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CITIZENS & NORTHERN CORP - Quarter Report: 2017 September (Form 10-Q)

 

 

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2017

or

 

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

For the transition period from _______________ to _________________________.

 

Commission file number: 000-16084

 

CITIZENS & NORTHERN CORPORATION

(Exact name of Registrant as specified in its charter)

 

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

 

90-92 MAIN STREET, WELLSBORO, PA 16901

(Address of principal executive offices) (Zip code)

 

570-724-3411

(Registrant's telephone number including area code)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x  No ¨

 

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

 

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

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

 

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

 

Common Stock ($1.00 par value) 12,198,621 Shares Outstanding on October 30, 2017

 

 

 

   

 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

CITIZENS & NORTHERN CORPORATION

Index

 

Part I. Financial Information    
     
Item 1. Financial Statements    
     
Consolidated Balance Sheets (Unaudited) – September 30, 2017 and December 31, 2016   Page 3
     
Consolidated Statements of Income (Unaudited) – Three-month and  Nine-month Periods Ended September 30, 2017 and 2016   Page 4
     
Consolidated Statements of Comprehensive Income (Unaudited) - Three-month and Nine-month Periods Ended September 30, 2017 and 2016   Page 5
     
Consolidated Statements of Cash Flows (Unaudited) –  Nine-month Periods Ended September 30, 2017 and 2016   Page 6
     
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) - Nine Months Ended September 30, 2017 and 2016   Page 7
     
Notes to Unaudited Consolidated Financial Statements   Pages 8 – 38
     
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations   Pages 39 – 60
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk   Pages 60 – 62
     
Item 4. Controls and Procedures   Page 63
     
Part II. Other Information   Pages 64 – 65
     
Signatures   Page 66
     
Exhibit 31.1. Rule 13a-14(a)/15d-14(a) Certification -Chief Executive Officer   Page 67
     
Exhibit 31.2. Rule 13a-14(a)/15d-14(a) Certification - Chief Financial Officer   Page 68
     
Exhibit 32. Section 1350 Certifications   Page 69

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

ITEM 1. FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS

(In Thousands, Except Share and Per Share Data) (Unaudited)

 

   September 30,   December 31, 
   2017   2016 
ASSETS          
Cash and due from banks:          
Noninterest-bearing  $19,902   $17,551 
Interest-bearing   12,948    14,558 
Total cash and due from banks   32,850    32,109 
Available-for-sale securities, at fair value   365,086    395,077 
Loans held for sale   437    142 
           
Loans receivable   801,012    751,835 
Allowance for loan losses   (8,900)   (8,473)
Loans, net   792,112    743,362 
           
Bank-owned life insurance   19,985    19,704 
Accrued interest receivable   4,027    3,963 
Bank premises and equipment, net   15,366    15,397 
Foreclosed assets held for sale   1,650    2,180 
Deferred tax asset, net   4,319    5,117 
Intangible assets - Goodwill and core deposit intangibles   11,956    11,959 
Other assets   12,133    13,282 
TOTAL ASSETS  $1,259,921   $1,242,292 
           
LIABILITIES          
Deposits:          
Noninterest-bearing  $236,758   $224,175 
Interest-bearing   784,867    759,668 
Total deposits   1,021,625    983,843 
Short-term borrowings   7,739    26,175 
Long-term borrowings   31,256    38,454 
Accrued interest and other liabilities   8,288    7,812 
TOTAL LIABILITIES   1,068,908    1,056,284 
           
STOCKHOLDERS' EQUITY          
Preferred stock, $1,000 par value; authorized 30,000 shares; $1,000 liquidation          
preference per share; no shares issued   0    0 
Common stock, par value $1.00 per share; authorized 20,000,000 shares;          
issued 12,655,171; outstanding 12,197,527 at September 30, 2017 and          
12,113,228 December 31, 2016   12,655    12,655 
Paid-in capital   71,818    71,730 
Retained earnings   114,836    112,790 
Treasury stock, at cost; 457,644 shares at September 30, 2017 and 541,943          
shares at December 31, 2016   (8,670)   (10,269)
Accumulated other comprehensive income (loss)   374    (898)
TOTAL STOCKHOLDERS' EQUITY   191,013    186,008 
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY  $1,259,921   $1,242,292 

 

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

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Consolidated Statements of Income

(In Thousands Except Per Share Data) (Unaudited)

 

   3 Months Ended   9 Months Ended 
   Sept. 30,   Sept. 30,   Sept. 30,   Sept. 30, 
   2017   2016   2017   2016 
INTEREST INCOME                    
Interest and fees on loans:                    
Taxable  $8,889   $8,347   $25,872   $24,407 
Tax-exempt   531    457    1,482    1,357 
Interest on mortgages held for sale   10    7    20    21 
Interest on balances with depository institutions   67    29    140    89 
Income from available-for-sale securities:                    
Taxable   1,335    1,429    4,090    4,474 
Tax-exempt   789    835    2,459    2,578 
Dividends   5    27    15    66 
Total interest and dividend income   11,626    11,131    34,078    32,992 
INTEREST EXPENSE                    
Interest on deposits   639    549    1,735    1,550 
Interest on short-term borrowings   9    30    131    133 
Interest on long-term borrowings   337    365    1,050    1,090 
Total interest expense   985    944    2,916    2,773 
Net interest income   10,641    10,187    31,162    30,219 
Provision for loan losses   322    538    778    1,224 
Net interest income after provision for loan losses   10,319    9,649    30,384    28,995 
OTHER INCOME                    
Service charges on deposit accounts   1,168    1,221    3,346    3,523 
Service charges and fees   115    118    316    335 
Trust and financial management revenue   1,292    1,172    3,969    3,567 
Brokerage revenue   187    216    551    569 
Insurance commissions, fees and premiums   26    26    98    74 
Interchange revenue from debit card transactions   561    481    1,649    1,431 
Net gains from sale of loans   297    236    651    699 
Loan servicing fees, net   35    28    162    39 
Increase in cash surrender value of life insurance   97    97    281    286 
Other operating income   288    289    1,013    957 
Sub-total   4,066    3,884    12,036    11,480 
Realized gains on available-for-sale securities, net   5    584    257    1,089 
Total other income   4,071    4,468    12,293    12,569 
OTHER EXPENSES                    
Salaries and wages   3,985    3,901    11,825    11,701 
Pensions and other employee benefits   1,216    1,060    3,890    3,499 
Occupancy expense, net   580    601    1,758    1,770 
Furniture and equipment expense   471    435    1,372    1,301 
FDIC Assessments   93    151    283    448 
Pennsylvania shares tax   336    287    1,008    932 
Professional fees   269    245    750    816 
Automated teller machine and interchange expense   346    291    945    807 
Software subscriptions   299    237    870    729 
Other operating expense   1,597    1,371    4,865    4,183 
Total other expenses   9,192    8,579    27,566    26,186 
Income before income tax provision   5,198    5,538    15,111    15,378 
Income tax provision   1,262    1,451    3,620    3,847 
NET INCOME  $3,936   $4,087   $11,491   $11,531 
EARNINGS PER COMMON SHARE - BASIC  $0.32   $0.34   $0.94   $0.95 
EARNINGS PER COMMON SHARE - DILUTED  $0.32   $0.34   $0.94   $0.95 

 

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

 

 4 

 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Consolidated Statements of Comprehensive Income

(In Thousands) (Unaudited)

 

   Three Months Ended   Nine Months Ended 
   Sept. 30,   Sept. 30, 
   2017   2016   2017   2016 
Net income  $3,936   $4,087   $11,491   $11,531 
                     
Unrealized (losses) gains on available-for-sale securities:                    
Unrealized holding (losses) gains on available-for-sale securities   (213)   (1,661)   2,067    5,544 
Reclassification adjustment for gains realized in income   (5)   (584)   (257)   (1,089)
Other comprehensive (loss) gain on available-for-sale securities   (218)   (2,245)   1,810    4,455 
                     
Unfunded pension and postretirement obligations:                    
Changes from plan amendments and actuarial gains and losses included in accumulated other comprehensive gain   0    0    166    26 
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost   (6)   (5)   (18)   (15)
Other comprehensive (loss) gain on unfunded retirement obligations   (6)   (5)   148    11 
                     
Other comprehensive (loss) income before income tax   (224)   (2,250)   1,958    4,466 
Income tax related to other comprehensive income   78    786    (686)   (1,564)
                     
Net other comprehensive (loss) income   (146)   (1,464)   1,272    2,902 
                     
Comprehensive income  $3,790   $2,623   $12,763   $14,433 

 

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

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands) (Unaudited)

 

   9 Months Ended 
   Sept. 30,   Sept. 30, 
   2017   2016 
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net income  $11,491   $11,531 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for loan losses   778    1,224 
Realized gains on available-for-sale securities, net   (257)   (1,089)
Depreciation expense   1,239    1,188 
Accretion and amortization on securities, net   866    1,065 
Increase in cash surrender value of life insurance   (281)   (286)
Stock-based compensation and other expense   475    484 
Deferred income taxes   112    7 
Decrease in fair value of servicing rights   145    247 
Gains on sales of loans, net   (651)   (699)
Origination of loans for sale   (19,277)   (19,366)
Proceeds from sales of loans   19,473    19,565 
Decrease (increase) in accrued interest receivable and other assets   207    (305)
Increase in accrued interest payable and other liabilities   624    187 
Other   86    84 
Net Cash Provided by Operating Activities   15,030    13,837 
CASH FLOWS FROM INVESTING ACTIVITIES:          
Proceeds from maturities of certificates of deposit   348    1,060 
Purchase of certificates of deposit   (100)   (2,280)
Proceeds from sales of available-for-sale securities   24,118    21,573 
Proceeds from calls and maturities of available-for-sale securities   47,285    54,472 
Purchase of available-for-sale securities   (40,211)   (59,582)
Redemption of Federal Home Loan Bank of Pittsburgh stock   5,487    3,661 
Purchase of Federal Home Loan Bank of Pittsburgh stock   (4,725)   (2,364)
Net increase in loans   (50,128)   (39,647)
Proceeds from bank owned life insurance   0    1,442 
Purchase of premises and equipment   (1,209)   (1,188)
Proceeds from sale of foreclosed assets   1,035    361 
Other   144    115 
Net Cash Used in Investing Activities   (17,956)   (22,377)
CASH FLOWS FROM FINANCING ACTIVITIES:          
Net increase in deposits   37,782    56,265 
Net decrease in short-term borrowings   (18,436)   (38,906)
Proceeds from long-term borrowings   3,000    0 
Repayments of long-term borrowings   (10,198)   (229)
Purchase of treasury stock   0    (3,723)
Sale of treasury stock   98    126 
Tax benefit from compensation plans   0    129 
Common dividends paid   (8,331)   (8,333)
Net Cash Provided by Financing Activities   3,915    5,329 
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS   989    (3,211)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR   28,621    33,313 
CASH AND CASH EQUIVALENTS, END OF PERIOD  $29,610   $30,102 
           
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:          
Accrued purchase of available-for-sale securities  $0   $1,494 
Assets acquired through foreclosure of real estate loans  $608   $1,508 
Interest paid  $2,942   $2,764 
Income taxes paid  $3,163   $3,185 

 

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

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Consolidated Statements of Changes in Stockholders' Equity

(In Thousands Except Share and Per Share Data)

(Unaudited)

 

                       Accumulated         
                       Other         
   Common   Treasury   Common   Paid-in   Retained   Comprehensive   Treasury     
   Shares   Shares   Stock   Capital   Earnings   (Loss) Income   Stock   Total 
Nine Months Ended September 30, 2017                                        
Balance, December 31, 2016   12,655,171    541,943   $12,655   $71,730   $112,790   $(898)  $(10,269)  $186,008 
Net income                       11,491              11,491 
Other comprehensive income, net                            1,272         1,272 
Cash dividends declared on common  stock, $0.78 per share                       (9,445)             (9,445)
Shares issued for dividend reinvestment  Plan        (48,092)        203              911    1,114 
Shares issued from treasury and redeemed  related to exercise of stock options        (9,681)        (86)             184    98 
Restricted stock granted        (30,782)        (583)             583    0 
Forfeiture of restricted stock        4,256         79              (79)   0 
Stock-based compensation expense                  475                   475 
Balance, September 30, 2017   12,655,171    457,644   $12,655   $71,818   $114,836   $374   $(8,670)  $191,013 
                                         
Nine Months Ended September 30, 2016                                        
Balance, December 31, 2015   12,655,171    474,548   $12,655   $71,654   $109,454   $2,528   $(8,804)  $187,487 
Net income                       11,531              11,531 
Other comprehensive income, net                            2,902         2,902 
Cash dividends declared on common  stock, $0.78 per share                       (9,435)             (9,435)
Shares issued for dividend reinvestment  Plan        (53,596)        90              1,012    1,102 
Treasury stock purchased        187,300                        (3,723)   (3,723)
Shares issued from treasury and redeemed  related to exercise of stock options        (7,371)        (13)             139    126 
Restricted stock granted        (35,427)        (658)             658    0 
Forfeiture of restricted stock        2,719         48              (48)   0 
Stock-based compensation expense                  480                   480 
Other stock-based expense        (225)                       4    4 
Tax effect of stock option exercises                  (2)                  (2)
Tax benefit from dividends on restricted stock                  17                   17 
Tax benefit from compensation plans                       114              114 
Balance, September 30, 2016   12,655,171    567,948   $12,655   $71,616   $111,664   $5,430   $(10,762)  $190,603 

 

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

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Notes to Unaudited Consolidated Financial Statements

 

1. BASIS OF INTERIM PRESENTATION

 

The consolidated financial information included herein, with the exception of the consolidated balance sheet dated December 31, 2016, is unaudited. Such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations, comprehensive income, cash flows and changes in stockholders’ equity for the interim periods; however, the information does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for a complete set of financial statements. Certain 2016 information has been reclassified for consistency with the 2017 presentation.

 

Operating results reported for the three-month and nine-month periods ended September 30, 2017 might not be indicative of the results for the year ending December 31, 2017. The Corporation evaluates subsequent events through the date of filing with the Securities and Exchange Commission.

 

2. PER SHARE DATA

 

Basic earnings per common share are calculated using the two-class method to determine income attributable to common shareholders. Unvested restricted stock awards that contain nonforfeitable rights to dividends are considered participating securities under the two-class method. Distributed dividends and an allocation of undistributed net income to participating securities reduce the amount of income attributable to common shareholders. Income attributable to common shareholders is then divided by weighted-average common shares outstanding for the period to determine basic earnings per common share.

 

Diluted earnings per common share are calculated under the more dilutive of either the treasury method or the two-class method. Diluted earnings per common share is computed using weighted-average common shares outstanding, plus weighted-average common shares available from the exercise of all dilutive stock options, less the number of shares that could be repurchased with the proceeds of stock option exercises based on the average share price of the Corporation's common stock during the period.

 

   3 Months Ended   9 Months Ended 
   Sept. 30,   Sept. 30,   Sept. 30,   Sept. 30, 
   2017   2016   2017   2016 
Basic                    
Net income  $3,936,000   $4,087,000   $11,491,000   $11,531,000 
Less: Dividends and undistributed earnings allocated to participating securities   (20,000)   (22,000)   (59,000)   (63,000)
Net income attributable to common shares  $3,916,000   $4,065,000   $11,432,000   $11,468,000 
Basic weighted-average common shares outstanding   12,124,854    12,014,267    12,105,673    12,032,619 
Basic earnings per common share (a)  $0.32   $0.34   $0.94   $0.95 
                     
Diluted                    
Net income attributable to common shares  $3,916,000   $4,065,000   $11,432,000   $11,468,000 
Basic weighted-average common shares outstanding   12,124,854    12,014,267    12,105,673    12,032,619 
Dilutive effect of potential common stock arising from stock options   37,409    29,799    40,624    24,020 
Diluted weighted-average common shares outstanding   12,162,263    12,044,066    12,146,297    12,056,639 
Diluted earnings per common share (a)  $0.32   $0.34   $0.94   $0.95 

 

(a) Basic and diluted earnings per share under the two-class method are determined on net income reported on the income statement less earnings allocated to nonvested restricted shares with nonforfeitable dividends (participating securities).

 

The weighted-average number of nonvested restricted shares outstanding was 61,233 shares in the three-month period ended September 30, 2017 and 64,130 shares in the three-month period ended September 30, 2016. The weighted-average number of nonvested restricted shares outstanding was 62,825 shares in the nine-month period ended September 30, 2017 and 65,935 shares in the nine-month period ended September 30, 2016.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Stock options that were anti-dilutive were excluded from net income per share calculations. There were no anti-dilutive instruments in the three-month or nine-month periods ended September 30, 2017. Weighted-average common shares available from anti-dilutive instruments totaled 22,715 shares in the third quarter 2016 and 39,054 shares in the nine-month period ended September 30, 2016.

 

3. COMPREHENSIVE INCOME

 

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

 

(In Thousands)  Before-Tax   Income Tax   Net-of-Tax 
   Amount   Effect   Amount 
Nine Months Ended September 30, 2017               
Unrealized gains on available-for-sale securities:               
Unrealized holding gains on available-for-sale securities  $2,067   $(723)  $1,344 
Reclassification adjustment for (gains) realized in income   (257)   89    (168)
Other comprehensive income on available-for-sale securities   1,810    (634)   1,176 
                
Unfunded pension and postretirement obligations:               
Changes from plan amendments and actuarial gains and losses               
included in other comprehensive income   166    (58)   108 
Amortization of net transition obligation, prior service cost and net               
actuarial loss included in net periodic benefit cost   (18)   6    (12)
Other comprehensive income on unfunded retirement obligations   148    (52)   96 
                
Total other comprehensive income  $1,958  $(686)  $1,272 

 

(In Thousands)  Before-Tax   Income Tax   Net-of-Tax 
   Amount   Effect   Amount 
Nine Months Ended September 30, 2016               
Unrealized gains on available-for-sale securities:               
Unrealized holding gains on available-for-sale securities  $5,544   $(1,941)  $3,603 
Reclassification adjustment for (gains) realized in income   (1,089)   381    (708)
Other comprehensive income on available-for-sale securities   4,455    (1,560)   2,895 
                
Unfunded pension and postretirement obligations:               
Changes from plan amendments and actuarial gains and losses               
included in other comprehensive income   26    (9)   17 
Amortization of net transition obligation, prior service cost and net               
actuarial loss included in net periodic benefit cost   (15)   5    (10)
Other comprehensive income on unfunded retirement obligations   11    (4)   7 
                
Total other comprehensive income  $4,466   $(1,564)  $2,902 

 

 9 

 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

(In Thousands)  Before-Tax   Income Tax   Net-of-Tax 
   Amount   Effect   Amount 
Three Months Ended September 30, 2017               
Unrealized losses on available-for-sale securities:               
Unrealized holding losses on available-for-sale securities  $(213)  $75   $(138)
Reclassification adjustment for (gains) realized in income   (5)   1    (4)
Other comprehensive loss on available-for-sale securities   (218)   76    (142)
                
Unfunded pension and postretirement obligations:               
Changes from plan amendments and actuarial gains and losses               
included in other comprehensive income   0    0    0 
Amortization of net transition obligation, prior service cost and net               
actuarial loss included in net periodic benefit cost   (6)   2    (4)
Other comprehensive loss on unfunded retirement obligations   (6)   2    (4)
                
Total other comprehensive loss  $(224)  $78   $(146)

 

(In Thousands)  Before-Tax   Income Tax   Net-of-Tax 
   Amount   Effect   Amount 
Three Months Ended September 30, 2016               
Unrealized losses on available-for-sale securities:               
Unrealized holding losses on available-for-sale securities  $(1,661)  $580   $(1,081)
Reclassification adjustment for (gains) realized in income   (584)   204    (380)
Other comprehensive loss on available-for-sale securities   (2,245)   784    (1,461)
                
Unfunded pension and postretirement obligations:               
Changes from plan amendments and actuarial gains and losses               
included in other comprehensive income   0    0    0 
Amortization of net transition obligation, prior service cost and net               
actuarial loss included in net periodic benefit cost   (5)   2    (3)
Other comprehensive loss on unfunded retirement obligations   (5)   2    (3)
                
Total other comprehensive loss  $(2,250)  $786   $(1,464)

 

 10 

 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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

 

(In Thousands)  Unrealized       Accumulated 
   Holding Gains   Unfunded   Other 
   (Losses)   Retirement   Comprehensive 
   on Securities   Obligations   Income 
Nine Months Ended September 30, 2017               
Balance, beginning of period  $(949)  $51   $(898)
Change during nine months ended September 30, 2017   1,176    96    1,272 
Balance, end of period  $227   $147   $374 
                
Nine Months Ended September 30, 2016               
Balance, beginning of period  $2,493   $35   $2,528 
Change during nine months ended September 30, 2016   2,895    7    2,902 
Balance, end of period  $5,388   $42   $5,430 
                
Three Months Ended September 30, 2017               
Balance, beginning of period  $369   $151   $520 
Change during three months ended September 30, 2017   (142)   (4)   (146)
Balance, end of period  $227   $147   $374 
                
Three Months Ended September 30, 2016               
Balance, beginning of period  $6,849   $45   $6,894 
Change during three months ended September 30, 2016   (1,461)   (3)   (1,464)
Balance, end of period  $5,388   $42   $5,430 

 

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

 

For the Nine Months Ended September 30, 2017       
(In Thousands)       
   Reclassified from    
Details about Accumulated Other  Accumulated Other   Affected Line Item in the Consolidated
Comprehensive Income Components  Comprehensive Income   Statements of Income
Unrealized gains and losses on available-for-sale Securities  $(257)  Realized gains on available-for-sale securities, net
    89   Income tax provision
    (168)  Net of tax
Amortization of defined benefit pension and postretirement items:        
Prior service cost   (23)  Pensions and other employee benefits
Actuarial loss   5   Pensions and other employee benefits
    (18)  Total before tax
    6   Income tax provision
    (12)  Net of tax
Total reclassifications for the period  $(180)   

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

For the Nine Months Ended September 30, 2016       
(In Thousands)       
   Reclassified from    
Details about Accumulated Other  Accumulated Other   Affected Line Item in the Consolidated
Comprehensive Income Components  Comprehensive Income   Statements of Income
Unrealized gains and losses on available-for-sale securities  $(1,089)  Realized gains on available-for-sale securities, net
    381   Income tax provision
    (708)  Net of tax
Amortization of defined benefit pension and postretirement items:        
Prior service cost   (23)  Pensions and other employee benefits
Actuarial loss   8   Pensions and other employee benefits
    (15)  Total before tax
    5   Income tax provision
    (10)  Net of tax
Total reclassifications for the period  $(718)   

 

For the Three Months Ended September 30, 2017       
(In Thousands)       
   Reclassified from    
Details about Accumulated Other  Accumulated Other   Affected Line Item in the Consolidated
Comprehensive Income Components  Comprehensive Income   Statements of Income
Unrealized gains and losses on available-for-sale securities  $(5)  Realized gains on available-for-sale securities, net
    1   Income tax provision
    (4)  Net of tax
Amortization of defined benefit pension and postretirement items:        
Prior service cost   (8)  Pensions and other employee benefits
Actuarial loss   2   Pensions and other employee benefits
    (6)  Total before tax
    2   Income tax provision
    (4)  Net of tax
Total reclassifications for the period  $(8)   

 

For the Three Months Ended September 30, 2016       
(In Thousands)       
   Reclassified from    
Details about Accumulated Other  Accumulated Other   Affected Line Item in the Consolidated
Comprehensive Income Components  Comprehensive Income   Statements of Income
Unrealized gains and losses on available-for-sale Securities  $(584)  Realized gains on available-for-sale securities, net
    204   Income tax provision
    (380)  Net of tax
Amortization of defined benefit pension and postretirement items:        
Prior service cost   (8)  Pensions and other employee benefits
Actuarial loss   3   Pensions and other employee benefits
    (5)  Total before tax
    2   Income tax provision
    (3)  Net of tax
Total reclassifications for the period  $(383)   

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

4. CASH AND DUE FROM BANKS

 

Cash and due from banks at September 30, 2017 and December 31, 2016 include the following:

 

(In thousands)  Sept. 30,   Dec. 31, 
   2017   2016 
Cash and cash equivalents  $29,610   $28,621 
Certificates of deposit   3,240    3,488 
Total cash and due from banks  $32,850   $32,109 

 

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

 

The Corporation is required to maintain reserves against deposit liabilities in the form of cash and balances with the Federal Reserve Bank of Philadelphia. The reserves are based on deposit levels, account activity, and other services provided by the Federal Reserve Bank. Required reserves were $17,213,000 at September 30, 2017 and $16,654,000 at December 31, 2016.

 

5. FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS

 

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

 

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

 

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

 

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

 

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

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

At September 30, 2017 and December 31, 2016, assets measured at fair value and the valuation methods used are as follows:

 

       September 30, 2017     
   Quoted Prices   Other         
   in Active   Observable   Unobservable   Total 
   Markets   Inputs   Inputs   Fair 
(In Thousands)  (Level 1)   (Level 2)   (Level 3)   Value 
                 
Recurring fair value measurements                    
AVAILABLE-FOR-SALE SECURITIES:                    
Obligations of U.S. Government agencies  $0   $7,946   $0   $7,946 
Obligations of states and political subdivisions:                    
Tax-exempt   0    110,557    0    110,557 
Taxable   0    27,816    0    27,816 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                    
Residential pass-through securities   0    54,917    0    54,917 
Residential collateralized mortgage obligations   0    129,243    0    129,243 
Commercial mortgage-backed securities   0    33,629    0    33,629 
Total debt securities   0    364,108    0    364,108 
Marketable equity securities   978    0    0    978 
Total available-for-sale securities   978    364,108    0    365,086 
Servicing rights   0    0    1,277    1,277 
Total recurring fair value measurements  $978   $364,108   $1,277   $366,363 
                     
Nonrecurring fair value measurements                    
Impaired loans with a valuation allowance  $0   $0   $3,258   $3,258 
Valuation allowance   0    0    (1,077)   (1,077)
Impaired loans, net   0    0    2,181    2,181 
Foreclosed assets held for sale   0    0    1,650    1,650 
Total nonrecurring fair value measurements  $0   $0   $3,831   $3,831 

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

       December 31, 2016     
   Quoted Prices   Other         
   in Active   Observable   Unobservable   Total 
   Markets   Inputs   Inputs   Fair 
(In Thousands)  (Level 1)   (Level 2)   (Level 3)   Value 
                 
Recurring fair value measurements                    
AVAILABLE-FOR-SALE SECURITIES:                    
Obligations of U.S. Government agencies  $0   $9,541   $0   $9,541 
Obligations of states and political subdivisions:                    
Tax-exempt   0    119,037    0    119,037 
Taxable   0    30,297    0    30,297 
Mortgage-backed securities issued or guaranteed  by U.S. Government agencies or sponsored  agencies:                    
Residential pass-through securities   0    58,404    0    58,404 
Residential collateralized mortgage obligations   0    146,608    0    146,608 
Commercial mortgage-Backed securities   0    30,219    0    30,219 
Total debt securities   0    394,106    0    394,106 
Marketable equity securities   971    0    0    971 
Total available-for-sale securities   971    394,106    0    395,077 
Servicing rights   0    0    1,262    1,262 
Total recurring fair value measurements  $971   $394,106   $1,262   $396,339 
                     
Nonrecurring fair value measurements                    
Impaired loans with a valuation allowance  $0   $0   $3,372   $3,372 
Valuation allowance   0    0    (674)   (674)
Impaired loans, net   0    0    2,698    2,698 
Foreclosed assets held for sale   0    0    2,180    2,180 
Total nonrecurring fair value measurements  $0   $0   $4,878   $4,878 

 

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

 

At September 30, 2017 and December 31, 2016, quantitative information regarding significant techniques and inputs used for assets measured on a recurring basis using unobservable inputs (Level 3 methodologies) are as follows:

 

   Fair Value at              
   9/30/17   Valuation  Unobservable   Method or Value As of
Asset  (In Thousands)   Technique  Input(s)   9/30/17
Servicing rights  $1,277   Discounted cash flow  Discount rate   13.00%  Rate used through modeling period
           Loan prepayment speeds   147.00%  Weighted-average PSA
           Servicing fees   0.25%  of loan balances
               4.00%  of payments are late
               5.00%  late fees assessed
              $1.94   Miscellaneous fees per account per month
           Servicing costs  $6.00   Monthly servicing cost per account
              $24.00   Additional monthly servicing cost per loan on loans more than 30 days delinquent
               1.50%  of loans more than 30 days delinquent
               3.00%  annual increase in servicing costs

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

   Fair Value at              
   12/31/16   Valuation  Unobservable      Method or Value As of
Asset  (In Thousands)   Technique  Input(s)      12/31/16
Servicing rights  $1,262   Discounted cash flow  Discount rate   13.00%  Rate used through modeling period
           Loan prepayment speeds   138.00%  Weighted-average PSA
           Servicing fees   0.25%  of loan balances
               4.00%  of payments are late
               5.00%  late fees assessed
              $1.94   Miscellaneous fees per account per month
           Servicing costs  $6.00   Monthly servicing cost per account
              $24.00   Additional monthly servicing cost per loan on loans more than 30 days delinquent
               1.50%  of loans more than 30 days delinquent
               3.00%  annual increase in servicing costs

 

The fair value of servicing rights is affected by expected future interest rates. Increases (decreases) in future expected interest rates tend to increase (decrease) the fair value of the Corporation’s servicing rights because of changes in expected prepayment behavior by the borrowers on the underlying loans. Unrealized gains (losses) in fair value of servicing rights are included in Loan servicing fees, net, in the unaudited consolidated statements of income.

 

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

 

(In Thousands)  Three Months Ended   Nine Months Ended 
   Sept. 30,
2017
   Sept. 30,
2016
   Sept. 30,
2017
   Sept. 30,
2016
 
Servicing rights balance, beginning of period  $1,279   $1,224   $1,262   $1,296 
Issuances of servicing rights   65    52    160    159 
Unrealized losses included in earnings   (67)   (68)   (145)   (247)
Servicing rights balance, end of period  $1,277   $1,208   $1,277   $1,208 

 

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

 

At September 30, 2017 and December 31, 2016, quantitative information regarding significant techniques and inputs used for nonrecurring fair value measurements using unobservable inputs (Level 3 methodologies) are as follows:

 

(In Thousands, Except                    Weighted- 
Percentages)      Valuation             Average 
   Balance at   Allowance at   Fair Value at   Valuation  Unobservable  Discount at 
Asset  9/30/17   9/30/17   9/30/17   Technique  Inputs  9/30/17 
                       
Impaired loans:                          
Commercial:                          
Commercial loans secured by real estate  $2,686   $952   $1,734   Sales comparison  Discount to appraised value   16%
Commercial and industrial   75    75    0   Sales comparison  Discount to appraised value   100%
Loans secured by farmland   497    50    447   Sales comparison  Discount to appraised value   53%
Total impaired loans  $3,258   $1,077   $2,181            
Foreclosed assets held for sale - real estate:                          
Residential (1-4 family)  $640   $0   $640   Sales comparison  Discount to appraised value   35%
Land   646    0    646   Sales comparison  Discount to appraised value   34%
Commercial real estate   364    0    364   Sales comparison  Discount to appraised value   63%
Total foreclosed assets held for sale  $1,650   $0   $1,650            

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

(In Thousands, Except                    Weighted- 
Percentages)      Valuation             Average 
   Balance at   Allowance at   Fair Value at   Valuation  Unobservable  Discount at 
Asset  12/31/16   12/31/16   12/31/16   Technique  Inputs  12/31/16 
                       
Impaired loans:                          
Commercial:                          
Commercial loans secured by real estate  $2,773   $528   $2,245   Sales comparison  Discount to appraised value   7%
Commercial and industrial   95    95    0   Sales comparison  Discount to appraised value   100%
Loans secured by farmland   504    51    453   Sales comparison  Discount to appraised value   55%
Total impaired loans  $3,372   $674   $2,698            
Foreclosed assets held for sale -real estate:                          
Residential (1-4 family)  $1,102   $0   $1,102   Sales comparison  Discount to appraised value   35%
Land   650    0    650   Sales comparison  Discount to appraised value   33%
Commercial real estate   428    0    428   Sales comparison  Discount to appraised value   50%
Total foreclosed assets held for sale  $2,180   $0   $2,180            

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

DEPOSITS - The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, money market and interest checking accounts, is (by definition) equal to the amount payable on demand at September 30, 2017 and December 31, 2016. The fair value of time deposits, such as certificates of deposit and Individual Retirement Accounts, is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value estimates of deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market, commonly referred to as the core deposit intangible.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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

 

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

 

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

 

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

 

(In Thousands)  Valuation  September 30, 2017   December 31, 2016 
   Method(s)  Carrying   Fair   Carrying   Fair 
   Used  Amount   Value   Amount   Value 
Financial assets:                       
Cash and cash equivalents  Level 1  $29,610   $29,610   $28,621   $28,621 
Certificates of deposit  Level 2   3,240    3,239    3,488    3,481 
Available-for-sale securities  See Above   365,086    365,086    395,077    395,077 
Restricted equity securities (included in Other Assets)  Level 2   3,664    3,664    4,426    4,426 
Loans held for sale  Level 1   437    437    142    142 
Loans, net  Level 3   792,112    777,413    743,362    725,787 
Accrued interest receivable  Level 2   4,027    4,027    3,963    3,963 
Servicing rights  Level 3   1,277    1,277    1,262    1,262 
                        
Financial liabilities:                       
Deposits with no stated maturity  Level 2   801,942    801,942    771,625    771,625 
Time deposits  Level 2   219,683    220,017    212,218    212,274 
Short-term borrowings  Level 2   7,739    7,626    26,175    26,024 
Long-term borrowings  Level 2   31,256    31,460    38,454    39,062 
Accrued interest payable  Level 2   39    39    65    65 

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

6. SECURITIES

 

Amortized cost and fair value of available-for-sale securities at September 30, 2017 and December 31, 2016 are summarized as follows:

 

       September 30, 2017     
       Gross   Gross     
       Unrealized   Unrealized     
   Amortized   Holding   Holding   Fair 
(In Thousands)  Cost   Gains   Losses   Value 
                 
Obligations of U.S. Government agencies  $8,028   $0   $(82)  $7,946 
Obligations of states and political subdivisions:                    
Tax-exempt   108,521    2,678    (642)   110,557 
Taxable   27,538    316    (38)   27,816 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                    
Residential pass-through securities   55,247    113    (443)   54,917 
Residential collateralized mortgage obligations   130,375    323    (1,455)   129,243 
Commercial mortgage-backed securities   34,028    31    (430)   33,629 
Total debt securities   363,737    3,461    (3,090)   364,108 
Marketable equity securities   1,000    0    (22)   978 
Total  $364,737   $3,461   $(3,112)  $365,086 

 

       December 31, 2016     
       Gross   Gross     
       Unrealized   Unrealized     
   Amortized   Holding   Holding   Fair 
(In Thousands)  Cost   Gains   Losses   Value 
                 
Obligations of U.S. Government agencies  $9,671   $5   $(135)  $9,541 
Obligations of states and political subdivisions:                    
Tax-exempt   118,140    2,592    (1,695)   119,037 
Taxable   30,073    303    (79)   30,297 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                    
Residential pass-through securities   58,922    306    (824)   58,404 
Residential collateralized mortgage obligations   147,915    408    (1,715)   146,608 
Commercial mortgage-backed securities   30,817    0    (598)   30,219 
Total debt securities   395,538    3,614    (5,046)   394,106 
Marketable equity securities   1,000    0    (29)   971 
Total  $396,538   $3,614   $(5,075)  $395,077 

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

The following table presents gross unrealized losses and fair value of available-for-sale securities with unrealized loss positions that are not deemed to be other-than-temporarily impaired, aggregated by length of time that individual securities have been in a continuous unrealized loss position at September 30, 2017 and December 31, 2016:

 

September 30, 2017  Less Than 12 Months   12 Months or More   Total 
(In Thousands)  Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Losses   Value   Losses   Value   Losses 
                         
Obligations of U.S. Government agencies  $7,946   $(82)  $0   $0   $7,946   $(82)
Obligations of states and political subdivisions:                              
Tax-exempt   21,028    (238)   14,890    (404)   35,918    (642)
Taxable   7,073    (38)   0    0    7,073    (38)
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                              
Residential pass-through securities   47,572    (443)   0    0    47,572    (443)
Residential collateralized mortgage obligations   64,948    (747)   25,718    (708)   90,666    (1,455)
Commercial mortgage-backed securities   24,890    (275)   4,760    (155)   29,650    (430)
Total debt securities   173,457    (1,823)   45,368    (1,267)   218,825    (3,090)
Marketable equity securities   1,000    (22)   0    0    1,000    (22)
Total temporarily impaired available-for-sale securities  $174,457   $(1,845)  $45,368   $(1,267)  $219,825   $(3,112)

 

December 31, 2016  Less Than 12 Months   12 Months or More   Total 
(In Thousands)  Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Losses   Value   Losses   Value   Losses 
                         
Obligations of U.S. Government agencies  $7,899   $(135)  $0   $0   $7,899   $(135)
Obligations of states and political subdivisions:                              
Tax-exempt   54,479    (1,676)   1,278    (19)   55,757    (1,695)
Taxable   9,594    (79)   0    0    9,594    (79)
Mortgage-backed securities issued or guaranteed  by U.S. Government agencies or sponsored  agencies:                              
Residential pass-through securities   48,674    (824)   0    0    48,674    (824)
Residential collateralized mortgage obligations   85,198    (1,124)   16,073    (591)   101,271    (1,715)
Commercial mortgage-backed securities   30,219    (598)   0    0    30,219    (598)
Total debt securities   236,063    (4,436)   17,351    (610)   253,414    (5,046)
Marketable equity securities   1,000    (29)   0    0    1,000    (29)
Total temporarily impaired available-for-sale securities  $237,063   $(4,465)  $17,351   $(610)  $254,414   $(5,075)

 

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

 

(In Thousands)  3 Months Ended   9 Months Ended 
   Sept. 30,   Sept. 30,   Sept. 30,   Sept. 30, 
   2017   2016   2017   2016 
Gross realized gains from sales  $47   $584   $315   $1,090 
Gross realized losses from sales   (42)   0    (58)   (1)
Net realized gains  $5   $584   $257   $1,089 

 

 20 

 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

The amortized cost and fair value of available-for-sale debt securities by contractual maturity are shown in the following table as of September 30, 2017. Actual maturities may differ from contractual maturities because counterparties may have the right to call or prepay obligations with or without call or prepayment penalties.

 

   Amortized   Fair 
(In Thousands)  Cost   Value 
         
Due in one year or less  $12,478   $12,491 
Due from one year through five years   71,673    73,134 
Due from five years through ten years   36,361    36,517 
Due after ten years   23,575    24,177 
Sub-total   144,087    146,319 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:          
Residential pass-through securities   55,247    54,917 
Residential collateralized mortgage obligations   130,375    129,243 
Commercial mortgage-backed securities   34,028    33,629 
Total  $363,737   $364,108 

 

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

 

Investment securities carried at $224,612,000 at September 30, 2017 and $230,803,000 at December 31, 2016 were pledged as collateral for public deposits, trusts and certain other deposits as provided by law. See Note 8 for information concerning securities pledged to secure borrowing arrangements.

 

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

 

A summary of information management considered in evaluating debt and equity securities for other-than-temporary impairment (“OTTI”) at September 30, 2017 is provided below.

 

Debt Securities

 

At September 30, 2017, management performed an assessment for possible OTTI of the Corporation’s debt securities on an issue-by-issue basis, relying on information obtained from various sources, including publicly available financial data, ratings by external agencies, brokers and other sources. The extent of individual analysis applied to each security depended on the size of the Corporation’s investment, as well as management’s perception of the credit risk associated with each security. Based on the results of the assessment, management believes impairment of debt securities at September 30, 2017 to be temporary.

 

Equity Securities

 

The Corporation’s marketable equity securities at September 30, 2017 and December 31, 2016 consisted exclusively of one mutual fund. At September 30, 2017, there was an unrealized loss on the mutual fund of $22,000, and at December 31, 2016 there was an unrealized loss of $29,000. Management determined an OTTI charge was not required on this security at September 30, 2017 and December 31, 2016.

 

The Corporation had no realized gains or losses from the sale of equity securities in the first nine months of 2017. The Corporation realized gains from sales of bank stocks totaling $560,000 in the three-month period ended September 30, 2016 and $837,000 during the first nine months of 2016.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

C&N Bank is a member of the Federal Home Loan Bank of Pittsburgh (FHLB-Pittsburgh), which is one of 11 regional Federal Home Loan Banks. As a member, C&N Bank is required to purchase and maintain stock in FHLB-Pittsburgh. There is no active market for FHLB-Pittsburgh stock, and it must ordinarily be redeemed by FHLB-Pittsburgh in order to be liquidated. C&N Bank’s investment in FHLB-Pittsburgh stock, included in Other Assets in the consolidated balance sheet, was $3,534,000 at September 30, 2017 and $4,296,000 at December 31, 2016. The Corporation evaluated its holding of FHLB-Pittsburgh stock for impairment and deemed the stock to not be impaired at September 30, 2017 and December 31, 2016. In making this determination, management concluded that recovery of total outstanding par value, which equals the carrying value, is expected. The decision was based on review of financial information that FHLB-Pittsburgh has made publicly available.

 

7. LOANS

 

The loans receivable portfolio is segmented into residential mortgage, commercial and consumer loans. Loans outstanding at September 30, 2017 and December 31, 2016 are summarized by segment, and by classes within each segment, as follows:

 

Summary of Loans by Type        
(In Thousands)  Sept. 30,   Dec. 31, 
   2017   2016 
Residential mortgage:          
Residential mortgage loans - first liens  $355,285   $334,102 
Residential mortgage loans - junior liens   24,694    23,706 
Home equity lines of credit   36,534    38,057 
1-4 Family residential construction   25,286    24,908 
Total residential mortgage   441,799    420,773 
Commercial:          
Commercial loans secured by real estate   158,520    150,468 
Commercial and industrial   83,243    83,854 
Political subdivisions   54,730    38,068 
Commercial construction and land   13,937    14,287 
Loans secured by farmland   7,744    7,294 
Multi-family (5 or more) residential   7,566    7,896 
Agricultural loans   6,137    3,998 
Other commercial loans   12,383    11,475 
Total commercial   344,260    317,340 
Consumer   14,953    13,722 
Total   801,012    751,835 
Less: allowance for loan losses   (8,900)   (8,473)
Loans, net  $792,112   $743,362 

 

The Corporation grants loans to individuals as well as commercial and tax-exempt entities. Commercial, residential and personal loans are made to customers geographically concentrated in the Pennsylvania and New York counties that comprise the market serviced by Citizens & Northern Bank. Although the Corporation has a diversified loan portfolio, a significant portion of its debtors’ ability to honor their contracts is dependent on the local economic conditions within the region. There is no concentration of loans to borrowers engaged in similar businesses or activities that exceed 10% of total loans at either September 30, 2017 or December 31, 2016.

 

The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and recorded as a reduction of the investment in loans. The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Corporation’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available. In the process of evaluating the loan portfolio, management also considers the Corporation’s exposure to losses from unfunded loan commitments. As of September 30, 2017 and December 31, 2016, management determined that no allowance for credit losses related to unfunded loan commitments was required.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Transactions within the allowance for loan losses, summarized by segment and class, for the three-month and nine-month periods ended September 30, 2017 and 2016 were as follows:

 

Three Months Ended September 30, 2017  June 30,               Sept. 30, 
(In Thousands)  2017
Balance
   Charge-offs   Recoveries   Provision
(Credit)
   2017
Balance
 
Allowance for Loan Losses:                         
Residential mortgage:                         
Residential mortgage loans - first liens  $3,052   $0   $1   $112   $3,165 
Residential mortgage loans - junior liens   261    0    1    3    265 
Home equity lines of credit   332    0    0    (6)   326 
1-4 Family residential construction   251    0    0    (8)   243 
Total residential mortgage   3,896    0    2    101    3,999 
Commercial:                         
Commercial loans secured by real estate   2,610    0    0    27    2,637 
Commercial and industrial   910    0    1    93    1,004 
Commercial construction and land   162    0    0    (13)   149 
Loans secured by farmland   107    0    0    3    110 
Multi-family (5 or more) residential   169    0    0    2    171 
Agricultural loans   42    0    0    16    58 
Other commercial loans   105    0    0    12    117 
Total commercial   4,105    0    1    140    4,246 
Consumer   134    (67)   7    81    155 
Unallocated   500    0    0    0    500 
Total Allowance for Loan Losses  $8,635   $(67)  $10   $322   $8,900 

 

Three Months Ended September 30, 2016  June 30,               Sept. 30, 
(In Thousands)  2016
Balance
   Charge-offs   Recoveries   Provision
(Credit)
   2016
Balance
 
Allowance for Loan Losses:                         
Residential mortgage:                         
Residential mortgage loans - first liens  $2,830   $(31)  $2   $155   $2,956 
Residential mortgage loans - junior liens   239    0    0    9    248 
Home equity lines of credit   359    0    0    0    359 
1-4 Family residential construction   222    0    0    14    236 
Total residential mortgage   3,650    (31)   2    178    3,799 
Commercial:                         
Commercial loans secured by real estate   2,083    0    0    304    2,387 
Commercial and industrial   1,038    (2)   1    1    1,038 
Commercial construction and land   105    0    0    41    146 
Loans secured by farmland   103    0    0    3    106 
Multi-family (5 or more) residential   248    0    0    (5)   243 
Agricultural loans   47    0    0    (4)   43 
Other commercial loans   119    0    0    (3)   116 
Total commercial   3,743    (2)   1    337    4,079 
Consumer   138    (28)   12    23    145 
Unallocated   398    0    0    0    398 
Total Allowance for Loan Losses  $7,929   $(61)  $15   $538   $8,421 

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Nine Months Ended September 30, 2017  Dec. 31,               Sept. 30, 
(In Thousands)  2016
Balance
   Charge-offs   Recoveries   Provision
(Credit)
   2017
Balance
 
Allowance for Loan Losses:                         
Residential mortgage:                         
Residential mortgage loans - first liens  $3,033   $(162)  $15   $279   $3,165 
Residential mortgage loans - junior liens   258    (16)   3    20    265 
Home equity lines of credit   350    0    0    (24)   326 
1-4 Family residential construction   249    0    0    (6)   243 
Total residential mortgage   3,890    (178)   18    269    3,999 
Commercial:                         
Commercial loans secured by real estate   2,380    (96)   0    353    2,637 
Commercial and industrial   999    (1)   3    3    1,004 
Commercial construction and land   162    0    0    (13)   149 
Loans secured by farmland   110    0    0    0    110 
Multi-family (5 or more) residential   241    0    0    (70)   171 
Agricultural loans   40    0    0    18    58 
Other commercial loans   115    0    0    2    117 
Total commercial   4,047    (97)   3    293    4,246 
Consumer   138    (127)   30    114    155 
Unallocated   398    0    0    102    500 
Total Allowance for Loan Losses  $8,473   $(402)  $51   $778   $8,900 

 

Nine Months Ended September 30, 2016  Dec. 31,               Sept. 30, 
(In Thousands)  2015
Balance
   Charge-offs   Recoveries   Provision
(Credit)
   2016
Balance
 
Allowance for Loan Losses:                         
Residential mortgage:                         
Residential mortgage loans - first liens  $2,645   $(73)  $2   $382   $2,956 
Residential mortgage loans - junior liens   219    0    0    29    248 
Home equity lines of credit   347    0    0    12    359 
1-4 Family residential construction   207    0    0    29    236 
Total residential mortgage   3,418    (73)   2    452    3,799 
Commercial:                         
Commercial loans secured by real estate   1,939    0    2    446    2,387 
Commercial and industrial   981    (2)   2    57    1,038 
Commercial construction and land   58    0    0    88    146 
Loans secured by farmland   106    0    0    0    106 
Multi-family (5 or more) residential   675    (595)   0    163    243 
Agricultural loans   45    0    0    (2)   43 
Other commercial loans   118    0    0    (2)   116 
Total commercial   3,922    (597)   4    750    4,079 
Consumer   122    (67)   39    51    145 
Unallocated   427    0    0    (29)   398 
Total Allowance for Loan Losses  $7,889   $(737)  $45   $1,224   $8,421 

 

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

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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

 

The following tables summarize the aggregate credit quality classification of outstanding loans by risk rating as of September 30, 2017 and December 31, 2016:

 

September 30, 2017                    
(In Thousands)      Special             
   Pass   Mention   Substandard   Doubtful   Total 
Residential Mortgage:                         
Residential mortgage loans - first liens  $346,545   $314   $8,372   $54   $355,285 
Residential mortgage loans - junior liens   24,463    107    124    0    24,694 
Home equity lines of credit   35,933    62    539    0    36,534 
1-4 Family residential construction   25,286    0    0    0    25,286 
Total residential mortgage   432,227    483    9,035    54    441,799 
Commercial:                         
Commercial loans secured by real estate   149,607    1,394    7,519    0    158,520 
Commercial and Industrial   77,045    3,658    2,529    11    83,243 
Political subdivisions   54,730    0    0    0    54,730 
Commercial construction and land   13,848    10    79    0    13,937 
Loans secured by farmland   5,759    587    1,385    13    7,744 
Multi-family (5 or more) residential   6,974    0    592    0    7,566 
Agricultural loans   5,133    278    726    0    6,137 
Other commercial loans   12,310    0    73    0    12,383 
Total commercial   325,406    5,927    12,903    24    344,260 
Consumer   14,840    0    113    0    14,953 
Totals  $772,473   $6,410   $22,051   $78   $801,012 

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

December 31, 2016                    
(In Thousands)      Special             
   Pass   Mention   Substandard   Doubtful   Total 
Residential Mortgage:                         
Residential mortgage loans - first liens  $324,377   $408   $9,258   $59   $334,102 
Residential mortgage loans - junior liens   23,274    132    300    0    23,706 
Home equity lines of credit   37,360    123    574    0    38,057 
1-4 Family residential construction   24,820    0    88    0    24,908 
Total residential mortgage   409,831    663    10,220    59    420,773 
Commercial:                         
Commercial loans secured by real estate   139,358    3,092    8,018    0    150,468 
Commercial and Industrial   79,202    4,180    461    11    83,854 
Political subdivisions   38,068    0    0    0    38,068 
Commercial construction and land   14,136    70    81    0    14,287 
Loans secured by farmland   5,745    129    1,404    16    7,294 
Multi-family (5 or more) residential   7,277    0    619    0    7,896 
Agricultural loans   3,208    0    790    0    3,998 
Other commercial loans   11,401    0    74    0    11,475 
Total commercial   298,395    7,471    11,447    27    317,340 
Consumer   13,546    0    176    0    13,722 
Totals  $721,772   $8,134   $21,843   $86   $751,835 

 

The general component of the allowance for loan losses covers pools of loans including commercial loans not considered individually impaired, as well as smaller balance homogeneous classes of loans, such as residential real estate, home equity lines of credit and other consumer loans. Accordingly, the Corporation generally does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are subject to a restructuring agreement. The pools of loans are evaluated for loss exposure based upon average historical net charge-off rates for each loan class, adjusted for qualitative factors (described in the following paragraphs). The time period used in determining the average historical net charge-off rate for each loan class is based on management’s evaluation of an appropriate time period that captures an historical loss experience relevant to the current portfolio. Throughout 2016 and at March 31, 2017, a three-year average net charge-off rate was used for all loan classes. At June 30, 2017 and September 30, 2017, a five-year average net charge-off rate was used for commercial loans secured by real estate and for multi-family residential loans, while a three-year average net charge-off rate was used for all other loan classes.

 

Qualitative risk factors are evaluated for the impact on each of the three segments (residential mortgage, commercial and consumer) within the loan portfolio. Each qualitative factor is assigned a value to reflect improving, stable or declining conditions based on management’s judgment using relevant information available at the time of the evaluation. The adjustment for qualitative factors is applied as an increase or decrease to the average net charge-off rate for each loan class within each segment.

 

The qualitative factors used in the general component calculations are designed to address credit risk characteristics associated with each segment. The Corporation’s credit risk associated with all of the segments is significantly impacted by these factors, which include economic conditions within its market area, the Corporation’s lending policies, changes or trends in the portfolio, risk profile, competition, regulatory requirements and other factors. Further, the residential mortgage segment is significantly affected by the values of residential real estate that provide collateral for the loans. The majority of the Corporation’s commercial segment loans (approximately 55% at September 30, 2017) is secured by real estate, and accordingly, the Corporation’s risk for the commercial segment is significantly affected by commercial real estate values. The consumer segment includes a wide mix of loans for different purposes, primarily secured loans, including loans secured by motor vehicles, manufactured housing and other types of collateral.

 

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

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

The scope of loans reviewed individually each quarter to determine if they are impaired include all loan relationships greater than $200,000 for which there is at least one extension of credit graded Special Mention, Substandard or Doubtful. Loans that are individually reviewed, but which are determined to not be impaired, are combined with all remaining loans that are not reviewed on a specific basis, and such loans are included within larger pools of loans based on similar risk and loss characteristics for purposes of determining the general component of the allowance. The loans that have been individually reviewed, but which have been determined to not be impaired, are included in the “Collectively Evaluated” column in the table summarizing the allowance and associated loan balances as of September 30, 2017 and December 31, 2016. All loans classified as troubled debt restructurings (discussed in more detail below) and all loan relationships less than $200,000 in the aggregate, but with an estimated loss of $100,000 or more, are individually evaluated for impairment.

 

The following tables present a summary of loan balances and the related allowance for loan losses summarized by portfolio segment and class for each impairment method used as of September 30, 2017 and December 31, 2016:

 

September 30, 2017  Loans:   Allowance for Loan Losses: 
(In Thousands)                        
   Individually   Collectively       Individually   Collectively     
   Evaluated   Evaluated   Totals   Evaluated   Evaluated   Totals 
Residential mortgage:                              
Residential mortgage loans - first liens  $723   $354,562   $355,285   $0   $3,165   $3,165 
Residential mortgage loans - junior liens   62    24,632    24,694    0    265    265 
Home equity lines of credit   0    36,534    36,534    0    326    326 
1-4 Family residential construction   0    25,286    25,286    0    243    243 
Total residential mortgage   785    441,014    441,799    0    3,999    3,999 
Commercial:                              
Commercial loans secured by real estate   5,917    152,603    158,520    952    1,685    2,637 
Commercial and industrial   476    82,767    83,243    165    839    1,004 
Political subdivisions   0    54,730    54,730    0    0    0 
Commercial construction and land   0    13,937    13,937    0    149    149 
Loans secured by farmland   1,371    6,373    7,744    50    60    110 
Multi-family (5 or more) residential   392    7,174    7,566    0    171    171 
Agricultural loans   8    6,129    6,137    0    58    58 
Other commercial loans   0    12,383    12,383    0    117    117 
Total commercial   8,164    336,096    344,260    1,167    3,079    4,246 
Consumer   20    14,933    14,953    0    155    155 
Unallocated                            500 
                               
Total  $8,969   $792,043   $801,012   $1,167   $7,233   $8,900 

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

December 31, 2016  Loans:   Allowance for Loan Losses: 
(In Thousands)                        
   Individually   Collectively       Individually   Collectively     
   Evaluated   Evaluated   Totals   Evaluated   Evaluated   Totals 
Residential mortgage:                              
Residential mortgage loans - first liens  $753   $333,349   $334,102   $0   $3,033   $3,033 
Residential mortgage loans - junior liens   68    23,638    23,706    0    258    258 
Home equity lines of credit   0    38,057    38,057    0    350    350 
1-4 Family residential construction   0    24,908    24,908    0    249    249 
Total residential mortgage   821    419,952    420,773    0    3,890    3,890 
Commercial:                              
Commercial loans secured by real estate   8,005    142,463    150,468    528    1,852    2,380 
Commercial and industrial   212    83,642    83,854    95    904    999 
Political subdivisions   0    38,068    38,068    0    0    0 
Commercial construction and land   0    14,287    14,287    0    162    162 
Loans secured by farmland   1,394    5,900    7,294    51    59    110 
Multi-family (5 or more) residential   392    7,504    7,896    0    241    241 
Agricultural loans   13    3,985    3,998    0    40    40 
Other commercial loans   0    11,475    11,475    0    115    115 
Total commercial   10,016    307,324    317,340    674    3,373    4,047 
Consumer   23    13,699    13,722    0    138    138 
Unallocated                            398 
                               
Total  $10,860   $740,975   $751,835   $674   $7,401   $8,473 

 

Summary information related to impaired loans at September 30, 2017 and December 31, 2016 is as follows:

 

(In Thousands)  September 30, 2017   December 31, 2016 
   Unpaid           Unpaid         
   Principal   Recorded   Related   Principal   Recorded   Related 
   Balance   Investment   Allowance   Balance   Investment   Allowance 
With no related allowance recorded:                              
Residential mortgage loans - first liens  $752   $723   $0   $783   $753   $0 
Residential mortgage loans - junior liens   62    62    0    68    68    0 
Commercial loans secured by real estate   3,231    3,231    0    6,975    5,232    0 
Commercial and industrial   78    78    0    117    117    0 
Loans secured by farmland   874    874    0    890    890    0 
Multi-family (5 or more) residential   987    392    0    987    392    0 
Agricultural loans   8    8    0    13    13    0 
Consumer   20    20    0    23    23    0 
Total with no related allowance recorded   6,012    5,388    0    9,856    7,488    0 
                               
With a related allowance recorded:                              
Commercial loans secured by real estate   2,686    2,686    952    2,773    2,773    528 
Commercial and industrial   398    398    165    95    95    95 
Loans secured by farmland   497    497    50    504    504    51 
Total with a related allowance recorded   3,581    3,581    1,167    3,372    3,372    674 
Total  $9,593   $8,969   $1,167   $13,228   $10,860   $674 

 

 28 

 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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

 

                   Interest Income Recognized on 
   Average Investment in Impaired Loans   Impaired Loans on a Cash Basis 
(In Thousands)  3 Months Ended   9 Months Ended   3 Months Ended   9 Months Ended 
   Sept. 30,   Sept. 30,   Sept. 30,   Sept. 30, 
   2017   2016   2017   2016   2017   2016   2017   2016 
Residential mortgage:                                        
Residential mortgage loans - first lien  $733   $789   $738   $818   $8   $11   $25   $33 
Residential mortgage loans - junior lien   64    72    65    72    1    0    3    2 
Total residential mortgage   797    861    803    890    9    11    28    35 
Commercial:                                        
Commercial loans secured by real estate   6,200    7,022    6,377    6,524    36    83    127    274 
Commercial and industrial   393    577    317    619    13    7    20    17 
Loans secured by farmland   1,378    1,408    1,382    1,413    10    13    32    51 
Multi-family (5 or more) residential   392    492    392    541    0    0    0    0 
Agricultural loans   10    13    11    14    0    0    1    1 
Total commercial   8,373    9,512    8,479    9,111    59    103    180    343 
Consumer   25    17    27    16    0    0    0    0 
Total  $9,195   $10,390   $9,309   $10,017   $68   $114   $208   $378 

 

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

 

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

 

(In Thousands)  September 30, 2017   December 31, 2016 
   Past Due       Past Due     
   90+ Days and       90+ Days and     
   Accruing   Nonaccrual   Accruing   Nonaccrual 
Residential mortgage:                    
Residential mortgage loans - first liens  $1,739   $4,352   $3,022   $3,770 
Residential mortgage loans - junior liens   4    0    114    0 
Home equity lines of credit   208    59    320    11 
Total residential mortgage   1,951    4,411    3,456    3,781 
Commercial:                    
Commercial loans secured by real estate   126    5,732    2,774    3,080 
Commercial and industrial   632    476    286    119 
Commercial construction and land   53    0    0    0 
Loans secured by farmland   215    1,313    219    1,331 
Multi-family (5 or more) residential   0    392    0    392 
Agricultural loans   0    8    0    13 
Total commercial   1,026    7,921    3,279    4,935 
Consumer   2    68    103    20 
                     
Totals  $2,979   $12,400   $6,838   $8,736 

 

 29 

 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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

 

The table below presents a summary of the contractual aging of loans as of September 30, 2017 and December 31, 2016:

 

   As of September 30, 2017   As of December 31, 2016 
   Current &               Current &             
(In Thousands)  Past Due   Past Due   Past Due       Past Due   Past Due   Past Due     
   Less than   30-89   90+       Less than   30-89   90+     
   30 Days   Days   Days   Total   30 Days   Days   Days   Total 
Residential mortgage:                                        
Residential mortgage loans - first liens  $347,083   $4,410   $3,792   $355,285   $321,670   $6,695   $5,737   $334,102 
Residential mortgage loans - junior liens   24,409    281    4    24,694    23,268    324    114    23,706 
Home equity lines of credit   35,908    369    257    36,534    37,603    134    320    38,057 
1-4 Family residential construction   24,597    689    0    25,286    24,567    341    0    24,908 
Total residential mortgage   431,997    5,749    4,053    441,799    407,108    7,494    6,171    420,773 
                                         
Commercial:                                        
Commercial loans secured by real estate   155,276    215    3,029    158,520    147,464    82    2,922    150,468 
Commercial and industrial   82,407    151    685    83,243    83,364    185    305    83,854 
Political subdivisions   54,730    0    0    54,730    38,068    0    0    38,068 
Commercial construction and land   13,858    26    53    13,937    14,199    88    0    14,287 
Loans secured by farmland   6,726    57    961    7,744    6,181    83    1,030    7,294 
Multi-family (5 or more) residential   7,135    39    392    7,566    7,439    65    392    7,896 
Agricultural loans   6,052    77    8    6,137    3,981    4    13    3,998 
Other commercial loans   12,383    0    0    12,383    11,475    0    0    11,475 
Total commercial   338,567    565    5,128    344,260    312,171    507    4,662    317,340 
Consumer   14,720    163    70    14,953    13,446    153    123    13,722 
                                         
Totals  $785,284   $6,477   $9,251   $801,012   $732,725   $8,154   $10,956   $751,835 

 

Nonaccrual loans are included in the contractual aging in the immediately preceding table. A summary of the contractual aging of nonaccrual loans at September 30, 2017 and December 31, 2016 is as follows:

 

   Current &             
(In Thousands)  Past Due   Past Due   Past Due     
   Less than   30-89   90+     
   30 Days   Days   Days   Total 
September 30, 2017 Nonaccrual Totals  $5,629   $499   $6,272   $12,400 
December 31, 2016 Nonaccrual Totals  $4,199   $419   $4,118   $8,736 

 

Loans whose terms are modified are classified as Troubled Debt Restructurings (TDRs) if the Corporation grants such borrowers concessions, and it is deemed that those borrowers are experiencing financial difficulty. Loans classified as TDRs are designated as impaired. The outstanding balance of loans subject to TDRs, as well as contractual aging information at September 30, 2017 and December 31, 2016 is as follows:

 

   Current &                 
(In Thousands)  Past Due   Past Due   Past Due         
   Less than   30-89   90+         
   30 Days   Days   Days   Nonaccrual   Total 
September 30, 2017 Totals  $658   $0   $0   $3,075   $3,733 
December 31, 2016 Totals  $5,453   $350   $0   $2,874   $8,677 

 

 30 

 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

At September 30, 2017 and December 31, 2016, there were no commitments to loan additional funds to borrowers whose loans have been classified as TDRs.

 

TDRs that occurred during the three-month and nine-month periods ended September 30, 2017 and 2016 are as follows:

 

(Balances in Thousands)  Three Months Ended   Three Months Ended 
   September 30, 2017   September 30, 2016 
       Post-       Post- 
   Number   Modification   Number   Modification 
   of   Recorded   of   Recorded 
   Loans   Investment   Loans   Investment 
Consumer,                    
Accepted short fall from sale of residential real estate on a mortgage loan and made unsecured loan to same borrower   0   $0    1   $25 

 

   Nine Months Ended   Nine Months Ended 
   September 30, 2017   September 30, 2016 
       Post-       Post- 
   Number   Modification   Number   Modification 
   of   Recorded   of   Recorded 
   Loans   Investment   Loans   Investment 
Residential mortgage,                    
Extended maturity with interest rate reduction   0   $0    1   $102 
Commercial and industrial,                    
Extended maturity with interest rate increase   0    0    1    5 
Consumer,                    
Accepted short fall from sale of residential real                    
estate on a mortgage loan and made unsecured                    
loan to same borrower   0    0    1    25 
Total   0   $0    3   $132 

 

There were no defaults on loans for which modifications considered to be TDRs were entered into within the previous 12 months in the three-month periods ended September 30, 2017 and 2016. In the nine-month periods ended September 30 2017 and 2016, defaults on loans for which modifications considered to be TDRs were entered into within the previous 12 months are summarized as follows:

 

(Balances in Thousands)  Nine Months Ended   Nine Months Ended 
   September 30, 2017   September 30, 2016 
   Number       Number     
   of   Recorded   of   Recorded 
   Loans   Investment   Loans   Investment 
Residential mortgage - first liens   0   $0    1   $242 
Residential mortgage - junior liens   0    0    1    30 
Commercial and industrial   0    0    1    5 
Consumer   0    0    1    28 
Total   0   $0    4   $305 

 

 31 

 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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

 

(In Thousands)  Sept. 30,   Dec. 31, 
   2017   2016 
Foreclosed residential real estate  $640   $1,102 

 

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

 

(In Thousands)  Sept. 30,   Dec. 31, 
   2017   2016 
Residential real estate in process of foreclosure  $1,871   $2,738 

 

8. BORROWED FUNDS

 

Short-term borrowings include the following:

 

(In Thousands)  Sept. 30,   Dec. 31, 
   2017   2016 
FHLB-Pittsburgh borrowings  $3,000   $21,000 
Customer repurchase agreements   4,739    5,175 
Total short-term borrowings  $7,739   $26,175 

 

The FHLB-Pittsburgh loan facilities are collateralized by qualifying loans secured by real estate with a book value totaling $495,047,000 at September 30, 2017 and $471,454,000 at December 31, 2016. Also, the FHLB-Pittsburgh loan facilities require the Corporation to invest in established amounts of FHLB-Pittsburgh stock. The carrying values of the Corporation’s holdings of FHLB-Pittsburgh stock (included in Other Assets) were $3,534,000 at September 30, 2017 and $4,296,000 at December 31, 2016.

 

At September 30, 2017, the short-term borrowing from FHLB-Pittsburgh of $3,000,000 was a term borrowing with an interest rate of 1.23%, maturing in June 2018. At December 31, 2016, the short-term borrowing from FHLB-Pittsburgh of $21,000,000 was an overnight borrowing with an interest rate of 0.74%.

 

The Corporation engages in repurchase agreements with certain commercial customers. These agreements provide that the Corporation sells specified investment securities to the customers on an overnight basis and repurchases them on the following business day. The weighted average interest rate paid by the Corporation on customer repurchase agreements was 0.10% at September 30, 2017 and December 31, 2016.

 

Long-term borrowings are as follows:

 

(In Thousands)  Sept. 30,   Dec. 31, 
   2017   2016 
FHLB-Pittsburgh borrowings  $4,256   $11,454 
Repurchase agreement   27,000    27,000 
Total long-term borrowings  $31,256   $38,454 

 

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

 

(In Thousands)  Sept. 30,   Dec. 31, 
   2017   2016 
Loan matured in June 2017 with a rate of 6.83%  $0   $4 
Loan matured in September 2017 with a rate of 3.81%   0    10,000 
Loan maturing in December 2018 with a rate of 1.35%   3,000    0 
Loan maturing in April 2020 with a rate of 4.79%   510    646 
Loan maturing in June 2025 with a rate of 4.91%   746    804 
Total long-term FHLB-Pittsburgh borrowings  $4,256   $11,454 

 

 32 

 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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

 

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

 

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

 

The carrying value of the underlying securities was $30,055,000 at September 30, 2017 and $31,494,000 at December 31, 2016, detailed in the following table:

 

(In Thousands)  Sept. 30,   Dec. 31, 
   2017   2016 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:          
Residential pass-through securities  $14,120   $18,181 
Residential collateralized mortgage obligations   16,935    13,313 
Total  $30,055   $31,494 

 

9. DEFINED BENEFIT PLANS

 

The Corporation sponsors a defined benefit health care plan that provides postretirement medical benefits and life insurance to employees who meet certain age and length of service requirements. Full-time employees no longer accrue service time toward the Corporation-subsidized portion of the medical benefits. The plan contains a cost-sharing feature which causes participants to pay for all future increases in costs related to benefit coverage. Accordingly, actuarial assumptions related to health care cost trend rates do not significantly affect the liability balance at September 30, 2017 and December 31, 2016, and are not expected to significantly affect the Corporation's future expenses. The Corporation uses a December 31 measurement date for the postretirement plan.

 

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

 

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

 

Defined Benefit Plans                
(In Thousands)  Pension   Postretirement 
   Nine Months Ended   Nine Months Ended 
   Sept. 30,   Sept. 30, 
   2017   2016   2017   2016 
Service cost  $0   $0   $27   $27 
Interest cost   18    20    43    47 
Expected return on plan assets   (23)   (20)   0    0 
Amortization of prior service cost   0    0    (23)   (23)
Recognized net actuarial loss   5    8    0    0 
Net periodic benefit cost  $0   $8   $47   $51 

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Defined Benefit Plans                
(In Thousands)  Pension   Postretirement 
   Three Months Ended   Three Months Ended 
   Sept. 30,   Sept. 30, 
   2017   2016   2017   2016 
Service cost  $0   $0   $9   $9 
Interest cost   6    7    15    16 
Expected return on plan assets   (8)   (7)   0    0 
Amortization of prior service cost   0    0    (8)   (8)
Recognized net actuarial loss   2    3    0    0 
Net periodic benefit cost  $0   $3   $16   $17 

 

In the first nine months of 2017, the Corporation funded postretirement contributions totaling $36,000, with estimated annual postretirement contributions of $62,000 expected in 2017 for the full year. No defined benefit pension contributions are required in 2017, though the Corporation may make discretionary contributions.

 

10. STOCK-BASED COMPENSATION PLANS

 

The Corporation has a Stock Incentive Plan for a selected group of officers and an Independent Directors Stock Incentive Plan. In the first quarter 2017, the Corporation awarded 22,312 shares of restricted stock under the Stock Incentive Plan and 8,470 shares of restricted stock under the Independent Directors Stock Incentive Plan. The 2017 restricted stock awards under the Stock Incentive Plan vest ratably over three years, and vesting for one-half of the 14,897 restricted shares awarded to Executive Officers depends on the Corporation meeting a return on average equity (“ROAE”) target each year. The 2017 restricted stock issued under the Independent Directors Stock Incentive Plan vests over one year.

 

Compensation cost related to restricted stock is recognized based on the market price of the stock at the grant date over the vesting period. Management has estimated restricted stock expense in the first nine months of 2017 based on an assumption that the ROAE target for awards to Executive Officers in 2016 and 2017 will not be met, resulting in forfeiture of the restricted stock.

 

Annual stock-based compensation for the year ending December 31, 2017 is estimated to total $632,000. If the ROAE targets for awards to Executive Officers in 2016 and 2017 are met or exceeded, total annual stock-based compensation would increase by approximately $123,000. Total stock-based compensation expense attributable to restricted stock awards amounted to $153,000 in the third quarter 2017 and $475,000 in the nine-month period ended September 30, 2017. Total stock-based compensation expense attributable to restricted stock awards amounted to $155,000 in the third quarter 2016 and $480,000 in the nine-month period ended September 30, 2016.

 

11. INCOME TAXES

 

The net deferred tax asset at September 30, 2017 and December 31, 2016 represents the following temporary difference components:

 

   September 30,   December 31, 
(In Thousands)  2017   2016 
Deferred tax assets:          
Unrealized holding losses on securities  $0   $512 
Allowance for loan losses   3,150    2,998 
Other deferred tax assets   2,582    2,658 
Total deferred tax assets   5,732    6,168 
           
Deferred tax liabilities:          
Unrealized holding gains on securities   122    0 
Defined benefit plans - ASC 835   79    27 
Bank premises and equipment   1,101    913 
Core deposit intangibles   5    6 
Other deferred tax liabilities   106    105 
Total deferred tax liabilities   1,413    1,051 
Deferred tax asset, net  $4,319   $5,117 

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

The provision for income tax for the three-month and nine month periods ended September 30, 2017 and 2016 is based on the Corporation’s estimate of the effective tax rate expected to be applicable for the full year. The effective tax rates for the Corporation are as follows:

 

   Three Months Ended   Nine Months Ended 
(Dollars In thousands)  September 30,   September 30, 
   2017   2016   2017   2016 
Income before income tax provision  $5,198   $5,538   $15,111   $15,378 
Income tax provision   1,262    1,451    3,620    3,847 
Effective tax rate   24.28%   26.20%   23.96%   25.02%

 

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

 

The Corporation has investments in three limited partnerships that manage affordable housing projects that have qualified for the federal low-income housing tax credit. The Corporation’s expected return from these investments is based on the receipt of tax credits and tax benefits from deductions of operating losses. The Corporation uses the effective yield method to account for these investments, with the benefits recognized as a reduction of the provision for income taxes. For two of the three limited partnership investments, the tax credits have been received in full in prior years, and the Corporation has fully realized the benefits of the credits and amortized its initial investments in the partnerships. The most recent affordable housing project was completed in 2013, and the Corporation received tax credits in 2013 through 2016 and expects to continue to receive tax credits annually through 2022. The carrying amount of the Corporation’s investment is $634,000 at September 30, 2017 and $713,000 at December 31, 2016 (included in Other Assets in the consolidated balance sheets). For the year ending December 31, 2017, the estimated amount of tax credits and other tax benefits to be received is $157,000 and the estimated amount to be recognized as a reduction of the provision for income taxes is $73,000. The total reduction in the provision for income taxes resulting from this investment is $18,000 in the third quarter 2017 and $55,000 for the nine months ended September 30, 2017, and $19,000 in the third quarter 2016 and $57,000 for the nine months ended September 30, 2016.

 

The Corporation has no unrecognized tax benefits, nor pending examination issues related to tax positions taken in preparation of its income tax returns. With limited exceptions, the Corporation is no longer subject to examination by the Internal Revenue Service for years prior to 2014.

 

12. CONTINGENCIES

 

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

 

13. RECENT ACCOUNTING PRONOUNCEMENTS

 

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

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which provides a principles-based framework for revenue recognition under U.S. GAAP. The core principle of the five-step revenue recognition framework is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Several additional ASUs have been issued subsequent to ASU 2014-09 to provide clarifying guidance related to various revenue recognition areas and to defer the effective date of the standard by a year, making it applicable for the Corporation in the first quarter 2018 and for the annual period ending December 31, 2018. The amendments should be applied either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the amendments recognized at the date of initial application. Additionally, the ASU requires expanded disclosures to help users of financial statements better understand the nature, amount, timing, and uncertainty of revenue that is recognized. More than 70% of the Corporation’s revenue comes from net interest income and is explicitly out of the scope of ASU 2014-09. The Corporation’s largest sources of noninterest revenue which are subject to the guidance include Trust and financial management revenue, service charges on deposit accounts and interchange revenue from debit card transactions. Management has reviewed the Corporation’s larger noninterest revenue streams and does not expect the adoption of ASU 2014-09 to have a material effect on the Corporation’s financial condition or results of operations. Management is in the process of reviewing the expanded disclosure requirements that will be effective in the first quarter 2018.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities. This makes significant changes in U.S. GAAP related to certain aspects of recognition, measurement, presentation and disclosure of financial instruments. The changes provided for in this Update that are applicable to the Corporation are as follows: (1) require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; however, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer; (2) for equity investments without readily determinable fair values, require a qualitative assessment to identify impairment, and if a qualitative assessment indicates that impairment exists, requiring an entity to measure the investment at fair value; (3) eliminate the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (4) require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (5) require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments (at September 30, 2017 and December 31, 2016, the Corporation has no liabilities for which the fair value measurement option has been elected); (6) require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (7) clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The amendments in this Update will become effective for the Corporation for annual and interim periods beginning in the first quarter 2018. With limited exceptions, early adoption of the amendments in this Update is not permitted. Amendments are to be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values should be applied prospectively. The Corporation’s current exposure related to investments in marketable equity securities and other issues considered in ASU 2016-01 is limited, and accordingly, initial adoption of this ASU is not expected to have a significant impact on the Corporation’s financial position. Management is in the process of reviewing the changes in disclosure requirements that will become effective in the first quarter 2018.

 

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

 

In March 2016, the FASB issued ASU No. 2016-07, Investments – Equity Method and Joint Ventures. This ASU eliminates the requirement that when an investment qualifies for the equity method as a result of an increase in the level of ownership interest or influence, an investor must adjust the investment, results of operations and retained earnings retroactively as if the equity method had been in effect during all previous periods the investment had been held. The ASU requires the equity method investor to add the cost of acquiring an additional interest in the investee to the basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for the equity method. The ASU further requires that an entity that has an available-for-sale equity security that becomes qualified for the equity method recognize through earnings the unrealized gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method. The amendments in this Update were effective for the Corporation for annual and interim periods beginning in the first quarter 2017. Initial adoption of this ASU in 2017 did not have a significant impact on the Corporation.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation. This ASU changes several aspects of accounting for share-based payment transactions, and includes some changes that apply only to nonpublic companies. This Update includes amendments that currently apply, or may apply in the future, to the Corporation related to the following: (1) accounting for the difference between the deduction for tax purposes and the amount of compensation cost recognized for financial reporting purposes; (2) classification of excess tax benefits on the statement of cash flows; (3) accounting for forfeitures; (4) accounting for awards partially settled in cash in excess of the employer’s minimum statutory tax withholding requirements; and (5) classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax-withholding purposes. The amendments in this Update were effective for the Corporation for annual and interim periods beginning in the first quarter 2017. The ASU provides separate transition provisions for each of the amendments. Initial adoption of this ASU in 2017 did not have a significant impact on the Corporation.

 

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

 

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

 

·The amendments in the Update retain many of the disclosure requirements related to credit quality in current U.S. GAAP, updated to reflect the change from an incurred loss methodology to an expected credit loss methodology.

 

·In addition, the Update requires that disclosure of credit quality indicators in relation to the amortized cost of financing receivables, a current requirement, be further disaggregated by year of origination.

 

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

 

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

 

The Corporation is in the early stages of evaluating the potential impact of adopting this amendment.

 

In June 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) – Classification of Certain Cash Receipts and Cash Payments. This Update provides clarification regarding eight specific cash flow issues with the objective of reducing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. For the Corporation, the amendments in this Update are effective beginning in the first quarter 2018. The amendments in this Update should be applied using a retroactive transition method to each period presented. The Corporation anticipates there will be no adjustments to the Consolidated Statements of Cash Flows, as previously reported, as a result of the clarifications provided in the Update.

 

In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350) to simplify the accounting for goodwill impairment. This guidance, among other things, removes step 2 of the goodwill impairment test thus eliminating the need to determine the fair value of individual assets and liabilities of the reporting unit. Upon adoption of this ASU, goodwill impairment will be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. This may result in more or less impairment being recognized than under current guidance. This Update will become effective for the Corporation’s annual and interim goodwill impairment tests beginning in the first quarter of 2020.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

In March 2017, the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20). This Update will shorten the amortization period for certain callable debt securities held at a premium. Under current U.S. GAAP, entities generally amortize the premium over the contractual life of the instrument. Discounts will continue to be amortized to maturity. The amendments in this Update are effective for the Corporation for annual and interim periods beginning in the first quarter 2019. An entity should apply the amendments in this Update through a cumulative-effect adjustment directly to retained earnings as of the beginning of the year of adoption. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The Corporation does not expect adoption of the amendments to have a significant impact on its financial position.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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

AND RESULTS OF OPERATIONS

 

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

 

·changes in monetary and fiscal policies of the Federal Reserve Board and the U. S. Government, particularly related to changes in interest rates
·changes in general economic conditions
·legislative or regulatory changes
·downturn in demand for loan, deposit and other financial services in the Corporation’s market area
·increased competition from other banks and non-bank providers of financial services
·technological changes and increased technology-related costs
·changes in accounting principles, or the application of generally accepted accounting principles.

 

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

 

EARNINGS OVERVIEW

 

Basic and diluted earnings per common share were $0.32 for the third quarter 2017, as compared to $0.34 in the second quarter 2017 and $0.34 in the third quarter 2016. For the nine months ended September 30, 2017, basic and diluted earnings per common share were $0.94 as compared to $0.95 for the first nine months of 2016. The return on average assets for the first nine months of 2017 was 1.23%, and the return on average equity was 8.13%. Highlights related to the Corporation’s earnings results for the comparative periods are presented below.

 

Net income for the third quarter 2017 of $3,936,000 was lower by $151,000 (3.7%) than the third quarter 2016 amount. Some of the more significant fluctuations in revenues and expenses between the three-month period ended September 30, 2017 and the corresponding period in 2016 were as follows:

 

·Net interest income increased $454,000 (4.5%) in the third quarter 2017 as compared to the third quarter 2016. The net interest margin of 3.83% for the third quarter 2017 was higher than the third quarter 2016 level of 3.74%. The improvement in the margin included the impact of a favorable change in the mix of earning assets, including growth in loans and a reduction in securities. Average total loans outstanding were higher by $55.3 million (7.5%) in the third quarter 2017 as compared to the third quarter 2016, while average total available-for-sale securities were lower by $41.0 million. Average total deposits were $26.8 million (2.7%) higher in the third quarter 2017 as compared to the third quarter 2016.

 

·The third quarter 2017 provision for loan losses was $216,000 lower than the third quarter 2016 amount. The third quarter 2017 provision included $141,000 related to the change in total specific allowances on impaired loans, as adjusted for net charge-offs during the period, and an increase of $181,000 in the collectively determined allowance for loan losses. In comparison, the third quarter 2016 provision included a $478,000 increase in total specific allowances on impaired loans, as adjusted for net charge-offs during the period, and a $60,000 increase in the collectively determined portion of the allowance. The increase in total specific allowances on impaired loans in the third quarter 2016 included the initial recognition of an allowance of $528,000 on a real estate secured commercial loan for which the specific allowance had increased to $952,000 at September 30, 2017. The outstanding balance of this loan was $2,686,000 at September 30, 2017.

 

·Noninterest revenue increased $182,000 (4.7%) in the third quarter 2017 over the third quarter 2016 amount. Trust and financial management revenue increased $120,000 (10.2%), reflecting growth in assets under management resulting from market appreciation and new business, as well as a recent increase in fee levels. Interchange revenue from debit card transactions increased $80,000 (16.6%), reflecting benefits from a consulting project in 2016 that identified opportunities for improvements in card-related volumes and processing. Net gains from sales of loans increased $61,000 (25.8%) in the third quarter 2017 as compared to the third quarter 2016, reflecting increases in sales volume and average profit margin. Service charges on deposit accounts decreased $53,000 (4.3%), as revenue from consumer overdrafts declined due to lower volume.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

·Realized gains on available-for-sale securities totaled $5,000 in the third quarter 2017, down from $584,000 in the third quarter 2016. Within this category, gains from sales of bank stocks totaled $560,000 in the third quarter 2016. The Corporation sold its investments in bank stocks over the course of 2014 through 2016, and has held no such investments throughout 2017.

 

·Total noninterest expenses increased $613,000 (7.1%) in the third quarter 2017 over the third quarter 2016 amount. Other operating expense increased $226,000. The increase in other operating expense included an increase of $97,000 in attorney fees, mainly related to a commercial loan workout situation, and an increase in accounting and auditing expense of $46,000 resulting from an increase in outsourced internal audit activity. Pensions and other employee benefits expense increased $156,000, mainly due to higher health care expenses on the Corporation’s partially self-insured plan. Salaries and wages expense increased $84,000, or 2.2%. Software subscriptions increased $62,000, including costs associated with new applications as well as annual licensing increases. Automated teller machine and interchange expense increased $55,000, including increased costs related to fraud protection services and higher volume of debit card transactions. Pennsylvania shares tax increased $49,000, reflecting a tax rate increase and an increase in C&N Bank capital. FDIC assessments expense decreased $58,000, reflecting a lower assessment level.

 

·The income tax provision of $1,262,000 in the third quarter 2017 (24.3% of pre-tax income) was $189,000 lower than the third quarter 2016 tax provision of $1,451,000 (26.2% of pre-tax income). The lower amount of tax provision and effective tax rate in the third quarter 2017 resulted primarily from lower pre-tax income. Also, in the third quarter 2016, the tax provision included a $39,000 catch up adjustment for an increase in the New York State tax provision related to a change in tax methodology that first became effective in 2015.

 

Net income was $11,491,000 for the first nine months of 2017, a decrease of $40,000 (0.4%) from net income for the first nine months of 2016. Some of the more significant fluctuations in revenues and expenses between the nine-month period ended September 30, 2017 and the corresponding period in 2016 were as follows:

 

·Net interest income was $943,000 (3.1%) higher for the first nine months of 2017 as compared to the first nine months of 2016. The net interest margin was 3.81% for the first nine months of 2017, up from 3.77% for the first nine months of 2016. Average total loans outstanding were up $57.6 million (8.0%) in the first nine months of 2017 as compared to the first nine months of 2016, while average total available-for-sale securities were lower by $33.0 million. Average total deposits were $20.4 million (2.1%) higher in the first nine months of 2017 as compared to the first nine months of 2016.

 

·The provision for loan losses of $778,000 for the first nine months of 2017 was $446,000 lower than the amount for the first nine months of 2016. In 2017, the provision included $844,000 related to the change in total specific allowances on impaired loans, as adjusted for net charge-offs during the period and a $102,000 increase in the unallocated portion of the allowance, with a reduction in the provision of $168,000 related to the reduction in the collectively determined allowance for loan losses. The reduction in the collectively determined allowance included the effects of an improvement in aggregate net charge-off experience and a reduction in the qualitative factors used to estimate the allowance as of September 30, 2017. The net increase in specific allowances in the first nine months of 2017 included an increase in the allowance related to one real estate secured commercial loan of $424,000 to $952,000 at September 30, 2017 as compared to $528,000 at December 31, 2016. The increase in the specific allowance for this loan was based on an updated appraisal. In comparison, the provision for the first nine months of 2016 included $557,000 related to the change in total specific allowances on impaired loans, as adjusted for net charge-offs during the period, a $29,000 decrease in the unallocated portion of the allowance and an increase in the provision of $696,000 related to an increase in the collectively determined allowance for loan losses. The increase in the collectively determined portion of the allowance at September 30, 2016 as compared to the end of the preceding year resulted from loan growth and slight increases in the net charge-off and qualitative factors used to estimate the allowance.

 

·Noninterest revenue increased $556,000 (4.8%) in the first nine months of 2017 as compared to the first nine months of 2016. Trust and financial management revenue increased $402,000 (11.3%), reflecting growth in assets under management resulting from market appreciation and new business, as well as a recent increase in fee levels and an estimated $215,000 of additional revenue from changing the frequency of billings to monthly for certain services. Interchange revenue from debit card transactions increased $218,000 (15.2%), reflecting improvements in card-related volumes and processing. Loan servicing fees, net, increased $123,000, as the fair value of mortgage servicing rights decreased by $145,000 in the first nine months of 2017 as compared to a reduction of $247,000 in the first nine months of 2016. Service charges on deposit accounts decreased $177,000 (5.0%), as revenue from consumer overdrafts declined due to lower volume.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

·Realized gains on available-for-sale securities totaled $257,000 in the first nine months of 2017, down from $1,089,000 in the first nine months of 2016. Within this category, gains from sales of bank stocks totaled $837,000 in the first nine months of 2016. As noted above, the Corporation sold all of its investments in bank stocks prior to 2017.

 

·Total noninterest expenses increased $1,380,000 (5.3%) for the first nine months of 2017 as compared to the first nine months of 2016. Other operating expense increased $682,000. Within other operating expense, the largest variances included increases of $182,000 in loan collection expenses, $129,000 in attorney fees (mainly related to a commercial loan workout situation) and $94,000 in accounting and auditing expense stemming from increased internal audit outsourcing. Pensions and other employee benefits expense increased $391,000, primarily as a result of higher health care expenses on the Corporation’s partially self-insured plan. Software subscriptions increased $141,000, including costs associated with new applications as well as annual licensing increases. Automated teller machine and interchange expense increased $138,000, including increased costs related to fraud protection services and higher volume of debit card transactions. FDIC assessments expense decreased $165,000, reflecting a lower assessment level. Professional fees expense decreased $66,000, reflecting a reduction in information technology and sales and service-related consulting expense.

 

·The income tax provision was $3,620,000 for the first nine months of 2017 (24.0% of pre-tax income), down from $3,847,000 (25.0% of pre-tax income) for the first nine months of 2016. The lower amount of tax provision and effective tax rate in 2017 resulted from lower pre-tax income, along with the effects of a change in accounting for stock-based compensation that requires recognition of the tax benefits as a reduction in the tax provision and a $30,000 catch up adjustment in 2016 for an increase in the New York State tax provision related to a change in tax methodology that first became effective in 2015.

 

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

 

TABLE I - QUARTERLY FINANCIAL DATA                         
(Dollars In Thousands, Except Per Share Data)
(Unaudited)
  For the Three Months Ended:                 
   Sept. 30,   June 30,   Mar. 31,   Dec. 31,   Sept. 30,   June 30,   Mar. 31, 
   2017   2017   2017   2016   2016   2016   2016 
Interest income  $11,626   $11,340   $11,112   $11,106   $11,131   $10,924   $10,937 
Interest expense   985    978    953    920    944    925    904 
Net interest income   10,641    10,362    10,159    10,186    10,187    9,999    10,033 
Provision (credit) for loan losses   322    4    452    (3)   538    318    368 
Net interest income after provision (credit) for loan losses   10,319    10,358    9,707    10,189    9,649    9,681    9,665 
Other income   4,066    4,106    3,864    4,031    3,884    3,906    3,690 
Net gains on available-for-sale securities   5    107    145    69    584    122    383 
Other expenses   9,192    9,076    9,298    8,558    8,579    8,535    9,072 
Income before income tax provision   5,198    5,495    4,418    5,731    5,538    5,174    4,666 
Income tax provision   1,262    1,374    984    1,500    1,451    1,303    1,093 
Net income  $3,936   $4,121   $3,434   $4,231   $4,087   $3,871   $3,573 
Net income attributable to common shares  $3,916   $4,100   $3,416   $4,209   $4,065   $3,850   $3,553 
Basic earnings per common share  $0.32   $0.34   $0.28   $0.35   $0.34   $0.32   $0.29 
Diluted earnings per common share  $0.32   $0.34   $0.28   $0.35   $0.34   $0.32   $0.29 

 

CRITICAL ACCOUNTING POLICIES

 

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

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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

 

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

 

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

 

NET INTEREST INCOME

 

The Corporation’s primary source of operating income is net interest income, which is equal to the difference between the amounts of interest income and interest expense. Tables II, III and IV include information regarding the Corporation’s net interest income for the three-month and nine-month periods ended September 30, 2017 and September 30, 2016. In each of these tables, the amounts of interest income earned on tax-exempt securities and loans have been adjusted to a fully taxable-equivalent basis. Accordingly, the net interest income amounts reflected in these tables exceed the amounts presented in the consolidated financial statements. The discussion that follows is based on amounts in the related Tables.

 

Nine-Month Periods Ended September 30, 2017 and 2016

 

For the nine-month periods, fully taxable equivalent net interest income was $33,240,000 in 2017, $943,000 (2.9%) higher than in 2016. Interest income was $1,084,000 higher in 2017 as compared to 2016; interest expense was also higher by $141,000 in comparing the same periods. As presented in Table III, the Net Interest Margin was 3.81% in 2017 as compared to 3.77% in 2016, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) increased to 3.67% in the nine-month period ended September 30, 2017 from 3.64% in the nine-month period ended September 30, 2016.

 

INTEREST INCOME AND EARNING ASSETS

 

Interest income totaled $36,154,000 in 2017, an increase of 3.1% from 2016. The overall yield on earning assets increased to 4.15% in 2017 from 4.09% in 2016, reflecting the impact of loan growth and a reduction in lower-yielding securities as a percentage of total earning assets.

 

Interest and fees on loans receivable increased $1,656,000, or 6.3%. The average balance of gross loans receivable increased $57,563,000, or 8.0%, to $773,138,000 in 2017 from $715,575,000 in 2016. The Corporation experienced growth in both mortgage and commercial loans. The Corporation’s average yield on loans receivable declined to 4.87% in 2017 from 4.94% in 2016 as average interest rates on new loans have been lower than the average rates on loans that have been fully or partially paid off.

 

As indicated in Table III, average available-for-sale securities (at amortized cost) totaled $374,298,000 in 2017, a decrease of $33,049,000 (8.1%) from 2016. The Corporation’s yield on securities was 2.81% in 2017 as compared to 2.78% in 2016.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES

 

Interest expense increased $141,000, or 5.1%, to $2,914,000 in 2017 from $2,773,000 in 2016. Table III shows that the overall cost of funds on interest-bearing liabilities increased to 0.48% in 2017 from 0.45% in 2016. The increase in interest expense is mainly a result of increases in rates paid on interest checking accounts and certificates of deposit.

 

Total average deposits (interest-bearing and noninterest-bearing) increased 2.1%, to $985,961,000 in 2017 from $965,584,000 in 2016. Increases in the average balances of demand deposits, savings and interest checking accounts were contributors to the increase in total average deposits, while the average balances of money market accounts and Individual Retirement Accounts (IRAs) declined.

 

Total average borrowed funds decreased $3,618,000 to $60,858,000 in 2017 from $64,476,000 in 2016. The average rate on borrowed funds was 2.59% in 2017 compared to 2.53% in 2016 primarily due to an increase in short term borrowing rates in 2017.

 

Three-Month Periods Ended September 30, 2017 and 2016

 

For the three-month periods, fully taxable equivalent net interest income was $11,337,000 in 2017, which was $468,000 (4.3%) higher than in 2016. Interest income was $507,000 higher in 2017 as compared to 2016, while interest expense was higher by $39,000 in comparing the same periods. As presented in Table III, the Net Interest Margin was 3.83% in 2017 as compared to 3.74% in 2016, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) was 3.68% in 2017 as compared to 3.61% in 2016. The yield on earning assets increased to 4.16% in the third quarter 2017 from 4.07% in the third quarter 2016, while the overall cost of funds on interest-bearing liabilities increased to 0.48% in the third quarter 2017 from 0.46% in the third quarter 2016.

 

Interest income totaled $12,320,000 in 2017, an increase of $507,000 (4.3%) from 2016. Interest and fees from loans receivable increased $656,000, or 7.3%, in 2017 as compared to 2016, while income from available-for-sale securities decreased $190,000 (7.0%). As indicated in Table III, for the three-month periods, the average balance of gross loans receivable increased 7.5% to $788,346,000 in 2017 from $733,016,000 in 2016. The average rate of return on loans was 4.88% in 2017, down slightly from 4.91% in 2016. Total average available-for-sale securities (at amortized cost) in 2017 decreased to $363,495,000 from $404,526,000 in 2016. The average rate of return on available-for-sale securities was 2.78% for 2017, up from 2.69% in 2016.

 

For the three-month periods, interest expense increased $39,000, or 4.1%, to $983,000 in 2017 from $944,000 in 2016. This included an increase of $89,000 in interest expense on deposits, as the average rate paid on deposits increased 0.05%, including increases of 0.10% on interest checking and 0.08% on certificates of deposit. Total average deposits (interest-bearing and noninterest-bearing) amounted to $1,010,201,000 in the third quarter 2017, an increase of $26,848,000 (2.7%) from the third quarter 2016 total. The increase in total average deposits consisted of increases in noninterest-bearing demand deposits of $16,959,000 and an overall increase in interest bearing deposits of $9,889,000, including increases of $18,844,000 in interest checking and $11,756,000 in savings accounts partially offset by decreases in money market accounts, IRAs and certificates of deposit.

 

Interest expense on total borrowed funds decreased $50,000 in 2017 as compared to 2016. Interest expense on short-term borrowings decreased $22,000 and interest expense on long-term borrowings decreased by $28,000 in 2017 as compared to 2016. The average balance of total borrowed funds decreased to $43,608,000 in the third quarter 2017 from $57,226,000 in the third quarter 2016, while the average rate on borrowed funds increased to 3.14% in the third quarter 2017 from 2.75% in the third quarter 2016.

 

The average balance of short-term borrowings decreased to $7,139,000 in the third quarter 2017 from $18,655,000 in 2016, and the average rate on short-term borrowings decreased to 0.44% in 2017 from 0.64% in 2016.

 

The average balance of long-term borrowings was $36,469,000 in the third quarter 2017, at an average rate of 3.67%, down from an average balance of $38,571,000 at an average rate of 3.76% in the third quarter 2016. Borrowings are classified as long-term within the Tables based on their term at origination; however, within this category, a borrowing with a balance of $10,000,000 at a rate of 3.81% matured in September 2017 and a borrowing with a balance of $27,000,000 at a rate of 3.595% matures in December 2017.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

TABLE II - ANALYSIS OF INTEREST INCOME AND EXPENSE

 

   Three Months Ended       Nine Months Ended     
   September 30,   Increase/   September 30,   Increase/ 
(In Thousands)  2017   2016   (Decrease)   2017   2016   (Decrease) 
                         
INTEREST INCOME                              
Available-for-sale securities:                              
Taxable  $1,341   $1,456   $(115)  $4,106   $4,540   $(434)
Tax-exempt   1,202    1,277    (75)   3,753    3,941    (188)
Total available-for-sale securities   2,543    2,733    (190)   7,859    8,481    (622)
Interest-bearing due from banks   67    29    38    140    89    51 
Loans held for sale   10    7    3    20    21    (1)
Loans receivable:                              
Taxable   8,889    8,347    542    25,872    24,407    1,465 
Tax-exempt   811    697    114    2,263    2,072    191 
Total loans receivable   9,700    9,044    656    28,135    26,479    1,656 
Total Interest Income   12,320    11,813    507    36,154    35,070    1,084 
                               
INTEREST EXPENSE                              
Interest-bearing deposits:                              
Interest checking   141    78    63    324    210    114 
Money market   94    89    5    264    254    10 
Savings   36    34    2    106    99    7 
Certificates of deposit   255    238    17    717    660    57 
Individual Retirement Accounts   111    109    2    322    326    (4)
Other time deposits   1    1    0    1    1    0 
Total interest-bearing deposits   638    549    89    1,734    1,550    184 
Borrowed funds:                              
Short-term   8    30    (22)   130    133    (3)
Long-term   337    365    (28)   1,050    1,090    (40)
Total borrowed funds   345    395    (50)   1,180    1,223    (43)
Total Interest Expense   983    944    39    2,914    2,773    141 
                               
Net Interest Income  $11,337   $10,869   $468   $33,240   $32,297   $943 

 

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

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

TABLE III - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES

(Dollars in Thousands)

 

   3 Months       3 Months       9 Months       9 Months     
   Ended   Rate of   Ended   Rate of   Ended   Rate of   Ended   Rate of 
   9/30/2017   Return/   9/30/2016   Return/   9/30/2017   Return/   9/30/2016   Return/ 
   Average   Cost of   Average   Cost of   Average   Cost of   Average   Cost of 
   Balance   Funds %   Balance   Funds %   Balance   Funds %   Balance   Funds % 
EARNING ASSETS                                        
Available-for-sale securities, at amortized cost:                                        
Taxable  $251,774    2.11%  $291,847    1.98%  $259,539    2.12%  $298,421    2.03%
Tax-exempt   111,721    4.27%   112,679    4.51%   114,759    4.37%   108,926    4.83%
Total available-for-sale securities   363,495    2.78%   404,526    2.69%   374,298    2.81%   407,347    2.78%
Interest-bearing due from banks   21,260    1.25%   17,138    0.67%   17,042    1.10%   20,566    0.58%
Loans held for sale   781    5.08%   556    5.01%   496    5.39%   516    5.44%
Loans receivable:                                        
Taxable   717,012    4.92%   671,408    4.95%   706,065    4.90%   654,256    4.98%
Tax-exempt   71,334    4.51%   61,608    4.50%   67,073    4.51%   61,319    4.51%
Total loans receivable   788,346    4.88%   733,016    4.91%   773,138    4.87%   715,575    4.94%
Total Earning Assets   1,173,882    4.16%   1,155,236    4.07%   1,164,974    4.15%   1,144,004    4.09%
Cash   18,325         17,523         17,213         16,548      
Unrealized gain/loss on securities   1,449         9,654         402         8,154      
Allowance for loan losses   (8,769)        (8,050)        (8,755)        (7,913)     
Bank premises and equipment   15,431         15,379         15,618         15,409      
Intangible Assets   11,958         11,966         11,958         11,968      
Other assets   40,944         38,225         42,038         38,563      
Total Assets  $1,253,220        $1,239,933        $1,243,448        $1,226,733      
                                         
INTEREST-BEARING LIABILITIES                                        
Interest-bearing deposits:                                        
Interest checking  $219,633    0.25%  $200,789    0.15%  $208,071    0.21%  $197,628    0.14%
Money market   194,947    0.19%   205,158    0.17%   192,265    0.18%   199,211    0.17%
Savings   145,025    0.10%   133,269    0.10%   142,292    0.10%   131,880    0.10%
Certificates of deposit   119,351    0.85%   123,475    0.77%   116,500    0.82%   118,256    0.75%
Individual Retirement Accounts   96,934    0.45%   103,259    0.42%   97,981    0.44%   104,280    0.42%
Other time deposits   1,472    0.27%   1,523    0.26%   1,126    0.12%   1,157    0.12%
Total interest-bearing deposits   777,362    0.33%   767,473    0.28%   758,235    0.31%   752,412    0.28%
Borrowed funds:                                        
Short-term   7,139    0.44%   18,655    0.64%   23,118    0.75%   25,828    0.69%
Long-term   36,469    3.67%   38,571    3.76%   37,740    3.72%   38,648    3.77%
Total borrowed funds   43,608    3.14%   57,226    2.75%   60,858    2.59%   64,476    2.53%
Total Interest-bearing Liabilities   820,970    0.48%   824,699    0.46%   819,093    0.48%   816,888    0.45%
Demand deposits   232,839         215,880         227,726         213,172      
Other liabilities   8,801         9,057         8,181         8,249      
Total Liabilities   1,062,610         1,049,636         1,055,000         1,038,309      
Stockholders' equity, excluding other comprehensive income/loss   189,520         183,966         188,041         183,078      
Accumulated other comprehensive income/loss   1,090         6,331         407         5,346      
Total Stockholders' Equity   190,610         190,297         188,448         188,424      
Total Liabilities and Stockholders' Equity  $1,253,220        $1,239,933        $1,243,448        $1,226,733      
Interest Rate Spread        3.68%        3.61%        3.67%        3.64%
Net Interest Income/Earning Assets        3.83%        3.74%        3.81%        3.77%
                                         
Total Deposits (Interest-bearing and Demand)  $1,010,201        $983,353        $985,961        $965,584      

 

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

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

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

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

TABLE IV - ANALYSIS OF VOLUME AND RATE CHANGES

 

(In Thousands)  3 Months Ended 9/30/17 vs. 9/30/16   9 Months Ended 9/30/17 vs. 9/30/16 
   Change in   Change in   Total   Change in   Change in   Total 
   Volume   Rate   Change   Volume   Rate   Change 
EARNING ASSETS                              
Available-for-sale securities:                              
Taxable  $(206)  $91   $(115)  $(612)  $178   $(434)
Tax-exempt   (13)   (62)   (75)   202    (390)   (188)
Total available-for-sale securities   (219)   29    (190)   (410)   (212)   (622)
Interest-bearing due from banks   8    30    38    (17)   68    51 
Loans held for sale   3    0    3    (1)   0    (1)
Loans receivable:                              
Taxable   583    (41)   542    1,886    (421)   1,465 
Tax-exempt   112    2    114    192    (1)   191 
Total loans receivable   695    (39)   656    2,078    (422)   1,656 
Total Interest Income   487    20    507    1,650    (566)   1,084 
                               
INTEREST-BEARING LIABILITIES                              
Interest-bearing deposits:                              
Interest checking   8    55    63    12    102    114 
Money market   (5)   10    5    (9)   19    10 
Savings   3    (1)   2    8    (1)   7 
Certificates of deposit   (8)   25    17    (10)   67    57 
Individual Retirement Accounts   (7)   9    2    (21)   17    (4)
Other time deposits   0    0    0    0    0    0 
Total interest-bearing deposits   (9)   98    89    (20)   204    184 
Borrowed funds:                              
Short-term   (21)   (1)   (22)   (15)   12    (3)
Long-term   (19)   (9)   (28)   (26)   (14)   (40)
Total borrowed funds   (40)   (10)   (50)   (41)   (2)   (43)
Total Interest Expense   (49)   88    39    (61)   202    141 
                               
Net Interest Income  $536   $(68)  $468   $1,711   $(768)  $943 

 

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

 

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

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

NONINTEREST INCOME

 

TABLE V - COMPARISON OF NONINTEREST INCOME

(Dollars In Thousands)

 

   9 Months Ended         
   September 30,   $   % 
   2017   2016   Change   Change 
Service charges on deposit accounts  $3,346   $3,523   $(177)   (5.0)
Service charges and fees   316    335    (19)   (5.7)
Trust and financial management revenue   3,969    3,567    402    11.3 
Brokerage revenue   551    569    (18)   (3.2)
Insurance commissions, fees and premiums   98    74    24    32.4 
Interchange revenue from debit card transactions   1,649    1,431    218    15.2 
Net gains from sales of loans   651    699    (48)   (6.9)
Loan servicing fees, net   162    39    123    315.4 
Increase in cash surrender value of life insurance   281    286    (5)   (1.7)
Other operating income   1,013    957    56    5.9 
Total noninterest income before realized gains on available-for-sale securities, net  $12,036   $11,480   $556    4.8 

 

Table V excludes realized gains on available-for-sale securities, which are discussed in the “Earnings Overview” section of Management’s Discussion and Analysis. Total noninterest income shown in Table V increased $556,000 (4.8%) in the first nine months of 2017 over the first nine months of 2016 amount. The most significant variances include the following:

 

·Trust and financial management revenue increased $402,000 (11.3%). The increase in revenue included the impact of a change in the frequency of billings for many accounts from a quarterly billing cycle to monthly, resulting in additional fees of $215,000 more than would otherwise have been recognized in the first nine months of 2017. (Trust revenue is recognized on a cash basis, which would not ordinarily vary significantly from an amount determined on an accrual basis.) The increase also included the effects of a recent increase in fee levels and an increase in the value of assets under management to $924,907,000 at September 30, 2017, up 6.6% from one year earlier. The increase in value of Trust assets under management resulted from appreciation in equity values and new business.

 

·Interchange revenue from debit card transactions increased $218,000 (15.2%), reflecting improvements in card-related volumes and processing.

 

·Loan servicing fees, net, increased $123,000. This category includes fees received from servicing residential mortgage loans that have been originated and sold, adjusted for changes in the fair value of servicing rights. The fair value of mortgage servicing rights decreased by $145,000 in the first nine months of 2017 as compared to a reduction of $247,000 in the same period of 2016.

 

·Other operating income increased $56,000 in the first nine months of 2017 as compared to the same period in 2016. Within this category there were increases in revenue from merchant services, check sales, dividends from Federal Home Loan Bank of Pittsburgh stock, realization of tax credits and fees from sales of loans on an agency basis under government programs (primarily FHA). These increases were partially offset by a net $116,000 decrease in interchange revenue from credit card transactions, as interchange fees from the Corporation’s recently implemented credit card offering have been less than the amount received in 2016 under an agency arrangement.

 

·Service charges on deposit accounts decreased $177,000 (5.0%), as revenue from consumer overdrafts declined due to lower volume.

 

·Net gains from sales of loans were $48,000 lower for the first nine months of 2017 as compared to 2016, due to a lower average profit margin. The reduction in average profit margin resulted from competitive pricing pressures.

 

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TABLE VI - COMPARISON OF NONINTEREST INCOME

(Dollars In Thousands)

 

   3 Months Ended         
   September 30,   $   % 
   2017   2016   Change   Change 
Service charges on deposit accounts  $1,168   $1,221   $(53)   (4.3)
Service charges and fees   115    118    (3)   (2.5)
Trust and financial management revenue   1,292    1,172    120    10.2 
Brokerage revenue   187    216    (29)   (13.4)
Insurance commissions, fees and premiums   26    26    0    0.0 
Interchange revenue from debit card transactions   561    481    80    16.6 
Net gains from sales of loans   297    236    61    25.8 
Loan servicing fees, net   35    28    7    25.0 
Increase in cash surrender value of life insurance   97    97    0    0.0 
Other operating income   288    289    (1)   (0.3)
Total noninterest income before realized gains on available-for-sale securities, net  $4,066   $3,884   $182    4.7 

 

Table VI excludes realized gains on available-for-sale securities, which are discussed in the “Earnings Overview” section of Management’s Discussion and Analysis. Total noninterest income shown in Table VI increased $182,000 (4.7%) in the third quarter of 2017 as compared to the third quarter of 2016. The most significant variances include the following:

 

·Trust and financial management revenue increased $120,000 (10.2%), reflecting growth in assets under management resulting from market appreciation and new business, as well as a recent increase in fee levels.

 

·Interchange revenue from debit card transactions increased $80,000 (16.6%), reflecting benefits from a consulting project in 2016 that identified opportunities for improvements in card-related volumes and processing.

 

·Net gains from sales of loans increased $61,000 (25.8%) in the third quarter 2017 as compared to the third quarter 2016, reflecting increases in sales volume and average profit margin.

 

·Service charges on deposit accounts decreased $53,000 (4.3%), as revenue from consumer overdrafts declined due to lower volume.

 

NONINTEREST EXPENSE

 

TABLE VII - COMPARISON OF NONINTEREST EXPENSE

(Dollars In Thousands)

 

   9 Months Ended         
   September 30,   $   % 
   2017   2016   Change   Change 
Salaries and wages  $11,825   $11,701   $124    1.1 
Pensions and other employee benefits   3,890    3,499    391    11.2 
Occupancy expense, net   1,758    1,770    (12)   (0.7)
Furniture and equipment expense   1,372    1,301    71    5.5 
FDIC Assessments   283    448    (165)   (36.8)
Pennsylvania shares tax   1,008    932    76    8.2 
Professional fees   750    816    (66)   (8.1)
Automated teller machine and interchange expense   945    807    138    17.1 
Software subscriptions   870    729    141    19.3 
Other operating expense   4,865    4,183    682    16.3 
Total noninterest expense  $27,566   $26,186   $1,380    5.3 

 

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As shown in Table VII, total noninterest expense increased $1,380,000 (5.3%) in the first nine months of 2017 as compared to the first nine months of 2016. The most significant variances include the following:

 

·Other operating expense increased $682,000. Within other operating expense, the largest variances included increases of $182,000 in loan collection expenses, $129,000 in attorney fees (mainly related to a commercial loan workout situation) and $94,000 in accounting and auditing expense stemming from increased internal audit outsourcing.

 

·Pensions and other employee benefits expense increased $391,000, primarily as a result of higher health care expenses on the Corporation’s partially self-insured plan.

 

·Software subscriptions increased $141,000, including costs associated with new applications as well as annual licensing increases.

 

·Automated teller machine and interchange expense increased $138,000, including increased costs related to fraud protection services and higher volume of debit card transactions.

 

·FDIC assessments expense decreased $165,000, reflecting a lower assessment level.

 

·Professional fees expense decreased $66,000, reflecting a reduction in information technology and sales and service-related consulting expense.

 

TABLE VIII - COMPARISON OF NONINTEREST EXPENSE

(Dollars In Thousands)

 

   3 Months Ended         
   September 30,   $   % 
   2017   2016   Change   Change 
Salaries and wages  $3,985   $3,901   $84    2.2 
Pensions and other employee benefits   1,216    1,060    156    14.7 
Occupancy expense, net   580    601    (21)   (3.5)
Furniture and equipment expense   471    435    36    8.3 
FDIC Assessments   93    151    (58)   (38.4)
Pennsylvania shares tax   336    287    49    17.1 
Professional fees   269    245    24    9.8 
Automated teller machine and interchange expense   346    291    55    18.9 
Software subscriptions   299    237    62    26.2 
Other operating expense   1,597    1,371    226    16.5 
Total noninterestexpense  $9,192   $8,579   $613    7.1 

 

As shown in Table VIII, total noninterest expense increased $613,000 (7.1%) in the third quarter 2017 as compared to the third quarter 2016. The most significant variances include the following:

 

·Other operating expense increased $226,000. The increase in other operating expense included an increase of $97,000 in attorney fees, mainly related to a commercial loan workout situation, and an increase in accounting and auditing expense of $46,000 resulting from an increase in outsourced internal audit activity.

 

·Pensions and other employee benefits expense increased $156,000, mainly due to higher health care expenses on the Corporation’s partially self-insured plan.

 

·Salaries and wages expense increased $84,000, or 2.2%.

 

·Software subscriptions increased $62,000, including costs associated with new applications as well as annual licensing increases.

 

·Automated teller machine and interchange expense increased $55,000, including increased costs related to fraud protection services and higher volume of debit card transactions.

 

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·Pennsylvania shares tax increased $49,000, reflecting a tax rate increase and an increase in C&N Bank capital.

 

·FDIC assessments expense decreased $58,000, reflecting a lower assessment level.

 

FINANCIAL CONDITION

 

This section includes information regarding the Corporation’s lending activities or other significant changes or exposures that are not otherwise addressed in Management’s Discussion and Analysis. Significant changes in the average balances of the Corporation’s earning assets and interest-bearing liabilities are described in the “Net Interest Income” section of Management’s Discussion and Analysis. Other significant balance sheet items, including the allowance for loan losses and stockholders’ equity, are discussed in separate sections of Management’s Discussion and Analysis. There are no significant concerns that have arisen related to the Corporation’s off-balance sheet loan commitments or outstanding standby letters of credit at September 30, 2017, and management does not expect capital expenditures to have a material, detrimental effect on the Corporation’s financial condition in 2017.

 

Gross loans outstanding (excluding mortgage loans held for sale) were $801,012,000 at September 30, 2017, up 6.5% from $751,835,000 at December 31, 2016 and up 7.9 % from $742,338,000 at September 30, 2016. Total outstanding mortgages and other consumer real estate loans were $21,026,000 (5.0%) higher at September 30, 2017 as compared to December 31, 2016 and increased $31,539,000 (7.7%) compared to September 30, 2016. Total outstanding commercial loans were higher by $26,920,000 (8.5%) at September 30, 2017 as compared to December 31, 2016 and $24,988,000 (7.8%) as compared to September 30, 2016. Average loans outstanding in the first nine months of 2017 of $773,138,000 were $57,563,000 (8.0%) higher than the corresponding total in the first nine months of 2016. The increase in loans outstanding over the last quarter of 2016 and first three quarters of 2017 have included significant increases in mortgages and other consumer real estate loans as well as commercial loans.

 

While the Corporation’s lending activities are primarily concentrated in its market area, a portion of the Corporation’s commercial loan segment consists of participation loans. Participation loans represent portions of larger commercial transactions for which other institutions are the “lead banks”. Although not the lead bank, the Corporation conducts detailed underwriting and monitoring of participation loan opportunities. Participation loans are included in the “Commercial and industrial,” “Commercial loans secured by real estate” and “Political subdivisions” classes in the loan tables presented in this Form 10-Q. Total participation loans outstanding amounted to $53,559,000 at September 30, 2017, up from $47,508,000 at December 31, 2016 and $48,670,000 at September 30, 2016. At September 30, 2017, the balance of participation loans outstanding includes a total of $45,369,000 to businesses located outside of the Corporation’s market area, including $11,806,000 from participations in loans originated through the Corporation’s membership in a network that originates loans throughout the U.S. The Corporation’s participation loans originated through the network consist of loans to businesses that are larger than the Corporation’s typical commercial customer base. The loans originated through the network are considered “leveraged loans,” meaning the businesses typically have minimal tangible book equity and the extent of collateral available is limited, though at the time of origination the businesses have demonstrated strong cash flow performance in their recent histories. Total leveraged participation loans, including loans originated through the network and two loans originated through another lead institution, totaled $13,490,000 at September 30, 2017, $15,207,000 at December 31, 2016 and $14,688,000 at September 30, 2016.

 

Since 2009, the Corporation has originated and sold residential mortgage loans to the secondary market through the MPF Xtra program administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Residential mortgages originated and sold through the MPF Xtra program consist primarily of conforming, prime loans sold to the Federal National Mortgage Association (Fannie Mae), a quasi-government entity. In 2014, the Corporation began to originate and sell residential mortgage loans to the secondary market through the MPF Original program, which is also administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Residential mortgages originated and sold through the MPF Original program consist primarily of conforming, prime loans sold to the Federal Home Loan Bank of Pittsburgh.

 

For loan sales originated under the MPF Xtra and Original programs, the Corporation provides customary representations and warranties to investors that specify, among other things, that the loans have been underwritten to the standards established by the investor. The Corporation may be required to repurchase a loan and reimburse a portion of fees received, or reimburse the investor for a credit loss incurred on a loan, if it is determined that the representations and warranties have not been met. Such repurchases or reimbursements generally result from an underwriting or documentation deficiency. At September 30, 2017, the total outstanding balance of loans the Corporation has repurchased

as a result of identified instances of noncompliance amounted to $1,817,000, and the corresponding total outstanding balance repurchased at December 31, 2016 was $1,852,000.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

At September 30, 2017, outstanding balances of loans sold and serviced through the two programs totaled $169,581,000, including loans sold through the MPF Xtra program of $109,692,000 and loans sold through the Original program of $59,889,000. At December 31, 2016, outstanding balances of loans sold and serviced through the two programs totaled $163,296,000, including loans sold through the MPF Xtra program of $116,978,000 and loans sold through the Original program of $46,318,000. Based on the fairly limited volume of required repurchases to date, no allowance has been established for representation and warranty exposures as of September 30, 2017 and December 31, 2016.

 

For loans sold under the Original program, the Corporation provides a credit enhancement whereby the Corporation would assume credit losses in excess of a defined First Loss Account (“FLA”) balance, up to specified amounts. The FLA is funded by the Federal Home Loan Bank of Pittsburgh based on a percentage of the outstanding balance of loans sold. At September 30, 2017, the Corporation has recorded an allowance in the amount of $244,000 for credit losses on loans sold under the MPF Original Program which is included in “Accrued interest and other liabilities” in the accompanying balance sheet. The corresponding recorded allowance at December 31, 2016 was $196,000. The Corporation does not provide a credit enhancement for loans sold through the Xtra program.

 

PROVISION AND ALLOWANCE FOR LOAN LOSSES

 

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

 

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

 

The allowance for loan losses was $8,900,000 at September 30, 2017, up from $8,473,000 at December 31, 2016. Table X shows total specific allowances on impaired loans increased $493,000 to $1,167,000 at September 30, 2017 from $674,000 at December 31, 2016. The net increase in specific allowances in the first nine months of 2017 included an increase of $424,000 in the allowance related to one real estate secured commercial loan. The increase in the specific allowance for this loan was based on an updated appraisal. At September 30, 2017, the outstanding balance of this loan was $2,686,000, and the related allowance was $952,000.

 

Table X also shows that the collectively determined portion of the allowance related to commercial loans decreased $294,000, to $3,079,000 at September 30, 2017 from $3,373,000 at December 31, 2016. The decrease in the collectively determined allowance on commercial loans resulted from an aggregate improvement (reduction) in the net charge-off experience and qualitative factors used to value the allowance on commercial loans, partially offset by the impact of an increase in outstanding loans. The aggregate net charge-off experience factor used in the allowance calculation on commercial loans was 0.09% lower at September 30, 2017 as compared to December 31, 2016. The Corporation’s aggregate net charge-off rate on commercial loans has been improving over the past several quarters, as the effects on the overall rate of a large ($1,486,000) charge-off in 2014 on a commercial loan secured by real estate has gradually diminished. The qualitative factors used in the allowance calculation for commercial loans were 0.06% lower at September 30, 2017 as compared to December 31, 2016, reflecting a pattern of overall improvement in loan delinquency levels and a reduction in the unemployment rate throughout most of the Corporation’s market area over the previous 12-18 months.

 

Throughout 2016 and at March 31, 2017, a rolling three-year average net charge-off rate was used for all loan classes. At June 30, 2017 and September 30, 2017, a five-year average net charge-off rate was used for commercial loans secured by real estate and for multi-family residential loans, while a three-year average net charge-off rate was used for all other loan classes. The change in time period for these two loan classes was based on management’s evaluation of an appropriate time period that captures an historical loss experience relevant to the current portfolio.

 

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The provision for loan losses by segment in the three-month and nine-month periods ended September 30, 2017 and 2016 is as follows:

 

(In Thousands)  3 Months Ended   9 Months Ended 
   Sept. 30,   Sept. 30,   Sept. 30,   Sept. 30, 
   2017   2016   2017   2016 
Residential mortgage  $101   $178   $269   $452 
Commercial   140    337    293    750 
Consumer   81    23    114    51 
Unallocated   0    0    102    (29)
                     
Total  $322   $538   $778   $1,224 

 

The overall decreases in the provision for loan losses for the third quarter and first nine months of 2017 as compared to the corresponding periods of 2016 reflect decreases in the collectively determined allowance for loan losses including a reduction in the qualitative factors used to determine the allowance as well as a reduction in the historical average net charge-offs as a percentage of outstanding loans as described above. More detail related to the largest segments, residential mortgage and commercial, is as follows:

 

·The provision for the residential mortgage segment in the third quarter 2017 included $103,000 related to an increase in the collectively determined portion of the allowance. The third quarter 2017 increase in the collectively determined portion of the allowance on residential mortgage loans resulted from the increase in outstanding mortgage loans partially offset by a 0.03% reduction in qualitative factors, reflecting improvements in delinquency trends and a reduction in the unemployment rate in the Corporation’s market area over the previous 12-18 months. In comparison, the provision for the residential mortgage segment in the third quarter 2016 included $29,000 related to net charge-offs during the period and an increase of $149,000 in the collectively determined portion of the allowance. The increase in the collectively determined portion of the allowance in the third quarter 2016 resulted mainly from growth in outstanding loans.

 

·For the first nine months of 2017, the provision for the residential mortgage segment included net charge-offs totaling $160,000 and a net increase in the collectively determined allowance of $109,000. The net increase in the collectively determined portion of the allowance for residential mortgage loans included the effects of an increase in loans outstanding, partially offset by a 0.03% reduction in qualitative factors used to calculate the allowance at September 30, 2017 as compared to December 31, 2016. For the first nine months of 2016, the provision for the residential mortgage segment included net charge-offs totaling $71,000 and a net increase in the collectively determined allowance of $381,000.

 

·The provision for the commercial segment in the third quarter 2017 included $83,000 related to the change in total specific allowances on impaired loans, as adjusted for net charge-offs during the period in addition to an increase of $57,000 in the collectively determined allowance for loan losses. The increase in the collectively determined allowance on commercial loans was primarily due to an increase in commercial loan balances. In the third quarter 2016, the provision for the commercial segment included a net increase of $433,000 related to the change in total specific allowances on impaired loans, as adjusted for net charge-offs during the period and a decrease of $96,000 in the collectively determined allowance for loan losses.

 

·The provision for the commercial segment for the first nine months of 2017 included $587,000 related to the change in total specific allowances on impaired loans, as adjusted for net charge-offs during the period offset by a decrease of $294,000 in the collectively determined allowance for loan losses. The increase in specific allowances on commercial loans in the first nine months of 2017 included an increase of $424,000 related to a commercial loan that previously had an allowance, as mentioned above. As noted above, the reduction in the collectively determined allowance on commercial loans included the effects of reductions in net charge-off experience and qualitative factors used in calculating the allowance. For the first nine months of 2016, the provision for the commercial segment included $458,000 related to the change in total specific allowances on impaired loans, as adjusted for net charge-offs during the period and an increase of $292,000 in the collectively determined allowance for loan losses.

 

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Table XI presents information related to past due and impaired loans, and loans that have been modified under terms that are considered troubled debt restructurings (TDRs). Total nonperforming loans as a percentage of outstanding loans was 1.92% at September 30, 2017, down from 2.07% at December 31, 2016, and nonperforming assets as a percentage of total assets was 1.35% at September 30, 2017, down from 1.43% at December 31, 2016. Table XI presents data at September 30, 2017 and at the end of each of the years ended December 31, 2012 through 2016. For the range of dates presented in Table XI, total nonperforming loans as a percentage of loans has ranged from a low of 1.41% at December 31, 2012 to a high of 2.80% at December 31, 2013, and total nonperforming assets as a percentage of assets have ranged from a low of 0.82% at December 31, 2012 to a high of 1.53% at December 31, 2013.

 

The balance of loans subject to troubled debt restructurings (TDRs) was $3,733,000 at September 30, 2017, which was $4,944,000 lower than the corresponding total at December 31, 2016, mainly due to removal of one commercial relationship from TDR status. At September 30, 2017, the outstanding contractual balances of loans to this borrower totaled $6,454,000, and the recorded investments totaled $4,649,000. In 2014, the Corporation entered into a forbearance agreement with this commercial borrower which was extended for two additional twelve-month periods, most recently in July 2016. The Corporation recorded a charge-off of $1,486,000 in the second quarter 2014, as the payment amounts based on the forbearance agreement were not sufficient to fully amortize the contractual amount of principal outstanding on the loans. In December 2016, the Corporation and the borrower entered into a modification agreement, terminating the forbearance agreement and establishing loan terms with essentially the same interest rate and monthly payment amounts as had been in effect under the forbearance agreement. The interest rates provided for in the modification agreement were equal to or greater than rates the Corporation would be willing to accept for loans with comparable terms to borrowers with a comparable risk profile at the time of the modification. The borrower has made all required payments on the loans in accordance with the terms of the forbearance agreement, as extended, and the modification agreement. Accordingly, the loans were restored to full accrual status at December 31, 2016 and are no longer included in the amounts reported as TDRs at September 30, 2017.

 

Total impaired loans of $8,969,000 at September 30, 2017 are down $1,891,000 from the corresponding amount at December 31, 2016 of $10,860,000, including a decrease in impaired loans without a valuation allowance of $2,100,000. This net decrease in impaired loans is the result of: (1) removal from impairment status of the loans with the modification agreement noted in the previous paragraph, partially offset by (2) the addition of one commercial loan secured by real estate with an outstanding balance of approximately $2.8 million at September 30, 2017. This commercial loan was reviewed in the third quarter 2017 to determine if a specific allowance for loan losses would be required, and it was determined that no allowance was required at September 30, 2017 based on the estimated net realizable value of the related collateral.

 

Total nonperforming assets of $17,029,000 at September 30, 2017 are $725,000 lower than the corresponding amount at December 31, 2016, summarized as follows:

 

·Total nonaccrual loans at September 30, 2017 of $12,400,000 was $3,664,000 higher than the corresponding December 31, 2016 total, including the effect of classifying as nonaccrual the real estate secured commercial loan with a balance of approximately $2.8 million noted above.

 

·Total loans past due 90 days or more and still accruing interest amounted to $2,979,000 at September 30, 2017, a decrease of $3,859,000 from the total at December 31, 2016. The decrease in 2017 in the balance of loans past due 90 days or more and still accruing interest included the effects of moving the previously noted commercial loan with a balance of $2.8 million to nonaccrual status at September 30, 2017. The reduction in loans past due 90 days or more also included a reduction in residential mortgage loans in that aging category. The Corporation reviews the status of loans past due 90 days or more each quarter to determine if it is appropriate to continue to accrue interest, and has determined the loans included in this category are well secured and that ultimate collection of all principal and interest is probable.

 

·Foreclosed assets held for sale consisted of real estate, and totaled $1,650,000 at September 30, 2017, a decrease of $530,000 from $2,180,000 at December 31, 2016. At September 30, 2017, the Corporation held 13 such properties for sale, with total carrying values of $640,000 related to residential real estate, $646,000 of land and $364,000 related to commercial real estate. At December 31, 2016, the Corporation held 19 such properties for sale, with total carrying values of $1,102,000 related to residential real estate, $650,000 of land and $428,000 related to commercial real estate. The Corporation evaluates the carrying values of foreclosed assets each quarter based on the most recent market activity or appraisals for each property.

 

Over the period 2012-2016 and the first nine months of 2017, each period includes a few large commercial relationships that have required significant monitoring and workout efforts. As a result, a limited number of relationships may significantly impact the total amount of allowance required on impaired loans, and may significantly impact the amount of total charge-offs reported in any one period.

 

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Management believes it has been conservative in its decisions concerning identification of impaired loans, estimates of loss, and nonaccrual status; however, the actual losses realized from these relationships could vary materially from the allowances calculated as of September 30, 2017. Management continues to closely monitor its commercial loan relationships for possible credit losses, and will adjust its estimates of loss and decisions concerning nonaccrual status, if appropriate.

 

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

 

TABLE IX - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES

(Dollars In Thousands)

   9 Months Ended                     
   Sept. 30,   Sept. 30,   Years Ended December 31, 
   2017   2016   2016   2015   2014   2013   2012 
Balance, beginning of year  $8,473   $7,889   $7,889   $7,336   $8,663   $6,857   $7,705 
Charge-offs:                                   
Residential mortgage   (178)   (73)   (73)   (217)   (327)   (95)   (552)
Commercial   (97)   (597)   (597)   (251)   (1,715)   (459)   (498)
Consumer   (127)   (67)   (87)   (94)   (97)   (117)   (171)
Total charge-offs   (402)   (737)   (757)   (562)   (2,139)   (671)   (1,221)
Recoveries:                                   
Residential mortgage   18    2    3    1    25    24    18 
Commercial   3    4    35    214    264    348    8 
Consumer   30    39    82    55    47    58    59 
Total recoveries   51    45    120    270    336    430    85 
Net charge-offs   (351)   (692)   (637)   (292)   (1,803)   (241)   (1,136)
Provision for loan losses   778    1,224    1,221    845    476    2,047    288 
Balance, end of period  $8,900   $8,421   $8,473   $7,889   $7,336   $8,663   $6,857 
Net charge-offs as a % of average loans   0.05%   0.10%   0.09%   0.04%   0.29%   0.04%   0.16%

 

TABLE X - COMPONENTS OF THE ALLOWANCE FOR LOAN LOSSES

(In Thousands)

   Sept. 30,   As of December 31, 
   2017   2016   2015   2014   2013   2012 
ASC 310 - Impaired loans  $1,167   $674   $820   $769   $2,333   $623 
ASC 450 - Collective segments:                              
Commercial   3,079    3,373    3,103    2,732    2,583    2,594 
Residential mortgage   3,999    3,890    3,417    3,295    3,156    3,011 
Consumer   155    138    122    145    193    188 
Unallocated   500    398    427    395    398    441 
Total Allowance  $8,900   $8,473   $7,889   $7,336   $8,663   $6,857 

 

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TABLE XI - PAST DUE AND IMPAIRED LOANS, NONPERFORMING ASSETS                
AND TROUBLED DEBT RESTRUCTURINGS (TDRs)                        
(Dollars In Thousands)  As of                     
   Sept. 30,   As of December 31, 
   2017   2016   2015   2014   2013   2012 
Impaired loans with a valuation allowance  $3,581   $3,372   $1,933   $3,241   $9,889   $2,710 
Impaired loans without a valuation allowance   5,388    7,488    8,041    9,075    6,432    4,719 
Total impaired loans  $8,969   $10,860   $9,974   $12,316   $16,321   $7,429 
Total loans past due 30-89 days and still accruing  $5,978   $7,735   $7,057   $7,121   $8,305   $7,756 
                               
Nonperforming assets:                              
Total nonaccrual loans  $12,400   $8,736   $11,517   $12,610   $14,934   $7,353 
Total loans past due 90 days or more and still accruing   2,979    6,838    3,229    2,843    3,131    2,311 
Total nonperforming loans   15,379    15,574    14,746    15,453    18,065    9,664 
Foreclosed assets held for sale (real estate)   1,650    2,180    1,260    1,189    892    879 
Total nonperforming assets  $17,029   $17,754   $16,006   $16,642   $18,957   $10,543 
                               
Loans subject to troubled debt restructurings (TDRs):                              
Performing  $658   $5,803   $1,186   $1,807   $3,267   $906 
Nonperforming   3,075    2,874    5,178    5,388    908    1,155 
Total TDRs  $3,733   $8,677   $6,364   $7,195   $4,175   $2,061 
                               
Total nonperforming loans as a % of loans   1.92%   2.07%   2.09%   2.45%   2.80%   1.41%
Total nonperforming assets as a % of assets   1.35%   1.43%   1.31%   1.34%   1.53%   0.82%
Allowance for loan losses as a % of total loans   1.11%   1.13%   1.12%   1.16%   1.34%   1.00%
Allowance for loan losses as a % of nonperforming loans   57.87%   54.40%   53.50%   47.47%   47.95%   70.95%

 

TABLE XII - SUMMARY OF LOANS BY TYPE        
Summary of Loans by Type        
(In Thousands)  Sept. 30,   As of December 31, 
   2017   2016   2015   2014   2013   2012 
Residential mortgage:                              
Residential mortgage loans - first liens  $355,285   $334,102   $304,783   $291,882   $299,831   $311,627 
Residential mortgage loans - junior liens   24,694    23,706    21,146    21,166    23,040    26,748 
Home equity lines of credit   36,534    38,057    39,040    36,629    34,530    33,017 
1-4 Family residential construction   25,286    24,908    21,121    16,739    13,909    12,842 
Total residential mortgage   441,799    420,773    386,090    366,416    371,310    384,234 
Commercial:                              
Commercial loans secured by real estate   158,520    150,468    154,779    145,878    147,215    158,413 
Commercial and industrial   83,243    83,854    75,196    50,157    42,387    48,442 
Political subdivisions   54,730    38,068    40,007    17,534    16,291    31,789 
Commercial construction and land   13,937    14,287    5,122    6,938    17,003    28,200 
Loans secured by farmland   7,744    7,294    7,019    7,916    10,468    11,403 
Multi-family (5 or more) residential   7,566    7,896    9,188    8,917    10,985    6,745 
Agricultural loans   6,137    3,998    4,671    3,221    3,251    3,053 
Other commercial loans   12,383    11,475    12,152    13,334    14,631    362 
Total commercial   344,260    317,340    308,134    253,895    262,231    288,407 
Consumer   14,953    13,722    10,656    10,234    10,762    11,269 
Total   801,012    751,835    704,880    630,545    644,303    683,910 
Less: allowance for loan losses   (8,900)   (8,473)   (7,889)   (7,336)   (8,663)   (6,857)
Loans, net  $792,112   $743,362   $696,991   $623,209   $635,640   $677,053 

 

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LIQUIDITY

 

Liquidity is the ability to quickly raise cash at a reasonable cost. An adequate liquidity position permits the Corporation to pay creditors, compensate for unforeseen deposit fluctuations and fund unexpected loan demand. At September 30, 2017, the Corporation maintained overnight interest-bearing deposits with the Federal Reserve Bank of Philadelphia and other correspondent banks totaling $9,709,000.

 

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

 

The Corporation has a line of credit with the Federal Reserve Bank of Philadelphia’s Discount Window. Management intends to use this line of credit as a contingency funding source. As collateral for the line, the Corporation has pledged available-for-sale securities with a carrying value of $18,470,000 at September 30, 2017.

 

The Corporation’s outstanding, available, and total credit facilities at September 30, 2017 and December 31, 2016 are as follows:

 

   Outstanding   Available   Total Credit 
(In Thousands)  Sept. 30,   Dec. 31,   Sept. 30,   Dec. 31,   Sept. 30,   Dec. 31, 
   2017   2016   2017   2016   2017   2016 
Federal Home Loan Bank of Pittsburgh  $7,256   $32,454   $351,683   $306,767   $358,939   $339,221 
Federal Reserve Bank Discount Window   0    0    18,009    15,636    18,009    15,636 
Other correspondent banks   0    0    45,000    45,000    45,000    45,000 
Total credit facilities  $7,256   $32,454   $414,692   $367,403   $421,948   $399,857 

 

At September 30, 2017, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of a short-term borrowing of $3,000,000 and long-term borrowings with a total amount of $4,256,000. At December 31, 2016, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowings of $21,000,000 and long-term borrowings with a total amount of $11,454,000. Additional information regarding borrowed funds is included in Note 8 of the unaudited consolidated financial statements.

 

Additionally, the Corporation uses repurchase agreements placed with brokers to borrow funds secured by investment assets and “RepoSweep” arrangements to borrow funds from commercial banking customers on an overnight basis. If required to raise cash in an emergency situation, the Corporation could sell available-for-sale securities to meet its obligations. At September 30, 2017, the carrying value of available-for-sale securities in excess of amounts required to meet pledging or repurchase agreement obligations was $146,551,000.

 

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

 

STOCKHOLDERS’ EQUITY AND CAPITAL ADEQUACY

 

The Corporation and C&N Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Details concerning capital ratios at September 30, 2017 and December 31, 2016 are presented below. Management believes, as of September 30, 2017 and December 31, 2016, that the Corporation and C&N Bank meet all capital adequacy requirements to which they are subject and maintain capital conservation buffers (described in more detail below) that allow the Corporation and C&N Bank to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. Further, as reflected in the table below, the Corporation’s and C&N Bank’s capital ratios at September 30, 2017 and December 31, 2016 exceed the Corporation’s policy threshold levels.

 

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(Dollars in Thousands)                      Minimum To Be Well     
           Minimum   Minimum To Maintain   Capitalized Under   Minimum To Meet 
           Capital   Capital Conservation   Prompt Corrective   the Corporation's 
   Actual   Requirement   Buffer at Reporting Date   Action Provisions   Policy Thresholds 
   Amount   Ratio   Amount   Ratio   Amount   Ratio   Amount   Ratio   Amount Ratio 
September 30, 2017:                                                  
Total capital to risk-weighted assets:                                                  
Consolidated  $187,820    23.56%  $63,768    ³8%   $73,732    ³9.25%   $79,710    ³10%   $83,696    ³10.5% 
C&N Bank   166,093    20.95%   63,415    ³8%    73,324    ³9.25%    79,269    ³10%    83,232    ³10.5% 
Tier 1 capital to risk-weighted assets:                                                  
Consolidated   178,676    22.42%   47,826    ³6%    57,790    ³7.25%    63,768    ³8%    67,754    ³8.5% 
C&N Bank   156,949    19.80%   47,561    ³6%    57,470    ³7.25%    63,415    ³8%    67,379    ³8.5% 
Common equity tier 1 capital to risk-weighted assets:                                                  
Consolidated   178,676    22.42%   35,870    ³4.5%    45,833    ³5.75%    51,812    ³6.5%    55,797    ³7% 
C&N Bank   156,949    19.80%   35,671    ³4.5%    45,580    ³5.75%    51,525    ³6.5%    55,488    ³7% 
Tier 1 capital to average assets:                                                  
Consolidated   178,676    14.40%   49,632    ³4%    N/A    N/A    62,041    ³5%    62,041    ³5% 
C&N Bank   156,949    12.80%   49,053    ³4%    N/A    N/A    61,316    ³5%    61,316    ³5% 
                                                   
December 31, 2016:                                                  
Total capital to risk-weighted assets:                                                  
Consolidated  $183,597    23.60%  $62,245    ³8%   $67,108    ³8.625%   $77,806    ³10%   $81,697    ³10.5% 
C&N Bank   162,705    21.03%   61,894    ³8%    66,730    ³8.625%    77,368    ³10%    81,236    ³10.5% 
Tier 1 capital to risk-weighted assets:                                                  
Consolidated   174,928    22.48%   46,684    ³6%    51,547    ³6.625%    62,245    ³8%    66,135    ³8.5% 
C&N Bank   154,036    19.91%   46,421    ³6%    51,256    ³6.625%    61,894    ³8%    65,762    ³8.5% 
Common equity tier 1 capital to risk-weighted assets:                                                  
Consolidated   174,928    22.48%   35,013    ³4.5%    39,876    ³5.125%    50,574    ³6.5%    54,464    ³7% 
C&N Bank   154,036    19.91%   34,815    ³4.5%    39,651    ³5.125%    50,289    ³6.5%    54,157    ³7% 
Tier 1 capital to average assets:                                                  
Consolidated   174,928    14.27%   49,026    ³4%    N/A    N/A    61,282    ³5%    61,282    ³5% 
C&N Bank   154,036    12.73%   48,404    ³4%    N/A    N/A    60,506    ³5%    60,506    ³5% 

 

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

 

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

 

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

 

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

 

   As of January 1: 
   2017   2018   2019 
Minimum common equity tier 1 capital ratio   4.5%   4.5%   4.5%
Common equity tier 1 capital conservation buffer   1.25%   1.875%   2.5%
Minimum common equity tier 1 capital ratio plus               
capital conservation buffer   5.75%   6.375%   7.0%
Phase-in of most deductions from common equity               
tier 1 capital   80%   100%   100%
Minimum tier 1 capital ratio   6.0%   6.0%   6.0%
Minimum tier 1 capital ratio plus capital               
conservation buffer   7.25%   7.875%   8.5%
Minimum total capital ratio   8.0%   8.0%   8.0%
Minimum total capital ratio plus capital               
conservation buffer   9.25%   9.875%   10.5%

 

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

 

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

 

At September 30, 2017, the Corporation’s Capital Conservation Buffer, determined based on the minimum total capital ratio, was 15.56%. C&N Bank’s Capital Conservation Buffer (also determined based on the minimum total capital ratio) was 12.95%.

 

The Corporation’s total stockholders’ equity is affected by fluctuations in the fair values of available-for-sale securities. The difference between amortized cost and fair value of available-for-sale securities, net of deferred income tax, is included in Accumulated Other Comprehensive Income (Loss) within stockholders’ equity. The balance in Accumulated Other Comprehensive Income (Loss) related to unrealized gains (losses) on available-for-sale securities, net of deferred income tax, amounted to $227,000 at September 30, 2017 and ($949,000) at December 31, 2016. Changes in accumulated other comprehensive income (loss) are excluded from earnings and directly increase or decrease stockholders’ equity. If available-for-sale securities are deemed to be other-than-temporarily impaired, unrealized losses are recorded as a charge against earnings, and amortized cost for the affected securities is reduced. Note 6 to the unaudited consolidated financial statements provides additional information concerning management’s evaluation of available-for-sale securities for other-than-temporary impairment at September 30, 2017.

 

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Stockholders’ equity is also affected by the underfunded or overfunded status of defined benefit pension and postretirement plans. The balance in Accumulated Other Comprehensive Income related to defined benefit plans, net of deferred income tax, was $147,000 at September 30, 2017 and $51,000 at December 31, 2016.

 

COMPREHENSIVE INCOME

 

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

 

Comprehensive Income totaled $3,790,000 for the three months ended September 30, 2017 as compared to $2,623,000 in the third quarter 2016. For the three months ended September 30, 2017, Comprehensive Income included: (1) Net Income of $3,936,000, which was $151,000 lower than in the third quarter 2016; (2) Other Comprehensive Loss from a decrease in net unrealized gains on available-for-sale securities of ($142,000) as compared to Other Comprehensive Loss of ($1,461,000) from a decrease in net unrealized gains on available-for-sale securities in the third quarter 2016; and (3) Other Comprehensive Loss from defined benefit plans of ($4,000) for the third quarter 2017 as compared to ($3,000) for the third quarter 2016.

 

Comprehensive Income totaled $12,763,000 for the nine months ended September 30, 2017 as compared to $14,433,000 for the nine months ended September 30, 2016. In the nine months ended September 30, 2017, Comprehensive Income included: (1) Net Income of $11,491,000, which was $40,000 lower than in the first nine months of 2016; (2) Other Comprehensive Income from an increase in net unrealized gains on available-for-sale securities, net of deferred income tax, of $1,176,000 as compared to Other Comprehensive Income of $2,895,000 in the first nine months of 2016; and (3) Other Comprehensive Income from defined benefit plans of $96,000 as compared to Other Comprehensive Income of $7,000 in the first nine months of 2016.

 

INCOME TAXES

 

The income tax provision in interim periods is based on the Corporation’s estimate of the effective tax rate expected to be applicable for the full year. The income tax provision for the first nine months of 2017 was $3,620,000, or 24% of pre-tax earnings, $227,000 lower than the provision for the first nine months of 2016 of $3,847,000, or 25% of pre-tax income. The Corporation’s effective tax rates differ from the statutory rate of 35% principally because of the effects of tax-exempt interest income.

 

The Corporation recognizes deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax basis of assets and liabilities. At September 30, 2017 the net deferred tax asset was $4,319,000, down from $5,117,000 at December 31, 2016. The most significant change in temporary difference components was a net reduction of $634,000 related to unrealized gains and losses on available-for-sale securities. At September 30, 2017, the net deferred tax liability associated with the unrealized gain was $122,000, while at December 31, 2016, the deferred tax asset associated with the unrealized loss was $512,000.

 

The Corporation uses currently enacted tax rates to value deferred tax assets and liabilities. The U.S. Congress is in the process of evaluating draft legislation which includes a reduction in U.S. corporate income tax rates. If corporate tax rates were reduced, management expects the Corporation would record an initial charge against earnings to lower the carrying amount of the net deferred tax asset, and then would record a lower tax provision going forward on an ongoing basis.

 

The Corporation regularly reviews deferred tax assets for recoverability based on history of earnings, expectations for future earnings and expected timing of reversals of temporary differences. Realization of deferred tax assets ultimately depends on the existence of sufficient taxable income, including taxable income in prior carryback years, as well as future taxable income. Further, as discussed above, realization of deferred tax assets would be impacted if income tax rates are lowered from currently enacted levels.

 

Management believes the recorded net deferred tax asset at September 30, 2017 is fully realizable; however, if management determines the Corporation will be unable to realize all or part of the net deferred tax asset, the Corporation would adjust the deferred tax asset, which would negatively impact earnings.

 

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

 

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INFLATION

 

The Corporation is significantly affected by the Federal Reserve Board’s efforts to control inflation through changes in short-term interest rates. Since September 2007, the Federal Reserve has maintained the fed funds target rate at extremely low levels by historical standards. Further, throughout the period of low interest rates, the Federal Reserve has injected massive amounts of liquidity into the nation’s monetary system through a variety of programs. Since late 2015, the Federal Reserve has begun to move its fed funds target rate higher, in an effort to re-establish a more normalized level by historical standards, with 0.25% increases in December 2015 and 2016, March 2017 and June 2017, resulting in the current range of 1% to 1.25%. Inflation has remained subdued, measured for most of 2016 and the first nine months of 2017 at levels below the Federal Open Market Committee’s 2% longer run objective, though there have been some reports of wage pressure as the U.S. employment picture has gradually improved over the past several years.

 

Although management cannot predict future changes in the rates of inflation, management monitors the impact of economic trends, including any indicators of inflationary pressures, in managing interest rate and other financial risks.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

MARKET RISK

 

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

 

The Corporation’s major category of market risk, interest rate risk, is discussed in the following section.

 

INTEREST RATE RISK

 

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

 

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

 

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

 

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

 

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Table XIII, which follows this discussion, is based on the results of calculations performed using the simulation model as of July 31, 2017 and December 31, 2016. Table XIII reflects two significant changes to the analysis using July 31, 2017 data as compared to the analysis based on December 31, 2016 data, as follows:

 

·Management lowered assumptions of sensitivity of market interest rate changes on some types of the Corporation’s deposits. This change resulted in a reduction in the amount of increase in interest expense in the rising rate scenarios presented in Table XIII. The reduction in estimated sensitivity was based on data showing the Corporation’s prior sensitivity assumptions were higher than may be expected based on industry norms.

 

·The policy limits for present value of equity volatility were lowered based on a determination that the prior levels were so high they would be unlikely to be approached, thereby limiting their effectiveness as a tool for timely identification of long-term interest rate risk.

 

Table XIII shows that as of the respective dates, the changes in net interest income and changes in market value were within the policy limits in all scenarios.

 

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TABLE XIII - THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES

 

July 31, 2017 Data                    
(Dollars In Thousands)  Period Ending July 31, 2018     
                     
Basis Point  Interest   Interest   Net Interest   NII   NII 
Change in Rates  Income   Expense   Income (NII)   % Change   Risk Limit 
+400  $55,775   $18,524   $37,251    -8.5%   25.0%
+300   52,948    14,786    38,162    -6.2%   20.0%
+200   50,134    11,047    39,087    -4.0%   15.0%
+100   47,293    7,309    39,984    -1.8%   10.0%
0   44,329    3,630    40,699    0.0%   0.0%
-100   41,209    2,690    38,519    -5.4%   10.0%
-200   39,217    2,450    36,767    -9.7%   15.0%
-300   38,711    2,302    36,409    -10.5%   20.0%
-400   38,483    2,302    36,181    -11.1%   25.0%

 

   Market Value of Portfolio Equity at July 31, 2017 
             
   Present   Present   Present 
Basis Point  Value   Value   Value 
Change in Rates  Equity   % Change   Risk Limit 
+400  $194,644    -15.0%   40.0%
+300   201,803    -11.9%   30.0%
+200   210,522    -8.1%   25.0%
+100   219,626    -4.1%   15.0%
0   228,967    0.0%   0.0%
-100   229,156    0.1%   15.0%
-200   228,292    -0.3%   25.0%
-300   254,212    11.0%   30.0%
-400   292,504    27.7%   40.0%

 

December 31, 2016 Data                
(Dollars in Thousands)      Period Ending December 31, 2017     
                     
Basis Point  Interest   Interest   Net Interest   NII   NII 
Change in Rates  Income   Expense   Income (NII)   % Change   Risk Limit 
+400  $53,712   $22,315   $31,397    -20.5%   25.0%
+300   51,128    17,545    33,583    -15.0%   20.0%
+200   48,500    12,809    35,691    -9.6%   15.0%
+100   45,845    8,102    37,743    -4.4%   10.0%
0   43,132    3,643    39,489    0.0%   0.0%
-100   40,581    2,978    37,603    -4.8%   10.0%
-200   38,881    2,949    35,932    -9.0%   15.0%
-300   38,269    2,936    35,333    -10.5%   20.0%
-400   38,104    2,936    35,168    -10.9%   25.0%

 

   Market Value of Portfolio Equity at December 31, 2016 
             
   Present   Present   Present 
Basis Point  Value   Value   Value 
Change in Rates  Equity   % Change   Risk Limit 
+400  $168,600    -24.6%   50.0%
+300   180,500    -19.3%   45.0%
+200   194,471    -13.1%   35.0%
+100   208,830    -6.7%   25.0%
0   223,744    0.0%   0.0%
-100   227,806    1.8%   25.0%
-200   229,602    2.6%   35.0%
-300   252,118    12.7%   45.0%
-400   290,792    30.0%   50.0%

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

ITEM 4. CONTROLS AND PROCEDURES

 

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

 

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

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings
   
  The Corporation and C&N Bank are involved in various legal proceedings incidental to their business. Management believes the aggregate liability, if any, resulting from such pending and threatened legal proceedings will not have a material, adverse effect on the Corporation’s financial condition or results of operations.
   
Item 1A. Risk Factors
   
  There have been no material changes from the risk factors previously disclosed in Item 1A of the Corporation’s Form 10-K filed February 16, 2017.
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
   
  Issuer Purchases of Equity Securities
   
  The following table sets forth a summary of the purchases by the Corporation, on the open market, of its equity securities during the third quarter 2017:

 

Period  Total Number
of Shares
Purchased
   Average
Price Paid
per Share
   Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
   Maximum Number of
Shares that May Yet
be Purchased Under
the Plans or
Programs
 
July 1 - 31, 2017   0   $0    0    600,000 
August 1 - 31, 2017   0   $0    0    600,000 
September 1 - 30, 2017   0   $0    0    600,000 

 

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

 

Item 3. Defaults Upon Senior Securities
   
  None
   
Item 4. Mine Safety Disclosures
   
  Not applicable
   
Item 5. Other Information
   
  None

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Item 6. Exhibits

 

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

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

SIGNATURES

 

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

 

 

  CITIZENS & NORTHERN CORPORATION  
       
November 2, 2017 By: /s/ J. Bradley Scovill  
Date President and Chief Executive Officer  
     
November 2, 2017 By: /s/ Mark A. Hughes  
Date Treasurer and Chief Financial Officer  

 

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