fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. A public business entity that is a U.S. Securities and Exchange Commission (SEC) filer should adopt the amendments in this Update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842), which deferred the effective date for ASC 350, Intangibles – Goodwill and Other, for smaller reporting companies to fiscal years beginning after December 15, 2022, and interim periods within those fiscal years. This Update is not expected to have a significant impact on the Company’s consolidated financial statements.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes the Disclosure Requirements for Fair Value Measurements. The Update removes the requirement to disclose the amount of and reasons for transfers between Level I and Level II of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level III fair value measurements. The Update requires disclosure of changes in unrealized gains and losses for the period included in other comprehensive income (loss) for recurring Level III fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level III fair value measurements. This Update is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. This Update is not expected to have a significant impact on the Company’s consolidated financial statements.

In August 2018, the FASB issued ASU 2018-14, Compensation – Retirement Benefits (Topic 715-20). This Update amends ASC 715 to add, remove and clarify disclosure requirements related to defined benefit pension and other postretirement plans. The Update eliminates the requirement to disclose the amounts in accumulated other comprehensive income expected to be recognized as part of net periodic benefit cost over the next year. The Update also removes the disclosure requirements for the effects of a one-percentage-point change on the assumed health care costs and the effect of this change in rates on service cost, interest cost and the benefit obligation for postretirement health care benefits. This Update is effective for public business entities for fiscal years ending after December 15, 2020, and must be applied on a retrospective basis. For all other entities, this Update is effective for fiscal years ending after December 15, 2021. This Update is not expected to have a significant impact on the Company’s consolidated financial statements.

In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, which affects a variety of topics in the Codification and applies to all reporting entities within the scope of the affected accounting guidance. Topic 326, Financial Instruments – Credit Losses amendments are effective for SEC registrants for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. For all other public business entities, the effective date is for fiscal years beginning after December 15, 2020, and for all other entities, the effective date is for fiscal years beginning after December 15, 2021. Topic 815, Derivatives and Hedging amendments are effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods beginning after December 15, 2020. For entities that have adopted the amendments in Update 2017-12, the effective date is as of the beginning of the first annual period beginning after the issuance of this Update. Topic 825, Financial Instruments amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years. In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). This Update defers the effective date of ASU 2016-13 for SEC filers that are eligible to be smaller reporting companies, non-SEC filers and all other companies to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Furthermore, the ASU provides a one-year deferral of the effective dates of the ASUs on derivatives and hedging for companies that are not public business entities. The Company qualifies as a smaller reporting company and does not expect to early adopt these ASUs.

In May 2019, the FASB issued ASU 2019-05, Financial Instruments – Credit Losses, Topic 326, which allows entities to irrevocably elect the fair value option for certain financial assets previously measured at amortized cost upon adoption of the new credit losses standard. To be eligible for the transition election, the existing financial asset must otherwise be both within the scope of the new credit losses standard and eligible for the applying the fair value option in ASC 825-10.3. The election must be applied on an instrument-by-instrument basis and is not available for either available-for-sale or held-to-maturity debt securities. For entities that elect the fair value option, the difference between the carrying amount and the fair value of the financial asset would be recognized through a cumulative-effect adjustment to opening retained earnings as of the date an entity adopted ASU 2016-13. Changes in fair value of that financial asset would subsequently be reported in current earnings. For entities that have not yet adopted ASU 2016-13, the effective dates and transition requirements are the same as those in ASU 2016-13. For entities that have adopted ASU 2016-13, ASU 2019-05 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted once ASU 2016-13 has been adopted. In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). The Update defers the effective date of ASU 2016-13 for SEC filers that are eligible to be smaller reporting companies, non-SEC filers and all other companies to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company qualifies as a smaller reporting company and does not expect to early adopt ASU 2016-13.

In July 2019, the FASB issued ASU 2019-07, Codification Updates to SEC Sections, Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No. 33-10532, Disclosure Update and Simplification, and Nos. 33-10231 and 33-10442, Investment Company Reporting Modernization, and Miscellaneous Updates. This ASU amends various SEC paragraphs pursuant to the issuance of SEC Final Rule Releases No. 33-10532, Disclosure Update and Simplification, and Nos. 33-10231 and 33-10442, Investment Company Reporting Modernization. Other miscellaneous updates to agree to the electronic Code of Federal Regulations also have been incorporated.

In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). The Update defers the effective dates of ASU 2016-13 for SEC filers that are eligible to be smaller reporting companies, non-SEC filers, and all other companies to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. This Update also amends the mandatory effective date for the elimination of Step 2 from the goodwill impairment test under ASU No. 2017-04, Intangibles ‒ Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (Goodwill), to align with those used for credit losses. Furthermore, the ASU provides a one-year deferral of the effective dates of the ASUs on derivatives and hedging and leases for companies that are not public business entities. The Company qualifies as a smaller reporting company and does not expect to early adopt these ASUs.

In November 2019, the FASB issued ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, to clarify its new credit impairment guidance in ASC 326, based on implementation issues raised by stakeholders. This Update clarified, among other things, that expected recoveries are to be included in the allowance for credit losses for these financial assets; an accounting policy election can be made to adjust the effective interest rate for existing troubled debt restructurings based on the prepayment assumptions instead of the prepayment assumptions applicable immediately prior to the restructuring event; and extends the practical expedient to exclude accrued interest receivable from all additional relevant disclosures involving amortized cost basis. The effective dates in this Update are the same as those applicable for ASU 2019-10. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740), to simplify the accounting for income taxes, change the accounting for certain tax transactions, and make minor improvements to the codification. This Update provides a policy election to not allocate consolidated income taxes when a member of a consolidated tax return is not subject to income tax and provides guidance to evaluate whether a step-up in tax basis of goodwill relates to a business combination in which book goodwill was recognized or a separate transaction. The Update also changes current guidance for making an intraperiod allocation, if there is a loss in continuing operations and gains outside of continuing operations; determining when a deferred tax liability is recognized after an investor in a foreign entity transitions to or from the equity method of accounting; accounting for tax law changes and year-to-date losses in interim periods; and determining how to apply the income tax guidance to franchise taxes that are partially based on income. For public business entities, the amendments in this Update are effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2020. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

In January 2020, the FASB issued ASU 2020-1, Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815), to clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting for the purposes of applying the measurement alternative in accordance with Topic 321 immediately before applying or upon discontinuing the equity method. The amendments also clarify that, for the purpose of applying paragraph 815-10-15-141(a) an entity should not consider whether, upon the settlement of the forward contract or exercise of the purchased option, individually or with existing investments, the underlying securities would be accounted for under the equity method in Topic 323 or the fair value option, in accordance with the financial instruments guidance in Topic 825. An entity also would evaluate the remaining characteristics in paragraph 815-10-15-141 to determine the accounting for those forward contracts and purchased options. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

In January 2020, the FASB issued ASU 2020-2, Financial Instruments – Credit Losses (Topic 326) and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842), February 2020, to add and amend SEC paragraphs in the Accounting Standards Codification to reflect the issuance of SEC Staff Accounting Bulletin No. 119, related to the new credit losses standard, and comments by the SEC staff related to the revised effective date of the new leases standard. This ASU is effective upon issuance. This did not have a significant impact on the Company’s financial statements.

In March 2020, the FASB issued ASU 2020-3, Codification Improvements to Financial Instruments. This ASU was issued to improve and clarify various financial instruments topics, including the current expected credit losses (CECL) standard issued in 2016. The ASU includes seven issues that describe the areas of improvement and the related amendments to GAAP; they are intended to make the standards easier to understand and apply and to eliminate inconsistencies, and they are narrow in scope and are not expected to significantly change practice for most entities. Among its provisions, the ASU clarifies that all entities, other than public business entities that elected the fair value option, are required to provide certain fair value disclosures under ASC 825, Financial Instruments, in both interim and annual financial statements. It also clarifies that the contractual term of a net investment in a lease under Topic 842 should be the contractual term used to measure expected credit losses under Topic 326. Amendments related to ASU 2019-04 are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is not permitted before an entity’s adoption of ASU 2016-01. Amendments related to ASU 2016-13 for entities that have not yet adopted that guidance are effective upon adoption of the amendments in ASU 2016-13. Early adoption is not permitted before an entity’s adoption of ASU 2016-13. Amendments related to ASU 2016-13 for entities that have adopted that guidance are effective for fiscal years beginning after December 15, 2019, including interim periods within those years. Other amendments are effective upon issuance of this ASU. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

In March 2020, the FASB issued ASU 2020-4, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, March 2020, to provide temporary optional expedients and exceptions to the U.S. GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from LIBOR and other interbank offered rates to alternative reference rates, such as Secured Overnight Financing Rate. Entities can elect not to apply certain modification accounting requirements to contracts affected by what the guidance calls reference rate reform, if certain criteria are met. An entity that makes this election would not have to remeasure the contracts at the modification date or reassess a previous accounting determination. Also, entities can elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform, if certain criteria are met, and can make a one-time election to sell and/or reclassify held-to-maturity debt securities that reference an interest rate affected by reference rate reform. The amendments in this ASU are effective for all entities upon issuance through December 31, 2022. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

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

Forward-Looking Statements

We have made forward-looking statements in this document, and in documents that we incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or expected future results of operations of Citizens Financial Services, Inc., First Citizens Community Bank, First Citizens Insurance Agency, Inc., 1^st Realty of PA LLC or the combined Company. When we use words such as “believes,” “expects,” “anticipates,” or similar expressions, we are making forward-looking statements. For a variety of reasons, actual results could differ materially from those contained in or implied by forward-looking statements. The Company cautions readers that the following important factors, among others, could in the future affect the Company’s actual results and could cause the Company’s actual results for subsequent periods to differ materially from those expressed in any forward-looking statement:

•	The scope, duration and severity of the COVID-19 pandemic and its effects on our business and operations, our customers, including their ability to make timely payments on loans, our service providers, and on the economy and financial markets in general.

•	Interest rates could change more rapidly or more significantly than we expect.

•	The economy could change significantly in an unexpected way, which would cause the demand for new loans and the ability of borrowers to repay outstanding loans to change in ways that our models do not anticipate.

•	The financial markets could suffer a significant disruption, which may have a negative effect on our financial condition and that of our borrowers, and on our ability to raise money by issuing new securities.

•	It could take us longer than we anticipate to implement strategic initiatives designed to increase revenues or manage expenses, or we may be unable to implement those initiatives at all.

•	We may not be able to successfully integrate businesses we acquire or be able to fully realize the expected financial and other benefits from acquisitions.

•	Acquisitions and dispositions of assets could affect us in ways that management has not anticipated.

•	We may become subject to new legal obligations or the resolution of litigation may have a negative effect on our financial condition or operating results.

•	We may become subject to new and unanticipated accounting, tax, or regulatory practices or requirements.

•	We could experience greater loan delinquencies than anticipated, adversely affecting our earnings and financial condition.

•	We could experience greater losses than expected due to the ever increasing volume of information theft and fraudulent scams impacting our customers and the banking industry.

•	We could lose the services of some or all of our key personnel, which would negatively impact our business because of their business development skills, financial expertise, lending experience, technical expertise and market area knowledge.

•	The agricultural economy is subject to extreme swings in both the costs of resources and the prices received from the sale of products, which could negatively impact some of our customers.

•	Agricultural customers could be affected by factors outside of their control including adverse weather conditions, loss of crops or livestock due to diseases or other factors, and government policies, regulations and tariffs.

•	Loan concentrations in certain industries could negatively impact financial results, if financial results or economic conditions deteriorate.

•	A budget impasse in the Commonwealth of Pennsylvania could impact our asset values, liquidity and profitability as a result of either delayed or reduced funding to school districts and municipalities who are customers of the Bank.

•

Companies providing support services related to the exploration and drilling of the natural gas reserves in our market area may be affected by federal, state and local laws and regulations such as restrictions on production, permitting, changes in taxes and environmental protection, which could negatively impact our customers and, as a result, negatively impact our loan and deposit volume and loan quality. Additionally, the activities the companies providing support services related to the exploration and drilling of the natural gas reserves may be dependent on the market price of natural gas. As a result, decreases in the market price of natural gas could also negatively impact these companies, our customers.

Additional factors that may affect our results are discussed under “Part II – Item 1A – Risk Factors” in this report and in the Company’s 2019 Annual Report on Form 10-K under “Item 1.A/ Risk Factors.” Except as required by applicable law and regulation, we assume no obligation to update or revise any forward-looking statements after the date on which they are made.

Introduction

The following is management's discussion and analysis of the financial condition and results of operations at the dates and for the periods presented in the accompanying consolidated financial statements for the Company. Our consolidated financial condition and results of operations consist almost entirely of the Bank’s financial condition and results of operations. Management’s discussion and analysis should be read in conjunction with the preceding financial statements presented under Part I. The results of operations for the three months ended March 31, 2020 are not necessarily indicative of the results you may expect for the full year.

The Company currently engages in the general business of banking throughout our service area of Potter, Tioga, Clinton, Bradford and Centre counties in north central Pennsylvania, Lebanon, Berks, Schuylkill and Lancaster counties in south central Pennsylvania and Allegany County in southern New York and with the recently closed MidCoast acquisition, the Cities of Wilmington and Dover, Delaware. We also have a limited branch office in Union county, Pennsylvania, which primarily serves agricultural and commercial customers in the central Pennsylvania market. We maintain our central office in Mansfield, Pennsylvania. Presently we operate 28 banking facilities, 27 of which operate as bank branches. In Pennsylvania, the Company has full service offices located in Mansfield, Blossburg, Ulysses, Genesee, Wellsboro, Troy, Sayre, Canton, Gillett, Millerton, LeRaysville, Towanda, Rome, the Mansfield Wal-Mart Super Center, Mill Hall, Schuylkill Haven, Friedensburg, Mt. Aetna, Fredericksburg, Mount Joy, Fivepointville, State College and two branches near the city of Lebanon, Pennsylvania. The Fivepointville branch was opened in the first quarter of 2019. The limited branch office is located in Winfield, Pennsylvania. In New York, our office is in Wellsville. With the merger completed in the second quarter, we added three branches in Delaware with two being in the Wilmington market and one in Dover.

Covid-19 Pandemic Response and Loan Profile

In response to the Covid-19 pandemic, the Company created a payment relief program that includes the following:

•	Waiver of late fees for March, April and May

•	Interest only payment options for consumers and businesses for 60-90 days.

•	Deferral of principal payments for consumers and businesses in certain

industries for 60-120 days

•	Waiver of early withdrawal penalties through May 1, 2020 on CDs

Through April 30, 2020, we have modified 169 loans totaling $52.0 million, which have primarily been business related. Additionally, in accordance with government regulations, we have paused all foreclosure actions during March and April.

We also are participating in the Paycheck Protection Program for loans provided under the auspices of the Small Business Adminstration (SBA). During the first round of the program, we received approval for 422 loans totaling $47.2 million that will earn interest at 1% and will generate fee revenue of approximately $2.0 million over the next 24 months. A portion of these loans may be forgiven by the SBA depending on the customers usage of the proceeds. We are currently submitting loans as part of the second phase of this program. As of April 30, 2020, 557 loans have been approved totaling $52.3 million.

The Company tracks industry concentrations to identify risks that could lead to additional credit exposure. As a result of the Covid 19 pandemic, the Company has determined that Hotels/Motels and restaurants represent a higher level of credit risk. At March 31, 2020, the Company has limited loan concentrations to these industries as follows:

•	Hotels/Motels - $18.9 million or 1.7% of outstanding loans, and 87.6% pass rated

•	Restaurants - $13.1 million or 1.2% of outstanding loans, and 86.8% pass rated

Our agricultural relationships are also being strained by the pandemic as demand for certain products has declined and processing plant issues have resulted in further strains on our customers as a result of the pandemic. Agricultural lending comprises $346.8 million, or 31.7% of outstanding balances as of March 31, 2020.

Risk Management

Risk identification and management are essential elements for the successful management of the Company. In the normal course of business, the Company is subject to various types of risk, including interest rate, credit, liquidity, reputational and regulatory risk.

Interest rate risk is the sensitivity of net interest income and the market value of financial instruments to the direction and frequency of changes in market interest rates. Interest rate risk results from various re-pricing frequencies and the maturity structure of the financial instruments owned by the Company. The Company uses its asset/liability and funds management policy to control and manage interest rate risk.

Credit risk represents the possibility that a customer may not perform in accordance with contractual terms. Credit risk results from loans with customers and the purchasing of securities. The Company’s primary credit risk is in the loan portfolio. The Company manages credit risk by adhering to an established credit policy and through a disciplined evaluation of the adequacy of the allowance for loan losses. Also, the investment policy limits the amount of credit risk that may be taken in the investment portfolio.

Liquidity risk represents the inability to generate or otherwise obtain funds at reasonable rates to satisfy commitments to borrowers and obligations to depositors. The Company has established guidelines within its asset/liability and funds management policy to manage liquidity risk. These guidelines include, among other things, contingent funding alternatives.

Reputational risk, or the risk to our business, earnings, liquidity, and capital from negative public opinion, could result from our actual or alleged conduct in a variety of areas, including legal and regulatory compliance, lending practices, corporate governance, litigation, ethical issues, or inadequate protection of customer information, including fraudulent activity outside the Company’s control. We expend significant resources to comply with regulatory requirements. Failure to comply could result in reputational harm or significant legal or remedial costs. Damage to our reputation could adversely affect our ability to retain and attract new customers, and adversely impact our earnings and liquidity.

Regulatory and compliance risk represents the possibility that a change in law, regulations or regulatory policy may have a material effect on the business of the Company. We cannot predict what legislation might be enacted or what regulations might be adopted, or if adopted, the effect thereof on our operations.

Competition

The banking industry in the Bank’s service areas continue to be extremely competitive, both among commercial banks and with other financial service providers such as consumer finance companies, thrifts, investment firms, mutual funds, insurance companies, credit unions, agricultural cooperatives and internet entities for loans and deposits. Competition in our north central Pennsylvania market has increased as a result of other financial institutions looking to expand into new markets. With larger population centers in our central and south central markets, as well as the new Delaware operations, we experience more competition to gather deposits and to make loans. Mortgage banking firms, financial companies, financial affiliates of industrial companies, brokerage firms, retirement fund management firms and even government agencies provide additional competition for loans, deposits and other financial services. The Bank is generally competitive with all competing financial institutions in its service areas with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans.

Trust and Investment Services; Oil and Gas Services

Our Investment and Trust Services Division offers professional trust administration, investment management services, estate planning and administration, and custody of securities. In addition to traditional trust and investment services offered, we assist our customers through various oil and gas specific leasing matters from lease negotiations to establishing a successful approach to personal wealth management. Assets held by the Company in a fiduciary or agency capacity for its customers are not included in the Consolidated Balance Sheets since such items are not assets of the Company. Revenues and fees of the Trust Department are reflected in trust income in the Consolidated Statement of Income. As of March 31, 2020 and December 31, 2019, the Trust Department had $110.4 million and $134.3 million of assets under management, respectively.

Our Investment Representatives offer full service brokerage services and financial planning throughout the Bank’s market area. Products such as mutual funds, annuities, health and life insurance are made available through our insurance subsidiary, First Citizens Insurance Agency, Inc. The assets associated with these products are not included in the Consolidated Balance Sheets since such items are not assets of the Company. Assets owned and invested by customers of the Bank through the Bank’s Investment Representatives decreased from $215.4 million at December 31, 2019 to $200.1 million at March 31, 2020. Fee income from the sale of these products is reflected in brokerage and insurance income in the Consolidated Statement of Income. Management believes that there are opportunities to increase non-interest income through these products and services, especially in our central and south central Pennsylvania markets.

Results of Operations

Overview of the Income Statement

The Company had net income of $4,531,000 for the first three months of 2020 compared to $4,405,000 for last year’s comparable period, an increase of $126,000, or 2.9%. Basic earnings per share for the first three months of 2020 were $1.29, compared to $1.25 last year, representing a 3.2% increase. Annualized return on assets and return on equity for the three months of 2020 were 1.24% and 11.48%, respectively, compared with 1.22% and 12.12% for last year’s comparable period.

Net Interest Income

Net interest income, the most significant component of the Company’s earnings, is the amount by which interest income generated from interest-earning assets exceeds interest expense paid on interest-bearing liabilities.

Net interest income for the first three months of 2020 was $12,890,000, an increase of $975,000, or 8.2%, compared to the same period in 2019. For the first three months of 2020 and 2019, the provision for loan losses totaled $400,000. Consequently, net interest income after the provision for loan losses was $12,490,000 in the first three months of 2020 compared to $11,515,000 during the first three months of 2019.

The following table sets forth the average balances of, and the interest earned or incurred on, for each principal category of assets, liabilities and stockholders’ equity, the related rates, net interest income and interest rate spread created for the three months ended March 31, 2020 and 2019 on a tax equivalent basis (dollars in thousands):

	Analysis of Average Balances and Interest Rates
	Three Months Ended
	March 31, 2020							March 31, 2019
	Average				Average			Average				Average
	Balance (1)		Interest		Rate			Balance (1)		Interest		Rate
(dollars in thousands)	$				$	%		$				$	%
ASSETS
Short-term investments:
Interest-bearing deposits at banks		9,538		3		0.17			8,759		7		0.32
Total short-term investments		9,538		3		0.17			8,759		7		0.32
Interest bearing time deposits at banks		14,272		92		2.59			15,498		97		2.54
Investment securities:
Taxable		179,893		1,217		2.71			196,187		1,242		2.53
Tax-exempt (3)		62,555		493		3.15			55,866		451		3.23
Total investment securities		242,448		1,710		2.82			252,053		1,693		2.69
Loans (2)(3)(4):
Residential mortgage loans		215,838		2,843		5.30			215,670		2,825		5.31
Construction		17,726		223		5.06			28,439		357		5.09
Commercial Loans		415,199		5,534		5.36			401,813		5,423		5.47
Agricultural Loans		360,179		4,112		4.59			334,520		3,739		4.53
Loans to state & political subdivisions		94,122		939		0.01			100,922		978		3.93
Other loans		9,461		171		7.27			9,768		184		7.64
Loans, net of discount		1,112,525		13,822		5.00			1,091,132		13,506		5.05
Total interest-earning assets		1,378,783		15,627		4.56			1,367,442		15,303		4.54
Cash and due from banks		6,263							6,741
Bank premises and equipment		16,062							16,263
Other assets		56,983							54,278
Total non-interest earning assets		79,308							77,282
Total assets		1,458,091							1,444,724
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
NOW accounts		332,068		437		0.53			328,357		578		0.71
Savings accounts		225,985		184		0.33			211,149		184		0.35
Money market accounts		174,294		393		0.91			161,424		505		1.27
Certificates of deposit		261,278		973		1.50			293,385		1,047		1.45
Total interest-bearing deposits		993,625		1,987		0.93			994,315		2,314		0.94
Other borrowed funds		93,849		462		1.98			113,829		788		2.81
Total interest-bearing liabilities		1,087,474		2,449		0.91			1,108,144		3,102		1.14
Demand deposits		196,604							176,989
Other liabilities		16,082							14,199
Total non-interest-bearing liabilities		212,686							191,188
Stockholders' equity		157,931							145,392
Total liabilities & stockholders' equity		1,458,091							1,444,724
Net interest income				13,178							12,201
Net interest spread (5)						3.65	%						3.40	%
Net interest income as a percentage
of average interest-earning assets						3.84	%						3.62	%
Ratio of interest-earning assets
to interest-bearing liabilities						127	%						123	%

(1) Averages are based on daily averages.
(2) Includes loan origination and commitment fees.
(3) Tax exempt interest revenue is shown on a tax equivalent basis for proper comparison using
a statutory federal income tax rate of 21%.
(4) Income on non-accrual loans is accounted for on a cash basis, and the loan balances are included in interest-earning assets.
(5) Interest rate spread represents the difference between the average rate earned on interest-earning assets
and the average rate paid on interest-bearing liabilities.

Tax exempt revenue is shown on a tax-equivalent basis (non-Gaap) for proper comparison using a federal statutory income tax rate of 21% for the three months ended March 31, 2020 and 2019. For purposes of the comparison, as well as the discussion that follows, this presentation facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Company’s Federal statutory rate during the corresponding period. The following table represents the adjustment to convert net interest income to net interest income on a fully taxable equivalent basis for the periods ended March 31, 2020 and 2019 (in thousands):

	For the Three Months
	Ended March 31,
	2020		2019
Interest and dividend income from investment securities
and interest bearing deposits at banks (non-tax adjusted)	$	1,701	$	1,703
Tax equivalent adjustment		104		94
Interest and dividend income from investment securities
and interest bearing deposits at banks (tax equivalent basis)	$	1,805	$	1,797



Interest and fees on loans (non-tax adjusted)	$	13,638	$	13,314
Tax equivalent adjustment		184		192
Interest and fees on loans (tax equivalent basis)	$	13,822	$	13,506



Total interest income	$	15,339	$	15,017
Total interest expense		2,449		3,102
Net interest income		12,890		11,915
Total tax equivalent adjustment		288		286
Net interest income (tax equivalent basis)	$	13,178	$	12,201

The following table shows the tax-equivalent effect of changes in volume and rate on interest income and expense (in thousands):

	Three months ended March 31, 2020 vs 2019 (1)
	Change in			Change			Total
	Volume			in Rate			Change
Interest Income:
Short-term investments:
Interest-bearing deposits at banks	$	1		$	(5	)	$	(4	)
Interest bearing time deposits at banks		(7	)		2			(5	)
Investment securities:
Taxable		(143	)		118			(25	)
Tax-exempt		52			(10	)		42
Total investments		(91	)		108			17
Loans:
Residential mortgage loans		26			(8	)		18
Construction		(132	)		(2	)		(134	)
Commercial Loans		218			(107	)		111
Agricultural Loans		323			50			373
Loans to state & political subdivisions		(60	)		21			(39	)
Other loans		(4	)		(9	)		(13	)
Total loans, net of discount		371			(55	)		316
Total Interest Income		274			50			324
Interest Expense:
Interest-bearing deposits:
NOW accounts		13			(154	)		(141	)
Savings accounts		28			(28	)		-
Money Market accounts		51			(163	)		(112	)
Certificates of deposit		(109	)		35			(74	)
Total interest-bearing deposits		(17	)		(310	)		(327	)
Other borrowed funds		(116	)		(210	)		(326	)
Total interest expense		(133	)		(520	)		(653	)
Net interest income	$	407		$	570		$	977
(1)The portion of the total change attributable to both volume and rate changes, which can not be separated, has been allocated proportionally to the change due to volume and the change due to rate prior to allocation.

Tax equivalent net interest income increased from $12,201,000 for the three month period ended March 31, 2019 to $13,178,000 for the three month period ended March 31, 2020, an increase of $977,000. The tax equivalent net interest margin increased from 3.62% for the first three months of 2019 to 3.84% for the comparable period in 2020. The increase is primarily caused by the decrease in the cost on interest-bearing liabilities and the increase in average outstanding loans.

Total tax equivalent interest income for the 2020 three month period increased $324,000 as compared to the 2019 three month period. This increase was a result of an increase of $274,000 due to a change in volume as average interest-bearing assets increased $11.3 million and due to an increase in the yield on interest-earning assets of 2 basis points, which corresponds to an increase of $50,000. As a result of converting investment assets to loans, the yield on average interest earning assets increased 2 basis points from 4.54% to 4.56%.

Tax equivalent investment income for the three months ended March 31, 2020 increased $17,000 over the same period last year. The primary cause of the increase was an increase in the average yield on investment securities of 13 basis points.

•

The yield on taxable securities increased 18 basis points from 2.53% to 2.71% as a result of calls of investments that were purchased at a discount. This resulted in an increase in investment income of $118,000. The average balance of taxable securities decreased $16.3 million, which resulted in a decrease in investment income of $143,000.

•

The average balance of tax-exempt securities increased by $6.7 million, which resulted in an increase in investment income of $52,000. The yield on tax-exempt securities decreased 8 basis points from 3.23% to 3.15%, which corresponds to a decrease in interest income of $10,000. The yield decrease was attributable to higher yielding securities being called and maturing. For a discussion of the Company’s current investment strategy, see the “Financial Condition – Investments”.

Total loan interest income increased $316,000 for the three months ended March 31, 2020 compared to the same period last year, as a result of loan growth achieved in 2019 that occurred primarily in our central and south central Pennsylvania markets.

•

The average balance of commercial loans increased $13.4 million from a year ago. The growth was attributable to organic growth in our central and south central Pennsylvania markets as well as completed construction projects. This had a positive impact of $218,000 on total interest income due to volume. The yield decreased 11 basis points to 5.36%, which decreased loan interest income $107,000.

•

Interest income on agricultural loans increased $373,000 from 2019 to 2020. The increase in the average balance of agricultural loans of $25.7 million is primarily attributable to loan growth in our central and south central Pennsylvania markets. The increase in the average balance of these loans resulted in an increase in interest income due to volume of $323,000. The yield on agricultural loans increased 6 basis points to 4.59%, which increased loan interest income $50,000.

•	The average balance of construction loans decreased $10.7 million from a year ago as a result of several large commercial and agricultural construction projects being completed in 2019. This resulted in a decrease of $132,000 on total interest income due to volume.

Total interest expense decreased $653,000 for the three months ended March 31, 2020 compared with the comparative period last year primarily as a result of a decrease in the cost of interest-bearing liabilities. Interest expense decreased $520,000 due to rate as a result of a decrease in the average rate paid on interest-bearing liabilities from 1.14% to 0.91%. The decrease was driven by the Federal Reserve interest arate cuts in the second half of 2019 and the first quarter of 2020.

•

The average balance of interest bearing deposits decreased $690,000 from March 31, 2019 to March 31, 2020. The primary decrease was in certificates of deposits, which decreased $32.1 million due to a decrease in brokered certificate balances of $14.4 million. We also had a municipal customer utilize maturing funds to complete a construction project. We experienced increases in NOW accounts of $3.7 million, savings accounts of $14.8 million and money market accounts of $12.9 million. The cumulative effect of these volume changes was a decrease in interest expense of $17,000. (see also “Financial Condition – Deposits”). The average rate paid on interest bearing deposits was 0.93% for the first three months of 2020 and 0.94% for the comparable period in 2019. This resulted in a decrease in interest expense of $310,000. The decrease was due to the Federal Reserve cutting interest rates during 2019 and 2020.

•

The average balance of other borrowed funds decreased $20.0 million from a year ago. This resulted in a decrease in interest expense of $116,000. There was a decrease in the average rate paid on other borrowed funds from 2.81% to 1.98% due to the decrease in the overnight borrowing rate as a result of the Federal Reserve interest rate decreases in 2019 and 2020 resulting in a decrease in interest expense of $210,000.

Provision for Loan Losses

For the three month period ended March 31, 2020 and 2019, we recorded a provision for loan losses of $400,000. The provision remained consistent in 2020 due to the uncertainty in the economic environment due to the Covid 19 pandemic, which has resulted in an increase in unemployment claims, which offset the fact that loans decreased during the first quarter of 2020. (see “Financial Condition – Allowance for Loan Losses and Credit Quality Risk”).

Non-interest Income

The following table shows the breakdown of non-interest income for the three months ended March 31, 2020 and 2019 (dollars in thousands):

	Three months ended March 31,					Change
	2020			2019		Amount			%
Service charges	$	1,081		$	1,099	$	(18	)		(1.6	)
Trust		198			232		(34	)		(14.7	)
Brokerage and insurance		340			293		47			16.0
Gains on loans sold		167			99		68			68.7
Equity security (losses) gains, net		(254	)		11		(265	)		(2,409.1	)
Earnings on bank owned life insurance		156			151		5			3.3
Other		163			148		15			10.1
Total	$	1,851		$	2,033	$	(182	)		(9.0	)

Non-interest income for the three months ended March 31, 2020 totaled $1,851,000, a decrease of $182,000 when compared to the same period in 2019. During the first three months of 2020, net equity security losses amounted to $254,000 as a result of market losses associated with the Covid-19 pandemic compared to gains of $11,000 last year. We did not sell any available for sale securities or equity securities in the first three months of 2020 or 2019.

The increase in brokerage and insurance revenues for the first three months of 2020 is attributable to growth in our south central market. The decrease in Trust revenues is due to estate settlement fees and lower asset levels in 2020 compared to 2019. The gains on loans sold is attributable to a $1.1 million increase in loans sold.

Non-interest Expense

The following tables reflect the breakdown of non-interest expense for the three months ended March 31, 2020 and 2019 (dollars in thousands):

	Three months ended
	March 31,				Change
	2020		2019		Amount			%
Salaries and employee benefits	$	5,414	$	5,029	$	385			7.7
Occupancy		526		592		(66	)		(11.1	)
Furniture and equipment		131		155		(24	)		(15.5	)
Professional fees		325		442		(117	)		(26.5	)
FDIC insurance		71		111		(40	)		(36.0	)
Pennsylvania shares tax		275		275		-			-
Amortization of intangibles		50		66		(16	)		(24.2	)
Merger and acquisition		376		-		376		NA
Software expenses		247		227		20			8.8
ORE expenses		32		107		(75	)		(70.1	)
Other		1,474		1,318		156			11.8
Total	$	8,921	$	8,322	$	599			7.2

Non-interest expenses increased $599,000 for the three months ended March 31, 2020 compared to the same period in 2019. Salaries and employee benefits increased $385,000 or 7.7%. The increase was due to merit increases effective at the beginning of 2020 and increased health care expenses.

The decrease in occupancy expenses is due to the closure of one branch in the first quarter of 2020 and lower snow plowing expenses. The decrease in professional fees was due to fees incurred in the first quarter of 2019 to settle litigation with a customer in bankruptcy. The decrease in furniture and fixture is due to replacing a significant number of computers in 2019. The decrease in OREO expenses is due to improved rental revenues to offset expenses. The increase in merger and acquisition costs was due to costs associated with the MidCoast acquisition that closed in April 2020. The decrease in FDIC insurance was due to credit received from the FDIC as the Deposit Insurance Fund reserve ratio exceeded 1.38%.

Provision for Income Taxes

The provision for income taxes was $889,000 for the three month period ended March 31, 2020 compared to $821,000 for the same period in 2019. The increase is primarily attributable to the increase in income before the provision for income taxes of $194,000 for the comparable periods. Through management of our municipal loan and bond portfolios, management is focused on minimizing our effective tax rate. Our effective tax rate was 16.4% and 15.7% for the first three months of 2020 and 2019, respectively, compared to the statutory rate of 21%.

We are invested in four limited partnerships that have established low-income housing projects in our market areas. We anticipate recognizing an aggregate of $388,000 of tax credits over the next 2.75 years, with an additional $106,000 anticipated to be recognized during 2020.

Financial Condition

Total assets were $1.46 billion at March 31, 2020, a decrease of $1.6 million from $1.47 billion at December 31, 2019. Cash and cash equivalents increased $3.0 million to $21.5 million. Available for Sale securities increased $17.1 million and net loans decreased $22.3 million to $1.08 billion at March 31, 2020. Total deposits decreased $6.0 million to $1.21 billion since year-end 2019, while borrowed funds decreased $1.6 million to $83.6 million.

Cash and Cash Equivalents

Cash and cash equivalents totaled $21.5 million at March 31, 2020 compared to $18.5 million at December 31, 2019, an increase of $3.0 million. Management actively measures and evaluates its liquidity position through our Asset–Liability Committee and believes its liquidity needs are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources including the Bank’s core deposits, Federal Home Loan Bank financing, federal funds lines with correspondent banks, brokered certificates of deposit and the portion of the investment and loan portfolios that mature within one year. Management expects that these sources of funds will permit us to meet cash obligations and off-balance sheet commitments as they come due.

Investments

The following table shows the composition of the investment portfolio (including debt and equity securities) as of March 31, 2020 and December 31, 2019 (dollars in thousands):

	March 31, 2020				December 31, 2019
	Amount		%		Amount		%
Debt securities:
U. S. Agency securities	$	77,510		30.0	$	84,863		35.1
U. S. Treasury notes		28,313		11.0		27,661		11.5
Obligations of state & political subdivisions		74,778		28.9		61,455		25.5
Corporate obligations		3,347		1.3		3,328		1.4
Mortgage-backed securities in
government sponsored entities		73,840		28.6		63,399		26.2
Equity securities		649		0.2		701		0.3
Total	$	258,437		100.0	$	241,407		100.0

	March 31, 2020/
	December 31, 2019
	Change
	Amount			%
Debt securities:
U. S. Agency securities	$	(7,353	)		(8.7	)
U. S. Treasury notes		652			2.4
Obligations of state & political subdivisions		13,323			21.7
Corporate obligations		19			0.6
Mortgage-backed securities in
government sponsored entities		10,441			16.5
Equity securities		(52	)		(7.4	)
Total	$	17,030			7.1

Our investment portfolio increased by $17.0 million, or 7.1%, from December 31, 2019 to March 31, 2020. During 2020, we purchased $5.8 million of U.S. agency obligations, $23.4 million state and political securities, $12.7 million of mortgage backed securities and $202,000 of equity securities, which was offset by $3.8 million of principal repayments and $25.2 million of calls and maturities that occurred during the first three months of 2020. As a result of changes in interest rates, the unrealized gain on available for sale investment portfolio increased $4.3 million. We did not sell any investments during the first three months of 2020. Excluding our short-term investments consisting of monies held primarily at the Federal Reserve for liquidity purposes, our investment portfolio for the three month period ended March 31, 2020 yielded 2.82%, compared to 2.69% in the comparable period in 2019 on a tax equivalent basis.

The investment strategy for 2020 has been to utilize cashflows from the investment and loan portfolios to purchase mortgage backed securities in government sponsored entities and obligations of state and political securities. The increase in the investment portfolio was in response to opportunities provided by the Covid-19 pandemic that allowed the Company to purchase high quality municipal securities and mortgage backed securities with relatively large spreads compared to recent periods. We continually monitor interest rate trading ranges and try to focus purchases to times when rates are in the top third of the trading range. The Bank believes its investment strategy has appropriately mitigated its interest rate risk exposure for various rate environments, while providing sufficient cashflows to meet liquidity needs.

Management continues to monitor the earnings performance and the liquidity of the investment portfolio on a regular basis. Through active balance sheet management and analysis of the investment portfolio, the Company believes it maintains sufficient liquidity to satisfy depositor withdrawal requirements and various credit needs of its customers.

Loans

The following table shows the composition of the loan portfolio as of March 31, 2020 and December 31, 2019 (dollars in thousands):

	March 31,						December 31,
	2020						2019
	Amount			%			Amount		%
Real estate:
Residential	$	216,179			19.8		$	217,088		19.5
Commercial		338,490			30.9			342,023		30.7
Agricultural		300,606			27.5			311,464		27.9
Construction		17,926			1.6			15,519		1.4
Consumer		9,533			0.9			9,947		0.8
Other commercial loans		71,038			6.5			69,970		6.3
Other agricultural loans		46,170			4.2			55,112		4.9
State & political subdivision loans		93,778			8.6			94,446		8.5
Total loans		1,093,720			100.0			1,115,569		100.0
Less allowance for loan losses		14,247						13,845
Net loans	$	1,079,473					$	1,101,724

	March 31, 2020/
	December 31, 2019
	Change
	Amount			%
Real estate:
Residential	$	(909	)		(0.4	)
Commercial		(3,533	)		(1.0	)
Agricultural		(10,858	)		(3.5	)
Construction		2,407			15.5
Consumer		(414	)		(4.2	)
Other commercial loans		1,068			1.5
Other agricultural loans		(8,942	)		(16.2	)
State & political subdivision loans		(668	)		(0.7	)
Total loans	$	(21,849	)		(2.0	)

The Bank’s lending efforts have historically been focused in north central Pennsylvania and southern New York. The acquisition of FNB in 2015 expanded the focus into Lebanon, Lancaster and Schuylkill County markets in south central Pennsylvania. The opening of the Winfield office in 2016 and the acquisition of the State College branch in 2017 has increased our presence in the central Pennsylvania market. The recently closed MidCoast acquisition has expanded our lending market into Wilmington and Dover, Delaware. We originate loans primarily through direct loans to our existing customer base, with new customers generated through the strong relationships our lending teams have with their customers and our lenders expertise in certain areas, as well as by referrals from real estate brokers, building contractors, attorneys, accountants, corporate and advisory board members, existing customers and the Bank’s website. The Bank offers a variety of loans although historically most of our lending has focused on real estate loans including residential, commercial, agricultural, and construction loans. All lending is governed by a lending policy that is developed and administered by management and approved by the Board of Directors. As of March 31, 2020, the Company had one industry specific loan concentration to the dairy industry, totaling $149.7 million or 13.7% of total loans.

During the first three months of 2020, the primary driver of the decrease in the loan portfolio was two large relationships paying off in the first quarter. Commercial and agricultural loan demand is subject to significant competitive pressures, the yield curve, and overall national, regional and local economic conditions.

While the Bank lends to companies that service the exploration for natural gas in our market area, the Bank has not originated any loans to companies performing the actual drilling and exploration activities. Loans made by the Bank are to service industry customers which include trucking companies, stone quarries and other support businesses, favoring customers that had a relationship with the Bank prior to supporting the exploration for natural gas. We also have originated loans to businesses and individuals for restaurants, hotels and apartment rentals that have been developed and expanded to meet the housing and living needs of the gas industry workers. Due to our understanding of the industry and its cyclical nature, the loans made for natural gas-related activities have been originated in accordance with specific policies and procedures for lending to these entities, which include more stringent loan to value thresholds, shortened amortization periods, and expansion of our monitoring of loan concentrations associated with this activity.

Residential real estate loans decreased slightly during the first three months of 2020. Loan demand for conforming mortgages, which the Company typically sells on the secondary market, increased slightly in 2020 when compared to 2019. For loans sold on the secondary market, the Company recognizes fee income for servicing these sold loans, which is included in non-interest income.

In response to the Covid-19 pandemic, the Company has implemented programs to assist our customers. These include allowing customers to make interest only payments for up to 60 days and allowing certain customers in specific industries like hospitality to defer both principal and interest payments for up to 120 days. The Company has also agreed to waive late fees for March, April and May of 2020.

Allowance for Loan Losses

The allowance for loan losses is maintained at a level which in management’s judgment is adequate to absorb probable future loan losses inherent in the loan portfolio at the balance sheet date. The provision for loan losses is charged against current income. Loans deemed not collectable are charged-off against the allowance while subsequent recoveries increase the allowance. The following table presents an analysis of the allowance for loan losses and non-performing loans and assets as of and for the three months ended March 31, 2020 and for the years ended December 31, 2019, 2018, 2017 and 2016 (dollars in thousands):

	March 31			December 31,
	2020			2019			2018			2017			2016
Balance
at beginning of period	$	13,845		$	12,884		$	11,190		$	8,886		$	7,106
Charge-offs:
Real estate:
Residential		-			32			118			107			85
Commercial		1			578			66			41			100
Agricultural		-			-			-			30			-
Consumer		8			49			40			130			100
Other commercial loans		-			38			91			-			55
Other agricultural loans		-			60			50			5			-
Total loans charged-off		9			757			365			313			340
Recoveries:
Real estate:
Residential		-			-			69			-			-
Commercial		1			-			3			11			479
Agricultural		-			-			-			-			-
Consumer		8			33			31			49			88
Other commercial loans		2			10			30			16			33
Other agricultural loans		-			-			1			1			-
Total loans recovered		11			43			134			77			600

Net loans (recovered) charged-off		(2	)		714			231			236			(260	)
Provision charged to expense		400			1,675			1,925			2,540			1,520
Balance at end of year	$	14,247		$	13,845		$	12,884		$	11,190		$	8,886

Loans outstanding at end of period	$	1,093,720		$	1,115,569		$	1,081,883		$	1,000,525		$	799,611
Average loans outstanding, net	$	1,112,525		$	1,102,565		$	1,044,250		$	883,355		$	725,881
Non-performing assets:
Non-accruing loans	$	11,302		$	11,536		$	13,724		$	10,171		$	11,454
Accrual loans - 90 days or more past due		164			487			68			555			405
Total non-performing loans	$	11,466		$	12,023		$	13,792		$	10,726		$	11,859
Foreclosed assets held for sale		3,056			3,404			601			1,119			1,036
Total non-performing assets	$	14,522		$	15,427		$	14,393		$	11,845		$	12,895

Annualized net charge-offs (recoveries) to average loans		0.00	%		0.06	%		0.02	%		0.03	%		(0.04	%)
Allowance to total loans		1.30	%		1.24	%		1.19	%		1.12	%		1.11	%
Allowance to total non-performing loans		124.25	%		115.15	%		93.42	%		104.33	%		74.93	%
Non-performing loans as a percent of loans
net of unearned income		1.05	%		1.08	%		1.27	%		1.07	%		1.48	%
Non-performing assets as a percent of loans
net of unearned income		1.33	%		1.38	%		1.33	%		1.18	%		1.61	%

Management believes that it uses the best information available when establishing the allowance for loan losses and that the allowance for loan losses is adequate as of March 31, 2020. However, future adjustments could be required if circumstances differ substantially from assumptions and estimates used in making the initial determination. A prolonged downturn in the economy, high unemployment rates, significant changes in the value of collateral and delays in receiving financial information from borrowers could result in increased levels of non-performing assets, charge-offs, loan loss provisions and reduction in income. Additionally, bank regulatory agencies periodically examine the Bank’s allowance for loan losses. The banking agencies could require the recognition of additions to the allowance for loan losses based upon their judgment of information available to them at the time of their examination.

On a monthly basis, problem loans are identified and updated primarily using internally prepared past due reports. Based on data surrounding the collection process of each identified loan, the loan may be added or deleted from the monthly watch list. The watch list includes loans graded special mention, substandard, doubtful, and loss, as well as additional loans that management may choose to include. Watch list loans are continually monitored going forward until satisfactory conditions exist that allow management to upgrade and remove the loan. In certain cases, loans may be placed on non-accrual status or charged-off based upon management’s evaluation of the borrower’s ability to pay. All commercial loans, which include commercial real estate, agricultural real estate, state and political subdivision loans and other commercial and agricultural loans, on non-accrual are evaluated quarterly for impairment.

The allowance for loan losses was $14,247,000 or 1.30% of total loans as of March 31, 2020 as compared to $13,845,000 or 1.24% of loans as of December 31, 2019. The $402,000 increase in the allowance during the first three months of 2020 is the result of a $400,000 provision and net recoveries of $2,000. The following table shows the distribution of the allowance for loan losses and the percentage of loans compared to total loans by loan category as of March 31, 2020 and December 31, 2019, 2018, 2017 and 2016 (dollars in thousands):

	March 31,				December 31
	2020				2019				2018				2017				2016
	Amount		%		Amount		%		Amount		%		Amount		%		Amount		%
Real estate loans:
Residential	$	1,154		19.8	$	1,114		19.4	$	1,105		19.9	$	1,049		21.4	$	1,064		25.9
Commercial		4,729		30.9		4,549		30.7		4,115		29.5		3,867		30.8		3,589		31.6
Agricultural		4,878		27.5		5,022		27.9		4,264		26.3		3,143		24.0		1,494		15.5
Construction		56		1.6		43		1.4		58		3.1		23		1.3		47		3.2
Consumer		117		0.9		112		0.9		120		0.9		124		1.0		122		1.4
Other commercial loans		835		6.5		1,255		6.3		1,354		6.9		1,272		7.2		1,327		7.3
Other agricultural loans		1,297		4.2		961		4.9		752		3.9		492		3.8		312		2.9
State & political subdivision loans		558		8.6		536		8.5		762		9.5		816		10.5		833		12.2
Unallocated		623		N/A		253		N/A		354		N/A		404		N/A		98		N/A
Total allowance for loan losses	$	14,247		100.0	$	13,845		100.0	$	12,884		100.0	$	11,190		100.0	$	8,886		100.0

As a result of previous loss experiences and other risk factors utilized in determining the allowance, the Bank’s allocation of the allowance does not directly correspond to the actual balances of the loan portfolio. While commercial and agricultural real estate total 58.4% of the loan portfolio, 67.4% of the allowance is assigned to this segment of the loan portfolio as these loans have more inherent credit risk than residential real estate or loans to state and political subdivisions.

The following table identifies amounts of loans contractually past due 30 to 89 days and non-performing loans by loan category, as well as the change from December 31, 2019 to March 31, 2020 in non-performing loans(dollars in thousands). Non-performing loans include accruing loans that are contractually past due 90 days or more and non-accrual loans. Interest does not accrue on non-accrual loans. Subsequent cash payments received are applied to the outstanding principal balance or recorded as interest income, depending upon management's assessment of its ultimate ability to collect principal and interest.

	March 31, 2020								December 31, 2019
			Non-Performing Loans								Non-Performing Loans
	30 - 89 Days		90 Days						30 - 89 Days		90 Days
	Past Due		Past Due		Non-		Total Non-		Past Due		Past Due		Non-		Total Non-
(in thousands)	Accruing		Accruing		accrual		Performing		Accruing		Accruing		accrual		Performing
Real estate:
Residential	$	1,025	$	-	$	971	$	971	$	933	$	2	$	962	$	964
Commercial		1,609		55		5,038		5,093		1,225		-		5,080		5,080
Agricultural		201		98		2,464		2,562		118		299		2,578		2,877
Construction		-		-		-		-		-		-		-		-
Consumer		140		11		8		19		123		2		6		8
Other commercial loans		134		-		1,786		1,786		283		184		1,837		2,021
Other agricultural loans		50		-		1,035		1,035		29		-		1,073		1,073
Total nonperforming loans	$	3,159	$	164	$	11,302	$	11,466	$	2,711	$	487	$	11,536	$	12,023


	Change in Non-Performing Loans
	March 31, 2020 /December 31, 2019
(in thousands)	Amount			%
Real estate:
Residential	$	7			0.7
Commercial		13			0.3
Agricultural		(315	)		(10.9	)
Construction		-		NA
Consumer		11			137.5
Other commercial loans		(235	)		(11.6	)
Other agricultural loans		(38	)		(3.5	)
Total nonperforming loans	$	(557	)		(4.6	)

For the three months ended March 31, 2020 and 2019, we recorded a provision for loan losses of $400,000. Non-performing loans decreased $557,000 or 4.6%, from December 31, 2019 to March 31, 2020, primarily due to two customer relationships that were 90 days past due and accruing returning to current status in the first quarter of 2020. Approximately 59.1% of the Bank’s non-performing loans at March 31, 2020 are associated with the following three customer relationships:

•

A commercial loan relationship with $2.4 million outstanding, and additional letters of credit of $2.1 million available, secured by undeveloped land, stone quarries and equipment, was on non-accrual status as of March 31, 2020. The customer is an excavation company and expanded to meet the needs of the natural gas industry for stone for pad and road development. The decreased exploration activities have significantly impacted the cash flows of the customer. During 2019, the Company had the underlying equipment collateral appraised. The 2019 appraisal indicated a decrease in collateral values compared to the appraisal ordered for the loan origination and an appraisal performed in 2017, however, the loan is still considered well secured on a loan to value basis. Management determined that no specific reserve was required as of March 31, 2020.

•

An agricultural customer with a total loan relationship of $2.7 million, secured by real estate, equipment and cattle, was on non-accrual status as of March 31, 2020. The customer declared bankruptcy during the fourth quarter of 2018 and developed a workout plan that was approved in the fourth quarter of 2019 and resulted in monthly payments resuming in late 2019. Included within these loans to this customer are $1,022,000 of loans which are subject to Farm Service Agency guarantees. Depressed milk prices have created cash flow difficulties for this customer. Absent a sizable and sustained increase in milk prices, which is not assured, we will need to rely upon the collateral for repayment of interest and principal. As of March 31, 2020, there was a specific reserve of $199,000 for this relationship.

•

A commercial customer with a loan relationship of $1.7 million, secured by commercial real estate, business assets and vehicles, was on non-accrual status as of March 31, 2020. The business expanded into a new market, which has not grown as originally expected and has created cashflow issues. Management reviewed the collateral and determined that no specific reserve was required as of March 31, 2020.

Management of the Company believes that the allowance for loan losses as of March 31, 2020 is adequate, which is based on the following factors:

•	Three loan relationships comprised 59.1% of the non-performing loan balance, which had approximately $199,000 of specific reserves, as of March 31, 2020.

•	The Company has a history of low charge-offs, which have returned to lower levels in the first quarter of 2020 after being slightly elevated in 2019. Net charge-offs for the first quarter of 2020 were 0.0% and were 0.06% for all of 2019.

Bank Owned Life Insurance

The Company holds bank owned life insurance policies to offset future employee benefit costs. These policies provide the Bank with an asset that generates earnings to partially offset the current costs of benefits, and eventually (at the death of the insureds) provide partial recovery of cash outflows associated with the benefits. As of March 31, 2020 and December 31, 2019, the cash surrender value of the life insurance was $28.3 million and $28.1 million, respectively. The change in cash surrender value, net of purchases and amounts acquired through acquisitions, is recognized in the results of operations. The amounts recorded as non-interest income totaled $156,000 and $151,000 for the three month periods ended March 31, 2020 and 2019, respectively. The Company evaluates annually the risks associated with the life insurance policies, including limits on the amount of coverage and an evaluation of the various carriers’ credit ratings.

The Company agreements that were purchased directly from insurance companies are structured so that any death benefits received from a policy while the insured person is an active employee of the Bank will be split with the beneficiary of the policy. Under these agreements, the employee’s beneficiary will be entitled to receive 50% of the net amount at risk from the proceeds. The net amount at risk is the total death benefit payable less the cash surrender value of the policy as of the date of death. The policies acquired as part of the acquisition of FNB provide a fixed split-dollar benefit for the beneficiaries estate, which is dependent on several factors including whether the covered individual was a Director of FNB or an employee of FNB and their salary level. As of March 31, 2020 and December 31, 2019, included in other liabilities on the Consolidated Balance Sheet was a liability of $685,000 and $684,000, respectively, for the obligation under the split-dollar benefit agreements.

Premises and Equipment

Premises and equipment increased $289,000 to $16.2 million as of March 31, 2020 from December 31, 2019. This occurred primarily as a result of purchases made in the first quarter of 2020 offset by normal depreciation expense.

Deposits

The following table shows the composition of deposits as of March 31, 2020 and December 31, 2019 (dollars in thousands):

	March 31,						December 31,
	2020						2019
	Amount			%			Amount		%
Non-interest-bearing deposits	$	204,489			17.0		$	203,793		16.9
NOW accounts		342,396			28.4			340,273		28.1
Savings deposits		226,329			18.8			224,456		18.5
Money market deposit accounts		173,510			14.4			169,865		14.0
Certificates of deposit		258,426			21.4			272,731		22.5
Total	$	1,205,150			100.0		$	1,211,118		100.0

	March 31, 2020/
	December 31, 2019
	Change
	Amount			%
Non-interest-bearing deposits	$	696			0.3
NOW accounts		2,123			0.6
Savings deposits		1,873			0.8
Money market deposit accounts		3,645			2.1
Certificates of deposit		(14,305	)		(5.2	)
Total	$	(5,968	)		(0.5	)

Deposits decreased $6.0 million since December 31, 2019. The decrease in deposits is driven by a $14.3 million decrease in certificates of deposit, which is due to a $10.2 million decrease in brokered certificates since December 31, 2019. As of March 31, 2020, the Bank had $4.8 million of brokered certificates of deposit outstanding compared to $15.0 million as of December 31, 2019. We continue to enhance our cash management services to improve our customer services and to grow deposits through our current customers.

Borrowed Funds

Borrowed funds decreased $1.6 million during the first three months of 2020. The decrease was the result of repaying a $20.0 million short term loan through borrowing $12.5 million of overnight advances from the FHLB and $5.0 million of long-term advances from the FHLB. We also experienced an increase in repurchase agreements of $934,000. The Company’s current strategy for borrowings is to consider terms and structures to manage interest rate risk and liquidity in a flat to inverted interest rate environment. The Company's daily cash requirements or short-term investments are primarily met by using the financial instruments available through the Federal Home Loan Bank of Pittsburgh.

Stockholders’ Equity

We evaluate stockholders’ equity in relation to total assets and the risks associated with those assets. The greater the capital resource, the more likely a corporation will meet its cash obligations and absorb unforeseen losses. For these reasons, capital adequacy has been, and will continue to be, of paramount importance to the Company. As such, the Company has implemented policies and procedures to ensure that it has adequate capital levels. As part of this process, we routinely stress test our capital levels and identify potential risk and alternative sources of additional capital should the need arise.

Total stockholders’ equity was $159.9 million at March 31, 2020 compared to $154.8 million at December 31, 2019, an increase of $5,149,000, or 3.3%. Excluding accumulated other comprehensive income (loss), stockholders’ equity increased $1.6 million, or 1.0%. The Company purchased 23,412 shares of treasury stock at a weighted average cost of $54.64 per share. The Company reissued 204 shares to employees as a reward for years of services at a weighted average cost of $61.00 per share. For the three months of 2020, the Company had net income of $4.5 million and declared cash dividends of $2.0 million, or $0.55 per share, representing a cash dividend payout ratio of 43.2%.

All of the Company’s debt investment securities are classified as available-for-sale, making this portion of the Company’s balance sheet more sensitive to the changing market value of investments. As a result of changes in the interest rate environment and the defined benefit plan obligations, accumulated other comprehensive income increased approximately $3.5 million from December 31, 2019.

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory-and possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under U.S. GAAP, regulatory reporting requirements, and regulatory capital standards. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulatory capital standards to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and Tier 1 capital (as defined) to risk-weighted assets (as defined), common equity Tier 1 capital (as defined) to total risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of March 31, 2020 and December 31, 2019, that the Bank meets all capital adequacy requirements to which it was subject at such dates.

As permitted by applicable federal regulation, the Bank has opted to use the community bank leverage ratio (the “CBLR”) framework for determining its capital adequacy. Under the CBLR framework a qualifying community bank is considered well-capitalized if its leverage ratio (Tier 1 capital divided by average total consolidated assets) exceeds 9%. At March 31, 2020, the Bank was considered well-capitalized” under the CBLR framework, with a leverage ratio of 9.45%. Following the passage of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act in response to the COVID-19 pandemic, the federal banking regulators revised the CBLR framework as follows: (i) beginning in the second quarter of 2020, a qualifying community bank need only have a leverage ratio of at least 8%, subject to the other qualifying requirements, and (ii) if a qualifying community bank’s leverage ratio falls below 8%, then it will have two calendar quarters to maintain a leverage ratio of 7% or greater. These revisions under the CARES Act are effective April 23, 2020 and will terminate upon the earlier of the termination of the national emergency related to COVID-19 or December 31, 2020. Following such termination there is a grace period for returning to the 9% CBLR threshold. The CBLR will be set at 8% for the remainder of 2020, 8.5% for 2021, and 9% thereafter. The grace period is also adjusted to account for the graduating increase. As a result, in 2020 and 2021, a qualifying community bank utilizing the grace period must maintain a CBLR of at least 7% and 7.5%, respectively. Thereafter, a qualifying community bank utilizing the grace period must maintain a CBLR of at least 8%. If a qualifying community bank fails to maintain the applicable minimum CBLR during the grace period, or if it is unable to restore compliance with the CBLR within the grace period, then it will revert to the Basel III capital framework and the normal Prompt Corrective Action capital categories will apply.

Off-Balance Sheet Activities

Some financial instruments, such as loan commitments, credit lines, and letters of credit, are issued to meet customer financing needs. The contractual amount of financial instruments with off-balance sheet risk was as follows at March 31, 2020 and December 31, 2019 (in thousands):

	March 31, 2020		December 31, 2019
Commitments to extend credit	$	215,529	$	211,530
Standby letters of credit		16,717		17,857
	$	232,246	$	229,387

We also offer limited overdraft protection as a non-contractual courtesy which is available to demand deposit accounts in good standing. Overdraft charges as a result of ATM withdrawals and one time point of sale (non-recurring) transactions require prior approval of the customer. The non-contractual amount of financial instruments with off-balance sheet risk at March 31, 2020 and December 31, 2019 was $11,864,000 and $11,872,000, respectively. The Company reserves the right to discontinue this service without prior notice.

Liquidity

Liquidity is a measure of the Company's ability to efficiently meet normal cash flow requirements of both borrowers and depositors. To maintain proper liquidity, we use funds management policies, which include liquidity target ratios, along with our investment policies to assure we can meet our financial obligations to depositors, credit customers and stockholders. Liquidity is needed to meet depositors' withdrawal demands, extend credit to meet borrowers' needs, provide funds for normal operating expenses and cash dividends, and to fund other capital expenditures.

Cash generated by operating activities, investing activities and financing activities influences liquidity management. Our Company's historical activity in this area can be seen in the Consolidated Statement of Cash Flows. The most important source of funds is core deposits. Repayment of principal on outstanding loans and cash flows created from the investment portfolio are also factors in liquidity management. Other sources of funding include brokered certificates of deposit and the sale of loans or investments, if needed.

The Company's use of funds is shown in the investing activity section of the Consolidated Statement of Cash Flows, where the net loan activity is presented. Other uses of funds include purchasing stock from the Federal Home Loan Bank (FHLB) of Pittsburgh, as well as capital expenditures. Capital expenditures (including software purchases), during the first three months of 2020 were $507,000 compared to $105,000 during the same time period in 2019.

Short-term debt from the FHLB supplements the Bank’s availability of funds. The Bank achieves liquidity primarily from temporary or short‑term investments in the Federal Reserve and the FHLB. The Bank had a maximum borrowing capacity at the FHLB of approximately $537.8 million, of which $114.1 million was outstanding, at March 31, 2020. The Bank also had two federal funds lines with third party providers in the total amount of $34.0 million as of March 31, 2020, which are unsecured and undrawn upon. We also have a borrower in custody line with the Federal Reserve Bank of approximately $9.0 million, which also is not drawn upon as of March 31, 2020. The Company continues to evaluate its liquidity needs and as necessary finds additional sources.

Citizens Financial Services, Inc. is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, Citizens Financial Services, Inc. is responsible for paying any dividends declared to its shareholders. Citizens Financial also has repurchased shares of its common stock. Citizens Financial Services, Inc.’s primary source of income is dividends received from the Bank. Both federal and state laws impose restrictions on the ability of the Bank to pay dividends. In particular, the Bank may not, as a state-chartered bank which is a member of the Federal Reserve System, declare a dividend without approval of the Federal Reserve, unless the dividend to be declared by the Bank’s Board of Directors does not exceed the total of: (i) the Bank’s net profits for the current year to date, plus (ii) its retained net profits for the preceding two current years, less any required transfers to surplus. The Federal Reserve Board and the FDIC have formal and informal policies which provide that insured banks and bank holding companies should generally pay dividends only out of current operating earnings, with some exceptions. The Prompt Corrective Action Rules, described above, further limit the ability of banks to pay dividends, because banks which are not classified as well capitalized or adequately capitalized may not pay dividends and no dividend may be paid which would make the Bank undercapitalized after the dividend. At March 31, 2020, Citizens Financial Services, Inc. (on an unconsolidated basis) had liquid assets of $6.6 million.

Interest Rate and Market Risk Management

The objective of interest rate sensitivity management is to maintain an appropriate balance between the stable growth of income and the risks associated with maximizing income through interest sensitivity imbalances and the market value risk of assets and liabilities.

Because of the nature of our operations, we are not subject to foreign currency exchange or commodity price risk and, because we have no trading portfolio, we are not subject to trading risk. Currently, the Company has equity securities that represent only 0.04% of its total assets and, therefore, equity risk is not significant.

The primary components of interest-sensitive assets include adjustable-rate loans and investments, loan repayments, investment maturities and money market investments. The primary components of interest-sensitive liabilities include maturing certificates of deposit, IRA certificates of deposit and short-term borrowings. Savings deposits, NOW accounts and money market investor accounts are considered core deposits and are not short-term interest sensitive (except for the top-tier money market investor accounts, typically help by local governments, which are paid current market interest rates).

Gap analysis, one of the methods used by us to analyze interest rate risk, does not necessarily show the precise impact of specific interest rate movements on our Company's net interest income because the re-pricing of certain assets and liabilities is discretionary and is subject to competitive and other pressures. In addition, assets and liabilities within the same period may, in fact, be repaid at different times and at different rate levels. We have not experienced the kind of earnings volatility that might be indicated from gap analysis.

The Company currently uses a computer simulation model to better measure the impact of interest rate changes on net interest income. We use the model as part of our risk management and asset liability management processes that we believe will effectively identify, measure, and monitor the Company’s risk exposure. In this analysis, the Company examines the results of movements in interest rates with additional assumptions made concerning prepayment speeds on mortgage loans and mortgage securities. Shock scenarios, which assume a parallel shift in interest rates and is instantaneous, typically have the greatest impact on net interest income. The following is a rate shock analysis and the impact on net interest income as of March 31, 2020 (dollars in thousands):

		Change In	% Change In
	Prospective One-Year	Prospective	Prospective
Changes in Rates	Net Interest Income	Net Interest Income	Net Interest Income

-100 Shock	49,991	(540)	(1.07)
Base	50,531	-	-
+100 Shock	49,115	(1,416)	(2.80)
+200 Shock	47,884	(2,647)	(5.24)
+300 Shock	46,816	(3,715)	(7.35)
+400 Shock	45,618	(4,913)	(9.72)

The model makes estimates, at each level of interest rate change, regarding cash flows from principal repayments on loans and mortgage backed securities, call activity of other investment securities, and deposit selection, re-pricing and maturity structure. Because of these assumptions, actual results could differ significantly from these estimates which would result in significant differences in the calculated projected change on net interest income. Additionally, the changes above do not necessarily represent the level of change under which management would undertake specific measures to realign its portfolio in order to reduce the projected level of change. It should be noted that the changes in net interest income noted above are in line with Company policy for interest rate risk.

Item 3-Quantitative and Qualitative Disclosure about Market Risk

In the normal course of conducting business activities, the Company is exposed to market risk, principally interest rate risk, through the operations of its banking subsidiary. Interest rate risk arises from market driven fluctuations in interest rates that affect cash flows, income, expense and values of financial instruments and was discussed previously in this Form 10-Q. Management and a committee of the Board of Directors manage interest rate risk (see also “Interest Rate and Market Risk Management”).

Item 4-Control and Procedures

(a) Disclosure Controls and Procedures

The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the SEC (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

(b) Changes to Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting during the quarter ended March 31, 2020 that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting.

PART II ‑ OTHER INFORMATION

Item 1 ‑ Legal Proceedings

Management is not aware of any pending or threatened litigation that would have a material adverse effect on the consolidated financial position of the Company. Any pending proceedings are ordinary, routine litigation incidental to the business of the Company and its subsidiary. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Company and its subsidiary by government authorities.

Item 1A – Risk Factors

In addition to the risk factor discussed below and the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1.A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2019, which could materially affect our business, financial condition or future results. At March 31, 2020, the risk factors of the Company have not changed materially from those reported in our Annual Report on Form 10-K. However, the risks described in our Annual Report on Form 10-K are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

The COVID-19 pandemic has adversely impacted our business and financial results and that of many of our customers, and the ultimate impact will depend on future developments, which are highly uncertain, cannot be predicted and outside of our control, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.

The COVID-19 pandemic has created extensive disruptions to the global economy and to the lives of individuals throughout the world. Governments, businesses, and the public are taking unprecedented actions to contain the spread of COVID-19 and to mitigate its effects, including quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal and monetary stimulus, and legislation designed to deliver financial aid and other relief. While the scope, duration, and full effects of COVID-19 are rapidly evolving and not fully known, the pandemic and the efforts to contain it have disrupted global economic activity, adversely affected the functioning of financial markets, impacted market interest rates, increased economic and market uncertainty, and disrupted trade and supply chains. If these effects continue for a prolonged period or result in sustained economic stress or recession, many of the risk factors identified in our Form 10-K could be exacerbated and the effects of COVID-19 could have a material adverse impact on us in a number of ways as described in more detail below.

Credit Risk – Our risks of timely loan repayment and the value of collateral supporting the loans are affected by the strength of our borrowers’ businesses. Concern about the spread of COVID-19 has caused and is likely to continue to cause business shutdowns, limitations on commercial activity and financial transactions, labor shortages, supply chain interruptions, increased unemployment and commercial property vacancy rates, reduced profitability and ability for property owners to make mortgage payments, and overall economic and financial market instability, all of which may cause our customers to be unable to make scheduled loan payments. Hotel and restaurant operators and others in the leisure, hospitality and travel industries and the agricultural industry, among other industries, have been particularly hurt by COVID-19. If the effects of COVID-19 result in widespread and sustained repayment shortfalls on loans in our portfolio, we could incur significant delinquencies, foreclosures and credit losses, particularly if the available collateral is insufficient to cover our credit exposure. The future effects of COVID-19 on economic activity could negatively affect the collateral values associated with our existing loans, the ability to liquidate the real estate collateral securing our residential and commercial real estate loans, our ability to maintain loan origination volume and to obtain additional financing, the future demand for or profitability of our lending and services, and the financial condition and credit risk of our customers. Further, in the event of delinquencies, regulatory changes and policies designed to protect borrowers may slow or prevent us from making our business decisions or may result in a delay in our taking certain remediation actions, such as foreclosure. In addition, we have unfunded commitments to extend credit to customers. During a challenging economic environment like now, our customers depend more on our credit commitments and increased borrowings under these commitments could adversely impact our liquidity. Furthermore, in an effort to support our communities during the pandemic, we are participating in the Paycheck Protection Program under the CARES Act whereby loans to small businesses are made and those loans are subject to the regulatory requirements that would require forbearance of loan payments for a specified time or that would limit our ability to pursue all available remedies in the event of a loan default. If the borrower under the PPP loan fails to qualify for loan forgiveness, we are at the heightened risk of holding these loans at unfavorable interest rates as compared to the loans to customers that we would have otherwise extended credit.

Strategic Risk – Our success may be affected by a variety of external factors that may affect the price or marketability of our products and services, changes in interest rates that may increase our funding costs, reduced demand for our financial products due to economic conditions and the various response of governmental and nongovernmental authorities. The COVID-19 pandemic has significantly increased economic and demand uncertainty and has led to disruption and volatility in the global capital markets. Furthermore, many of the governmental actions have been directed toward curtailing household and business activity to contain COVID-19. These actions have been rapidly expanding in scope and intensity. For example, in many of our markets, local governments have acted to temporarily close or restrict the operations of most businesses. The future effects of COVID-19 on economic activity could negatively affect the future banking products we provide, including a decline in originating loans.

Operational Risk – Current and future restrictions on our workforce’s access to our facilities could limit our ability to meet customer servicing expectations and have a material adverse effect on our operations. We rely on business processes and branch activity that largely depend on people and technology, including access to information technology systems as well as information, applications, payment systems and other services provided by third parties. In response to COVID-19, we have modified our business practices with a portion of our employees working remotely from their homes to have our operations uninterrupted as much as possible. Further, technology in employees’ homes may not be as robust as in our offices and could cause the networks, information systems, applications, and other tools available to employees to be more limited or less reliable than in our offices. The continuation of these work-from-home measures also introduces additional operational risk, including increased cybersecurity risk from phishing, malware, and other cybersecurity attacks, all of which could expose us to risks of data or financial loss and could seriously disrupt our operations and the operations of any impacted customers.

Moreover, we rely on many third parties in our business operations, including the appraiser of the real property collateral, vendors that supply essential services such as loan servicers, providers of financial information, systems and analytical tools and providers of electronic payment and settlement systems, and local and federal government agencies, offices, and courthouses. In light of the developing measures responding to the pandemic, many of these entities may limit the availability and access of their services. If the third-party service providers continue to have limited capacities for a prolonged period or if additional limitations or potential disruptions in these services materialize, it may negatively affect our operations.

Interest Rate Risk/Market Value Risk – Our net interest income, lending and investment activities, deposits and profitability could be negatively affected by volatility in interest rates caused by uncertainties stemming from COVID-19. In March 2020, the Federal Reserve lowered the target range for the federal funds rate to a range from 0% to 0.25%, citing concerns about the impact of COVID-19 on financial markets and market stress in the energy sector. A prolonged period of extremely volatile and unstable market conditions would likely increase our funding costs and negatively affect market risk mitigation strategies. Higher income volatility from changes in interest rates and spreads to benchmark indices could cause a loss of future net interest income and a decrease in prevailing fair market values of our investment securities and other assets. Fluctuations in interest rates will impact both the level of income and expense recorded on most of our assets and liabilities and the market value of all interest-earning assets and interest-bearing liabilities, which in turn could have a material adverse effect on our net income, operating results, or financial condition.

Because there have been no comparable recent global pandemics that resulted in similar global impact, we do not yet know the full extent of COVID-19’s effects on our business, operations, or the global economy as a whole. Any future development will be highly uncertain and cannot be predicted, including the scope and duration of the pandemic, the effectiveness of our work-from-home arrangements, third party providers’ ability to support our operations, and any actions taken by governmental authorities and other third parties in response to the pandemic. The uncertain future development of this crisis could materially and adversely affect our business, operations, operating results, financial condition, liquidity or capital levels.

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

ISSUER PURCHASES OF EQUITY SECURITIES

Period	Total Number of Shares (or units Purchased)		Average Price Paid per Share (or Unit)		Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans of Programs		Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs (1)

1/1/20 to 1/31/20		2,100	$	64.00		2,100		46,540
2/1/20 to 2/29/20		1,612	$	61.00		1,612		44,928
3/1/20 to 3/31/20		19,700	$	53.12		19,700		25,228
Total		23,412	$	54.64		23,412		25,228

(1)

On October 20, 2015, the Company announced that the Board of Directors authorized the Company to repurchase up to an additional 150,000 shares. The repurchases will be conducted through open-market purchases or privately negotiated transactions and will be made from time to time depending on market conditions and other factors. No time limit was placed on the duration of the share repurchase program. Any repurchased shares will be held as treasury stock and will be available for general corporate purposes.

(2)

On April 21, 2020, the Company announced that the Board of Directors authorized the Company to repurchase up to an additional 150,000 shares at an aggregate purchase price not to exceed $12.0 million over a period of 36 months. The repurchases will be conducted through open-market purchases or privately negotiated transactions and will be made from time to time depending on market conditions and other factors. No time limit was placed on the duration of the share repurchase program. Any repurchased shares will be held as treasury stock and will be available for general corporate purposes.

Item 3 ‑ Defaults Upon Senior Securities

Not applicable.

Item 4 – Mine Safety Disclosure

Not applicable.

Item 5 ‑ Other Information

None

Item 6 ‑ Exhibits

(a) The following documents are filed as a part of this report:

	2.1		Agreement and Plan of Merger by and between Citizens Financial Services, Inc. and MidCoast Community Bancorp, Inc.⁽¹⁾
	3.1		Articles of Incorporation of Citizens Financial Services, Inc., as amended ⁽²⁾
	3.2		Bylaws of Citizens Financial Services, Inc.⁽³⁾
	4.1		Form of Common Stock Certificate. ⁽⁴⁾
	31.1		Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
	31.2		Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer

	32.1		Section 1350 Certification of Chief Executive Officer and Chief Financial Officer
	101		The following materials from the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2020, formatted in XBRL (Extensible Business Reporting Language): (i) The Consolidated Balance Sheet (unaudited), (ii) the Consolidated Statement of Income (unaudited), (iii) the Consolidated Statement of Comprehensive Income (unaudited), (iv) the Consolidated Statement of Changes in Stockholders’ Equity, (v) the Consolidated Statement of Cash Flows (unaudited) and (vi) related notes (unaudited).

⁽¹⁾ Incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K, as filed with the Commission on September 18, 2019

⁽²⁾ Incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2018, as filed with the Commission on August 9, 2018.

⁽³⁾ Incorporated by reference to Exhibit 9.01 to the Company’s Current Report on Form 8-K, as filed with the Commission on December 24, 2009.

⁽⁴⁾ Incorporated by reference to Exhibit 4 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005, as filed with the Commission on March 14, 2006.

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 Financial Services, Inc. (Registrant)

May 7, 2020	By:	/s/ Randall E. Black
		Randall E. Black
		President and Chief Executive Officer (Principal Executive Officer)



May 7, 2020	By:	/s/ Stephen J. Guillaume
		Stephen J. Guillaume
		Chief Financial Officer (Principal Financial and Accounting Officer)