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CITIZENS & NORTHERN CORP - Quarter Report: 2018 March (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 March 31, 2018

 

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) 12,262,474 Shares Outstanding on April 30, 2018

 

 

 

   

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

CITIZENS & NORTHERN CORPORATION

Index

 

Part I. Financial Information    
     
Item 1. Financial Statements   Page 3
   
Consolidated Balance Sheets (Unaudited) – March 31, 2018 and December 31, 2017   Page 3
     
Consolidated Statements of Income (Unaudited) – Three-month Periods Ended March 31, 2018 and 2017   Page 4

 

   
Consolidated Statements of Comprehensive Income (Unaudited) - Three-month Periods Ended March 31, 2018 and 2017   Page 5
   
Consolidated Statements of Cash Flows (Unaudited) – Three-month Periods Ended March 31, 2018 and 2017   Page 6
   
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) – Three-month Periods Ended March 31, 2018 and 2017   Page 7
     
Notes to Unaudited Consolidated Financial Statements   Pages 8 – 34
     
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations   Pages 35 – 54
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk   Pages 55 – 56
     
Item 4. Controls and Procedures   Page 57
     
Part II. Other Information   Pages 58 – 59
     
Signatures   Page 60

   
Exhibit 31.1. Rule 13a-14(a)/15d-14(a) Certification - Chief Executive Officer    
   
Exhibit 31.2. Rule 13a-14(a)/15d-14(a) Certification - Chief Financial Officer    
     
Exhibit 32. Section 1350 Certifications    

 

 2 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

ITEM 1. FINANCIAL STATEMENTS        
CONSOLIDATED BALANCE SHEETS        
(In Thousands, Except Share and Per Share Data) (Unaudited)        

 

  March 31,   December 31, 
   2018   2017 
ASSETS          
Cash and due from banks:          
Noninterest-bearing  $18,740   $25,664 
Interest-bearing   18,120    14,580 
Total cash and due from banks   36,860    40,244 
Available-for-sale debt securities, at fair value   341,133    355,937 
Marketable equity security   956    971 
Loans held for sale   225    765 
           
Loans receivable   817,349    815,713 
Allowance for loan losses   (9,049)   (8,856)
Loans, net   808,300    806,857 
           
Bank-owned life insurance   20,180    20,083 
Accrued interest receivable   3,899    4,048 
Bank premises and equipment, net   15,482    15,432 
Foreclosed assets held for sale   1,100    1,598 
Deferred tax asset, net   4,120    3,289 
Intangible assets - Goodwill and core deposit intangibles   11,953    11,954 
Other assets   13,908    15,781 
TOTAL ASSETS  $1,258,116   $1,276,959 
           
LIABILITIES          
Deposits:          
Noninterest-bearing  $250,839   $241,214 
Interest-bearing   767,242    767,235 
Total deposits   1,018,081    1,008,449 
Short-term borrowings   26,482    61,766 
Long-term borrowings   18,122    9,189 
Accrued interest and other liabilities   9,049    9,112 
TOTAL LIABILITIES   1,071,734    1,088,516 
           
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 12,264,284 at March 31, 2018 and 12,214,525 December 31, 2017   12,655    12,655 
Paid-in capital   71,716    72,035 
Retained earnings   114,953    113,608 
Treasury stock, at cost; 390,887 shares at March 31, 2018 and 440,646 shares at December 31, 2017   (7,404)   (8,348)
Accumulated other comprehensive loss   (5,538)   (1,507)
TOTAL STOCKHOLDERS' EQUITY   186,382    188,443 
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY  $1,258,116   $1,276,959 

 

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

 

 3 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Consolidated Statements of Income

(In Thousands Except Per Share Data) (Unaudited)

 

  3 Months Ended 
  March 31,   March 31, 
   2018   2017 
INTEREST INCOME          
Interest and fees on loans:          
Taxable  $9,201   $8,374 
Tax-exempt   556    450 
Interest on mortgages held for sale   2    4 
Interest on balances with depository institutions   50    32 
Income from available-for-sale debt securities:          
Taxable   1,363    1,403 
Tax-exempt   713    844 
Dividends on marketable equity security   5    5 
Total interest and dividend income   11,890    11,112 
INTEREST EXPENSE          
Interest on deposits   729    521 
Interest on short-term borrowings   199    77 
Interest on long-term borrowings   65    355 
Total interest expense   993    953 
Net interest income   10,897    10,159 
Provision for loan losses   292    452 
Net interest income after provision for loan losses   10,605    9,707 
NONINTEREST INCOME          
Trust and financial management revenue   1,422    1,180 
Brokerage revenue   212    156 
Insurance commissions, fees and premiums   44    41 
Service charges on deposit accounts   1,204    1,101 
Service charges and fees   86    80 
Interchange revenue from debit card transactions   579    520 
Net gains from sale of loans   184    166 
Loan servicing fees, net   128    72 
Increase in cash surrender value of life insurance   97    90 
Other noninterest income   450    458 
Sub-total   4,406    3,864 
Realized gains on securities, net   0    145 
Total noninterest income   4,406    4,009 
NONINTEREST EXPENSE          
Salaries and wages   4,124    3,868 
Pensions and other employee benefits   1,610    1,524 
Occupancy expense, net   637    578 
Furniture and equipment expense   271    313 
Data processing expenses   641    575 
Automated teller machine and interchange expense   322    294 
Pennsylvania shares tax   336    336 
Professional fees   276    187 
Directors' fees   184    185 
Other noninterest expense   1,494    1,438 
Total noninterest expense   9,895    9,298 
Income before income tax provision   5,116    4,418 
Income tax provision   741    984 
NET INCOME  $4,375   $3,434 
EARNINGS PER COMMON SHARE - BASIC  $0.36   $0.28 
EARNINGS PER COMMON SHARE - DILUTED  $0.36   $0.28 

 

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)

 

  Three Months Ended 
  March 31,   March 31, 
   2018   2017 
Net income  $4,375   $3,434 
           
Unrealized (losses) gains on available-for-sale securities:          
Unrealized holding (losses) gains on available-for-sale securities   (4,839)   636 
Reclassification adjustment for gains realized in income   0    (145)
Other comprehensive (loss) gain on available-for-sale securities   (4,839)   491 
           
Unfunded pension and postretirement obligations:          
Changes from plan amendments and actuarial gains and losses included in accumulated other comprehensive (loss) gain   93    166 
Amortization of prior service cost and net actuarial loss included in net periodic benefit cost   (5)   (6)
Other comprehensive gain on unfunded retirement obligations   88    160 
           
Other comprehensive (loss) income before income tax   (4,751)   651 
Income tax related to other comprehensive loss (income)   997    (228)
           
Net other comprehensive (loss) income   (3,754)   423 
           
Comprehensive income  $621   $3,857 

 

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

 

 5 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands) (Unaudited)

 

   3 Months Ended 
   March 31,   March 31, 
   2018   2017 
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net income  $4,375   $3,434 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for loan losses   292    452 
Realized gains on available-for-sale securities, net   0    (145)
Unrealized loss on marketable equity security   15    0 
Depreciation expense   412    404 
Accretion and amortization on securities, net   268    314 
Increase in cash surrender value of life insurance   (97)   (90)
Stock-based compensation and other expense   183    168 
Deferred income taxes   166    273 
(Increase) decrease in fair value of servicing rights   (20)   30 
Gains on sales of loans, net   (184)   (166)
Origination of loans for sale   (5,327)   (5,558)
Proceeds from sales of loans   6,001    5,657 
Decrease (increase) in accrued interest receivable and other assets   757    (171)
Decrease in accrued interest payable and other liabilities   (482)   (461)
Other   (29)   34 
Net Cash Provided by Operating Activities   6,330    4,175 
CASH FLOWS FROM INVESTING ACTIVITIES:          
Proceeds from maturities of certificates of deposit   820    100 
Purchase of certificates of deposit   (100)   (100)
Proceeds from sales of available-for-sale securities   0    13,856 
Proceeds from calls and maturities of available-for-sale securities   10,516    12,771 
Purchase of available-for-sale securities   (312)   (8,147)
Redemption of Federal Home Loan Bank of Pittsburgh stock   2,990    2,491 
Purchase of Federal Home Loan Bank of Pittsburgh stock   (1,706)   (2,130)
Net increase in loans   (1,805)   (10,580)
Purchase of premises and equipment   (467)   (745)
Proceeds from sale of foreclosed assets   603    469 
Other   51    46 
Net Cash Provided by Investing Activities   10,590    8,031 
CASH FLOWS FROM FINANCING ACTIVITIES:          
Net increase (decrease) in deposits   9,632    (3,592)
Net decrease in short-term borrowings   (35,284)   (5,431)
Proceeds from long-term borrowings   9,000    0 
Repayments of long-term borrowings   (67)   (66)
Sale of treasury stock   63    53 
Common dividends paid   (2,928)   (2,736)
Net Cash Used in Financing Activities   (19,584)   (11,772)
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS   (2,664)   434 
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR   37,004    28,621 
CASH AND CASH EQUIVALENTS, END OF PERIOD  $34,340   $29,055 
           
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:          
Assets acquired through foreclosure of real estate loans  $72   $216 
Accrued purchase of available-for-sale debt security  $507   $0 
Interest paid  $978   $951 
Income taxes paid  $125   $200 

 

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   Stock   Total 
Three Months Ended March 31, 2018                                        
Balance, December 31, 2017   12,655,171    440,646   $12,655   $72,035   $113,608   $(1,507)  $(8,348)  $188,443 
Impact of change in enacted income tax rate (a)                       325    (325)        0 
Impact of change in method of premium amortization of callable debt securities (b)                       (26)   26         0 
Impact of change in method of accounting for marketable equity security (c)                       (22)   22         0 
Net income                       4,375              4,375 
Other comprehensive loss, net                            (3,754)        (3,754)
Cash dividends declared on common stock, $0.27 per share                       (3,307)             (3,307)
Shares issued for dividend reinvestment plan        (16,371)        69              310    379 
Shares issued from treasury and redeemed                                        
related to exercise of stock options        (4,198)        (16)             79    63 
Restricted stock granted        (34,552)        (655)             655    0 
Forfeiture of restricted stock        5,362         100              (100)   0 
Stock-based compensation expense                  183                   183 
Balance, March 31, 2018   12,655,171    390,887   $12,655   $71,716   $114,953   $(5,538)  $(7,404)  $186,382 
                                         
Three Months Ended March 31, 2017                                        
Balance, December 31, 2016   12,655,171    541,943   $12,655   $71,730   $112,790   $(898)  $(10,269)  $186,008 
Net income                       3,434              3,434 
Other comprehensive income, net                            423         423 
Cash dividends declared on common stock, $0.26 per share                       (3,118)             (3,118)
Shares issued for dividend reinvestment plan        (15,831)        82              300    382 
Shares issued from treasury and redeemed related to exercise of stock options        (2,804)        1              52    53 
Restricted stock granted        (30,782)        (583)             583    0 
Forfeiture of restricted stock        3,038         56              (56)   0 
Stock-based compensation expense                  168                   168 
Balance, March 31, 2017   12,655,171    495,564   $12,655   $71,454   $113,106   $(475)  $(9,390)  $187,350 

 

(a)As described in more detail in the Recent Accounting Pronouncements - Adopted section of Note 1, this reclassification resulted from adoption of Accounting Standards Update (ASU) 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, effective January 1, 2018.

 

(b)As described in more detail in the Recent Accounting Pronouncements - Adopted section of Note 1, this reclassification resulted from adoption of ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20), effective January 1, 2018.

 

(c)As described in more detail in the Recent Accounting Pronouncements - Adopted section of Note 1, this reclassification resulted from adoption of ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities, effective January 1, 2018.

 

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

 

 7 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Notes to Unaudited Consolidated Financial Statements

 

1. BASIS OF INTERIM PRESENTATION AND STATUS OF RECENT ACCOUNTING PRONOUNCEMENTS

 

The consolidated financial statements include the accounts of Citizens & Northern Corporation and its subsidiaries, Citizens & Northern Bank (“C&N Bank”), Bucktail Life Insurance Company and Citizens & Northern Investment Corporation (collectively, “Corporation”), as well as C&N Bank’s wholly-owned subsidiary, C&N Financial Services Corporation. In December 2017, C&N Bank established a new entity, Northern Tier Holding LLC, for the purpose of acquiring, holding and disposing of real property acquired by the Bank. C&N Bank is the sole member of Northern Tier Holding LLC. All material intercompany balances and transactions have been eliminated in consolidation.

 

The consolidated financial information included herein, with the exception of the consolidated balance sheet dated December 31, 2017, 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 2017 information has been reclassified for consistency with the 2018 presentation.

 

Operating results reported for the three-month period ended March 31, 2018 might not be indicative of the results for the year ending December 31, 2018. The Corporation evaluates subsequent events through the date of filing with the Securities and Exchange Commission.

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

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

 

Recent Accounting Pronouncements - Adopted

 

In the first quarter 2018, the Corporation adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606).  Under the ASU, as modified by subsequent ASUs, revenue is recognized when a customer obtains control of promised services in an amount that reflects the consideration the entity expects to receive in exchange for those services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.  The Corporation applied the five-step method outlined in the ASU to all revenue streams scoped-in by the ASU and elected the modified retrospective implementation method. Substantially all of the Corporation’s interest income and certain noninterest income were not impacted by the adoption of this ASU because the revenue from those contracts with customers is covered by other guidance in U.S. GAAP. 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. Adoption of ASU 2014-09 did not change the timing and pattern of the Corporation’s revenue recognition related to scoped-in noninterest income. New disclosures required by the ASU have been included in Note 13.

 

In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which permits, but does not require, entities to reclassify tax effects stranded in accumulated other comprehensive income resulting from the Tax Cuts and Jobs Act of 2017 to retained earnings. Companies that elect to reclassify these amounts must reclassify stranded tax effects for all items accounted for in accumulated other comprehensive income. The Corporation elected early adoption and adopted this standard update, effective January 1, 2018. The Corporation’s stranded tax effects were related to valuation of the net deferred tax asset attributable to items of accumulated other comprehensive income (loss), which are unrealized gains (losses) on available-for-sale securities and unfunded defined benefit plan obligations. Adoption resulted in a reclassification between two categories of stockholders’ equity at January 1, 2018, with an increase of $325,000 in retained earnings and a decrease in accumulated other comprehensive loss for the same amount (no net change in stockholders’ equity).

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

In the first quarter 2018, the Corporation elected early adoption of ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20). This Update shortens the amortization period for certain callable debt securities held at a premium. Discounts will continue to be amortized to maturity. Adoption resulted in a reduction in retained earnings and corresponding increase in accumulated other comprehensive loss (no net change in stockholders’ equity) of $26,000 at January 1, 2018 for the cumulative after-tax impact of the change in accounting for debt securities held as of that date.

 

In the first quarter 2018, the Corporation adopted ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities. The guidance affects the accounting for equity investments, financial liabilities under the fair value option and the presentation and disclosure requirements of financial instruments. ASU 2016-01 was effective for the Corporation on January 1, 2018 and resulted in: (1) separate classification of a marketable equity security previously included in available-for-sale securities on the consolidated balance sheets, (2) changes in the fair value of the equity security being captured in the consolidated statements of income and (3) a reduction in retained earnings and corresponding increase in accumulated other comprehensive loss (no net change in stockholders’ equity) of $22,000 at January 1, 2018 for the after-tax impact of the change in accounting for the unrealized loss on the equity security. Additional disclosures related to equity securities are provided in Note 6. Adoption of the standard also resulted in the use of an exit price to determine the fair value of financial instruments not measured at fair value in the consolidated balance sheets. Further information regarding valuation of financial instruments is provided in Note 5.

 

Recently Issued But Not Yet Effective Accounting Pronouncements

 

ASU 2016-02, Leases (Topic 842) changes current GAAP by requiring that lease assets and liabilities arising from operating leases be recognized on the balance sheet. 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. 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 will become effective for the Corporation for annual and interim periods beginning in the first quarter 2019. Adoption of ASU 2016-02 is not expected to have a material impact on the Corporation’s consolidated financial statements. The Corporation leases certain properties and equipment under operating leases that will result in the recognition of lease assets and lease liabilities on the consolidated balance sheet under the ASU; however, the majority of the Corporation’s properties and equipment are owned, not leased.

 

ASU 2016-13, Financial Instruments-Credit Losses (Topic 326), changes accounting for credit losses on loans receivable and debt securities from an incurred loss methodology to an expected credit loss methodology. Among other things, ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Accordingly, ASU 2016-13 requires the use of forward-looking information to form credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, though the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, ASU 2016-13 amends the accounting for credit losses on debt securities and purchased financial assets with credit deterioration. The amendments in ASU 2016-13 will be effective for the Corporation beginning in the first quarter 2020. Earlier adoption is permitted beginning in the first quarter 2019; however, the Corporation does not currently plan to early adopt the ASU. The Corporation has formed a cross functional management team that is assessing alternative loss estimation methodologies and the Corporation’s data and system needs in order to evaluate the impact that adoption of this standard will have on the Corporation’s financial condition and results of operations. The Corporation 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.

 

ASU 2017-04, Intangibles – Goodwill and Other (Topic 350) simplifies 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 2020. The Corporation does not expect adoption of this ASU to have a material impact on its consolidated financial statements.

 

 9 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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 
   March 31,   March 31, 
   2018   2017 
Basic          
Net income  $4,375,000   $3,434,000 
Less: Dividends and undistributed earnings allocated to participating securities   (23,000)   (18,000)
Net income attributable to common shares  $4,352,000   $3,416,000 
Basic weighted-average common shares outstanding   12,189,471    12,085,729 
Basic earnings per common share (a)  $0.36   $0.28 
           
Diluted          
Net income attributable to common shares  $4,352,000   $3,416,000 
Basic weighted-average common shares outstanding   12,189,471    12,085,729 
Dilutive effect of potential common stock arising from stock options   32,785    45,681 
Diluted weighted-average common shares outstanding   12,222,256    12,131,410 
Diluted earnings per common share (a)  $0.36   $0.28 

 

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

 

The weighted-average number of nonvested restricted shares outstanding was 65,204 shares in the three-month period ended March 31, 2018 and 65,208 shares in the three-month period ended March 31, 2017.

 

Anti-dilutive stock options are excluded from net income per share calculations. There were no anti-dilutive instruments in the first quarter of 2018 or 2017.

 

 10 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

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:

 

   Before-Tax   Income Tax   Net-of-Tax 
(In Thousands)  Amount   Effect   Amount 
Three Months Ended March 31, 2018               
Other comprehensive loss on available-for-sale securities,               
Unrealized holding losses on available-for-sale securities  $(4,839)  $1,015   $(3,824)
                
Unfunded pension and postretirement obligations:               
Changes from plan amendments and actuarial gains and losses included in other comprehensive income   93    (19)   74 
Amortization of prior service cost and net actuarial loss included in net periodic benefit cost   (5)   1    (4)
Other comprehensive income on unfunded retirement obligations   88    (18)   70 
                
Total other comprehensive loss  $(4,751)  $997   $(3,754)

 

   Before-Tax   Income Tax   Net-of-Tax 
(In Thousands)  Amount   Effect   Amount 
Three Months Ended March 31, 2017               
Unrealized gains on available-for-sale securities:               
Unrealized holding gains on available-for-sale securities  $636   $(223)  $413 
Reclassification adjustment for (gains) realized in income   (145)   51    (94)
Other comprehensive income on available-for-sale securities   491    (172)   319 
                
Unfunded pension and postretirement obligations:               
Changes from plan amendments and actuarial gains and losses included in other comprehensive income   166    (58)   108 
Amortization of prior service cost and net actuarial loss included in net periodic benefit cost   (6)   2    (4)
Other comprehensive income on unfunded retirement obligations   160    (56)   104 
                
Total other comprehensive income  $651   $(228)  $423 

 

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

 

           Accumulated 
   Unrealized   Unfunded   Other 
   (Losses)   Retirement   Comprehensive 
(In Thousands)  on Securities   Obligations   Loss 
Three Months Ended March 31, 2018            
Balance, beginning of period  $(1,566)  $59   $(1,507)
Impact of change in enacted income tax rate   (337)   12    (325)
Impact of change in the method of premium amortization of callable debt securities   26    0    26 
Impact of change in the method of accounting for marketable equity security   22    0    22 
Other comprehensive (loss) income during three months ended March 31, 2018   (3,824)   70    (3,754)
Balance, end of period  $(5,679)  $141   $(5,538)

 

 11 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Three Months Ended March 31, 2017               
Balance, beginning of period  $(949)  $51   $(898)
Other comprehensive income during three months ended March 31, 2017   319    104    423 
Balance, end of period  $(630)  $155   $(475)

 

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

 

For the Three Months Ended March 31, 2018

(In Thousands)

 

   Reclassified from    
Details about Accumulated Other  Accumulated Other   Affected Line Item in the Consolidated
Comprehensive Loss Components  Comprehensive Loss   Statements of Income
Amortization of defined benefit pension and postretirement items:        
Prior service cost  $(8)  Other noninterest expense
Actuarial loss   3   Other noninterest expense
    (5)  Total before tax
    1   Income tax provision
    (4)  Net of tax
Total reclassifications for the period  $(4)   

 

For the Three Months Ended March 31, 2017

(In Thousands)

 

   Reclassified from    
Details about Accumulated Other  Accumulated Other   Affected Line Item in the Consolidated
Comprehensive Loss Components  Comprehensive Loss   Statements of Income
Unrealized gains and losses on available-for-sale        
securities  $(145)  Realized gains on securities, net
    51   Income tax provision
    (94)  Net of tax
Amortization of defined benefit pension and postretirement items:        
Prior service cost   (8)  Other noninterest expense
Actuarial loss   2   Other noninterest expense
    (6)  Total before tax
    2   Income tax provision
    (4)  Net of tax
Total reclassifications for the period  $(98)   

 

4. CASH AND DUE FROM BANKS

 

Cash and due from banks at March 31, 2018 and December 31, 2017 include the following:

 

   March 31,   Dec. 31, 
(In thousands)  2018   2017 
Cash and cash equivalents  $34,340   $37,004 
Certificates of deposit   2,520    3,240 
Total cash and due from banks  $36,860   $40,244 

 

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 $16,376,000 at March 31, 2018 and $17,178,000 at December 31, 2017.

 

 12 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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. 

 

 13 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

At March 31, 2018 and December 31, 2017, assets measured at fair value and the valuation methods used are as follows:

 

       March 31, 2018     
   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 DEBT SECURITIES:                    
Obligations of U.S. Government agencies  $0   $7,803   $0   $7,803 
Obligations of states and political subdivisions:                    
Tax-exempt   0    103,403    0    103,403 
Taxable   0    24,038    0    24,038 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                    
Residential pass-through securities   0    49,335    0    49,335 
Residential collateralized mortgage obligations   0    124,008    0    124,008 
Commercial mortgage-backed securities   0    32,546    0    32,546 
Total available-for-sale debt securities   0    341,133    0    341,133 
Marketable equity security   956    0    0    956 
Servicing rights   0    0    1,369    1,369 
Total recurring fair value measurements  $956   $341,133   $1,369   $343,458 
                     
Nonrecurring fair value measurements                    
Impaired loans with a valuation allowance  $0   $0   $4,368   $4,368 
Valuation allowance   0    0    (1,289)   (1,289)
Impaired loans, net   0    0    3,079    3,079 
Foreclosed assets held for sale   0    0    1,100    1,100 
Total nonrecurring fair value measurements  $0   $0   $4,179   $4,179 

 

 14 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

       December 31, 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 DEBT SECURITIES:                    
Obligations of U.S. Government agencies  $0   $7,873   $0   $7,873 
Obligations of states and political subdivisions:                    
Tax-exempt   0    105,111    0    105,111 
Taxable   0    25,573    0    25,573 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                    
Residential pass-through securities   0    52,347    0    52,347 
Residential collateralized mortgage obligations   0    131,814    0    131,814 
Commercial mortgage-backed securities   0    33,219    0    33,219 
Total available-for-sale debt securities   0    355,937    0    355,937 
Marketable equity security   971    0    0    971 
Servicing rights   0    0    1,299    1,299 
Total recurring fair value measurements  $971   $355,937   $1,299   $358,207 
                     
Nonrecurring fair value measurements                    
Impaired loans with a valuation allowance  $0   $0   $3,776   $3,776 
Valuation allowance   0    0    (1,183)   (1,183)
Impaired loans, net   0    0    2,593    2,593 
Foreclosed assets held for sale   0    0    1,598    1,598 
Total nonrecurring fair value measurements  $0   $0   $4,191   $4,191 

 

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 March 31, 2018 and December 31, 2017, 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           
   3/31/18   Valuation  Unobservable          Method or Value As of
Asset  (In Thousands)   Technique  Input(s)          3/31/18
Servicing rights  $1,369   Discounted cash flow  Discount rate   13.00%  Rate used through modeling period
           Loan prepayment speeds   118.00%  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

 

 15 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

   Fair Value at           
   12/31/17   Valuation  Unobservable          Method or Value As of
Asset  (In Thousands)   Technique  Input(s)          12/31/17
Servicing rights  $1,299   Discounted cash flow  Discount rate   13.00%  Rate used through modeling period
           Loan prepayment speeds   140.00%  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:

 

   Three Months Ended 
(In Thousands)  March 31, 2018   March 31, 2017 
Servicing rights balance, beginning of period  $1,299   $1,262 
Issuances of servicing rights   50    46 
Unrealized gains (losses) included in earnings   20    (30)
Servicing rights balance, end of period  $1,369   $1,278 

 

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. For commercial and industrial and agricultural loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging data or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.

 

 16 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

At March 31, 2018 and December 31, 2017, 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  3/31/18   3/31/18   3/31/18   Technique  Inputs  3/31/18 
                       
Impaired loans:                          
Residential mortgage loans - first liens  $515   $122   $393   Sales comparison  Discount to appraised value   26%
Commercial:                          
Commercial loans secured by real estate   2,607    884    1,723   Sales comparison  Discount to appraised value   16%
Commercial and industrial   75    75    0   Sales comparison  Discount to appraised value   100%
Loans secured by farmland   494    50    444   Sales comparison  Discount to appraised value   53%
Agricultural Loans   677    158    519   Sales comparison  Discount to appraised value   36%
Total impaired loans  $4,368   $1,289   $3,079            
Foreclosed assets held for sale - real estate:                          
Residential (1-4 family)  $396   $0   $396   Sales comparison  Discount to appraised value   32%
Land   632    0    632   Sales comparison  Discount to appraised value   35%
Commercial real estate   72    0    72   Sales comparison  Discount to appraised value   76%
Total foreclosed assets held for sale  $1,100   $0   $1,100            

 

(In Thousands, Except                    Weighted- 
Percentages)      Valuation             Average 
   Balance at   Allowance at   Fair Value at   Valuation  Unobservable  Discount at 
Asset  12/31/17   12/31/17   12/31/17   Technique  Inputs  12/31/17 
                       
Impaired loans:                          
Residential mortgage loans - first liens  $515   $122   $393   Sales comparison  Discount to appraised value   26%
Commercial:                          
Commercial loans secured by real estate   2,641    919    1,722   Sales comparison  Discount to appraised value   16%
Commercial and industrial   126    92    34   Sales comparison  Discount to appraised value   72%
Loans secured by farmland   494    50    444   Sales comparison  Discount to appraised value   53%
Total impaired loans  $3,776   $1,183   $2,593            
Foreclosed assets held for sale - real estate:                          
Residential (1-4 family)  $721   $0   $721   Sales comparison  Discount to appraised value   37%
Land   632    0    632   Sales comparison  Discount to appraised value   35%
Commercial real estate   245    0    245   Sales comparison  Discount to appraised value   71%
Total foreclosed assets held for sale  $1,598   $0   $1,598            

 

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.

 

 17 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

The estimated fair values, and related carrying amounts, of the Corporation’s financial instruments that are not recorded at fair value are as follows:

 

   Fair Value  March 31, 2018   December 31, 2017 
   Hierarchy  Carrying   Fair   Carrying   Fair 
(In Thousands)  Level  Amount   Value   Amount   Value 
Financial assets:                       
Cash and cash equivalents  Level 1  $34,340   $34,340   $37,004   $37,004 
Certificates of deposit  Level 2   2,520    2,508    3,240    3,234 
Restricted equity securities (included in Other Assets)  Level 2   6,228    6,228    6,556    6,556 
Loans held for sale  Level 1   225    225    765    765 
Loans, net  Level 3   808,300    808,653    806,857    789,891 
Accrued interest receivable  Level 2   3,899    3,899    4,048    4,048 
                        
Financial liabilities:                       
Deposits with no stated maturity  Level 2   793,351    793,351    794,778    794,778 
Time deposits  Level 2   224,730    224,814    213,671    213,734 
Short-term borrowings  Level 2   26,482    26,263    61,766    61,643 
Long-term borrowings  Level 2   18,122    18,155    9,189    9,256 
Accrued interest payable  Level 2   61    61    46    46 

 

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.

 

6. SECURITIES

 

Amortized cost and fair value of available-for-sale debt securities at March 31, 2018 and December 31, 2017 are summarized as follows:

 

       March 31, 2018     
       Gross   Gross     
       Unrealized   Unrealized     
   Amortized   Holding   Holding   Fair 
(In Thousands)  Cost   Gains   Losses   Value 
                 
Obligations of U.S. Government agencies  $8,023   $0   $(220)  $7,803 
Obligations of states and political subdivisions:                    
Tax-exempt   103,598    1,651    (1,846)   103,403 
Taxable   24,140    98    (200)   24,038 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                    
Residential pass-through securities   50,880    66    (1,611)   49,335 
Residential collateralized mortgage obligations   127,886    44    (3,922)   124,008 
Commercial mortgage-backed securities   33,793    0    (1,247)   32,546 
Total available-for-sale-debt securities  $348,320   $1,859   $(9,046)  $341,133 

 

 18 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

       December 31, 2017     
       Gross   Gross     
       Unrealized   Unrealized     
   Amortized   Holding   Holding   Fair 
(In Thousands)  Cost   Gains   Losses   Value 
                 
Obligations of U.S. Government agencies  $8,026   $0   $(153)  $7,873 
Obligations of states and political subdivisions:                    
Tax-exempt   103,673    2,291    (853)   105,111 
Taxable   25,431    226    (84)   25,573 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                    
Residential pass-through securities   52,992    79    (724)   52,347 
Residential collateralized mortgage obligations   134,314    110    (2,610)   131,814 
Commercial mortgage-backed securities   33,881    4    (666)   33,219 
Total available-for-sale debt securities  $358,317   $2,710   $(5,090)  $355,937 

 

The following table presents gross unrealized losses and fair value of available-for-sale debt 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 March 31, 2018 and December 31, 2017:

 

   Less Than 12 Months   12 Months or More   Total 
March 31, 2018  Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
(In Thousands)  Value   Losses   Value   Losses   Value   Losses 
                         
Obligations of U.S. Government agencies  $0   $0   $7,803   $(220)  $7,803   $(220)
Obligations of states and political subdivisions:                              
Tax-exempt   30,641    (439)   23,636    (1,407)   54,277    (1,846)
Taxable   14,526    (143)   2,245    (57)   16,771    (200)
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                              
Residential pass-through securities   27,259    (718)   21,227    (893)   48,486    (1,611)
Residential collateralized mortgage obligations   55,506    (1,210)   64,378    (2,712)   119,884    (3,922)
Commercial mortgage-backed securities   18,267    (539)   14,279    (708)   32,546    (1,247)
Total temporarily impaired available-for-sale debt securities  $146,199   $(3,049)  $133,568   $(5,997)  $279,767   $(9,046)

  

  Less Than 12 Months   12 Months or More   Total 
December 31, 2017  Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
(In Thousands)  Value   Losses   Value   Losses   Value   Losses 
                         
Obligations of U.S. Government agencies  $0   $0   $7,873   $(153)  $7,873   $(153)
Obligations of states and political subdivisions:                              
Tax-exempt   19,050    (135)   24,391    (718)   43,441    (853)
Taxable   9,279    (45)   2,116    (39)   11,395    (84)
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                              
Residential pass-through securities   25,255    (242)   22,549    (482)   47,804    (724)
Residential collateralized mortgage obligations   50,812    (589)   68,558    (2,021)   119,370    (2,610)
Commercial mortgage-backed securities   14,713    (173)   14,569    (493)   29,282    (666)
Total temporarily impaired available-for-sale debt securities  $119,109   $(1,184)  $140,056   $(3,906)  $259,165   $(5,090)

 

 19 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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

 

   3 Months Ended 
   March 31,   March 31, 
(In Thousands)  2018   2017 
Gross realized gains from sales  $0   $161 
Gross realized losses from sales   0    (16)
Net realized gains  $0   $145 

 

The amortized cost and fair value of available-for-sale debt securities by contractual maturity are shown in the following table as of March 31, 2018. 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  $18,713   $18,844 
Due from one year through five years   63,703    63,793 
Due from five years through ten years   33,100    32,226 
Due after ten years   20,245    20,381 
Sub-total   135,761    135,244 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:          
Residential pass-through securities   50,880    49,335 
Residential collateralized mortgage obligations   127,886    124,008 
Commercial mortgage-backed securities   33,793    32,546 
Total  $348,320   $341,133 

 

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 $209,321,000 at March 31, 2018 and $217,925,000 at December 31, 2017 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. The Corporation recognized no net impairment losses in earnings in the three-month periods ended March 31, 2018 and 2017.

 

A summary of information management considered in evaluating debt and equity securities for other-than-temporary impairment (“OTTI”) at March 31, 2018 is provided below.

 

Debt Securities

 

At March 31, 2018, 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 March 31, 2018 and December 31, 2017 to be temporary.

 

 20 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Equity Securities

 

The Corporation’s marketable equity security at March 31, 2018 and December 31, 2017 consisted exclusively of one mutual fund. As required by ASU 2016-01, the Corporation’s investment in the marketable equity security, previously included in available-for-sale securities, was separately classified in the consolidated balance sheets. Further, retained earnings was reduced by $22,000 and accumulated other comprehensive loss was increased by the same amount for the after-tax impact of the unrealized loss on the security at January 1, 2018. At March 31, 2018, there was an unrealized loss on the mutual fund of $44,000, and at December 31, 2017 there was an unrealized loss of $29,000, with the $15,000 increase in the unrealized loss included in other noninterest income in the consolidated statements of income for the three months ended March 31, 2018.

 

The Corporation had no realized gains or losses from the sale of equity securities in the first quarter of 2018 or 2017.

 

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 $5,142,000 at March 31, 2018 and $6,426,000 at December 31, 2017. The Corporation evaluated its holding of FHLB-Pittsburgh stock for impairment and deemed the stock to not be impaired at March 31, 2018 and December 31, 2017. 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 March 31, 2018 and December 31, 2017 are summarized by segment, and by classes within each segment, as follows:

 

Summary of Loans by Type  March 31,   Dec. 31, 
(In Thousands)  2018   2017 
         
Residential mortgage:          
Residential mortgage loans - first liens  $358,786   $359,987 
Residential mortgage loans - junior liens   25,870    25,325 
Home equity lines of credit   34,595    35,758 
1-4 Family residential construction   25,790    26,216 
Total residential mortgage   445,041    447,286 
Commercial:          
Commercial loans secured by real estate   161,571    159,266 
Commercial and industrial   89,346    88,276 
Political subdivisions   56,224    59,287 
Commercial construction and land   13,232    14,527 
Loans secured by farmland   7,015    7,255 
Multi-family (5 or more) residential   7,621    7,713 
Agricultural loans   5,803    6,178 
Other commercial loans   16,079    10,986 
Total commercial   356,891    353,488 
Consumer   15,417    14,939 
Total   817,349    815,713 
Less: allowance for loan losses   (9,049)   (8,856)
Loans, net  $808,300   $806,857 

 

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 March 31, 2018 or December 31, 2017.

 

 21 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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 March 31, 2018 and December 31, 2017, management determined that no allowance for credit losses related to unfunded loan commitments was required.

 

Transactions within the allowance for loan losses, summarized by segment and class, for the three-month periods ended March 31, 2018 and 2017 were as follows:

 

Three Months Ended March 31, 2018  Dec. 31,               March 31, 
(In Thousands)  2017
Balance
   Charge-offs   Recoveries   Provision
(Credit)
   2018
Balance
 
                     
Allowance for Loan Losses:                         
Residential mortgage:                         
Residential mortgage loans - first liens  $3,200   $(53)  $1   $(81)  $3,067 
Residential mortgage loans - junior liens   224    0    1    126    351 
Home equity lines of credit   296    0    0    (10)   286 
1-4 Family residential construction   243    0    0    (4)   239 
Total residential mortgage   3,963    (53)   2    31    3,943 
Commercial:                         
Commercial loans secured by real estate   2,584    (21)   0    72    2,635 
Commercial and industrial   1,065    0    2    (31)   1,036 
Commercial construction and land   150    0    0    (13)   137 
Loans secured by farmland   105    0    0    (3)   102 
Multi-family (5 or more) residential   172    0    0    (3)   169 
Agricultural loans   57    0    0    148    205 
Other commercial loans   102    0    0    47    149 
Total commercial   4,235    (21)   2    217    4,433 
Consumer   159    (41)   12    44    174 
Unallocated   499    0    0    0    499 
Total Allowance for Loan Losses  $8,856   $(115)  $16   $292   $9,049 

 

 22 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

Three Months Ended March 31, 2017  Dec. 31,               March 31, 
(In Thousands)  2016
Balance
   Charge-offs   Recoveries   Provision
(Credit)
   2017
Balance
 
                     
Allowance for Loan Losses:                         
Residential mortgage:                         
Residential mortgage loans - first liens  $3,033   $(63)  $2   $153   $3,125 
Residential mortgage loans - junior liens   258    0    1    (3)   256 
Home equity lines of credit   350    0    0    (12)   338 
1-4 Family residential construction   249    0    0    (9)   240 
Total residential mortgage   3,890    (63)   3    129    3,959 
Commercial:                         
Commercial loans secured by real estate   2,380    (96)   0    401    2,685 
Commercial and industrial   999    0    1    (94)   906 
Commercial construction and land   162    0    0    7    169 
Loans secured by farmland   110    0    0    1    111 
Multi-family (5 or more) residential   241    0    0    (5)   236 
Agricultural loans   40    0    0    (1)   39 
Other commercial loans   115    0    0    (6)   109 
Total commercial   4,047    (96)   1    303    4,255 
Consumer   138    (41)   15    20    132 
Unallocated   398    0    0    0    398 
Total Allowance for Loan Losses  $8,473   $(200)  $19   $452   $8,744 

 

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

 

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

 

 23 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

The following tables summarize the aggregate credit quality classification of outstanding loans by risk rating as of March 31, 2018 and December 31, 2017:

 

March 31, 2018      Special             
(In Thousands)  Pass   Mention   Substandard   Doubtful   Total 
Residential Mortgage:                         
Residential mortgage loans - first liens  $349,713   $313   $8,708   $52   $358,786 
Residential mortgage loans - junior liens   25,328    100    442    0    25,870 
Home equity lines of credit   34,045    99    451    0    34,595 
1-4 Family residential construction   25,790    0    0    0    25,790 
Total residential mortgage   434,876    512    9,601    52    445,041 
Commercial:                         
Commercial loans secured by real estate   152,743    924    7,904    0    161,571 
Commercial and Industrial   82,445    5,412    1,478    11    89,346 
Political subdivisions   56,224    0    0    0    56,224 
Commercial construction and land   13,155    0    77    0    13,232 
Loans secured by farmland   5,001    626    1,376    12    7,015 
Multi-family (5 or more) residential   7,047    0    574    0    7,621 
Agricultural loans   4,851    268    684    0    5,803 
Other commercial loans   16,007    0    72    0    16,079 
Total commercial   337,473    7,230    12,165    23    356,891 
Consumer   15,383    0    34    0    15,417 
Totals  $787,732   $7,742   $21,800   $75   $817,349 

 

December 31, 2017      Special             
(In Thousands)  Pass   Mention   Substandard   Doubtful   Total 
Residential Mortgage:                         
Residential mortgage loans - first liens  $350,609   $307   $9,019   $52   $359,987 
Residential mortgage loans - junior liens   24,795    104    426    0    25,325 
Home equity lines of credit   35,233    61    464    0    35,758 
1-4 Family residential construction   26,216    0    0    0    26,216 
Total residential mortgage   436,853    472    9,909    52    447,286 
Commercial:                         
Commercial loans secured by real estate   150,806    936    7,524    0    159,266 
Commercial and Industrial   82,724    3,896    1,645    11    88,276 
Political subdivisions   59,287    0    0    0    59,287 
Commercial construction and land   14,449    0    78    0    14,527 
Loans secured by farmland   5,283    581    1,379    12    7,255 
Multi-family (5 or more) residential   7,130    0    583    0    7,713 
Agricultural loans   5,203    270    705    0    6,178 
Other commercial loans   10,913    0    73    0    10,986 
Total commercial   335,795    5,683    11,987    23    353,488 
Consumer   14,853    0    86    0    14,939 
Totals  $787,501   $6,155   $21,982   $75   $815,713 

 

 24 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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 a loan: (1) is subject to a restructuring agreement, or (2) has an outstanding balance of $400,000 or more and a credit grade of Special Mention, Substandard or Doubtful. 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. At March 31, 2018 and December 31, 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 53% at March 31, 2018) is secured by real estate, and accordingly, the Corporation’s risk for the commercial segment is significantly affected by commercial real estate values. The consumer segment includes a wide mix of loans for different purposes, primarily secured loans, including loans secured by motor vehicles, manufactured housing and other types of collateral.

 

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

 

The scope of loans reviewed individually each quarter to determine if they are impaired include all commercial loan relationships greater than $200,000 and any residential mortgage or consumer loans of $400,000 or more 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 March 31, 2018 and December 31, 2017. All loans classified as troubled debt restructurings (discussed in more detail below) and all commercial loan relationships less than $200,000 or other loan relationships less than $400,000 in the aggregate, but with an estimated loss of $100,000 or more, are individually evaluated for impairment.

 

 25 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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 March 31, 2018 and December 31, 2017:

 

   Loans:   Allowance for Loan Losses: 
March 31, 2018  Individually   Collectively       Individually   Collectively     
(In Thousands)  Evaluated   Evaluated   Totals   Evaluated   Evaluated   Totals 
Residential mortgage:                              
Residential mortgage loans - first liens  $969   $357,817   $358,786   $0   $3,067   $3,067 
Residential mortgage loans - junior liens   300    25,570    25,870    122    229    351 
Home equity lines of credit   0    34,595    34,595    0    286    286 
1-4 Family residential construction   0    25,790    25,790    0    239    239 
                               
Total residential mortgage   1,269    443,772    445,041    122    3,821    3,943 
Commercial:                              
Commercial loans secured by real estate   5,982    155,589    161,571    884    1,751    2,635 
Commercial and industrial   498    88,848    89,346    157    879    1,036 
Political subdivisions   0    56,224    56,224    0    0    0 
Commercial construction and land   0    13,232    13,232    0    137    137 
Loans secured by farmland   1,362    5,653    7,015    50    52    102 
Multi-family (5 or more) residential   392    7,229    7,621    0    169    169 
Agricultural loans   684    5,119    5,803    158    47    205 
Other commercial loans   0    16,079    16,079    0    149    149 
                               
Total commercial   8,918    347,973    356,891    1,249    3,184    4,433 
                               
Consumer   19    15,398    15,417    0    174    174 
Unallocated                            499 
                               
Total  $10,206   $807,143   $817,349   $1,371   $7,179   $9,049 

 

   Loans:   Allowance for Loan Losses: 
December 31, 2017  Individually   Collectively       Individually   Collectively     
(In Thousands)  Evaluated   Evaluated   Totals   Evaluated   Evaluated   Totals 
Residential mortgage:                              
Residential mortgage loans - first liens  $984   $359,003   $359,987   $0   $3,200   $3,200 
Residential mortgage loans - junior liens   302    25,023    25,325    122    102    224 
Home equity lines of credit   0    35,758    35,758    0    296    296 
1-4 Family residential construction   0    26,216    26,216    0    243    243 
                               
Total residential mortgage   1,286    446,000    447,286    122    3,841    3,963 
Commercial:                              
Commercial loans secured by real estate   5,873    153,393    159,266    919    1,665    2,584 
Commercial and industrial   568    87,708    88,276    188    877    1,065 
Political subdivisions   0    59,287    59,287    0    0    0 
Commercial construction and land   0    14,527    14,527    0    150    150 
Loans secured by farmland   1,365    5,890    7,255    50    55    105 
Multi-family (5 or more) residential   392    7,321    7,713    0    172    172 
Agricultural loans   7    6,171    6,178    0    57    57 
Other commercial loans   0    10,986    10,986    0    102    102 
                               
Total commercial   8,205    345,283    353,488    1,157    3,078    4,235 
                               
Consumer   20    14,919    14,939    0    159    159 
Unallocated                            499 
                               
Total  $9,511   $806,202   $815,713   $1,279   $7,078   $8,856 

 

 26 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Summary information related to impaired loans at March 31, 2018 and December 31, 2017 is as follows:

 

   March 31, 2018   December 31, 2017 
   Unpaid           Unpaid         
   Principal   Recorded   Related   Principal   Recorded   Related 
(In Thousands)  Balance   Investment   Allowance   Balance   Investment   Allowance 
With no related allowance recorded:                              
Residential mortgage loans - first liens  $725   $696   $0   $740   $711   $0 
Residential mortgage loans - junior liens   58    58    0    60    60    0 
Commercial loans secured by real estate   3,375    3,375    0    3,230    3,230    0 
Commercial and industrial   92    92    0    119    119    0 
Loans secured by farmland   868    868    0    871    871    0 
Multi-family (5 or more) residential   987    392    0    987    392    0 
Agricultural loans   7    7    0    8    8    0 
Consumer   19    19    0    20    20    0 
Total with no related allowance recorded   6,131    5,507    0    6,035    5,411    0 
                               
With a related allowance recorded:                              
Residential mortgage loans - first liens   273    273    0    273    273    0 
Residential mortgage loans - junior liens   242    242    122    242    242    122 
Commercial loans secured by real estate   2,607    2,607    884    2,641    2,641    919 
Commercial and industrial   406    406    157    449    449    188 
Loans secured by farmland   494    494    50    495    495    50 
Agricultural loans   677    677    158    0    0    0 
Total with a related allowance recorded   4,699    4,699    1,371    4,100    4,100    1,279 
Total  $10,830   $10,206   $1,371   $10,135   $9,511   $1,279 

 

In the table immediately above, two loans to one borrower are presented under the Residential mortgage loans – first liens and Residential mortgage loans – junior liens classes. These loans are collateralized by one property, and the allowance associated with these loans was determined based on an analysis of the total amounts of the Corporation’s exposure in comparison to the estimated net proceeds if the Corporation were to sell the property.

 

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 
   3 Months Ended   3 Months Ended 
   March 31,   March 31, 
(In Thousands)  2018   2017   2018   2017 
Residential mortgage:                    
Residential mortgage loans - first lien  $1,046   $748   $19   $9 
Residential mortgage loans - junior lien   301    67    3    1 
Total residential mortgage   1,347    815    22    10 
Commercial:                    
Commercial loans secured by real estate   5,882    6,889    35    56 
Commercial and industrial   508    247    6    3 
Loans secured by farmland   1,364    1,390    6    8 
Multi-family (5 or more) residential   392    392    0    0 
Agricultural loans   346    12    11    1 
Total commercial   8,492    8,930    58    68 
Consumer   19    33    0    0 
Total  $9,858   $9,778   $80   $78 

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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:

 

   March 31, 2018   December 31, 2017 
   Past Due       Past Due     
   90+ Days and       90+ Days and     
(In Thousands)  Accruing   Nonaccrual   Accruing   Nonaccrual 
Residential mortgage:                    
Residential mortgage loans - first liens  $1,840   $4,354   $2,340   $5,131 
Residential mortgage loans - junior liens   10    242    105    242 
Home equity lines of credit   230    42    203    44 
Total residential mortgage   2,080    4,638    2,648    5,417 
Commercial:                    
Commercial loans secured by real estate   128    6,000    175    5,645 
Commercial and industrial   347    498    603    517 
Commercial construction and land   25    52    26    52 
Loans secured by farmland   215    1,307    271    1,308 
Multi-family (5 or more) residential   0    392    0    392 
Agricultural loans   0    684    0    7 
Total commercial   715    8,933    1,075    7,921 
Consumer   0    16    1    66 
                     
Totals  $2,795   $13,587   $3,724   $13,404 

 

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.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

The table below presents a summary of the contractual aging of loans as of March 31, 2018 and December 31, 2017:

 

   As of March 31, 2018   As of December 31, 2017 
   Current &               Current &             
   Past Due   Past Due   Past Due       Past Due   Past Due   Past Due     
   Less than   30-89   90+       Less than   30-89   90+     
(In Thousands)  30 Days   Days   Days   Total   30 Days   Days   Days   Total 
Residential mortgage:                                        
Residential mortgage loans - first liens  $351,132   $4,475   $3,179   $358,786   $347,032   $7,967   $4,988   $359,987 
Residential mortgage loans - junior liens   25,716    144    10    25,870    25,133    87    105    25,325 
Home equity lines of credit   33,960    381    254    34,595    34,789    732    237    35,758 
1-4 Family residential construction   25,651    139    0    25,790    25,667    549    0    26,216 
Total residential mortgage   436,459    5,139    3,443    445,041    432,621    9,335    5,330    447,286 
                                         
Commercial:                                        
Commercial loans secured by real estate   157,605    581    3,385    161,571    155,917    311    3,038    159,266 
Commercial and industrial   88,386    549    411    89,346    87,306    303    667    88,276 
Political subdivisions   56,224    0    0    56,224    59,287    0    0    59,287 
Commercial construction and land   12,839    316    77    13,232    14,400    49    78    14,527 
Loans secured by farmland   5,548    494    973    7,015    6,226    12    1,017    7,255 
Multi-family (5 or more) residential   7,229    0    392    7,621    7,321    0    392    7,713 
Agricultural loans   5,651    145    7    5,803    6,114    57    7    6,178 
Other commercial loans   16,079    0    0    16,079    10,986    0    0    10,986 
Total commercial   349,561    2,085    5,245    356,891    347,557    732    5,199    353,488 
Consumer   15,307    94    16    15,417    14,760    123    56    14,939 
                                         
Totals  $801,327   $7,318   $8,704   $817,349   $794,938   $10,190   $10,585   $815,713 

 

Nonaccrual loans are included in the contractual aging in the immediately preceding table. A summary of the contractual aging of nonaccrual loans at March 31, 2018 and December 31, 2017 is as follows:

 

   Current &             
   Past Due   Past Due   Past Due     
   Less than   30-89   90+     
(In Thousands)  30 Days   Days   Days   Total 
March 31, 2018 Nonaccrual Totals  $6,287   $1,391   $5,909   $13,587 
December 31, 2017 Nonaccrual Totals  $5,802   $741   $6,861   $13,404 

 

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 March 31, 2018 and December 31, 2017 is as follows:

 

   Current &                 
   Past Due   Past Due   Past Due         
   Less than   30-89   90+         
(In Thousands)  30 Days   Days   Days   Nonaccrual   Total 
March 31, 2018 Totals  $774   $0   $0   $2,987   $3,761 
December 31, 2017 Totals  $636   $0   $0   $3,027   $3,663 

 

At March 31, 2018 and December 31, 2017, there were no commitments to loan additional funds to borrowers whose loans have been classified as TDRs.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

TDRs that occurred during the three-month periods ended March 31, 2018 and 2017 are as follows:

 

   March 31, 2018   March 31, 2017 
       Post-       Post- 
   Number   Modification   Number   Modification 
   of   Recorded   of   Recorded 
(Balances in Thousands)  Loans   Investment   Loans   Investment 
Residential mortgage - first liens,                    
Reduced monthly payments for a six-month period   1   $80    0   $0 
Commercial loans secured by real estate,                    
Extended interest only payments for a six-month period   2    36    0    0 
Commercial and industrial,                    
Extended interest only payments for a six-month period   1    46    0    0 
Total   4   $162    0   $0 

 

In the three-month periods ended March 31, 2018 and 2017, defaults on loans for which modifications considered to be TDRs were entered into within the previous 12 months are summarized as follows:

 

   March 31, 2018   March 31, 2017 
   Number       Number     
   of   Recorded   of   Recorded 
(Balances in Thousands)  Loans   Investment   Loans   Investment 
Residential mortgage - first liens   0   $0    2   $293 
Residential mortgage - junior liens   0    0    1    28 
Consumer   0    0    1    26 
Total   0   $0    4   $347 

 

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 sheets) is as follows:

 

   March 31,   Dec. 31, 
(In Thousands)  2018   2017 
Foreclosed residential real estate  $396   $721 

 

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

 

   March 31,   Dec. 31, 
(In Thousands)  2018   2017 
Residential real estate in process of foreclosure  $1,470   $1,789 

 

8. BORROWED FUNDS

 

Short-term borrowings (initial maturity within one year) include the following:

 

   March 31,   Dec. 31, 
(In Thousands)  2018   2017 
FHLB-Pittsburgh borrowings  $21,000   $58,000 
Customer repurchase agreements   5,482    3,766 
Total short-term borrowings  $26,482   $61,766 

 

The FHLB-Pittsburgh loan facilities are collateralized by qualifying loans secured by real estate with a book value totaling $494,290,000 at March 31, 2018 and $488,889,000 at December 31, 2017. 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 $5,142,000 at March 31, 2018 and $6,426,000 at December 31, 2017.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

At March 31, 2018, the short-term borrowings from FHLB-Pittsburgh consisted of 7 advances of $3,000,000 each maturing monthly from April to October 2018, with a weighted average interest rate of 1.72%. At December 31, 2017, the short-term borrowings from FHLB-Pittsburgh of $58,000,000 included an overnight borrowing of $29,000,000 with an interest rate of 1.54% and other short-term advances totaling $29,000,000 with a weighted average rate of 1.69%.

 

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 March 31, 2018 and December 31, 2017. The carrying value of the underlying securities was $11,417,000 at March 31, 2018 and $12,158,000 at December 31, 2017.

 

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

 

   March 31,   Dec. 31, 
(In Thousands)  2018   2017 
Loan maturing in November 2018 with a rate of 1.63%  $3,000   $3,000 
Loan maturing in December 2018 with a rate of 1.35%   3,000    3,000 
Loan maturing in January 2019 with a rate of 1.83%   2,000    2,000 
Loan maturing in February 2019 with a rate of 1.95%   3,000    0 
Loan maturing in March 2019 with a rate of 2.15%   3,000    0 
Loan maturing in April 2019 with a rate of 2.24%   3,000    0 
Loan maturing in April 2020 with a rate of 4.79%   416    463 
Loan maturing in June 2025 with a rate of 4.91%   706    726 
Total long-term FHLB-Pittsburgh borrowings  $18,122   $9,189 

 

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 March 31, 2018 and December 31, 2017, 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:

 

   Pension   Postretirement 
   Three Months Ended   Three Months Ended 
Defined Benefit Plans  March 31,   March 31, 
(In Thousands)  2018   2017   2018   2017 
Service cost  $0   $0   $10   $9 
Interest cost   6    6    13    14 
Expected return on plan assets   (5)   (8)   0    0 
Amortization of prior service cost   0    0    (8)   (8)
Recognized net actuarial loss   3    2    0    0 
Net periodic benefit cost  $4   $0   $15   $15 

 

Service cost, interest cost and expected return on plan assets are included in pensions and other employee benefits expense in the consolidated statements of income in the first quarter 2018 and 2017. Amortization of prior service cost and the recognized net actuarial loss are included in other noninterest expense in the consolidated statements of income in the first quarter 2018 and 2017.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

In the first three months of 2018, the Corporation funded postretirement contributions totaling $12,000, with estimated annual postretirement contributions of $60,000 expected in 2018 for the full year. No defined benefit pension contributions are required in 2018, 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 2018, the Corporation awarded 25,466 shares of restricted stock under the Stock Incentive Plan and 9,086 shares of restricted stock under the Independent Directors Stock Incentive Plan. The 2018 restricted stock awards under the Stock Incentive Plan vest ratably over three years, and vesting for one-half of the 16,578 restricted shares awarded to Executive Officers depends on the Corporation meeting a return on average equity (“ROAE”) target each year. The 2018 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 fair value of the stock at the grant date over the vesting period, adjusted for estimated and actual forfeitures. Management has estimated restricted stock expense in the first three months of 2018 based on an assumption that the ROAE target for awards to Executive Officers in 2016, 2017 and 2018 will not be met, resulting in forfeiture of the restricted stock.

 

Total annual stock-based compensation for the year ending December 31, 2018 is estimated to total $714,000. If the ROAE targets for awards to Executive Officers in 2016, 2017 and 2018 are met or exceeded, total annual stock-based compensation would increase by approximately $190,000. Total stock-based compensation expense attributable to restricted stock awards amounted to $183,000 in the first quarter 2018 and $168,000 in the first quarter 2017.

 

11. INCOME TAXES

 

The net deferred tax asset at March 31, 2018 and December 31, 2017 represents the following temporary difference components:

 

   March 31,   December 31, 
(In Thousands)  2018   2017 
Deferred tax assets:          
Unrealized holding losses on securities:          
Included in accumulated other comprehensive loss  $1,508   $843 
Included in retained earnings   0    (337)
Allowance for loan losses   1,935    1,894 
Other deferred tax assets   1,544    1,726 
Total deferred tax assets   4,987    4,126 
           
Deferred tax liabilities:          
Defined benefit plans - ASC 835:          
Included in accumulated other comprehensive loss   37    31 
Included in retained earnings   0    (12)
Bank premises and equipment   765    751 
Core deposit intangibles   2    3 
Other deferred tax liabilities   63    64 
Total deferred tax liabilities   867    837 
Deferred tax asset, net  $4,120   $3,289 

 

In December 2017, the Corporation recognized an adjustment in the carrying value of the net deferred tax asset as a result of a reduction in the federal corporate income tax rate to 21%, effective January 1, 2018, from the 35% marginal rate that had previously been in effect. At December 31, 2017, the portion of the adjustment attributable to items of accumulated other comprehensive income (loss) were stranded in retained earnings, including components related to unrealized losses on securities and defined benefit plans. As described in Note 1, the Corporation elected early adoption of ASU 2018-02, resulting in a reclassification between two categories of stockholders’ equity at January 1, 2018, with an increase of $325,000 in retained earnings and a decrease in accumulated other comprehensive loss for the same amount. Management believes the Corporation’s accounting for the effects of the reduction in the federal income tax rate is materially complete at March 31, 2018.

 

 32 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

 

The provision for income tax for the three-month periods ended March 31, 2018 and 2017 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 
(Dollars In thousands)  March 31, 
   2018   2017 
Income before income tax provision  $5,116   $4,418 
Income tax provision   741    984 
Effective tax rate   14.48%   22.27%

 

The effective tax rate for each period presented differs from the statutory rate of 21% for the period ended March 31, 2018 and 35% for the period ended March 31, 2017 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 2017 and expects to continue to receive tax credits annually through 2022. The carrying amount of the Corporation’s investment is $581,000 at March 31, 2018 and $608,000 at December 31, 2017 (included in Other Assets in the consolidated balance sheets). For the year ending December 31, 2018, the estimated amount of tax credits and other tax benefits to be received is $150,000 and the estimated amount to be recognized as a reduction of the provision for income taxes is $54,000. The total reduction in the provision for income taxes resulting from this investment is $14,000 in the first quarter 2018 and $18,000 in the first quarter 2017.

 

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.   REVENUE RECOGNITION

 

As disclosed in Note 1, as of January 1, 2018, the Corporation adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606), as well as subsequent ASUs that modified ASC 606. The Company has elected to apply the ASU and all related ASUs using the modified retrospective implementation method. The implementation of the guidance had no material impact on the measurement or recognition of revenue of prior periods. The Corporation generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed; charged either on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.

 

Additional disclosures related to the Corporation’s largest sources of noninterest income within the consolidated statements of income that are subject to ASC 606 are as follows:

 

Trust and financial management revenue – C&N Bank’s trust division provides a wide range of financial services, including wealth management services for individuals, businesses and retirement funds, administration of 401(k) and other retirement plans, retirement planning, estate planning and estate settlement services. Trust clients are located primarily within the Corporation’s geographic markets. Assets held in a fiduciary capacity by C&N Bank are not the Corporation’s assets and are therefore not included in the consolidated balance sheets. The fair value of trust assets under management was approximately $916,295,000 at March 31, 2018 and $916,580,000 at December 31, 2017. Trust and financial management revenue is included within noninterest income in the consolidated statements of income.

 

 33 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Trust revenue is recorded on a cash basis, which is not materially different from the accrual basis. The majority (approximately 81%, based on annual 2017 results) of trust revenue is earned and collected monthly, with the amount determined based on a percentage of the fair value of the trust assets under management. Wealth management fees are contractually agreed with each customer, and fee levels vary based mainly on the size of assets under management. The services provided under such a contract represent a single performance obligation under the ASU because it embodies a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer. None of the contracts with trust customers provide for incentive-based fees. In addition to wealth management fees, trust revenue includes fees for provision of services, including employee benefit plan administration, tax return preparation and estate planning and settlement. Fees for such services are billed based on contractual arrangements or established fee schedules, and are typically billed upon completion of providing such services. The costs of acquiring trust customers are incremental and recognized within noninterest expense in the consolidated statements of income.

 

Service charges on deposit accounts - Deposits are included as liabilities in the consolidated balance sheets. Service charges on deposit accounts include: overdraft fees, which are charged when customers overdraw their accounts beyond available funds; automated teller machine (ATM) fees charged for withdrawals by deposit customers from other financial institutions’ ATMs; and a variety of other monthly or transactional fees for services provided to retail and business customers, mainly associated with checking accounts. All deposit liabilities are considered to have one-day terms and therefore related fees are recognized in income at the time when the services are provided to the customers. Incremental costs of obtaining deposit contracts are not significant and are recognized as expense when incurred within noninterest expense in the consolidated statements of income.

 

Interchange revenue from debit card transactions – The Corporation issues debit cards to consumer and business customers with checking, savings or money market deposit accounts. Debit card and ATM transactions are processed via electronic systems that involve several parties. The Corporation’s debit card and ATM transaction processing is executed via contractual arrangements with payment processing networks, a processor and a settlement bank. As described above, all deposit liabilities are considered to have one-day terms and therefore interchange revenue from customers’ use of their debit cards to initiate transactions are recognized in income at the time when the services are provided and related fees received in the Corporation’s deposit account with the settlement bank. Incremental costs associated with ATM and interchange processing are recognized as expense when incurred within noninterest expense in the consolidated statements of income.

 

 34 

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 $0.36 for the first quarter 2018, up from $0.16 in the fourth quarter 2017 and $0.28 in the first quarter 2017. First quarter 2018 earnings reflected the benefit of the reduction in the federal corporate income tax rate to 21%, effective January 1, 2018, from the 35% marginal tax rate in effect throughout 2017. In contrast, fourth quarter 2017 results included additional income tax expense related to a reduction in the carrying value of the net deferred tax asset, resulting in a reduction of $0.18 in diluted earnings per share. The annualized return on average assets for the first three months of 2018 was 1.39%, and the annualized return on average equity was 9.41%. Highlights related to the Corporation’s earnings results for the first quarters of 2018 and 2017 are presented below.

 

Net income for the first quarter 2018 of $4,375,000 was higher by $941,000 (27.4%) than the first quarter 2017 amount. Pre-tax income was $698,000 (15.8%) higher in the first quarter 2018 as compared to the first quarter 2017, while the income tax provision was $243,000 lower. As noted above, the marginal federal income tax rate in effect in 2018 is 21%, down from the 2017 marginal rate of 35%. Accordingly, the effective tax rate of 14.5% for the first quarter 2018 was significantly lower than the first quarter 2017 effective tax rate of 22.3%. Other significant earnings-related variances were as follows:

 

·Net interest income increased $738,000 (7.3%) in the first quarter 2018 over the first quarter 2017 amount. Total interest and dividend income increased $778,000, while interest expense increased $40,000. The net interest margin of 3.84% for the first quarter 2018 was 0.06% higher than the first quarter 2017 level. Despite the decrease in fully taxable-equivalent yields on municipal securities and loans resulting from the reduced corporate tax rate, the average yield on earning assets increased to 4.18% in the first quarter 2018 from 4.11% in the first quarter 2017. The improvement in average yield included the impact of an increase in average yield on taxable loans, reflecting the effects of recent increases in interest rates, along with a favorable change in the mix of earning assets with growth in loans and a reduction in securities. Average total loans outstanding were higher by $57.5 million (7.6%) in the first quarter 2018 as compared to the first quarter 2017, while average total available-for-sale debt securities were lower by $34.9 million. Average total deposits were $30.3 million (3.1%) higher in the first quarter 2018 as compared to the first quarter 2017. The average rate paid on interest-bearing liabilities of 0.49% in the first quarter 2018 was up 0.02% as compared to the first quarter 2017. The average rate paid on deposits was up 0.11% in the first quarter 2018 as compared to the first quarter 2017, while the average cost of borrowed funds dropped to 1.64% from 2.20% as a result of the pay-off of higher-cost borrowings that matured in the latter portion of 2017.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

·The provision for loan losses of $292,000 in the first quarter 2018 was lower than the first quarter 2017 provision of $452,000. As noted above, the first quarter 2018 provision included $191,000 attributable to the change in total specific allowances on impaired loans, as adjusted for net charge-offs during the period. In comparison, the first quarter 2017 provision included $388,000 from the net increase in specific allowances on impaired loans as adjusted for net charge-offs.

 

·Noninterest income, excluding net gains on securities, increased $542,000 (14.0%) in the first quarter 2018 over the first quarter 2017 amount. Trust and financial management revenue increased $242,000 (20.5%), reflecting growth in assets under management resulting from market appreciation and new business, as well as an increase in fee levels. Service charges on deposit accounts increased $103,000 (9.4%) in the first quarter 2018 over the first quarter 2017 total, mainly due to increased fees from the overdraft privilege program and reflecting the benefit of operational improvements to the program that were instituted early in 2018.

 

·There were no realized gains or losses from available-for-sale debt securities in the first quarter 2018. In comparison, gains from sales of securities totaled $145,000 in the first quarter 2017.

 

·Total noninterest expense increased $597,000 (6.4%) in the first quarter 2018 over the first quarter 2017 amount. Salaries and wages expense increased $256,000 (6.6%), including the effects of annual performance-based salary adjustments for a majority of employees along with an increase of $86,000 in estimated cash and stock-based compensation expense and an increase in the average number of full-time equivalent employees (FTEs) to 294 in the first quarter 2018 from 289 in the first quarter 2017. Pensions and other employee benefits expense increased $86,000, including an increase of $81,000 in health care expenses due to higher claims on the partially self-insured plan. Over the last half of 2017 and first three months of 2018, C&N installed a new telephone system throughout most locations and implemented a new loan origination system. Costs associated with these projects contributed to increases in professional fees, data processing and other noninterest expense in the first quarter 2018 as compared to the first quarter 2017.

 

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:         
   March 31,   Dec. 31,   Sept. 30,   June 30,   March 31, 
   2018   2017   2017   2017   2017 
Interest income  $11,890   $11,785   $11,626   $11,340   $11,112 
Interest expense   993    999    985    978    953 
Net interest income   10,897    10,786    10,641    10,362    10,159 
Provision for loan losses   292    23    322    4    452 
Net interest income after provision for loan losses   10,605    10,763    10,319    10,358    9,707 
Noninterest income   4,406    4,117    4,066    4,106    3,864 
Net gains on securities   0    0    5    107    145 
Noninterest expense   9,895    9,401    9,192    9,076    9,298 
Income before income tax provision   5,116    5,479    5,198    5,495    4,418 
Income tax provision   741    3,536    1,262    1,374    984 
Net income  $4,375   $1,943   $3,936   $4,121   $3,434 
Net income attributable to common shares  $4,352   $1,933   $3,916   $4,100   $3,416 
Basic earnings per common share  $0.36   $0.16   $0.32   $0.34   $0.28 
Diluted earnings per common share  $0.36   $0.16   $0.32   $0.34   $0.28 

 

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 periods ended March 31, 2018 and March 31, 2017. 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.

 

For the three-month periods, fully taxable equivalent net interest income was $11,226,000 in 2018, $385,000 (3.6%) higher than in 2017. Interest income was $425,000 higher in 2018 as compared to 2017, while interest expense was higher by $40,000 in comparing the same periods. As presented in Table III, the Net Interest Margin was 3.84% in 2018 as compared to 3.78% in 2017, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) was 3.69% in 2018, up from 3.64% in 2017.

 

INTEREST INCOME AND EARNING ASSETS

 

Interest income totaled $12,219,000 in 2018, an increase of 3.6% from 2017. Interest and fees on loans receivable increased $839,000, or 9.3%, to $9,901,000 in 2018 from $9,062,000 in 2017. Table IV shows the increase in interest on loans includes $672,000 attributable to an increase in volume and $167,000 related to an increase in average rate. The average balance of loans receivable increased $57,519,000 to $816,897,000 in 2018 from $759,378,000 in 2017. The increase in average balance is due to the continued loan growth the Corporation has experienced over the course of 2017 and the first quarter of 2018, especially in residential real estate, commercial loans, and tax-exempt loans. The average rate on taxable loans in 2018 was 5.04% compared to 4.87% in 2017 as current rates on variable rate loans and rates on recent new loan originations have increased, consistent with increases in market interest rates. The yield on tax-exempt loans receivable decreased to 3.72% in 2018 compared to 4.55% in 2017. This decrease reflects the reduced tax benefit on tax-exempt assets as compared to taxable assets resulting from the marginal tax rate being reduced to 21% in 2018 from 35% in 2017.

 

As indicated in Table III, average available-for-sale debt securities (at amortized cost) totaled $353,017,000 in 2018, a decrease of $34,862,000 (9.0%) from 2017. Proceeds from maturities and calls of securities have been used to help fund loan growth throughout 2017 and the first quarter of 2018. The average yield on available-for-sale debt securities decreased to 2.60% in 2018 from 2.81% in 2017. The reduction in yield on available-for-sale debt securities includes the impact of a reduced tax benefit on tax-exempt municipal bonds as a result of the reduction in the federal income tax rate.

 

INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES

 

Interest expense increased $40,000, or 4.2%, to $993,000 in 2018 from $953,000 in 2017. Table III shows that the overall cost of funds on interest-bearing liabilities increased to 0.49% in 2018 from 0.47% in 2017.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Interest expense on deposits increased $208,000 in 2018 over 2017. The average rate on interest-bearing deposits increased to 0.39% in 2018 from 0.28% in 2017. The average rate on certificates of deposit increased 0.20% while rates on interest checking accounts increased 0.18% when comparing the same periods. Total average deposits (interest-bearing and noninterest-bearing) increased 3.1% to $997,515,000 in 2018 from $967,223,000 in 2017.

 

Interest expense on total borrowed funds decreased $168,000 in 2018 as compared to 2017. The average balance of total borrowed funds decreased to $65,359,000 in 2018 from $79,805,000 in 2017. The average rate on total borrowed funds decreased to 1.64% in 2018, down from 2.20% in 2017.

 

Interest expense on short-term borrowings increased $122,000 to $199,000 in 2018 from $77,000 in 2017. The increase in interest expense is due primarily to higher short-term interest rates in 2018 compared 2017 as the average rate on short-term borrowings increased to 1.54% in 2018 from 0.75% in 2017. The average balance of short-term borrowings increased to $52,305,000 in the first quarter 2018 from $41,386,000 in 2017.

 

Interest expense on long-term borrowings decreased $290,000 to $65,000 in 2018 from $355,000 in 2017. The average balance of long-term borrowings was $13,054,000 in the first quarter 2018, at an average rate of 2.02%, down from an average balance of $38,419,000 at an average rate of 3.75% in 2017. The reduction in average balance and rate on long-term borrowings reflected the impact of repayments of two higher-cost borrowings in the latter portion of 2017. These borrowings included a $10 million FHLB advance with an interest rate of 3.81% and a $27 million repurchase agreement with a rate of 3.595%.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

TABLE II - ANALYSIS OF INTEREST INCOME AND EXPENSE

 

   Three Months Ended     
   March 31,   Increase/ 
(In Thousands)  2018   2017   (Decrease) 
INTEREST INCOME               
Available-for-sale debt securities:               
Taxable  $1,363   $1,403   ($40)
Tax-exempt   898    1,288    (390)
Total available-for-sale debt securities   2,261    2,691    (430)
Dividends on marketable equity security   5    5    0 
Interest-bearing due from banks   50    32    18 
Loans held for sale   2    4    (2)
Loans receivable:               
Taxable   9,201    8,374    827 
Tax-exempt   700    688    12 
Total loans receivable   9,901    9,062    839 
Total Interest Income   12,219    11,794    425 
                
INTEREST EXPENSE               
Interest-bearing deposits:               
Interest checking   181    77    104 
Money market   93    81    12 
Savings   37    34    3 
Certificates of deposit   305    224    81 
Individual Retirement Accounts   113    105    8 
Total interest-bearing deposits   729    521    208 
Borrowed funds:               
Short-term   199    77    122 
Long-term   65    355    (290)
Total borrowed funds   264    432    (168)
Total Interest Expense   993    953    40 
                
Net Interest Income  $11,226   $10,841   $385 

 

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 21% for 2018 and 35% for 2017.

 

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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     
   Ended   Rate of   Ended   Rate of 
   3/31/2018   Return/   3/31/2017   Return/ 
   Average   Cost of   Average   Cost of 
   Balance   Funds %   Balance   Funds % 
EARNING ASSETS                    
Available-for-sale debt securities, at amortized cost:                    
Taxable  $249,840    2.21%  $270,251    2.11%
Tax-exempt   103,177    3.53%   117,628    4.44%
Total available-for-sale debt securities   353,017    2.60%   387,879    2.81%
Marketable equity security   962    2.11%   1,000    2.03%
Interest-bearing due from banks   14,131    1.43%   14,923    0.87%
Loans held for sale   168    4.83%   201    8.07%
Loans receivable:                    
Taxable   740,655    5.04%   698,042    4.87%
Tax-exempt   76,242    3.72%   61,336    4.55%
Total loans receivable   816,897    4.92%   759,378    4.84%
Total Earning Assets   1,185,175    4.18%   1,163,381    4.11%
Cash   16,874         16,013      
Unrealized gain/loss on securities   (5,529)        (958)     
Allowance for loan losses   (9,002)        (8,593)     
Bank premises and equipment   15,451         15,712      
Intangible assets   11,954         11,959      
Other assets   42,781         43,878      
Total Assets  $1,257,704        $1,241,392      
                     
INTEREST-BEARING LIABILITIES                    
Interest-bearing deposits:                    
Interest checking  $212,981    0.34%  $201,120    0.16%
Money market   179,923    0.21%   191,103    0.17%
Savings   149,618    0.10%   138,805    0.10%
Certificates of deposit   123,974    1.00%   113,636    0.80%
Individual Retirement Accounts   94,311    0.49%   99,028    0.43%
Other time deposits   772    0.00%   791    0.00%
Total interest-bearing deposits   761,579    0.39%   744,483    0.28%
Borrowed funds:                    
Short-term   52,305    1.54%   41,386    0.75%
Long-term   13,054    2.02%   38,419    3.75%
Total borrowed funds   65,359    1.64%   79,805    2.20%
Total Interest-bearing Liabilities   826,938    0.49%   824,288    0.47%
Demand deposits   235,936         222,740      
Other liabilities   8,870         8,162      
Total Liabilities   1,071,744         1,055,190      
Stockholders' equity, excluding other comprehensive loss   190,129         186,689      
Accumulated other comprehensive loss   (4,169)        (487)     
Total Stockholders' Equity   185,960         186,202      
Total Liabilities and Stockholders' Equity  $1,257,704        $1,241,392      
Interest Rate Spread        3.69%        3.64%
Net Interest Income/Earning Assets        3.84%        3.78%
                     
Total Deposits (Interest-bearing and Demand)  $997,515        $967,223      

 

(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 21% in 2018 and 35% in 2017.

(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 3/31/18 vs. 3/31/17 
   Change in   Change in   Total 
   Volume   Rate   Change 
EARNING ASSETS               
Available-for-sale debt securities:               
Taxable  ($109)  $69   ($40)
Tax-exempt   (146)   (244)   (390)
Total available-for-sale debt securities   (255)   (175)   (430)
Marketable equity security   0    0    0 
Interest-bearing due from banks   (2)   20    18 
Loans held for sale   (1)   (1)   (2)
Loans receivable:               
Taxable   522    305    827 
Tax-exempt   150    (138)   12 
Total loans receivable   672    167    839 
Total Interest Income   414    11    425 
                
INTEREST-BEARING LIABILITIES               
Interest-bearing deposits:               
Interest checking   5    99    104 
Money market   (5)   17    12 
Savings   3    0    3 
Certificates of deposit   21    60    81 
Individual Retirement Accounts   (5)   13    8 
Total interest-bearing deposits   19    189    208 
Borrowed funds:               
Short-term   24    98    122 
Long-term   (171)   (119)   (290)
Total borrowed funds   (147)   (21)   (168)
Total Interest Expense   (128)   168    40 
                
Net Interest Income  $542   ($157)  $385 

 

(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 21% for 2018 and 35% for 2017.

 

(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

(In Thousands)

 

   3 Months Ended         
   March 31,   $   % 
   2018   2017   Change   Change 
Trust and financial management revenue  $1,422   $1,180   $242    20.5 
Brokerage revenue   212    156    56    35.9 
Insurance commissions, fees and premiums   44    41    3    7.3 
Service charges on deposit accounts   1,204    1,101    103    9.4 
Service charges and fees   86    80    6    7.5 
Interchange revenue from debit card transactions   579    520    59    11.3 
Net gains from sales of loans   184    166    18    10.8 
Loan servicing fees, net   128    72    56    77.8 
Increase in cash surrender value of life insurance   97    90    7    7.8 
Other noninterest income   450    458    (8)   (1.7)
Total noninterest income before realized gains on securities, net  $4,406   $3,864   $542    14.0 

 

Table V excludes realized gains on securities, which are discussed in the “Earnings Overview” section of Management’s Discussion and Analysis. Total noninterest income shown in Table V increased $542,000 (14.0%) in the first three months of 2018 over the first three months of 2017 amount. The most significant variances include the following:

 

·Trust and financial management revenue increased $242,000 (20.5%). The increase included the effects of a mid-year 2017 increase in fee levels and an increase in the value of assets under management to $916,295,000 at March 31, 2018, up 4.0% from one year earlier. The increase in value of Trust assets under management resulted from appreciation in equity values and new business.

 

·Service charges on deposit accounts increased $103,000 (9.4%), mainly due to increased fees from the overdraft privilege program and reflecting the benefit of operational improvements to the program that were instituted early in 2018.

 

·Interchange revenue from debit card transactions increased $59,000 (11.3%), reflecting an increase in volume of transactions.

 

·Loan servicing fees, net, increased $56,000. 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 increased by $20,000 in the first three months of 2018 as compared to a reduction of $30,000 in the same period of 2017.

 

·As a result of increased volume, broker-dealer revenue increased $56,000 (35.9%).

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

NONINTEREST EXPENSE

 

TABLE VI - COMPARISON OF NONINTEREST EXPENSE

(Dollars In Thousands)

 

   Three Months Ended         
   March 31,   $   % 
   2018   2017   Change   Change 
 Salaries and wages  $4,124   $3,868   $256    6.6 
 Pensions and other employee benefits   1,610    1,524    86    5.6 
 Occupancy expense, net   637    578    59    10.2 
 Furniture and equipment expense   271    313    (42)   (13.4)
 Data processing expenses   641    575    66    11.5 
 Automated teller machine and interchange expense   322    294    28    9.5 
 Pennsylvania shares tax   336    336    0    0.0 
 Professional fees   276    187    89    47.6 
 Directors' fees   184    185    (1)   (0.5)
 Other noninterest expense   1,494    1,438    56    3.9 
 Total noninterest expense  $9,895   $9,298   $597    6.4 

 

As shown in Table VI, total noninterest expense increased $597,000 (6.4%) in the first three months of 2018 as compared to the first three months of 2017. The most significant variances include the following:

 

·Salaries and wages expense increased $256,000 (6.6%), including the effects of annual performance-based salary adjustments for a majority of employees along with an increase of $86,000 in estimated cash and stock-based compensation expense and an increase in the average number of full-time equivalent employees (FTEs) to 294 in the first quarter 2018 from 289 in the first quarter 2017.

 

·Pensions and other employee benefits expense increased $86,000, including an increase of $81,000 in health care expenses due to higher claims on the partially self-insured plan.

 

·Professional fees were $89,000 higher in 2018 than in 2017. The increase in professional fees included expenses in the first quarter 2018 related to implementation of a new mortgage loan origination system as well as a consulting project related to Board governance and committee structure.

 

·Data processing expenses increased $66,000, including costs associated with the new mortgage loan origination system.

 

·Occupancy costs increased $59,000, primarily due to increases in fuel and utility costs.

 

·Other noninterest expense increased $56,000. Within this category, the largest changes were: (1) telecommunications expense, which increased $100,000 as a result of additional costs related to a new telephone system, along with costs from the prior legacy system during the transition period, and (2) collection expense, net of reimbursements, which was $101,000 lower in the first three months of 2018 than in the same period of 2017.

 

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 three months of 2018 was $741,000, or 14.5% of pre-tax earnings, which was $243,000 lower than the provision for the first three months of 2017 of $984,000, or 22.3% of pre-tax income. The Corporation benefited from the reduction in the federal corporate income tax rate to 21%, effective January 1, 2018, from the 35% marginal tax rate in effect throughout 2017. The Corporation’s effective tax rates differ from the statutory rate of 21% in the first three months of 2018 and 35% for the first three months of 2017 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 March 31, 2018 the net deferred tax asset was $4,120,000, up from $3,289,000 at December 31, 2017. The most significant change in temporary difference components was a net increase of $1,002,000 related to unrealized losses on available-for-sale securities. At March 31, 2018, the net deferred tax asset associated with the unrealized loss was $1,508,000, while at December 31, 2017, the deferred tax asset associated with the unrealized loss was $506,000, including $843,000 recorded as an offset to the pre-tax unrealized loss within accumulated other comprehensive loss, partially offset by $337,000 charged against retained earnings.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

The Corporation regularly reviews deferred tax assets for recoverability based on history of earnings, expectations for future earnings and expected timing of reversals of temporary differences. Realization of deferred tax assets ultimately depends on the existence of sufficient taxable income, including taxable income in prior carryback years, as well as future taxable income.

 

Management believes the recorded net deferred tax asset at March 31, 2018 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.

 

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 March 31, 2018, and management does not expect capital expenditures to have a material, detrimental effect on the Corporation’s financial condition in 2018.

 

Gross loans outstanding (excluding mortgage loans held for sale) were $817,349,000 at March 31, 2018, up 0.2% from $815,713,000 at December 31, 2017 and 7.3% from $762,021,000 at March 31, 2017. Total outstanding mortgages and other consumer real estate loans were $2,245,000 (0.5%) lower at March 31, 2018 as compared to December 31, 2017; and total outstanding commercial loans were higher by $3,403,000 (1.0%) at March 31, 2018 as compared to December 31, 2017. Average loans outstanding in the first quarter of 2018 of $816,897,000 were $57,519,000 (7.6%) higher than the corresponding total in the first quarter of 2017. The increase in loans outstanding over the last three quarters of 2017 and first quarter of 2018 have included significant increases in residential mortgages, tax-exempt loans and participation loans purchased.

 

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”, “Political subdivisions” and “Other commercial” classes in the loan tables presented in this Form 10-Q. Total participation loans outstanding amounted to $62,788,000 at March 31, 2018, up from $61,245,000 at December 31, 2017 and $43,586,000 at March 31, 2017. At March 31, 2018, the balance of participation loans outstanding includes a total of $52,596,000 to businesses located outside of the Corporation’s market area, including $9,977,000 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 $13,975,000 at March 31, 2018, and $15,328,000 at December 31, 2017.

 

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.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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 March 31, 2018, the total outstanding balance of loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $1,791,000, and the corresponding total outstanding balance repurchased at December 31, 2017 was $1,805,000.

 

At March 31, 2018, outstanding balances of loans sold and serviced through the two programs totaled $171,237,000, including loans sold through the MPF Xtra program of $105,197,000 and loans sold through the Original program of $66,040,000. At December 31, 2017, outstanding balances of loans sold and serviced through the two programs totaled $169,725,000, including loans sold through the MPF Xtra program of $107,117,000 and loans sold through the Original program of $62,608,000. Based on the fairly limited volume of required repurchases to date, no allowance has been established for representation and warranty exposures as of March 31, 2018 and December 31, 2017.

 

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 March 31, 2018, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $3,427,000, and the Corporation has recorded a related allowance for credit losses of $291,000 which is included in “Accrued interest and other liabilities” in the accompanying consolidated balance sheets. At December 31, 2017, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $5,742,000, and the related allowance for credit losses was $260,000. 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 $9,049,000 at March 31, 2018, up from $8,856,000 at December 31, 2017. Table VIII shows total specific allowances on impaired loans increased $92,000 to $1,371,000 at March 31, 2018 from $1,279,000 at December 31, 2017. The largest individual loan balance for which a specific allowance has been recorded is a real estate secured commercial loan with an outstanding balance of $2,607,000 and a specific allowance of $884,000 at March 31, 2018, down from an outstanding balance of $2,641,000 and a specific allowance of $919,000 at December 31, 2017. The net increase in specific allowances in the first three months of 2018 included the addition of a specific allowance of $158,000 on a commercial loan relationship with outstanding balances totaling $677,000 at March 31, 2018.

 

The provision for loan losses by segment in the three-month period ended March 31, 2018 and 2017 is as follows:

 

(In Thousands)  3 Months Ended 
   March 31,   March 31, 
   2018   2017 
Residential mortgage  $31   $129 
Commercial   217    303 
Consumer   44    20 
Total  $292   $452 

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

The provision for loan losses is further detailed as follows:

 

   3 Months   3 Months 
Residential mortgage segment  Ended   Ended 
(In thousands)  March 31,   March 31, 
   2018   2017 
Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs  $51   $60 
           
Increase (decrease) in collectively determined portion of the allowance attributable to:          
Loan (reduction) growth   (20)   37 
Changes in historical loss experience factors   0    32 
Changes in qualitative factors   0    0 
Total provision for loan losses -          
Residential mortgage segment  $31   $129 

 

   3 Months   3 Months 
Commercial segment  Ended   Ended 
(In thousands)  March 31,   March 31, 
   2018   2017 
Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs  $111   $302 
           
Increase (decrease) in collectively determined portion of the allowance attributable to:          
Loan growth   53    13 
Changes in historical loss experience factors   53    43 
Changes in qualitative factors   0    (55)
Total provision for loan losses -          
Commercial segment  $217   $303 

 

   3 Months   3 Months 
Consumer segment  Ended   Ended 
(In thousands)  March 31,   March 31, 
   2018   2017 
Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs  $29   $26 
           
Increase (decrease) in collectively determined portion of the allowance attributable to:          
Loan growth   4    2 
Changes in historical loss experience factors   10    (7)
Changes in qualitative factors   1    (1)
Total provision for loan losses -          
Consumer segment  $44   $20 

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

   3 Months   3 Months 
Total - All segments  Ended   Ended 
(In thousands)  March 31,   March 31, 
   2018   2017 
Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs  $191   $388 
          
Increase (decrease) in collectively determined portion of the allowance attributable to:          
Loan growth   37    52 
Changes in historical loss experience factors   63    68 
Changes in qualitative factors   1    (56)
Total provision for loan losses -          
All segments  $292   $452 

 

For the periods shown in the tables immediately above, the provision related to increases or decreases in specific allowances on impaired loans was affected by changes in the results of management’s assessment of the amount of probable or actual (charged-off) losses associated with a small number of larger, individual loans. This line item also includes net charge-offs or recoveries from smaller loans that had not been individually evaluated for impairment prior to charge-off.

 

In the tables immediately above, the portion of the net change in the collectively determined allowance attributable to loan growth was determined by applying the historical loss experience and qualitative factors used in the allowance calculation at the end of the preceding period to the net increase in loans outstanding (excluding loans specifically evaluated for impairment) for the period.

 

The effect on the provision of changes in historical loss experience and qualitative factors, as shown in the tables above, was determined by: (1) calculating the net change in each factor used in determining the allowance at the end of the period as compared to the preceding period, and (2) applying the net change in each factor to the outstanding balance of loans at the end of the preceding period (excluding loans specifically evaluated for impairment).

 

Table IX 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 2.00% at March 31, 2018, down from 2.10% at December 31, 2017, and nonperforming assets as a percentage of total assets was 1.39% at March 31, 2018, down from 1.47% at December 31, 2017. Table IX presents data at March 31, 2018 and at the end of each of the years ended December 31, 2013 through 2017. For the range of dates presented in Table IX, total nonperforming loans as a percentage of loans has ranged from a low of 2.00% at March 31, 2018 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 1.31% at December 31, 2015 to a high of 1.53% at December 31, 2013.

 

Total impaired loans of $10,206,000 at March 31, 2018 are up $695,000 from the corresponding amount at December 31, 2017 of $9,511,000, including an increase in impaired loans with a valuation allowance of $599,000. Table IX shows that over the period 2013-2017, the year-end total outstanding balance of impaired loans has ranged from a low of $9,511,000 in 2017 to a high of $16,321,000 in 2013.

 

Total nonperforming assets of $17,482,000 at March 31, 2018 are $1,244,000 lower than the corresponding amount at December 31, 2017, summarized as follows:

 

·Total nonaccrual loans at March 31, 2018 of $13,587,000 was $183,000 higher than the corresponding December 31, 2017 total of $13,404,000.

 

·Total loans past due 90 days or more and still accruing interest amounted to $2,795,000 at March 31, 2018, a decrease of $929,000 from the total at December 31, 2017. The reduction in loans past due 90 days or more included a reduction in residential mortgage loans of $568,000 and commercial loans of $360,000. 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.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

·Foreclosed assets held for sale consisted of real estate, and totaled $1,100,000 at March 31, 2018, a decrease of $498,000 from $1,598,000 at December 31, 2017. At March 31, 2018, the Corporation held 12 such properties for sale, with total carrying values of $396,000 related to residential real estate, $632,000 of land and $72,000 related to commercial real estate. At December 31, 2017, the Corporation held 16 such properties for sale, with total carrying values of $721,000 related to residential real estate, $632,000 of land and $245,000 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 2013-2017 and the first three months of 2018, 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.

 

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 March 31, 2018. 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 VII through X present historical data related to loans and the allowance for loan losses.

 

TABLE VII - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES

(Dollars In Thousands)

 

   March 31,   March 31,   Years Ended December 31, 
   2018   2017   2017   2016   2015   2014   2013 
Balance, beginning of year  $8,856   $8,473   $8,473   $7,889   $7,336   $8,663   $6,857 
Charge-offs:                                   
Residential mortgage   (53)   (63)   (197)   (73)   (217)   (327)   (95)
Commercial   (21)   (96)   (132)   (597)   (251)   (1,715)   (459)
Consumer   (41)   (41)   (150)   (87)   (94)   (97)   (117)
Total charge-offs   (115)   (200)   (479)   (757)   (562)   (2,139)   (671)
Recoveries:                                   
Residential mortgage   2    3    19    3    1    25    24 
Commercial   2    1    4    35    214    264    348 
Consumer   12    15    38    82    55    47    58 
Total recoveries   16    19    61    120    270    336    430 
Net charge-offs   (99)   (181)   (418)   (637)   (292)   (1,803)   (241)
Provision for loan losses   292    452    801    1,221    845    476    2,047 
Balance, end of period  $9,049   $8,744   $8,856   $8,473   $7,889   $7,336   $8,663 
Net charge-offs as a % of average loans   0.01%   0.02%   0.05%   0.09%   0.04%   0.29%   0.04%

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

 

TABLE VIII - COMPONENTS OF THE ALLOWANCE FOR LOAN LOSSES

(In Thousands)

 

   March 31,   As of December 31, 
   2018   2017   2016   2015   2014   2013 
ASC 310 - Impaired loans  $1,371   $1,279   $674   $820   $769   $2,333 
ASC 450 - Collective segments:                              
Commercial   3,184    3,078    3,373    3,103    2,732    2,583 
Residential mortgage   3,821    3,841    3,890    3,417    3,295    3,156 
Consumer   174    159    138    122    145    193 
Unallocated   499    499    398    427    395    398 
Total Allowance  $9,049   $8,856   $8,473   $7,889   $7,336   $8,663 

 

TABLE IX - PAST DUE AND IMPAIRED LOANS, NONPERFORMING ASSETS

AND TROUBLED DEBT RESTRUCTURINGS (TDRs)

(Dollars In Thousands)

 

   March 31,   As of December 31, 
   2018   2017   2016   2015   2014   2013 
Impaired loans with a valuation allowance  $4,699   $4,100   $3,372   $1,933   $3,241   $9,889 
Impaired loans without a valuation allowance   5,507    5,411    7,488    8,041    9,075    6,432 
Total impaired loans  $10,206   $9,511   $10,860   $9,974   $12,316   $16,321 
Total loans past due 30-89 days and still accruing  $5,927   $9,449   $7,735   $7,057   $7,121   $8,305 
                               
Nonperforming assets:                              
Total nonaccrual loans  $13,587   $13,404   $8,736   $11,517   $12,610   $14,934 
Total loans past due 90 days or more and still accruing   2,795    3,724    6,838    3,229    2,843    3,131 
Total nonperforming loans   16,382    17,128    15,574    14,746    15,453    18,065 
Foreclosed assets held for sale (real estate)   1,100    1,598    2,180    1,260    1,189    892 
Total nonperforming assets  $17,482   $18,726   $17,754   $16,006   $16,642   $18,957 
                               
Loans subject to troubled debt restructurings (TDRs):                              
Performing  $774   $636   $5,803   $1,186   $1,807   $3,267 
Nonperforming   2,987    3,027    2,874    5,178    5,388    908 
Total TDRs  $3,761   $3,663   $8,677   $6,364   $7,195   $4,175 
                               
Total nonperforming loans as a % of loans   2.00%   2.10%   2.07%   2.09%   2.45%   2.80%
Total nonperforming assets as a % of assets   1.39%   1.47%   1.43%   1.31%   1.34%   1.53%
Allowance for loan losses as a % of total loans   1.11%   1.09%   1.13%   1.12%   1.16%   1.34%
Allowance for loan losses as a % of nonperforming loans   55.24%   51.70%   54.40%   53.50%   47.47%   47.95%

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

TABLE X - SUMMARY OF LOANS BY TYPE

Summary of Loans by Type

(In Thousands)

 

   March 31,   As of December 31, 
   2018   2017   2016   2015   2014   2013 
Residential mortgage:                              
Residential mortgage loans - first liens  $358,786   $359,987   $334,102   $304,783   $291,882   $299,831 
Residential mortgage loans - junior liens   25,870    25,325    23,706    21,146    21,166    23,040 
Home equity lines of credit   34,595    35,758    38,057    39,040    36,629    34,530 
1-4 Family residential construction   25,790    26,216    24,908    21,121    16,739    13,909 
Total residential mortgage   445,041    447,286    420,773    386,090    366,416    371,310 
Commercial:                              
Commercial loans secured by real estate   161,571    159,266    150,468    154,779    145,878    147,215 
Commercial and industrial   89,346    88,276    83,854    75,196    50,157    42,387 
Political subdivisions   56,224    59,287    38,068    40,007    17,534    16,291 
Commercial construction and land   13,232    14,527    14,287    5,122    6,938    17,003 
Loans secured by farmland   7,015    7,255    7,294    7,019    7,916    10,468 
Multi-family (5 or more) residential   7,621    7,713    7,896    9,188    8,917    10,985 
Agricultural loans   5,803    6,178    3,998    4,671    3,221    3,251 
Other commercial loans   16,079    10,986    11,475    12,152    13,334    14,631 
Total commercial   356,891    353,488    317,340    308,134    253,895    262,231 
Consumer   15,417    14,939    13,722    10,656    10,234    10,762 
Total   817,349    815,713    751,835    704,880    630,545    644,303 
Less: allowance for loan losses   (9,049)   (8,856)   (8,473)   (7,889)   (7,336)   (8,663)
Loans, net  $808,300   $806,857   $743,362   $696,991   $623,209   $635,640 

 

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 March 31, 2018, the Corporation maintained overnight interest-bearing deposits with the Federal Reserve Bank of Philadelphia and other correspondent banks totaling $15,600,000.

 

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 $15,544,000 at March 31, 2018.

 

The Corporation’s outstanding, available, and total credit facilities at March 31, 2018 and December 31, 2017 are as follows:

 

   Outstanding   Available   Total Credit 
(In Thousands)  Mar 31,   Dec. 31,   Mar. 31,   Dec. 31,   Mar. 31,   Dec. 31, 
   2018   2017   2018   2017   2018   2017 
Federal Home Loan Bank of Pittsburgh  $39,122   $67,189   $319,222   $295,441   $358,344   $362,630 
Federal Reserve Bank Discount Window   0    0    15,141    15,877    15,141    15,877 
Other correspondent banks   0    0    45,000    45,000    45,000    45,000 
Total credit facilities  $39,122   $67,189   $379,363   $356,318   $418,485   $423,507 

 

At March 31, 2018, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of a short-term borrowings of $21,000,000 and long-term borrowings with a total amount of $18,122,000. At December 31, 2017, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowings of $29,000,000, short-term borrowings of $29,000,000 and long-term borrowings with a total amount of $9,189,000. Additional information regarding borrowed funds is included in Note 8 of the unaudited consolidated financial statements.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Additionally, the Corporation uses “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 or use repurchase agreements placed with brokers to borrow funds secured by investment assets. At March 31, 2018, the carrying value of available-for-sale securities in excess of amounts required to meet pledging or repurchase agreement obligations was $188,290,000.

 

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 March 31, 2018 and December 31, 2017 are presented below. Management believes, as of March 31, 2018 and December 31, 2017, 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 March 31, 2018 and December 31, 2017 exceed the Corporation’s policy threshold levels.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

(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 
March 31, 2018:                                                  
Total capital to risk-weighted assets:                                                  
Consolidated  $189,309    23.49%  $64,470    ³8%  $79,580    ³9.875%  $80,587    ³10%  $84,617    ³10.5%
C&N Bank   167,117    20.85%   64,116    ³8%   79,143    ³9.875%   80,145    ³10%   84,152    ³10.5%
Tier 1 capital to risk-weighted assets:                                                  
Consolidated   179,969    22.33%   48,352    ³6%   63,463    ³7.875%   64,470    ³8%   68,499    ³8.5%
C&N Bank   157,777    19.69%   48,087    ³6%   63,114    ³7.875%   64,116    ³8%   68,123    ³8.5%
Common equity tier 1 capital to risk-weighted assets:                                                  
Consolidated   179,969    22.33%   36,264    ³4.5%   51,374    ³6.375%   52,382    ³6.5%   56,411    ³7%
C&N Bank   157,777    19.69%   36,065    ³4.5%   51,092    ³6.375%   52,094    ³6.5%   56,101    ³7%
Tier 1 capital to average assets:                                                  
Consolidated   179,969    14.33%   50,239    ³4%   N/A    N/A    62,798    ³5%   62,798    ³5%
C&N Bank   157,777    12.75%   49,480    ³4%   N/A    N/A    61,850    ³5%   61,850    ³5%
December 31, 2017:                                                  
Consolidated  $187,097    23.07%  $64,872    ³8%  $75,008    ³9.25%  $81,090    ³10%  $85,144    ³10.5%
C&N Bank   165,142    20.47%   64,528    ³8%   74,611    ³9.25%   80,661    ³10%   84,694    ³10.5%
Tier 1 capital to risk-weighted assets:                                                  
Consolidated   177,981    21.95%   48,654    ³6%   58,790    ³7.25%   64,872    ³8%   68,926    ³8.5%
C&N Bank   156,026    19.34%   48,396    ³6%   58,479    ³7.25%   64,528    ³8%   68,561    ³8.5%
Common equity tier 1 capital to risk-weighted assets:                                                  
Consolidated   177,981    21.95%   36,490    ³4.5%   46,626    ³5.75%   52,708    ³6.5%   56,763    ³7%
C&N Bank   156,026    19.34%   36,297    ³4.5%   46,380    ³5.75%   52,429    ³6.5%   56,462    ³7%
Tier 1 capital to average assets:                                                  
Consolidated   177,981    14.23%   50,023    ³4%   N/A    N/A    62,529    ³5%   62,529    ³5%
C&N Bank   156,026    12.63%   49,418    ³4%   N/A    N/A    61,772    ³5%   61,772    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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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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 current and remaining transition schedule for capital ratios, including the capital conservation buffer, is as follows:

 

   As of January 1: 
   2018   2019 
Minimum common equity tier 1 capital ratio   4.5%   4.5%
Common equity tier 1 capital conservation buffer   1.875%   2.5%
Minimum common equity tier 1 capital ratio plus capital conservation buffer   6.375%   7.0%
Phase-in of most deductions from common equity tier 1 capital   100%   100%
Minimum tier 1 capital ratio   6.0%   6.0%
Minimum tier 1 capital ratio plus capital conservation buffer   7.875%   8.5%
Minimum total capital ratio   8.0%   8.0%
Minimum total capital ratio plus capital conservation buffer   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 March 31, 2018, the Corporation’s Capital Conservation Buffer, determined based on the minimum total capital ratio, was 15.49%. C&N Bank’s Capital Conservation Buffer (also determined based on the minimum total capital ratio) was 12.85%.

 

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 ($5,679,000) at March 31, 2018 and ($1,566,000) at December 31, 2017. 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 March 31, 2018.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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 $141,000 at March 31, 2018 and $59,000 at December 31, 2017.

 

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 $621,000 in the first quarter 2018 as compared to $3,857,000 in the first quarter 2017. For the three months ended March 31, 2018, Comprehensive Income included: (1) Net Income of $4,375,000, which was $941,000 higher than in the first quarter 2017; (2) Other Comprehensive Loss from a decrease in net unrealized losses on available-for-sale securities of ($3,824,000) as compared to Other Comprehensive Income of $319,000 from net unrealized gains on available-for-sale securities in the first quarter 2017; and (3) Other Comprehensive Income from defined benefit plans of $70,000 for the first quarter 2018 as compared to $104,000 for the first quarter 2017.

 

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 six separate 0.25% increases from December 2015 through March 2018, resulting in the current range of 1.50% to 1.75%. Inflation has remained subdued, measured through 2017 and the first three months of 2018 at levels below the Federal Open Market Committee’s 2% longer run objective, though the FOMC noted in its latest statement that the labor market continues to strengthen and that economic activity continues to rise at a moderate rate. The Committee continues to suggest that as market conditions continue to improve, further gradual increases in the federal funds rate will be warranted.

 

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.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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.

 

Table XI, which follows this discussion, is based on the results of calculations performed using the simulation model as of March 31, 2018 and December 31, 2017. The table shows that as of the respective dates, the changes in net interest income and changes in market value were within the policy limits in all scenarios.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

TABLE XI - THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES

 

March 31, 2018 Data                    
(Dollars In Thousands)  Period Ending March 31, 2019     
                     
Basis Point  Interest   Interest   Net Interest   NII   NII 
Change in Rates  Income   Expense   Income (NII)   % Change   Risk Limit 
+400  $59,148   $18,287   $40,861    -6.5%   25.0%
+300   56,381    14,757    41,624    -4.8%   20.0%
+200   53,639    11,227    42,412    -3.0%   15.0%
+100   50,817    7,697    43,120    -1.4%   10.0%
0   47,889    4,172    43,717    0.0%   0.0%
-100   44,619    2,927    41,692    -4.6%   10.0%
-200   41,874    2,510    39,364    -10.0%   15.0%
-300   40,563    2,390    38,173    -12.7%   20.0%
-400   40,263    2,390    37,873    -13.4%   25.0%

 

   Market Value of Portfolio Equity at March 31, 2018 
             
   Present   Present   Present 
Basis Point  Value   Value   Value 
Change in Rates  Equity   % Change   Risk Limit 
+400  $198,879    -15.0%   50.0%
+300   206,239    -11.9%   45.0%
+200   215,431    -7.9%   35.0%
+100   224,330    -4.1%   25.0%
0   233,972    0.0%   0.0%
-100   234,934    0.4%   25.0%
-200   233,932    0.0%   35.0%
-300   237,523    1.5%   45.0%
-400   276,905    18.3%   50.0%

 

December 31, 2017 Data                
(Dollars in Thousands)      Period Ending December 31, 2018     
                     
Basis Point  Interest   Interest   Net Interest   NII   NII 
Change in Rates  Income   Expense   Income (NII)   % Change   Risk Limit 
+400  $57,619   $19,730   $37,889    -10.8%   25.0%
+300   54,978    15,852    39,126    -7.9%   20.0%
+200   52,334    11,974    40,360    -5.0%   15.0%
+100   49,620    8,095    41,525    -2.2%   10.0%
0   46,717    4,243    42,474    0.0%   0.0%
-100   43,581    2,781    40,800    -3.9%   10.0%
-200   41,290    2,216    39,074    -8.0%   15.0%
-300   40,463    2,191    38,272    -9.9%   20.0%
-400   40,194    2,191    38,003    -10.5%   25.0%

 

   Market Value of Portfolio Equity at December 31, 2017 
             
   Present   Present   Present 
Basis Point  Value   Value   Value 
Change in Rates  Equity   % Change   Risk Limit 
+400  $195,385    -16.8%   50.0%
+300   203,648    -13.3%   45.0%
+200   213,689    -9.0%   35.0%
+100   224,389    -4.4%   25.0%
0   234,759    0.0%   0.0%
-100   236,030    0.5%   25.0%
-200   234,863    0.0%   35.0%
-300   252,464    7.5%   45.0%
-400   292,124    24.4%   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 15, 2018.

 

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 first quarter 2018:

 

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
 
January 1 - 31, 2018   0   $0    0    600,000 
February 1 - 28, 2018   0   $0    0    600,000 
March 1 - 31, 2018   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
     
May 3, 2018 By: /s/ J. Bradley Scovill
Date President and Chief Executive Officer
     
May 3, 2018 By: /s/ Mark A. Hughes
Date Treasurer and Chief Financial Officer

 

 60