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CITIZENS & NORTHERN CORP - Annual Report: 2019 (Form 10-K)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

(Mark One)

 

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

 

For the fiscal year ended December 31, 2019

 

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: 0-16084 

 

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)

 

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

 

Title of Each Class  Trading Symbol  Name of Each Exchange on Which Registered
Common Stock Par Value $1.00  CZNC  NASDAQ Capital Market

 

Securities registered pursuant to section 12(g) of the Act: None

 

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

 

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨

 

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

 

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

 

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

 

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

 

The aggregate market value of the registrant's common stock held by non-affiliates at June 30, 2019, the registrant’s most recently completed second fiscal quarter, was $348,405,379.

 

The number of shares of common stock outstanding at February 13, 2020 was 13,762,993.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s proxy statement for the annual meeting of its shareholders to be held April 16, 2020 are incorporated by reference into Parts III and IV of this report.

 

 

 

 

 

 

TABLE OF CONTENTS

 

  Page(s)
Part I:  
Item 1. Business 3-4
Item 1A. Risk Factors 4-6
Item 1B. Unresolved Staff Comments 6
Item 2. Properties 7
Item 3. Legal Proceedings 7
Item 4. Mine Safety Disclosure 7
   
Part II.  
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 8-10
Item 6. Selected Financial Data 11-12
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 13-36
Item 8. Financial Statements and Supplementary Data 37-86
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 87
Item 9A. Controls and Procedures 87-88
Item 9B. Other Information 88
   
Part III:  
Item 10. Directors, Executive Officers and Corporate Governance 88
Item 11. Executive Compensation 88
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 88
Item 13. Certain Relationships and Related Transactions, and Director Independence 88
Item 14. Principal Accountant Fees and Services 88
   
Part IV:  
Item 15. Exhibits and Financial Statement Schedules 89-92
Signatures 93

 

2

 

 

PART I

 

ITEM 1. BUSINESS

 

Citizens & Northern Corporation (“Corporation”) is a holding company whose principal activity is community banking. The Corporation’s principal office is located in Wellsboro, Pennsylvania. The largest subsidiary is Citizens & Northern Bank (“C&N Bank” or the “Bank”). The Corporation’s other wholly-owned subsidiaries are Citizens & Northern Investment Corporation and Bucktail Life Insurance Company (“Bucktail”). Citizens & Northern Investment Corporation was formed in 1999 to engage in investment activities. Bucktail reinsures credit and mortgage life and accident and health insurance on behalf of C&N Bank.

 

The Corporation’s acquisition of Monument Bancorp, Inc. (“Monument”) was completed April 1, 2019. Monument was the parent company of Monument Bank, a commercial bank which operated two community bank offices and one lending office in Bucks County, Pennsylvania. Monument merged with and into the Corporation and Monument Bank merged with and into C&N Bank. Total purchase consideration was $42.7 million, including 1,279,825 shares of the Corporation’s common stock issued with a value of $33.1 million and cash paid totaling $9.6 million. Holders of Monument common stock prior to the consummation of the merger held approximately 9.4% of the Corporation’s common stock outstanding immediately following the merger.

 

In December 2019, the Corporation announced a plan of merger to acquire Covenant Financial, Inc. (“Covenant”) in a transaction valued on December 18, 2019 at approximately $77 million. Under the terms of the definitive agreement, the Corporation will pay cash for 25% of the Covenant shares and will convert 75% of Covenant shares to the Corporation’s common stock. Covenant is the holding company for Covenant Bank, which operates banking offices in Bucks and Chester Counties of PA. Covenant had total assets of $516 million at December 31, 2019. Pursuant to the plan of merger, Covenant will merge with and into the Corporation and Covenant Bank will merge with and into C&N Bank The merger is subject to satisfaction of customary closing conditions, including receipt of regulatory approvals and approval of Covenant’s shareholders. The merger is expected to close in the third quarter 2020.

 

C&N Bank is a Pennsylvania banking institution that was formed by the consolidation of Northern National Bank of Wellsboro and Citizens National Bank of Towanda on October 1, 1971. Subsequent mergers included: First National Bank of Ralston in May 1972; Sullivan County National Bank in October 1977; Farmers National Bank of Athens in January 1984; and First National Bank of East Smithfield in May 1990. In 2005, the Corporation acquired Canisteo Valley Corporation and its subsidiary, First State Bank, a New York State chartered commercial bank with offices in Canisteo and South Hornell, NY. In 2010, the First State Bank operations were merged into C&N Bank and Canisteo Valley Corporation was merged into the Corporation. On May 1, 2007, the Corporation acquired Citizens Bancorp, Inc. (“Citizens”), with banking offices in Coudersport, Emporium and Port Allegany, Pennsylvania. Citizens Trust Company, the banking subsidiary of Citizens, was merged with and into C&N Bank as part of the transaction. C&N Bank has held its current name since May 6, 1975, at which time C&N Bank changed its charter from a national bank to a Pennsylvania bank.

 

C&N Bank provides an extensive range of banking services, including deposit and loan products for personal and commercial customers. The Bank also maintains a trust division that provides a wide range of financial services, such as 401(k) plans, retirement planning, estate planning, estate settlements and asset management. In January 2000, C&N Bank formed a subsidiary, C&N Financial Services Corporation (“C&NFSC”). C&NFSC is a licensed insurance agency that provides insurance products to individuals and businesses. In 2001, C&NFSC added a broker-dealer division, which offers mutual funds, annuities, educational savings accounts and other investment products through registered agents. C&NFSC’s operations are not significant in relation to the total operations of the Corporation.

 

In December 2017, C&N Bank established Northern Tier Holding LLC, to acquire, hold and dispose of real property acquired by the Bank. C&N Bank is the sole member of Northern Tier Holding LLC.

 

Over the past few years, the Corporation has begun to execute on a growth strategy. Presently, a majority of C&N Bank’s operations are conducted in its legacy markets in the northern tier of Pennsylvania and southern tier of New York. In 2019, with the acquisition of Monument and the opening of a lending office in York, Pennsylvania, the Bank expanded into new markets in Southeastern and southcentral Pennsylvania. Management expects the acquisition of Covenant to be completed in 2020, which will further increase the volume of activity in southeastern Pennsylvania.

 

All phases of the Bank’s business are competitive. The Bank competes with online financial institutions, local commercial banks headquartered in our market areas and other commercial banks with branches in our market area. Many of the online financial institutions and some of the banks that have branches in our market areas are larger in overall size. With respect to lending activities and attracting deposits, the Bank also competes with savings banks, savings and loan associations, insurance companies, regulated small loan companies and credit unions. Also, the Bank competes with mutual funds for deposits. C&N Bank competes with insurance companies, investment counseling firms, mutual funds and other business firms and individuals for trust, investment management, brokerage and insurance services. The Bank is generally competitive with all financial institutions in our service areas with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans. The Bank serves a diverse customer base and is not economically dependent on any small group of customers or on any individual industry.

 

3

 

 

At December 31, 2019, C&N Bank had total assets of $1,638,285,000, total deposits of $1,259,440,000, net loans outstanding of $1,172,386,000 and 336 full-time equivalent employees.

 

Most activities of the Corporation and its subsidiaries are regulated by federal or state agencies. The primary regulatory relationships are described as follows:

 

·The Corporation is a bank holding company formed under the provisions of Section 3 of the Federal Reserve Act. The Corporation is under the direct supervision of the Federal Reserve and must comply with the reporting requirements of the Federal Bank Holding Company Act.

 

·C&N Bank is a state-chartered, nonmember bank, supervised by the Federal Deposit Insurance Corporation and the Pennsylvania Department of Banking and Securities.

 

·C&NFSC is a Pennsylvania corporation. The Pennsylvania Department of Insurance regulates C&NFSC’s insurance activities. Brokerage products are offered through third party networking agreements.

 

·Bucktail is incorporated in the state of Arizona and supervised by the Arizona Department of Insurance.

 

A copy of the Corporation’s annual report on Form 10-K, quarterly reports on Form 10-Q, current events reports on Form 8-K, and amendments to these reports, will be furnished without charge upon written request to the Corporation’s Treasurer at P.O. Box 58, Wellsboro, PA 16901. Copies of these reports will be furnished as soon as reasonably possible after they are filed electronically with the Securities and Exchange Commission. The information is also available through the Corporation’s web site at www.cnbankpa.com.

 

ITEM 1A. RISK FACTORS

 

The Corporation is subject to the many risks and uncertainties applicable to all banking companies, as well as risks specific to the Corporation’s geographic locations. Although the Corporation seeks to effectively manage risks, and maintains a level of equity that exceeds the banking regulatory agencies’ thresholds for being considered “well capitalized” (see Note 18 to the consolidated financial statements), management cannot predict the future and cannot eliminate the possibility of credit, operational or other losses. Accordingly, actual results may differ materially from management's expectations. Some of the Corporation’s significant risks and uncertainties are discussed below.

 

Credit Risk from Lending Activities - A significant source of risk is the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loan agreements. Most of the Corporation’s loans are secured, but some loans are unsecured. With respect to secured loans, the collateral securing the repayment of these loans may be insufficient to cover the obligations owed under such loans. Collateral values may be adversely affected by changes in economic, environmental and other conditions, including declines in the value of real estate, changes in interest rates, changes in monetary and fiscal policies of the federal government, wide-spread disease, terrorist activity, environmental contamination and other external events. In addition, collateral appraisals that are out of date or that do not meet industry recognized standards may create the impression that a loan is adequately collateralized when it is not. The Corporation has adopted underwriting and credit monitoring procedures and policies, including regular reviews of appraisals and borrower financial statements, that management believes are appropriate to mitigate the risk of loss. Also, as discussed further in the “Provision and Allowance for Loan Losses” section of Management’s Discussion and Analysis, the Corporation attempts to estimate the amount of losses that may be inherent in the portfolio through a quarterly evaluation process that includes several members of management and that addresses specifically identified problem loans, as well as other quantitative data and qualitative factors. Such risk management and accounting policies and procedures, however, may not prevent unexpected losses that could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.

 

Interest Rate Risk - Business risk arising from changes in interest rates is an inherent factor in operating a banking organization. The Corporation’s assets are predominantly long-term, fixed-rate loans and debt securities. Funding for these assets comes principally from shorter-term deposits and borrowed funds. Accordingly, there is an inherent risk of lower future earnings or decline in fair value of the Corporation’s financial instruments when interest rates change. Significant fluctuations in interest rates could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.

 

Limited Geographic Diversification - The Corporation grants commercial, residential and personal loans to customers primarily in the Corporation’s legacy markets of the northern tier of Pennsylvania and southern tier of New York and, effective with the acquisition of Monument and opening of the York lending office in 2019, in southeastern and southcentral Pennsylvania. 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 these regions. Deterioration in economic conditions could adversely affect the quality of the Corporation's loan portfolio and the demand for its products and services, and accordingly, could have a material adverse effect on the Corporation's financial condition, results of operations or liquidity.

 

4

 

 

Competition - All phases of the Corporation’s business are competitive. Some competitors are much larger in total assets and capitalization than the Corporation, have greater access to capital markets and can offer a broader array of financial services. There can be no assurance that the Corporation will be able to compete effectively in its markets. Furthermore, developments increasing the nature or level of competition could have a material adverse effect on the Corporation's financial condition, results of operations or liquidity.

 

Growth Strategy –As described in Item 1, in 2019, the Corporation acquired Monument and opened a lending office in York, Pennsylvania. Also, in December 2019, the Corporation entered into an agreement to acquire Covenant. Further, management intends to continue to pursue additional acquisition opportunities. The Corporation’s future financial performance will depend on its ability to execute its strategic plan and manage its future growth. Failure to execute these plans could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.

 

Breach of Information Security and Technology Dependence - The Corporation relies on software, communication, and information exchange on a variety of computing platforms and networks and over the Internet. Despite numerous safeguards, the Corporation cannot be certain that its systems are entirely free from vulnerability to attack or other technological difficulties or failures. The Corporation relies on the services of a variety of vendors to meet its data processing and communication needs. If information security is breached or other technology difficulties or failures occur, information may be lost or misappropriated, services and operations may be interrupted, and the Corporation could be exposed to claims from customers. Any of these results could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.

 

Government Regulation and Monetary Policy - The Corporation and the banking industry are subject to extensive regulation and supervision under federal and state laws and regulations. The requirements and limitations imposed by such laws and regulations limit the way the Corporation conducts its business, undertakes new investments and activities and obtains financing. These regulations are designed primarily for the protection of the deposit insurance funds and consumers and not to benefit the Corporation's shareholders. Financial institution regulation has been the subject of significant legislation in recent years and may be the subject of further significant legislation in the future, none of which is in the control of the Corporation. Significant new laws or changes in, or repeals of, existing laws could have a material adverse effect on the Corporation's financial condition, results of operations or liquidity. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects short-term interest rates and credit conditions, and any unfavorable change in these conditions could have a material adverse effect on the Corporation's financial condition, results of operations or liquidity.

 

Bank Secrecy Act and Related Laws and Regulations - These laws and regulations have significant implications for all financial institutions. In recent years, they have increased due diligence requirements and reporting obligations for financial institutions, created new crimes and penalties, and required the federal banking agencies, in reviewing merger and other acquisition transactions, to consider the effectiveness of the parties to such transactions in combating money laundering activities. Even innocent noncompliance and inconsequential failure to follow the regulations could result in significant fines or other penalties, which could have a material adverse impact on the Corporation's financial condition, results of operations or liquidity.

 

The Federal Home Loan Bank of Pittsburgh - Through its subsidiary (C&N Bank), the Corporation is a member of the Federal Home Loan Bank of Pittsburgh (FHLB-Pittsburgh), which is one of 11 regional Federal Home Loan Banks. The Corporation has a line of credit with the FHLB-Pittsburgh that is secured by a blanket lien on its loan portfolio. Access to this line of credit is critical if a funding need arises. However, there can be no assurance that the FHLB-Pittsburgh will be able to provide funding when needed, nor can there be assurance that the FHLB-Pittsburgh will provide funds specifically to the Corporation should its financial condition deteriorate and/or regulators prevent that access. The inability to access this source of funds could have a materially adverse effect on the Corporation’s financial flexibility if alternate financing is not available at acceptable interest rates. The failure of the FHLB-Pittsburgh or the FHLB system in general, may materially impair the Corporation’s ability to meet short- and long-term liquidity needs or to meet growth plans.

 

The Corporation owns common stock of the FHLB-Pittsburgh to qualify for membership in the FHLB system and access services from the FHLB-Pittsburgh. The FHLB-Pittsburgh faces a variety of risks in its operations including interest rate risk, counterparty credit risk, and adverse changes in its regulatory framework. In addition, the 11 Federal Home Loan Banks are jointly liable for the consolidated obligations of the FHLB system. To the extent that one FHLB cannot meet its obligations, other FHLBs can be called upon to make required payments. Such risks affecting the FHLB-Pittsburgh could adversely impact the value of the Corporation’s investment in the common stock of the FHLB-Pittsburgh and/or affect its access to credit.

 

Soundness of Other Financial Institutions - In addition to the FHLB-Pittsburgh, the Corporation maintains other credit facilities that provide it with additional liquidity. These facilities include secured and unsecured borrowings from the Federal Reserve Bank and third-party commercial banks. The Corporation believes that it maintains a strong liquidity position and that it is well positioned to withstand foreseeable market conditions. However, legal agreements with counterparties typically include provisions allowing them to restrict or terminate the Corporation’s access to these credit facilities with or without advance notice and at their sole discretion.

 

5

 

 

Financial institutions are interconnected because of trading, clearing, counterparty, and other relationships. Financial market conditions have been negatively impacted in the past and such disruptions or adverse changes in the Corporation's results of operations or financial condition could, in the future, have a negative impact on available sources of liquidity. Such a situation may arise due to circumstances that are outside the Corporation’s control, such as general market disruptions or operational problems affecting the Corporation or third parties. The Corporation’s efforts to monitor and manage liquidity risk may not be successful or sufficient to deal with dramatic or unanticipated reductions in available liquidity. In such events, the Corporation’s cost of funds may increase, thereby reducing net interest income, or the Corporation may need to sell a portion of its securities and/or loan portfolio, which, depending upon market conditions, could necessitate realizing a loss.

 

Securities Markets – The fair value of the Corporation's available-for-sale debt securities, as well as the revenues the Corporation earns from its Trust and Financial Management and brokerage services, are sensitive to price fluctuations and market events.

 

Declines in the values of the Corporation’s securities holdings, combined with adverse changes in the expected cash flows from these investments, could result in other-than-temporary impairment charges. For additional information regarding debt securities, see the “Securities” section of Management’s Discussion and Analysis and Note 7 to the consolidated financial statements.

 

The Corporation's Trust and Financial Management revenue is determined, in part, from the value of the underlying investment portfolios. Accordingly, if the values of those investment portfolios decrease, whether due to factors influencing U.S. or international securities markets, in general, or otherwise, the Corporation's revenue could be negatively impacted. In addition, the Corporation's ability to sell its brokerage services is dependent, in part, upon consumers' level of confidence in securities markets.

 

Mortgage Banking – Since 2009, the Corporation has originated and sold residential mortgage loans to the secondary market through the MPF Xtra program. Since 2014, the Corporation has also originated and sold residential mortgage loans to the secondary market through the MPF Original program. Both of these programs are administered by the Federal Home Loan Banks of Pittsburgh and Chicago. At December 31, 2019, the total outstanding balance of residential mortgages sold and serviced through the two programs amounted to $178,446,000. The Corporation must strictly adhere to the MPF Xtra and MPF Original program guidelines for origination, underwriting and servicing loans, and failure to do so may result in the Corporation being forced to repurchase loans or being dropped from the program. As of December 31, 2019, the total outstanding balance of residential mortgage loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $1,770,000. If the volume of such forced repurchases of loans were to increase significantly, or if the Corporation were to be dropped from the programs, it could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

Not applicable.

 

6

 

 

ITEM 2. PROPERTIES

 

Except as noted below, the Bank owns its operating properties. All of the properties are in good condition. None of the owned properties are subject to encumbrance.

 

A listing of properties is as follows:

 

Main administrative offices:

 

90-92 Main Street  or  10 Nichols Street
Wellsboro, PA 16901    Wellsboro, PA 16901

 

Branch offices - Citizens & Northern Bank:

 

  428 S. Main Street   514 Main Street   41 Main Street
  Athens, PA  18810   Laporte, PA  18626   Tioga, PA  16946
           
  10 North Main Street   4534 Williamson Trail   428 Main Street**
  Coudersport, PA  16915   Liberty, PA  16930   Towanda, PA  18848
           
  465 North Main Street   1085 S. Main Street   64 Elmira Street
  Doylestown, PA 18901   Mansfield, PA  16933   Troy, PA  16947
           
  111 W. Main Street   612 James Monroe Avenue   90-92 Main Street
  Dushore, PA  18614   Monroeton, PA  18832   Wellsboro, PA  16901
           
  563 Main Street   3461 Route 405 Highway   1510 Dewey Avenue
  East Smithfield, PA  18817   Muncy, PA  17756   Williamsport, PA  17701
           
  104 W. Main Street   33 Swamp Road, Unit 7**   130 Court Street**
  Elkland, PA  16920   Newtown, PA 18940   Williamsport, PA  17701
           
  135 East Fourth Street   100 Maple Street   1467 Golden Mile Road
  Emporium, PA  15834   Port Allegany, PA  16743   Wysox, PA  18854
           
  230 Railroad Street   1827 Elmira Street   2 East Mountain Avenue**
  Jersey Shore, PA  17740   Sayre, PA  18840   South Williamsport, PA 17702
           
  102 E. Main Street   3 Main Street   6250 County Rte 64
  Knoxville, PA  17740   Canisteo, NY 14823   Hornell, NY 14843

 

Loan production offices of Citizens & Northern Bank:

 

250 East Water Street  2951 Whiteford Road Suite 102**  65 West Street Road Suite A201**
Elmira, NY 14901  York, PA 17402  Warminster, PA 18974

 

Facilities management office:

 

13 Water Street
Wellsboro, PA 16901

 

** designates leased facility

 

ITEM 3. LEGAL PROCEEDINGS

 

The Corporation and the 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 4. MINE SAFETY DISCLOSURE

 

Not applicable.

 

7

 

 

PART II

 

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

QUARTERLY SHARE DATA

 

Trades of the Corporation’s stock are executed through various brokers who maintain a market in the Corporation’s stock. The Corporation’s stock is listed on the NASDAQ Capital Market with the trading symbol CZNC. As of December 31, 2019, there were 2,094 shareholders of record of the Corporation’s common stock.

 

The following table sets forth the high and low sales prices of the common stock and dividends declared per quarter during 2019 and 2018.

 

   2019   2018 
           Dividend           Dividend 
           Declared           Declared 
           per           per 
   High   Low   Quarter   High   Low   Quarter 
First quarter  $27.07   $23.60   $0.37   $25.41   $22.00   $0.27 
Second quarter   29.25    25.02    0.27    27.72    22.64    0.27 
Third quarter   27.00    22.52    0.27    28.99    25.42    0.27 
Fourth quarter   28.58    24.23    0.27    28.48    23.72    0.27 

 

Future dividend payments will depend upon maintenance of a strong financial condition, future earnings and capital and regulatory requirements. Also, 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. These restrictions are described in Note 18 to the consolidated financial statements.

 

Effective April 21, 2016, the Corporation’s Board of Directors approved a treasury stock repurchase program. Under this 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 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.

 

The following table sets forth a summary of purchases by the Corporation, in the open market, of its equity securities during the fourth quarter 2019:

 

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
 
October 1 - 31, 2019   0   $-   0   600,000 
November 1 - 30, 2019   0   $-   0   600,000 
December 1 - 31, 2019   0   $-   0   600,000 

 

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PERFORMANCE GRAPH

 

Set forth below is a chart comparing the Corporation’s cumulative return to stockholders against the cumulative return of the Russell 2000 and a Peer Group Index of similar banking organizations selected by the Corporation for the five-year period commencing December 31, 2014 and ended December 31, 2019. The index values are market-weighted dividend-reinvestment numbers, which measure the total return for investing $100.00 five years ago. This meets Securities & Exchange Commission requirements for showing dividend reinvestment share performance over a five-year period and measures the return to an investor for placing $100.00 into a group of bank stocks and reinvesting any and all dividends into the purchase of more of the same stock for which dividends were paid.

 

 

   Period Ending 
Index  12/31/14   12/31/15   12/31/16   12/31/17   12/31/18   12/31/19 
Citizens & Northern Corporation   100.00   107.01   140.37   134.19   154.24   172.49 
Russell 2000 Index   100.00   95.59   115.95   132.94   118.30   148.49 
Peer Group   100.00   106.24   145.30   171.70   158.94   186.98 

 

Peer Group includes all publicly traded SEC filing Commercial Banks & Thrifts within NJ, NY, OH and PA with assets between $750M and $3.5B as of 9/30/2019

 

Source: S&P Global Market Intelligence

© 2020

 

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EQUITY COMPENSATION PLAN INFORMATION

 

The following table sets forth information concerning the Stock Incentive Plan and Independent Directors Stock Incentive Plan, both of which have been approved by the Corporation’s shareholders. The figures shown in the table below are as of December 31, 2019.

 

           Number of 
   Number of   Weighted-   Securities 
   Securities to be   average   Remaining 
   Issued Upon   Exercise   for Future 
   Exercise of   Price of   Issuance Under 
   Outstanding   Outstanding   Equity Compen- 
   Options   Options   sation Plans 
Equity compensation plans approved by shareholders   75,897   $18.69    333,832 
                
Equity compensation plans not approved by shareholders   0    N/A    0 

 

More details related to the Corporation’s equity compensation plans are provided in Notes 1 and 13 to the consolidated financial statements.

 

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ITEM 6. SELECTED FINANCIAL DATA

 

  As of or for the Year Ended December 31,
INCOME STATEMENT (In Thousands)  2019   2018   2017   2016   2015 
Interest and dividend income  $64,771   $50,328   $45,863   $44,098   $44,519 
Interest expense   10,283    4,625    3,915    3,693    4,602 
Net interest income   54,488    45,703    41,948    40,405    39,917 
Provision for loan losses   849    584    801    1,221    845 
Net interest income after provision for loan losses   53,639    45,119    41,147    39,184    39,072 
Noninterest income excluding securities gains   19,284    18,597    16,153    15,511    15,478 
Net gains on securities   23    2,033    257    1,158    2,861 
Loss on prepayment of debt   0    0    0    0    2,573 
Merger-related expenses   4,099    328    0    0    0 
Noninterest expense excluding loss on prepayment of debt and merger-related expenses   45,438    39,158    36,967    34,744    33,030 
Income before income tax provision   23,409    26,263    20,590    21,109    21,808 
Income tax provision   3,905    4,250    7,156    5,347    5,337 
Net income  $19,504   $22,013   $13,434   $15,762   $16,471 
Net income attributable to common shares  $19,404   $21,903   $13,365   $15,677   $16,387 

 

PER COMMON SHARE:                    
Basic earnings per share  $1.46   $1.79   $1.10   $1.30   $1.35 
Diluted earnings per share  $1.46   $1.79   $1.10   $1.30   $1.35 
Cash dividends declared per share  $1.18   $1.08   $1.04   $1.04   $1.04 
Book value per common share at period-end  $17.82   $16.02   $15.43   $15.36   $15.39 
Tangible book value per common share at period-end  $15.66   $15.05   $14.45   $14.37   $14.41 
Weighted average common shares outstanding - basic   13,298,736    12,219,209    12,115,840    12,032,820    12,149,252 
Weighted average common shares outstanding - diluted   13,321,559    12,257,368    12,155,136    12,063,055    12,171,084 
END OF PERIOD BALANCES (Dollars In Thousands)                         
Available-for-sale debt securities  $346,723   $363,273   $355,937   $394,106   $417,904 
Gross loans   1,182,222    827,563    815,713    751,835    704,880 
Allowance for loan losses   9,836    9,309    8,856    8,473    7,889 
Total assets   1,654,145    1,290,893    1,276,959    1,242,292    1,223,417 
Deposits   1,252,660    1,033,772    1,008,449    983,843    935,615 
Borrowings and subordinated debt   144,847    48,768    70,955    64,629    92,263 
Stockholders' equity   244,452    197,368    188,443    186,008    187,487 
Common shares outstanding   13,716,445    12,319,330    12,214,525    12,113,228    12,180,623 
AVERAGE BALANCES (In Thousands)                         
Total assets   1,540,469    1,276,140    1,247,759    1,229,866    1,243,209 
Earning assets   1,437,993    1,205,429    1,169,569    1,147,549    1,159,298 
Gross loans   1,057,559    822,346    780,640    723,076    657,727 
Deposits   1,213,687    1,027,831    990,917    970,447    968,201 
Stockholders' equity   229,446    187,895    188,958    188,373    188,905 

 

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ITEM 6. SELECTED FINANCIAL DATA (Continued)

 

  As of or for the Year Ended December 31,
KEY RATIOS  2019   2018   2017   2016   2015 
Return on average assets   1.27%   1.72%   1.08%   1.28%   1.32%
Return on average equity   8.50%   11.72%   7.11%   8.37%   8.72%
Average equity to average assets   14.89%   14.72%   15.14%   15.32%   15.19%
Net interest margin (1)   3.86%   3.90%   3.82%   3.76%   3.69%
Efficiency (2)   60.73%   59.69%   60.74%   59.22%   56.66%
Cash dividends as a % of diluted earnings per share   80.82%   60.34%   94.55%   80.00%   77.04%
Tier 1 leverage   13.10%   14.78%   14.23%   14.27%   14.31%
Tier 1 risk-based capital   19.19%   23.24%   21.95%   22.48%   23.29%
Total risk-based capital   20.70%   24.42%   23.07%   23.60%   24.40%
Tangible common equity/tangible assets   13.22%   14.50%   13.95%   14.15%   14.49%
Nonperforming assets/total assets   0.80%   1.37%   1.47%   1.43%   1.31%
Nonperforming loans/total loans   0.88%   1.94%   2.10%   2.07%   2.09%
Allowance for loan losses/total loans   0.83%   1.12%   1.09%   1.13%   1.12%
Net charge-offs/average loans   0.03%   0.02%   0.05%   0.09%   0.04%
                          
(1) Rates of return on tax-exempt securities and loans are calculated on a fully-taxable equivalent basis.                         
                          
(2) The efficiency ratio is calculated by dividing: (a) total noninterest expense excluding merger-related expenses and losses from prepayment of debt, by (b) the sum of net interest income (including income from tax-exempt securities and loans on a fully-taxable equivalent basis) and noninterest income excluding securities gains or losses.                         

 

12

 

 

 

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Certain statements in this section and elsewhere in this Annual Report on Form 10-K 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
·failure to achieve merger-related synergies and difficulties in integrating the business and operations of acquired institutions.

 

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

 

COMPLETED AND PENDING ACQUISITIONS

 

The Corporation’s acquisition of Monument Bancorp, Inc. (“Monument”) was completed April 1, 2019. Monument was the parent company of Monument Bank, a commercial bank which operated two community bank offices and one lending office in Bucks County, Pennsylvania. Total purchase consideration was $42.7 million, including 1,279,825 shares of the Corporation’s common stock issued with a value of $33.1 million and cash paid totaling $9.6 million. Holders of Monument common stock prior to the consummation of the merger held approximately 9.4% of the Corporation’s common stock outstanding immediately following the merger.

 

In connection with the transaction, the Corporation recorded goodwill of $16.4 million and a core deposit intangible asset of $1.5 million. Total loans acquired on April 1, 2019 were valued at $259.3 million, while total deposits assumed were valued at $223.3 million, borrowings were valued at $111.6 million and subordinated debt was valued at $12.4 million. The subordinated debt included an instrument with a fair value of $5.4 million that was redeemed on April 1, 2019 with no realized gain or loss. The Corporation acquired available-for-sale debt securities valued at $94.6 million and sold the securities in early April for approximately no realized gain or loss. The assets purchased and liabilities assumed in the merger were recorded at their estimated fair values at the time of closing and may be adjusted for up to one year subsequent to the acquisition. In the fourth quarter 2019, the Corporation recorded adjustments to various assets acquired and liabilities assumed from the merger, resulting in a net reduction in goodwill of $230,000.

 

Merger-related expenses associated with the Monument transaction totaled $3.8 million for the year ended December 31, 2019, including costs associated with termination of data processing contracts, conversion of Monument’s customer accounting data into the Corporation’s core system, severance and similar expenses, legal and other professional fees and various other costs.

 

In December 2019, the Corporation announced a plan of merger to acquire Covenant Financial, Inc. (“Covenant”) in a transaction valued on December 18, 2019 at approximately $77 million. Under the terms of the definitive agreement, the Corporation will pay cash for 25% of the Covenant shares and will convert 75% of Covenant shares to the Corporation’s common stock. Covenant is the holding company for Covenant Bank, which operates banking offices in Bucks and Chester Counties of PA. Covenant had total assets of $516 million at December 31, 2019. The merger is subject to satisfaction of customary closing conditions, including receipt of regulatory approvals and approval of Covenant’s shareholders. The merger is expected to close in the third quarter 2020. In the fourth quarter 2019, the Corporation incurred merger-related expenses totaling $287,000 related to the planned acquisition of Covenant. Management estimates pre-tax merger-related expenses associated with the Covenant acquisition will total approximately $8 million ($6.6 million, net of tax), with most of the expenses expected to be incurred in the third quarter 2020.

 

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EARNINGS OVERVIEW

 

Net income for the year ended December 31, 2019 was $19,504,000, or $1.46 per diluted share as compared to 2018 net income of $22,013,000 or $1.79 per share. Earnings for the year ended December 31, 2019 were significantly impacted by the Monument acquisition, including the effects of merger-related expenses described earlier. Earnings for the year ended December 31, 2018 included the benefit of a realized gain on a restricted equity security (Visa Inc. Class B stock) partially offset by the impact of a loss on available-for-sale debt securities. In 2018, pre-tax realized gains on Visa Class B stock totaled $2.3 million while pre-tax realized losses on available-for-sale securities totaled $288,000. Excluding the impact of merger-related expenses and net securities gains, adjusted (non-U.S. GAAP) earnings for 2019 would be $22,756,000 or $1.70 per share as compared to similarly adjusted (non-GAAP) earnings of $20,712,000 or $1.68 per share for 2018.

 

The following table provides a reconciliation of the Corporation’s 2019 earnings results under U.S. generally accepted accounting principles (U.S. GAAP) to comparative non-U.S. GAAP results excluding merger-related expenses and realized gains and losses on securities. Management believes disclosure of 2019 and 2018 earnings results, adjusted to exclude the impact of these items, provides useful information to investors for comparative purposes.

 

RECONCILIATION OF NET INCOME AND

DILUTED EARNINGS PER SHARE TO NON-U.S.

GAAP MEASURE 

 

   Year Ended Dec. 31, 2019   Year Ended Dec. 31, 2018 
   Income           Diluted   Income           Diluted 
   Before   Income       Earnings   Before   Income       Earnings 
   Income   Tax       per   Income   Tax       per 
   Tax   Provision   Net   Common   Tax   Provision   Net   Common 
(Dollars In Thousands, Except Per Share Data)  Provision   (1)   Income   Share   Provision   (1)   Income   Share 
Results as Presented Under U.S. GAAP  $23,409   $3,905   $19,504   $1.46   $26,263   $4,250   $22,013   $1.79 
Add: Merger-Related Expenses   4,099    829    3,270         328    23    305      
Less: Gain on Restricted Equity Security                       (2,321)   (487)   (1,834)     
Net (Gains) Losses on Available-for-sale Debt                                        
Securities   (23)   (5)   (18)        288    60    228      
Adjusted Earnings, Excluding Effect of Merger-                                        
Related Expenses, Gain on Restricted Equity                                        
Security and Net Gains and Losses on                                        
Available-for-Sale Debt Securities                                        
(Non-U.S. GAAP)  $27,485   $4,729   $22,756   $1.70   $24,558   $3,846   $20,712   $1.68 

 

(1)Income tax has been allocated based on an income tax rate of 21%. The tax benefit associated with merger-related expenses has been adjusted to reflect the estimated nondeductible portion of the expenses.

 

In 2019, interest income on loans acquired from Monument, partially offset by interest expense on deposits, borrowings and subordinated debt assumed, contributed to growth in net interest income, while costs associated with the expansion contributed to an increase in noninterest expenses.

 

Other significant variances were as follows:

 

·Net interest income was up $8,785,000 (19.2%) in 2019 over 2018, reflecting the benefits of growth, particularly from the Monument acquisition as well as loan growth from the York office (opened in March 2019) and organic loan and deposit growth from the Corporation’s legacy markets. The net interest margin was 3.86% for 2019, down from 3.90% in 2018. In 2019, the net interest margin included a net positive impact from accretion and amortization of purchase accounting adjustments of 0.04%. The average yield on earning assets in 2019 was up 0.30% over 2018, while the average rate paid on interest-bearing liabilities was up 0.46% between periods. The Monument acquisition and other factors contributed to growth in average noninterest-bearing demand deposits of $39.4 million and average stockholders’ equity (excluding accumulated other comprehensive income) of $33.8 million, which helped to offset some of the impact on the margin of compression in the interest rate spread.

 

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·The provision for loan losses of $849,000 for 2019 was higher than the 2018 provision by $265,000. The higher provision in 2019 resulted mainly from significant loan growth. The 2019 provision included a net reduction in expense of $232,000 related to specific loans (net decrease in specific allowances on loans of $554,000 and net charge-offs of $322,000), a net $1,193,000 charge attributable to loan growth and a net reduction in expense of $112,000 related to changes in historical loss and qualitative factors and the unallocated portion of the allowance. In comparison, the 2018 provision included $457,000 related to the change in total specific allowances on impaired loans, as adjusted for net charge-offs during the period, a charge of $178,000 due to loan growth and a net reduction in expense of $51,000 related to decreases in historical loss and qualitative factors.

 

·Noninterest income increased $687,000, or 3.7%, in 2019 over 2018. Total trust and brokerage revenue increased $516,000 as trust revenue reflected growth in assets under management from market value appreciation as well as new business and brokerage revenue increased as a result of an increase in volume. Increases in volume also led to increases in net gains from sales of mortgage loans of $242,000, interchange revenue from debit card transactions of $208,000 and service charges on deposit accounts of $187,000. Other noninterest income decreased $278,000, as the total for 2018 included income of $438,000 from a life insurance arrangement in which benefits were split between the Corporation and heirs of a former employee. Loan servicing fees, net, decreased $247,000, as the fair value of servicing rights decreased $331,000 in 2019 as compared to a decrease of $83,000 in 2018. The reduction in valuation of servicing fees at December 31, 2019 reflected the impact of higher assumed mortgage prepayments from lower interest rates.

 

·Noninterest expense, excluding merger-related expenses, increased $6,280,000 in 2019 over 2018. Significant variances included the following:

 

ØSalaries and wages expense increased $3,453,000, including $2,707,000 related to the Corporation’s new ventures in southeastern and southcentral Pennsylvania.

 

ØPensions and other employee benefits increased $578,000, mainly due to the increased number of employees resulting from expansion into new markets.

 

ØOther noninterest expense increased $1,454,000. Within other noninterest expense, expenses and net losses on other real estate properties increased $385,000, mainly due to significant costs incurred related to one commercial workout situation. Other increases within this category included increases in advertising expense of $327,000, loan collection expenses of $264,000, amortization of core deposit intangibles of $220,000, consulting related to the overdraft privilege program of $145,000 and credit card operating costs of $111,000. Also, within other noninterest expense, donations expense decreased $249,000 reflecting a 2018 donation of real estate that resulted in expense of $250,000 with no similar item in 2019.

 

ØData processing expenses increased $653,000, including significant increases in software licensing costs associated with lending, Trust and other functions. Other expense increases within this category included consulting expenses related to renegotiation of an interchange processing contract, costs related to product development efforts in connection with a fintech organization and costs from operating two core processing systems for most of the second quarter 2019.

 

ØAutomated teller machine and interchange expense decreased $201,000, reflecting cost reductions pursuant to a renegotiated service contract.

 

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

 

CRITICAL ACCOUNTING POLICIES

 

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

 

A material estimate that is particularly susceptible to significant change is the determination of the allowance for loan losses. 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. Management believes the allowance for loan losses is adequate and reasonable. Notes 1 and 8 to the consolidated financial statements provide an overview of the process management uses for evaluating and determining the allowance for loan losses, and additional discussion of the 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.

 

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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 7 to the 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 I, II and III include information regarding the Corporation’s net interest income in 2019 and 2018. 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 tables.

 

Fully taxable equivalent net interest income was $55,532,000 in 2019, $8,528,000 (18.1%) higher than in 2018. Interest income was $14,186,000 higher in 2019 as compared to 2018; interest expense was also higher by $5,658,000 in comparing the same periods. As presented in Table II, the Net Interest Margin was 3.86% in 2019 as compared to 3.90% in 2018, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) decreased to 3.56% in 2019 from 3.72% in 2018.

 

Accretion and amortization of purchase accounting-related adjustments had a positive effect on net interest income of $560,000, including an increase in income on loans of $1,100,000 partially offset by increases in interest expense on time deposits of $407,000 and on short-term borrowings of $133,000. The net positive impact to the net interest margin from accretion and amortization of purchase accounting adjustments was 0.04%.

 

INTEREST INCOME AND EARNING ASSETS

 

Interest income totaled $65,815,000 in 2019, an increase of 27.5% from 2018. Interest and fees on loans receivable increased $14,234,000, or 34.3%, to $55,725,000 in 2019 from $41,491,000 in 2018. Table III shows the increase in interest on loans includes $12,696,000 attributable to an increase in volume and $1,538,000 related to an increase in average rate. The average balance of loans receivable increased $235,213,000 (28.6%) to $1,057,559,000 in 2019 from $822,346,000 in 2018. The increase in average balance reflects the Corporation’s purchase of Monument on April 1, 2019 as well as significant commercial loan growth throughout 2019. The average yield on loans in 2019 was 5.27% compared to 5.05% in 2018.

 

Interest income on available-for-sale debt securities totaled $9,531,000 in 2019, a reduction of $156,000 from the total for 2018. As indicated in Table II, average available-for-sale debt securities (at amortized cost) totaled $357,284,000 in 2019, a decrease of $2,839,000 (0.8%) from 2018. The average yield on available-for-sale debt securities decreased to 2.67% in 2019 from 2.69% in 2018.

 

Interest income from interest-bearing deposits in banks totaled $514,000 in 2019, an increase of $99,000 over the total for 2018. The most significant categories of assets within this category include interest-bearing balances held with the Federal Reserve and investments in certificates of deposit issued by other banks. The increase in interest income from interest-bearing deposits with banks includes the effects of an increase in yield to 2.37% in 2019 from 1.90% in 2018, consistent with market increases in short-term interest rates over the course of 2018 that had a positive impact on short-term asset yields in the earlier months of 2019.

 

INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES

 

Interest expense increased $5,658,000, or 122.3%, to $10,283,000 in 2019 from $4,625,000 in 2018. Table II shows that the overall cost of funds on interest-bearing liabilities increased to 1.02% in 2019 from 0.56% in 2018.

 

Total average deposit balances (interest-bearing and noninterest-bearing) increased 18.1%, to $1,213,687,000 in 2019 from $1,027,831,000 in 2018, mainly as a result of the Monument acquisition.

 

 16 

 

 

Interest expense on deposits increased $4,488,000 in 2019 over 2018. The average rate on interest-bearing deposits increased to 0.89% in 2019 from 0.48% in 2018. Interest expense on time deposits increased $3,777,000 in 2019 of which $2,373,000 is from an increase in average rate and $1,404,000 due to an increase in volume. The increase in average rate on deposits reflects comparatively higher rates on deposits assumed from Monument, including significant growth in higher-cost time deposits. Amortization of purchase accounting-related adjustments added 0.05% to the average rate on total interest-bearing deposits.

 

Interest expense on borrowed funds increased $1,170,000 in 2019 as compared to 2018. Total average borrowed funds increased $32,277,000 to $82,712,000 in 2019 from $50,435,000 in 2018. The average rate on total borrowed funds was 2.53% in 2019 compared to 1.83% in 2018. The increase in the average rate on borrowed funds in 2019 reflects the impact of increases in market rates over the course of 2018 and the first quarter 2019 and the impact of higher-cost subordinated debt assumed from Monument.

 

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TABLE I - ANALYSIS OF INTEREST INCOME AND EXPENSE

    
             
   Years Ended December 31,   Increase/ 
(In Thousands)  2019   2018   (Decrease) 
INTEREST INCOME               
Interest-bearing due from banks  $514   $415   $99 
Available-for-sale securities               
Taxable   7,008    6,189    819 
Tax-exempt   2,523    3,498    (975)
Total available-for-sale securities   9,531    9,687    (156)
Loans receivable:               
Taxable   53,086    38,667    14,419 
Tax-exempt   2,639    2,824    (185)
Total loans receivable   55,725    41,491    14,234 
Other earning assets   45    36    9 
Total Interest Income   65,815    51,629    14,186 
                
INTEREST EXPENSE               
Interest-bearing deposits:               
Interest checking   1,155    950    205 
Money market   962    549    413 
Savings   246    153    93 
Time deposits   5,827    2,050    3,777 
Total interest-bearing deposits   8,190    3,702    4,488 
Borrowed funds:               
Short-term   733    366    367 
Long-term   1,013    557    456 
Subordinated debt   347    0    347 
Total borrowed funds   2,093    923    1,170 
Total Interest Expense   10,283    4,625    5,658 
                
Net Interest Income  $55,532   $47,004   $8,528 

 

(1)Interest income from tax-exempt securities and loans has been adjusted to a fully taxable-equivalent basis, using the Corporation’s marginal federal income tax rate of 21%.

(2)Fees on loans are included with interest on loans and amounted to $919,000 in 2019 and $912,000 in 2018.

 

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TABLE II - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES

                 
   Year       Year     
   Ended   Rate of   Ended   Rate of 
   12/31/2019   Return/   12/31/2018   Return/ 
   Average   Cost of   Average   Cost of 
(Dollars in Thousands)  Balance   Funds %   Balance   Funds % 
EARNING ASSETS                    
Interest-bearing due from banks  $21,711    2.37%  $21,800    1.90%
Available-for-sale securities,                    
at amortized cost:                    
Taxable   284,072    2.47%   262,461    2.36%
Tax-exempt   73,212    3.45%   97,662    3.58%
Total available-for-sale securities   357,284    2.67%   360,123    2.69%
Loans receivable:                    
Taxable   988,560    5.37%   746,309    5.18%
Tax-exempt   68,999    3.82%   76,037    3.71%
Total loans receivable   1,057,559    5.27%   822,346    5.05%
Other earning assets   1,439    3.13%   1,160    3.10%
Total Earning Assets   1,437,993    4.58%   1,205,429    4.28%
Cash   19,906         17,674      
Unrealized gain/loss on securities   1,347         (8,343)     
Allowance for loan losses   (8,876)        (9,033)     
Bank premises and equipment   15,914         15,156      
Intangible Assets   25,531         11,952      
Other assets   48,654         43,305      
Total Assets  $1,540,469        $1,276,140      
                     
INTEREST-BEARING LIABILITIES                    
Interest-bearing deposits:                    
Interest checking  $217,910    0.53%  $217,638    0.44%
Money market   194,849    0.49%   180,835    0.30%
Savings   167,677    0.15%   152,889    0.10%
Time deposits   344,446    1.69%   227,060    0.90%
Total interest-bearing deposits   924,882    0.89%   778,422    0.48%
Borrowed funds:                    
Short-term   33,521    2.19%   25,226    1.45%
Long-term   43,917    2.31%   25,209    2.21%
Subordinated debt   5,274    6.58%   0    0.00%
Total borrowed funds   82,712    2.53%   50,435    1.83%
Total Interest-bearing Liabilities   1,007,594    1.02%   828,857    0.56%
Demand deposits   288,805         249,409      
Other liabilities   14,624         9,979      
Total Liabilities   1,311,023         1,088,245      
Stockholders' equity, excluding                    
other comprehensive income/loss   228,103         194,333      
Other comprehensive income/loss   1,343         (6,438)     
Total Stockholders' Equity   229,446         187,895      
Total Liabilities and Stockholders' Equity  $1,540,469        $1,276,140      
Interest Rate Spread        3.56%        3.72%
Net Interest Income/Earning Assets        3.86%        3.90%
                     
Total Deposits (Interest-bearing                    
and Demand)  $1,213,687        $1,027,831      

 

(1)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%.

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

 

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TABLE III -  ANALYSIS OF VOLUME AND RATE CHANGES  

 

   Year Ended 12/31/19 vs. 12/31/18 
   Change in   Change in   Total 
(In Thousands)  Volume   Rate   Change 
EARNING ASSETS               
Interest-bearing due from banks  $(2)  $101   $99 
Available-for-sale securities:               
Taxable   525    294    819 
Tax-exempt   (847)   (128)   (975)
Total available-for-sale securities   (322)   166    (156)
Loans receivable:               
Taxable   12,963    1,456    14,419 
Tax-exempt   (267)   82    (185)
Total loans receivable   12,696    1,538    14,234 
Other earning assets   9    0    9 
Total Interest Income   12,381    1,805    14,186 
                
INTEREST-BEARING LIABILITIES               
Interest-bearing deposits:               
Interest checking   1    204    205 
Money market   46    367    413 
Savings   16    77    93 
Time deposits   1,404    2,373    3,777 
Total interest-bearing deposits   1,467    3,021    4,488 
Borrowed funds:               
Short-term   144    223    367 
Long-term   431    25    456 
Subordinated debt   347    0    347 
Total borrowed funds   922    248    1,170 
Total Interest Expense   2,389    3,269    5,658 
                
Net Interest Income  $9,992   $(1,464)  $8,528 

 

(1)Changes in income 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%.

(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 amounts of the change in each.

 

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NONINTEREST INCOME

 

The table below presents a comparison of noninterest income, excludes realized gains and losses on securities (which are discussed in the Earnings Overview section of Management’s Discussion and Analysis), and the gain on a restricted equity security (Visa Class B stock) in 2018.

 

TABLE IV - COMPARISON OF NONINTEREST INCOME

                 
   Years Ended         
   December 31,   $   % 
(Dollars in Thousands)  2019   2018   Change   Change 
Trust and financial management revenue  $6,106   $5,838   $268    4.6 
Brokerage revenue   1,266    1,018    248    24.4 
Insurance commissions, fees and premiums   167    105    62    59.0 
Service charges on deposit accounts   5,358    5,171    187    3.6 
Service charges and fees   332    343    (11)   (3.2)
Interchange revenue from debit card transactions   2,754    2,546    208    8.2 
Net gains from sales of loans   924    682    242    35.5 
Loan servicing fees, net   100    347    (247)   (71.2)
Increase in cash surrender value of life insurance   402    394    8    2.0 
Other noninterest income   1,875    2,153    (278)   (12.9)
Total noninterest income, excluding realized gains                    
(losses) on securities, net  $19,284   $18,597   $687    3.7 

 

Total noninterest income, excluding realized gains and losses on securities, increased $687,000 (3.7%) in 2019 compared to 2018. Changes of significance are discussed in the narrative that follows.

 

·Trust and financial management revenue increased $268,000 (4.6%), reflecting growth in the value of trust assets under management attributable to market appreciation, particularly in the latter portion of 2019, as well as new business. At December 31, 2019, the value of trust assets under management was $1,007,113,000, an increase of 16.8% from $862,517,000 at December 31, 2018.

 

·Brokerage revenue increased $248,000 (24.4%), mainly due to increased volume of brokerage transactions compared to 2018.

 

·Service charges on deposit accounts increased $187,000 (3.6%), which includes $52,000 attributable to the assumption of former Monument deposit accounts.

 

·Interchange revenue from debit card transactions increased $208,000 (8.2%), reflecting an increase in transaction volume.

 

·Net gains from sales of loans increased $242,000 (35.5%) due to increased volume of residential mortgage loans sold. The increased sales volume in 2019 reflected a decision to retain fewer mortgage loans on the balance sheet to accommodate funding for increased commercial lending opportunities in southeastern and southcentral Pennsylvania. The increased sales volume was also attributable, in part, to increased refinancing activity consistent with falling interest rates in the latter portion of the year. Gains on sales of loans totaled 3.1% of the origination cost of loans sold in 2019 as compared to 3.2% in 2018.

 

·Loan servicing fees, net, decreased $247,000, as the fair value of mortgage loan servicing rights decreased $331,000 in 2019 as compared to a decrease of $83,000 in 2018. At December 31, 2019, the value of mortgage servicing rights (included in other assets in the consolidated balance sheets) was $1,277,000, or 0.72% of the outstanding balance of loans sold and serviced, down from $1,404,000 or 0.82% of the outstanding balance of loans sold and serviced at December 31, 2018. The reduction in valuation of servicing fees at December 31,2019 reflected the impact of higher assumed mortgage prepayments from lower interest rates.

 

·Other noninterest income decreased $278,000, as the 2018 total included $438,000 from a life insurance arrangement in which benefits were split between the Corporation and heirs of a former employee. Income from tax credits decreased $167,000 to $155,000 in 2019 from $322,000 in 2018 as the 2018 total included $154,000 from a donation of real estate. Dividends on FHLB-Pittsburgh stock increased $167,000 to $487,000 in 2019 from $320,000 in 2018. Interchange revenue from credit card transactions increased $87,000 to $213,000 in 2019 from $126,000 in 2018 and revenue from merchant services increased $50,000 to $424,000 in 2019 from $374,000 in 2018.

 

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NONINTEREST EXPENSE 

 

TABLE V - COMPARISON OF NONINTEREST EXPENSE 

 

             
   Years Ended         
   December 31,   $   % 
(Dollars In Thousands)   2019   2018   Change   Change 
Salaries and wages  $20,644   $17,191   $3,453    20.1 
Pensions and other employee benefits   5,837    5,259    578    11.0 
Occupancy expense, net   2,629    2,497    132    5.3 
Furniture and equipment expense   1,289    1,196    93    7.8 
Data processing expenses   3,403    2,750    653    23.7 
Automated teller machine and interchange expense   1,103    1,304    (201)   (15.4)
Pennsylvania shares tax   1,380    1,318    62    4.7 
Professional fees   1,069    976    93    9.5 
Telecommunications   744    748    (4)   (0.5)
Directors' fees   673    706    (33)   (4.7)
Other noninterest expense   6,667    5,213    1,454    27.9 
Total noninterest expense, excluding merger-                    
related expenses   45,438    39,158    6,280    16.0 
Merger-related expenses   4,099    328    3,771    1,149.7 
Total noninterest expense  $49,537   $39,486   $10,051    25.5 

 

Total noninterest expenses increased $10,051,000 (25.5%) in 2019 as compared to 2018. Total noninterest expenses excluding merger-related expenses increased $6,280,000 (16.0%) in 2019 as compared to 2018. Merger-related expenses are discussed in the Completed and Pending Acquisitions section of Management’s Discussion and Analysis. Other changes of significance are discussed in the narrative that follows.

 

·Salaries and wages expense increased $3,453,000 (20.1%), including $2,707,000 related to new operations in southeastern Pennsylvania (former Monument locations) and the southcentral Pennsylvania (York) location, as well as costs arising from increased staffing for credit administration and other lending support functions. At December 31, 2019, the Corporation had 336 full-time equivalent employees as compared to 299 at December 31, 2018.

 

·Pensions and other employee benefits expense increased $578,000 (11.0%), mainly due to the additional staffing related to the new ventures. Within this category, employee health insurance expense totaled $1,964,000 in 2019, an increase of $48,000 (2.5%) over 2018. In 2019, health insurance expense was reduced by the effect of a credit of $201,000 resulting from prior overpayment of claims on the partially self-insured plan.

 

·Occupancy expense increased $132,000 (5.3%), reflecting the addition of the locations in southeastern and southcentral Pennsylvania.

 

·Data processing expenses increased $653,000 (23.7%), including the impact of increases in software licensing costs associated with lending, trust and other functions. Other expense increases within this category included consulting expenses related to renegotiation of an interchange processing contract, costs related to product development efforts in connection with a fintech organization and costs from operating two core processing systems for most of the second quarter 2019.

 

·Automated teller machine and interchange expense decreased $201,000 from 2018 to 2019 reflecting cost reductions pursuant to a renegotiated service contract.

 

·Other noninterest expense increased $1,454,000. Within this category, significant changes were as follows:

 

ØExpenses and net losses on other real estate properties increased $385,000 and loan collection expenses increased $264,000, including significant costs incurred related to one commercial workout situation.

 

ØAdvertising expense increased $327,000, reflecting costs associated with re-branding and targeted marketing efforts.

 

ØAmortization of core deposit intangibles increased $220,000, reflecting expense associated with the Monument acquisition.

 

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ØConsulting expense related to the overdraft privilege program increased $145,000 to $263,000 in 2019 from $118,000 in 2018, reflecting an increase in amounts payable based on enhancements to the program, including the impact of an under-accrual of $41,000 in 2018.

 

ØWithin this category, credit card operating costs totaled $257,000 in 2019, an increase of $111,000 over 2018.

 

ØDonations expense decreased $249,000 reflecting a 2018 donation of real estate that resulted in expense of $250,000 with no similar item in 2019.

 

INCOME TAXES

 

The effective income tax rate was 16.7% of pre-tax income in 2019, up from 16.2% in 2018.The Corporation’s effective tax rates differed from the statutory rate of 21% mainly because of the effects of tax-exempt interest income. The higher effective income tax rate in 2019 as compared to 2018 reflected the impact of a reduction in tax-exempt interest income, as the Corporation’s average total investment in tax-exempt securities (at amortized cost) and tax-exempt loans was $31.5 million lower in 2019 than in 2018, as proceeds from maturities and calls of tax-exempt assets were reinvested mainly in taxable securities and loans.

 

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 December 31, 2019, the net deferred tax asset was $2,618,000, down from the balance at December 31, 2018 of $4,110,000. The most significant change in temporary difference components was a net decrease of $2,079,000 related to unrealized gains or losses on available-for-sale securities. At December 31, 2019, the net deferred tax liability associated with the unrealized gain was $934,000, while at December 31, 2018, the deferred tax asset associated with the unrealized loss was $1,145,000.

 

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

 

Management believes the recorded net deferred tax asset at December 31, 2019 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 14 to the consolidated financial statements.

 

SECURITIES

 

The objectives of the Corporation’s available-for-sale debt securities (investment) portfolio are to maintain high credit quality, achieve good portfolio balance, support liquidity needs, maximize return on earning assets within reasonable risk parameters, provide an adequate amount of pledgeable securities, support local communities by purchasing securities they issue for public projects and programs, provide a means to hedge the Corporation’s interest rate risk exposure, and minimize taxes. Management continually evaluates the size and mix of securities held in the available-for-sale debt securities portfolio while considering these objectives.

 

Table VI shows the composition of the available-for-sale debt securities portfolio at December 31, 2019 and 2018. Comparison of the amortized cost totals of available-for-sale debt securities at each year-end presented reflects a decrease of $26,447,000 to $342,278,000 at December 31, 2019 from $368,725,000 at December 31, 2018. The reduction in securities resulted from opportunities for loan growth, as management identified opportunities to reinvest proceeds from maturities and sales of securities into loans. Within the securities portfolio, mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies and tax-exempt obligations of states and political subdivisions (municipal bonds) decreased, while investments in taxable municipal bonds and U.S. Government agency bonds increased. These changes in portfolio mix were based on changes in liquidity and interest rate risk management needs and current market yields for various categories of securities.

 

As reflected in Table VI, the fair value of available-for-sale securities as of December 31, 2019 was $4,445,000, or 1.3%, greater than the total amortized cost basis. In comparison, the aggregate unrealized loss position at December 31, 2018 was $5,452,000, or 1.5% of the total amortized cost basis. The unrealized appreciation in the portfolio in 2019 resulted mainly from a decrease in interest rates.

 

Management has reviewed the Corporation’s holdings as of December 31, 2019 and concluded that unrealized losses on all of the securities in an unrealized loss position are considered temporary. Note 7 to the consolidated financial statements provides more detail concerning the Corporation’s processes for evaluating securities for other-than-temporary impairment. Management will continue to closely monitor the status of impaired securities in 2020.

 

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TABLE VI - INVESTMENT SECURITIES                
   2019   2018 
   Amortized   Fair   Amortized   Fair 
(In Thousands)  Cost   Value   Cost   Value 
AVAILABLE-FOR-SALE DEBT SECURITIES:                    
Obligations of U.S. Government agencies  $16,380   $17,000   $12,331   $12,500 
Obligations of states and political subdivisions:                    
Tax-exempt   68,787    70,760    84,204    83,952 
Taxable   35,446    36,303    27,618    27,699 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                    
Residential pass-through securities   58,875    59,210    54,827    53,445 
Residential collateralized mortgage obligations   115,025    114,723    148,964    145,912 
Commercial mortgage-backed securities   47,765    48,727    40,781    39,765 
Total Available-for-Sale Debt Securities  $342,278   $346,723   $368,725   $363,273 

 

The following table presents the contractual maturities and the weighted-average yields (calculated based on amortized cost) of investment securities as of December 31, 2019. Yields on tax-exempt securities are presented on a fully taxable-equivalent basis. For callable securities, yields on securities purchased at a discount are based on yield-to-maturity, while yields on securities purchased at a premium are based on yield to the first call date. Yields on mortgage-backed securities are estimated and include the effects of prepayment assumptions. 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.

 

(In Thousands, Except for Percentages)  Within
One
Year
   Yield   One-
Five
Years
   Yield   Five-
Ten
Years
   Yield   After
Ten
Years
   Yield   Total   Yield 
AVAILABLE-FOR-SALE DEBT SECURITIES:                                                  
Obligations of U.S. Government agencies  $0    0.00%  $0    0.00%  $7,513    3.16%  $8,867    3.43%  $16,380    3.30%
Obligations of states and political subdivisions:                                                  
Tax-exempt   2,777    3.36%   16,230    3.03%   27,900    2.90%   21,880    3.48%   68,787    3.13%
Taxable   4,439    2.62%   15,396    2.94%   7,296    3.40%   8,315    3.17%   35,446    3.05%
Sub-total  $7,216    2.90%  $31,626    2.99%  $42,709    3.03%  $39,062    3.40%  $120,613    3.13%
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                                                  
Residential pass-through securities                                           58,875    2.41%
Residential collateralized mortgage obligations                                           115,025    1.84%
Commercial mortgage-backed securities                                           47,765    2.61%
Total                                          $342,278    2.50%

 

The Corporation’s mortgage-backed securities and collateralized mortgage obligations 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. As rates increase, cash flows generally decrease as prepayments on the underlying mortgage loans decrease. As rates decrease, cash flows generally increase as prepayments increase due to increased refinance activity and other factors. In the table above, the entire balances and weighted-average rates for mortgage-backed securities and collateralized mortgage obligations are shown in one period.

 

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 securities, 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 letters of credit at December 31, 2019, and management does not expect the amount of purchases of bank premises and equipment or the Covenant acquisition to have a material, detrimental effect on the Corporation’s financial condition in 2020.

 

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Table VII shows the composition of the loan portfolio as of the end of the years 2015 through 2019. From December 31, 2015 through December 31, 2018, total loans outstanding increased $122.7 million (17.4%) and the overall mix by segment remained fairly constant, with residential mortgage loans of approximately 55% to 56% of the portfolio at each year-end, and commercial loans of 43% to 44% of the portfolio. At December 31, 2019, gross loans outstanding totaled $1,182,222,000, an increase of $354.7 million (42.9%) from December 31, 2018. As previously noted, a significant portion of the Corporation’s loan growth in 2019 is attributable to the Monument acquisition and to new loans originated in the southeastern and southcentral Pennsylvania markets. In comparing gross outstanding balances at December 31, 2019 and 2018, total commercial loans increased $225.3 million (63.7%) and total residential mortgage loans increased $129.8 million (28.4%). The overall mix of the loan portfolio at December 31, 2019 was slightly less than 50% residential mortgage and 49% commercial loans.

 

While the Corporation’s lending activities are primarily concentrated in its market areas, 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-K. Total participation loans outstanding amounted to $64,633,000 at December 31, 2019, down from $67,340,000 at December 31, 2018. At December 31, 2019, the balance of participation loans outstanding includes a total of $46,206,000 to businesses located outside of the Corporation’s market areas. Also, included within participation loans are “leveraged loans,” meaning loans to businesses with minimal tangible book equity and for which the extent of collateral available is limited, though typically at the time of origination the businesses have demonstrated strong cash flow performance in their recent histories. Leveraged participation loans totaled $9,947,000 at December 31, 2019 and $13,315,000 at December 31, 2018.

 

Table VIII presents loan maturity data as of December 31, 2019. The interest rate simulation model used to prepare Table VIII classifies certain loans under different categories from the categories that appear in Table VII. Fixed-rate loans are shown in Table VIII based on their contractually scheduled principal repayments, and variable-rate loans are shown based on the date of the next change in rate. Table VIII shows that fixed-rate loans are approximately 30% of the loan portfolio and approximately 48% of the portfolio are variable-rate loans that re-price after more than one year. Variable-rate loans re-pricing after more than one year include residential and commercial real estate secured loans. The Corporation’s substantial investment in long-term, fixed-rate loans and variable-rate loans with extended periods until re-pricing is one of the concerns management attempts to address through interest rate risk management practices.

 

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. In late 2019, the Corporation began to originate and sell larger-balance, nonconforming mortgages under the MPF Direct Program, which is also administered by the Federal Home Loan Banks of Pittsburgh and Chicago. The Corporation will not retain servicing rights for loans sold under the MPF Direct Program. In 2019, the Corporation’s activity under the MPF Direct Program was minimal.

 

For loan sales originated under the MPF 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 December 31, 2019, the total outstanding balance of loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $1,770,000, and the corresponding total outstanding balance of repurchased loans at December 31, 2018 was $2,146,000.

 

At December 31, 2019, outstanding balances of loans sold and serviced through the MPF Xtra and Original programs totaled $178,446,000, including loans sold through the MPF Xtra program of $104,707,000 and loans sold through the Original program of $73,739,000. At December 31, 2018, outstanding balances of loans sold and serviced through the two programs totaled $171,742,000, including loans sold through the MPF Xtra program of $96,841,000 and loans sold through the Original Program of $74,901,000. Based on the fairly limited volume of required repurchases to date, no allowance has been established for representation and warranty exposures as of December 31, 2019 and December 31, 2018.

 

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 December 31, 2019, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $4,618,000, and the Corporation has recorded a related allowance for credit losses in the amount of $333,000 which is included in Accrued interest and other liabilities in the accompanying consolidated balance sheets. At December 31, 2018, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $4,157,000, and the related allowance for credit losses was $328,000. The Corporation does not provide a credit enhancement for loans sold through the Xtra program.

 

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TABLE VII - Five-year Summary of Loans by Type

 

(Dollars In Thousands)   2019   %   2018   %   2017   %   2016   %   2015   % 
Residential mortgage:                                                  
Residential mortgage loans - first liens  $510,641    43.2   $372,339    45.0   $359,987    44.1   $334,102    44.4   $304,783    43.2 
Residential mortgage loans - junior liens   27,503    2.3    25,450    3.1    25,325    3.1    23,706    3.2    21,146    3.0 
Home equity lines of credit   33,638    2.8    34,319    4.1    35,758    4.4    38,057    5.1    39,040    5.5 
1-4 Family residential construction   14,798    1.3    24,698    3.0    26,216    3.2    24,908    3.3    21,121    3.0 
Total residential mortgage   586,580    49.6    456,806    55.2    447,286    54.8    420,773    56.0    386,090    54.8 
Commercial:                                                  
Commercial loans secured by real estate   301,227    25.5    162,611    19.6    159,266    19.5    150,468    20.0    154,779    22.0 
Commercial and industrial   126,374    10.7    91,856    11.1    88,276    10.8    83,854    11.2    75,196    10.7 
Political subdivisions   53,570    4.5    53,263    6.4    59,287    7.3    38,068    5.1    40,007    5.7 
Commercial construction and land   33,555    2.8    11,962    1.4    14,527    1.8    14,287    1.9    5,122    0.7 
Loans secured by farmland   12,251    1.0    7,146    0.9    7,255    0.9    7,294    1.0    7,019    1.0 
Multi-family (5 or more) residential   31,070    2.6    7,180    0.9    7,713    0.9    7,896    1.1    9,188    1.3 
Agricultural loans   4,319    0.4    5,659    0.7    6,178    0.8    3,998    0.5    4,671    0.7 
Other commercial loans   16,535    1.4    13,950    1.7    10,986    1.3    11,475    1.5    12,152    1.7 
Total commercial   578,901    49.0    353,627    42.7    353,488    43.3    317,340    42.2    308,134    43.7 
Consumer   16,741    1.4    17,130    2.1    14,939    1.8    13,722    1.8    10,656    1.5 
Total   1,182,222    100.0    827,563    100.0    815,713    100.0    751,835    100.0    704,880    100.0 
Less: allowance for loan losses   (9,836)        (9,309)        (8,856)        (8,473)        (7,889)     
Loans, net  $1,172,386        $818,254        $806,857        $743,362        $696,991      

 

TABLE VIII – LOAN MATURITY DISTRIBUTION

 

   As of December 31, 2019 
     
   Fixed-Rate Loans   Variable- or Adjustable-Rate Loans 
   1 Year   1-5   >5       1 Year   1-5   >5     
(In Thousands)  or Less   Years   Years   Total   or Less   Years   Years   Total 
Real Estate  $3,988   $67,529   $187,706   $259,223   $167,318   $320,011   $180,631   $667,959 
Commercial   18,277    24,801    33,266    76,344    99,643    43,483    18,154    161,280 
Consumer   3,768    9,833    3,786    17,387    29    0    0    29 
Total  $26,033   $102,163   $224,758   $352,954   $266,990   $363,494   $198,785   $829,268 

 

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 recorded as a reduction of the investment in loans. Notes 1 and 8 to the consolidated financial statements provide 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 $9,836,000 at December 31, 2019, up from $9,309,000 at December 31, 2018. Table X shows that the collectively determined portion of the allowance increased $1,081,000 across all loan classes, including an increase in the collectively determined portion of the allowance related to commercial loans of $811,000. This increase was primarily due to loan growth in 2019.

 

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Table X shows total specific allowances on impaired loans decreased $554,000 to $1,051,000 at December 31, 2019 from $1,605,000 at December 31, 2018. This net decrease included the impact of specific allowances totaling $1,365,000 at December 31, 2018 on two commercial loans being eliminated in the first quarter 2019. These two loans were no longer considered impaired at March 31, 2019, were returned to full accrual status in the first quarter 2019 and remained in full accrual status at December 31, 2019. Partially offsetting this reduction, in the third quarter 2019 the Corporation recorded a specific allowance of $678,000 on a commercial construction loan with an outstanding balance of $1,261,000 at December 31, 2019.

 

Loans acquired from Monument that were identified as having a deterioration in credit quality (purchased credit impaired, or PCI), were valued at $441,000 at April 1, 2019 and December 31, 2019. The remainder of the portfolio was deemed to be the performing component of the portfolio. The calculation of the fair value of performing loans at acquisition included a discount for credit losses of $1,914,000, reflecting an estimate of the present value of credit losses based on market expectations. In the last nine months of 2019, the Corporation recognized accretion of the discount of $698,000, with a remaining discount for credit losses of $1,216,000 at December 31, 2019. None of the performing loans purchased were found to be impaired at December 31, 2019, and the purchased performing loans were excluded from the loan pools for which the general component of the allowance for loan losses was calculated. Accordingly, there was no allowance for loan losses at December 31, 2019 on loans purchased from Monument, which was the main reason the allowance dropped to 0.83% of total outstanding loans at December 31, 2019 from 1.12% at December 31, 2018.

 

The provision for loan losses by segment for 2019 and 2018 is as follows:

         
(In Thousands)  2019   2018 
Residential mortgage  $374   $173 
Commercial   197    204 
Consumer   192    207 
Unallocated   86    0 
Total  $849   $584 

 

The provision for loan losses is further detailed as follows:

 

Residential mortgage segment        
(In thousands)  2019   2018 
Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs  $238   $144 
           
Increase (decrease) in collectively determined portion of the allowance attributable to:          
Loan growth   171    94 
Changes in historical loss experience factors   47    (65)
Changes in qualitative factors   (82)   0 
Total provision for loan losses -          
Residential mortgage segment  $374   $173 
           

Commercial segment          
(In thousands)   2019    2018 
(Decrease) increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs  $(614)  $180 
           
Increase (decrease) in collectively determined portion of the allowance attributable to:          
Loan growth   1,025    45 
Changes in historical loss experience factors   (371)   (21)
Changes in qualitative factors   157    0 
Total provision for loan losses -          
Commercial segment  $197   $204 

 

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Consumer segment          
(In thousands)   2019    2018 
Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs  $144   $133 
           
Increase (decrease) in collectively determined portion of the allowance attributable to:          
Loan (reduction) growth   (3)   39 
Changes in historical loss experience factors   31    34 
Changes in qualitative factors   20    1 
Total provision for loan losses -          
Consumer segment  $192   $207 
           

Total - All segments          
(In thousands)   2019    2018 
(Decrease) increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs  $(232)  $457 
           
Increase (decrease) in collectively determined portion of the allowance attributable to:          
Loan growth   1,193    178 
Changes in historical loss experience factors   (293)   (52)
Changes in qualitative factors   95    1 
Sub-total   763    584 
Unallocated   86    0 
Total provision for loan losses -          
All segments  $849   $584 

 

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).

 

In 2019, net charge-offs were $322,000, including charge-offs of $379,000 and recoveries of $57,000. The Corporation’s overall net charge-off experience in 2019 was consistent with results over the past several years. Table XII shows the average rate of net charge-offs as a percentage of loans was 0.03% in 2019, with an annual average over the five-year period ended December 31, 2019 of 0.04%, and annual average rates ranging from a high of 0.09% in 2016 to a low of 0.02% in 2018.

 

Table XI presents information related to past due and impaired loans, and loans that have been modified under terms that are considered troubled debt restructurings (TDRs). Total nonperforming loans as a percentage of outstanding loans was 0.88% at December 31, 2019, down from 1.94% at December 31, 2018, and nonperforming assets as a percentage of total assets was 0.80% at December 31, 2019, down from 1.37% at December 31, 2018. Table XI presents data at the end of each of the years ended December 31, 2015 through 2019. Table XI shows that total nonperforming loans as a percentage of loans of 0.88% at December 31, 2019 was lower than the corresponding year-end ratio from 2015 through 2018. Similarly, the December 31, 2019 ratio of total nonperforming assets as a percentage of assets of 0.80% was lower than the corresponding ratio from 2015 through 2018. These improved credit-related ratios reflect the impact of acquired loans from Monument and significant additional loan growth in 2019, with a minimal amount of loans purchased or originated in 2019 classified as nonperforming, as well as a reduction in total nonperforming assets.

 

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Total impaired loans of $5,486,000 at December 31, 2019 are down $4,288,000 from the corresponding amount at December 31, 2018 of $9,774,000. In 2019, the two commercial loans referred to above for which specific allowances were eliminated were not considered to be impaired at December 31, 2019 but were considered impaired at December 31, 2018. Total outstanding balances of these loans were $3,781,000 at December 31, 2018. Table XI shows that the total balance of impaired loans at December 31, 2019 was lower than the year-end amounts over the period 2015-2018, which ranged from a low of $9,511,000 in 2017 to a high of $10,860,000 in 2016.

 

Total nonperforming assets of $13,311,000 at December 31, 2019 are $4,411,000 lower than the corresponding amount at December 31, 2018, summarized as follows:

 

·Total nonaccrual loans at December 31, 2019 of $9,218,000 was $3,895,000 lower than the corresponding December 31, 2018 total of $13,113,000.

 

·Total loans past due 90 days or more and still accruing interest amounted to $1,207,000 at December 31, 2019, a decrease of $1,699,000 from the total at December 31, 2018.

 

·Foreclosed assets held for sale consisted of real estate, and totaled $2,886,000 at December 31, 2019, an increase of $1,173,000 from $1,703,000 at December 31, 2018. Of this increase, $871,000 related to a property acquired through the Monument acquisition. At December 31, 2019, the Corporation held ten such properties for sale, with total carrying values of $292,000 related to residential real estate, $70,000 of land and $2,524,000 related to commercial real estate. At December 31, 2018, the Corporation held six such properties for sale, with total carrying values of $64,000 related to residential real estate, $110,000 of land and $1,529,000 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.

 

As reflected in Table XI, total loans past due 30-89 days and still accruing interest amounted to $8,889,000 at December 31, 2019, up from $7,142,000 at December 31, 2018 but lower than the amount at December 31, 2017 of $9,449,000. These variances include the effect of fluctuations in 30-89 day past due residential mortgage loans, which totaled $7,249,000 at December 31, 2019, up from $5,835,000 at December 31, 2018 but slightly lower than the amount at December 31, 2017 of $7,236,000. Management monitors the status of delinquent residential mortgage loans on an ongoing basis and has considered delinquency trends, which were generally favorable throughout most of 2019, in evaluating the allowance for loan losses at December 31, 2019.

 

Over the period 2015-2019, 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 December 31, 2019. Management continues to closely monitor its commercial loan relationships for possible credit losses, and will adjust its estimates of loss and decisions concerning nonaccrual status, if appropriate.

 

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

 

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TABLE IX - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES

 

   Years Ended December 31, 
(Dollars In Thousands)  2019   2018   2017   2016   2015 
Balance, beginning of year  $9,309   $8,856   $8,473   $7,889   $7,336 
Charge-offs:                         
Residential mortgage   (190)   (158)   (197)   (73)   (217)
Commercial   (6)   (165)   (132)   (597)   (251)
Consumer   (183)   (174)   (150)   (87)   (94)
Total charge-offs   (379)   (497)   (479)   (757)   (562)
Recoveries:                         
Residential mortgage   12    8    19    3    1 
Commercial   6    317    4    35    214 
Consumer   39    41    38    82    55 
Total recoveries   57    366    61    120    270 
Net charge-offs   (322)   (131)   (418)   (637)   (292)
Provision for loan losses   849    584    801    1,221    845 
Balance, end of period  $9,836   $9,309   $8,856   $8,473   $7,889 
Net charge-offs as a % of average loans   0.03%   0.02%   0.05%   0.09%   0.04%

 

 

TABLE X - COMPONENTS OF THE ALLOWANCE FOR LOAN LOSSES

     
   As of December 31, 
(In Thousands)  2019   2018   2017   2016   2015 
ASC 310 - Impaired loans  $1,051   $1,605   $1,279   $674   $820 
ASC 450 - Collective segments:                         
Commercial   3,913    3,102    3,078    3,373    3,103 
Residential mortgage   4,006    3,870    3,841    3,890    3,417 
Consumer   281    233    159    138    122 
Unallocated   585    499    499    398    427 
Total Allowance  $9,836   $9,309   $8,856   $8,473   $7,889 

 

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

 

   As of December 31, 
(Dollars In Thousands)  2019   2018   2017   2016   2015 
Impaired loans with a valuation allowance  $3,375   $4,851   $4,100   $3,372   $1,933 
Impaired loans without a valuation allowance   2,111    4,923    5,411    7,488    8,041 
Total impaired loans  $5,486   $9,774   $9,511   $10,860   $9,974 
                          
Total loans past due 30-89 days and still accruing  $8,889   $7,142   $9,449   $7,735   $7,057 
                          
Nonperforming assets:                         
Total nonaccrual loans  $9,218   $13,113   $13,404   $8,736   $11,517 
Total loans past due 90 days or more and still accruing   1,207    2,906    3,724    6,838    3,229 
Total nonperforming loans   10,425    16,019    17,128    15,574    14,746 
Foreclosed assets held for sale (real estate)   2,886    1,703    1,598    2,180    1,260 
Total nonperforming assets  $13,311   $17,722   $18,726   $17,754   $16,006 
                          
Loans subject to troubled debt restructurings (TDRs):                         
Performing  $889   $655   $636   $5,803   $1,186 
Nonperforming   1,737    2,884    3,027    2,874    5,178 
Total TDRs  $2,626   $3,539   $3,663   $8,677   $6,364 
                          
Total nonperforming loans as a % of loans   0.88%   1.94%   2.10%   2.07%   2.09%
Total nonperforming assets as a % of assets   0.80%   1.37%   1.47%   1.43%   1.31%
Allowance for loan losses as a % of total loans   0.83%   1.12%   1.09%   1.13%   1.12%
Allowance for loan losses as a % of nonperforming loans   94.35%   58.11%   51.70%   54.40%   53.50%

 

TABLE XII - FIVE-YEAR HISTORY OF LOAN LOSSES

 

(Dollars In Thousands)  2019   2018   2017   2016   2015   Average 
Average gross loans  $1,057,559   $822,346   $780,640   $723,076   $657,727   $808,270 
Year-end gross loans   1,182,222    827,563    815,713    751,835    704,880   $856,443 
Year-end allowance for loan losses   9,836    9,309    8,856    8,473    7,889   $8,873 
Year-end nonaccrual loans   9,218    13,113    13,404    8,736    11,517   $11,198 
Year-end loans 90 days or more past due and still accruing   1,207    2,906    3,724    6,838    3,229    3,581 
Net charge-offs   322    131    418    637    292    360 
Provision for loan losses   849    584    801    1,221    845    860 
Earnings coverage of charge-offs   76x   210x   56x   37x   85x   93x
Allowance coverage of charge-offs   31x   71x   21x   13x   27x   33x
Net charge-offs as a % of provision for loan losses   37.93%   22.43%   52.18%   52.17%   34.56%   41.86%
Net charge-offs as a % of average gross loans   0.03%   0.02%   0.05%   0.09%   0.04%   0.04%
Income before income taxes on a fully taxable equivalent basis   24,453    27,564    23,350    23,861    24,710    24,788 

 

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CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

 

The Corporation’s significant fixed and determinable contractual obligations as of December 31, 2019 include repayment obligations related to time deposits and borrowed funds. Information related to maturities of time deposits is provided in Note 11 to the consolidated financial statements. Information related to maturities of borrowed funds is provided in Note 12 to the consolidated financial statements. The Corporation’s operating lease and other commitments at December 31, 2019 are immaterial. Information concerning operating lease commitments is provided in Note 17 to the consolidated financial statements. The Corporation’s significant off-balance sheet arrangements include commitments to extend credit and standby letters of credit. Off-balance sheet arrangements are described in Note 16 to the consolidated financial statements.

 

As described in more detail in the Financial Condition section of Management’s Discussion and Analysis, the Corporation sells residential mortgage loans for which 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. At December 31, 2019, outstanding balances of such loans sold totaled $178,446,000.

 

Also, for loans sold under the MPF Original program, the Corporation provides a credit enhancement. At December 31, 2019, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $4,618,000, and the Corporation has recorded a related allowance for credit losses in the amount of $333,000 which is included in “Accrued interest and other liabilities” in the accompanying consolidated balance sheets.

 

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 December 31, 2019, the Corporation maintained overnight interest-bearing deposits with the Federal Reserve Bank of Philadelphia and other correspondent banks totaling $13,455,000.

 

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 $14,728,000 at December 31, 2019.

 

The Corporation’s outstanding, available, and total credit facilities at December 31, 2019 and 2018 are as follows:

 

   Outstanding   Available   Total Credit 
   Dec. 31,   Dec. 31,   Dec. 31,   Dec. 31,   Dec. 31,   Dec. 31, 
(In Thousands)  2019   2018   2019   2018   2019   2018 
Federal Home Loan Bank of Pittsburgh  $136,424   $42,915   $416,122   $318,699   $552,546   $361,614 
Federal Reserve Bank Discount Window   0    0    14,244    15,262    14,244    15,262 
Other correspondent banks   0    0    45,000    45,000    45,000    45,000 
Total credit facilities  $136,424   $42,915   $475,366   $378,961   $611,790   $421,876 

 

The significant increase in credit available from the Federal Home Loan Bank of Pittsburgh in 2019 resulted from an increase in the borrowing base created by the acquisition of real estate secured loans from Monument. At December 31, 2019, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowings of $64,000,000, short-term borrowings of $20,297,000 and long-term borrowings with a total amount of $52,127,000. At December 31, 2018, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowings of $7,000,000 and long-term borrowings with a total amount of $35,915,000. Additional information regarding borrowed funds is included in Note 12 to the consolidated financial statements.

 

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 debt securities to meet its obligations. At December 31, 2019, the carrying value of available-for-sale debt securities in excess of amounts required to meet pledging or repurchase agreement obligations was $170,948,000.

 

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

 

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STOCKHOLDERS’ EQUITY AND CAPITAL ADEQUACY

 

As required by the Economic Growth, Regulatory Relief, and Consumer Protection Act (discussed further in the Recent Legislative Developments section of Management’s Discussion and Analysis), in August 2018, the Federal Reserve Board issued an interim final rule that expanded applicability of the Board’s small bank holding company policy statement. The interim final rule raised the policy statement’s asset threshold from $1 billion to $3 billion in total consolidated assets for a bank holding company or savings and loan holding company that: (1) is not engaged in significant nonbanking activities; (2) does not conduct significant off-balance sheet activities; and (3) does not have a material amount of debt or equity securities, other than trust-preferred securities, outstanding. The interim final rule provides that, if warranted for supervisory purposes, the Federal Reserve may exclude a company from the threshold increase. Management believes the Corporation meets the conditions of the Federal Reserve’s small bank holding company policy statement and is therefore excluded from consolidated capital requirements at December 31, 2019; however, C&N Bank remains subject to regulatory capital requirements administered by the federal banking agencies.

 

Details concerning capital ratios at December 31, 2019 and December 31, 2018 are presented below and in Note 18 to the consolidated financial statements. Management believes, as of December 31, 2019, that C&N Bank meets all capital adequacy requirements to which it is subject and maintains a capital conservation buffer (described in more detail below) that allows the Bank to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. Further, the Corporation’s and C&N Bank’s capital ratios at December 31, 2019 and December 31, 2018 exceed the Corporation’s Board policy threshold levels.

 

                           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 
(Dollars In Thousands)  Amount   Ratio   Amount   Ratio   Amount   Ratio   Amount   Ratio   Amount   Ratio 
December 31, 2019:                                                  
Total capital to risk-weighted assets:                                                  
Consolidated  $228,057    20.70%   N/A    N/A    N/A    N/A    N/A    N/A   $115,689    ³10.5% 
C&N Bank   205,863    18.75%   87,817    ³8%    115,260    ³10.5%    109,771    ³10%    115,260    ³10.5% 
Tier 1 capital to risk-weighted assets:                                                  
Consolidated   211,388    19.19%   N/A    N/A    N/A    N/A    N/A    N/A    93,653    ³8.5% 
C&N Bank   195,694    17.83%   65,863    ³6%    93,306    ³8.5%    87,817    ³8%    93,306    ³8.5% 
Common equity tier 1 capital to risk-weighted assets:                                                  
Consolidated   211,388    19.19%   N/A    N/A    N/A    N/A    N/A    N/A    77,126    ³7% 
C&N Bank   195,694    17.83%   49,397    ³4.5%    76,840    ³7.0%    71,351    ³6.5%    76,840    ³7% 
Tier 1 capital to average assets:                                                  
Consolidated   211,388    13.10%   N/A    N/A    N/A    N/A    N/A    N/A    129,126    ³8% 
C&N Bank   195,694    12.24%   63,940    ³4%    N/A    N/A    79,925    ³5%    127,879    ³8% 
                                                   
December 31, 2018:                                                  
Total capital to risk-weighted assets:                                                  
Consolidated  $199,226    24.42%   N/A    N/A    N/A    N/A    N/A    N/A   $85,653    ³10.5% 
C&N Bank   176,499    21.75%   64,916    ³8%    80,130    ³9.875%    81,145    ³10%    85,202    ³10.5% 
Tier 1 capital to risk-weighted assets:                                                  
Consolidated   189,589    23.24%   N/A    N/A    N/A    N/A    N/A    N/A    69,338    ³8.5% 
C&N Bank   166,862    20.56%   48,687    ³6%    63,901    ³7.875%    64,916    ³8%    68,976    ³8.5% 
Common equity tier 1 capital to risk-weighted assets:                                                  
Consolidated   189,589    23.24%   N/A    N/A    N/A    N/A    N/A    N/A    57,102    ³7% 
C&N Bank   166,862    20.56%   36,515    ³4.5%    51,730    ³6.375%    52,744    ³6.5%    56,801    ³7% 
Tier 1 capital to average assets:                                                  
Consolidated   189,589    14.78%   N/A    N/A    N/A    N/A    N/A    N/A    102,634    ³8% 
C&N Bank   166,862    13.16%   50,715    ³4%    N/A    N/A    63,394    ³5%    101,430    ³8% 

 

 33 

 

 

Capital ratios presented in the table above were slightly lower at December 31, 2019 as compared to December 31, 2018 but remain at levels well in excess of regulatory requirements. Management expects C&N Bank to maintain capital levels that exceed the regulatory standards for well-capitalized institutions and the applicable capital conservation buffer, including the impact of the pending acquisition of Covenant, 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. In addition, 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. These restrictions are described in Note 18 to the consolidated financial statements. Further, although the Corporation is no longer subject to the specific consolidated capital requirements described herein, the Corporation’s ability to pay dividends, repurchase stock or engage in other activities may be limited by the Federal Reserve if the Corporation fails to hold sufficient capital commensurate with its overall risk profile.

 

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). This 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 and is added to the minimum required risk-based capital ratios (as defined) for common equity tier 1 capital, tier 1 capital and total capital. In 2019, the minimum risk-based capital ratios, and the capital ratios including the capital conservation buffer, are as follows:

 

Minimum common equity tier 1 capital ratio   4.5%
Minimum common equity tier 1 capital ratio plus     
capital conservation buffer   7.0%
Minimum tier 1 capital ratio   6.0%
Minimum tier 1 capital ratio plus capital     
conservation buffer   8.5%
Minimum total capital ratio   8.0%
Minimum total capital ratio plus capital     
conservation buffer   10.5%

 

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

(as a % of risk-weighted assets)

 

Maximum Payout

(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 December 31, 2019, C&N Bank’s Capital Conservation Buffer (also determined based on the minimum total capital ratio) was 10.75%.

 

The Corporation’s total stockholders’ equity is affected by fluctuations in the fair values of available-for-sale debt securities. The difference between amortized cost and fair value of available-for-sale debt 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 debt securities, net of deferred income tax, amounted to $3,511,000 at December 31, 2019 and ($4,307,000) at December 31, 2018. Changes in accumulated other comprehensive income (loss) are excluded from earnings and directly increase or decrease stockholders’ equity. If available-for-sale debt 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 7 to the consolidated financial statements provides additional information concerning management’s evaluation of available-for-sale debt securities for other-than-temporary impairment at December 31, 2019.

 

34

 

 

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 (Loss) related to defined benefit plans, net of deferred income tax, was $180,000 at December 31, 2019 and $137,000 at December 31, 2018.

 

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.

 

Comprehensive Income totaled $27,365,000 in 2019 as compared to $19,627,000 in 2018. In 2019, Comprehensive Income included: (1) Net Income of $19,504,000, which was $2,509,000 less than in 2018; (2) Other Comprehensive Income from unrealized gains on available-for-sale securities, net of deferred income tax, of $7,818,000 as compared to Other Comprehensive Loss of ($2,452,000) in 2018; and (3) Other Comprehensive Income from defined benefit plans of $43,000 in 2019 as compared to Other Comprehensive Income of $66,000 in 2018. Fluctuations in interest rates significantly affected fair values of available-for-sale securities in 2019 and 2018, and accordingly had an effect on Other Comprehensive Income (Loss) in each year.

 

RECENT LEGISLATIVE DEVELOPMENTS

 

On May 24, 2018, President Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Act”), which was designed to ease certain restrictions imposed by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Most of the changes made by the new Act can be grouped into five general areas: mortgage lending; certain regulatory relief for “community” banks; enhanced consumer protections in specific areas, including subjecting credit reporting agencies to additional requirements; certain regulatory relief for large financial institutions, including increasing the threshold at which institutions are classified as systemically important financial institutions (from $50 billion to $250 billion) and therefore subject to stricter oversight, and revising the rules for larger institution stress testing; and certain changes to federal securities regulations designed to promote capital formation.

 

As noted in the Stockholders’ Equity and Capital Adequacy section of Management’s Discussion and Analysis, as required by the Act, the Federal Reserve Board issued an interim final rule that expanded applicability of the Board’s small bank holding company policy statement, raising the policy statement’s asset threshold from $1 billion to $3 billion in total consolidated assets for a bank holding company or savings and loan holding company, subject to other conditions. Management believes the Corporation meets the conditions of the Federal Reserve’s small bank holding company policy statement and is therefore excluded from consolidated capital requirements at December 31, 2019. Further, qualification as a small bank holding company allows the Corporation to file more abbreviated, and less frequent, consolidated and holding company reports with the Federal Reserve.

 

Also, as required by the Act, in October 2019 the Federal Reserve Board, FDIC and Office of the Comptroller of the Currency finalized a rule that would provide qualifying community banking organizations an option to calculate a simple leverage ratio, rather than multiple measures of capital adequacy. Under the rule, a community banking organization would be eligible to elect the community bank leverage ratio framework if it has less than $10 billion in total consolidated assets, limited amounts of certain assets and off-balance sheet exposures, and a community bank leverage ratio greater than 9%. A qualifying community banking organization that has chosen the proposed framework would not be required to calculate the existing risk-based and leverage capital requirements.  Such a community banking organization would be considered to have satisfied the risk-based and leverage capital requirements in the agencies’ generally applicable capital rule and be considered well capitalized for the agencies’ prompt corrective action rules provided it has a community bank leverage ratio greater than 9 percent. The Corporation is in the process of evaluating whether it will adopt the optional community bank leverage ratio framework.

 

Some of the other key provisions of the Act as it relates to community banks and bank holding companies include, but are not limited to: (i) designating mortgages held in portfolio as “qualified mortgages” for banks with less than $10 billion in assets, subject to certain documentation and product limitations; (ii) exempting banks with less than $10 billion in assets from Volcker Rule requirements relating to proprietary trading; (iii) assisting smaller banks with obtaining stable funding by providing an exception for reciprocal deposits from FDIC restrictions on acceptance of brokered deposits; (iv) raising the eligibility for use of short-form Call Reports from $1 billion to $5 billion in assets; and (v) clarifying definitions pertaining to high volatility commercial real estate loans (HVCRE), which require higher capital allocations, so that only loans with increased risk are subject to higher risk weightings.

 

35

 

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

See Note 2 to the consolidated financial statements for a description of recent accounting pronouncements and their recent or potential future effects on the Corporation’s financial statements.

 

36

 

 

ITEM 8. FINANCIAL STATEMENTS        
CONSOLIDATED BALANCE SHEETS        
  December 31,   December 31, 
(In Thousands, Except Share and Per Share Data)  2019   2018 
ASSETS          
Cash and due from banks:          
Noninterest-bearing  $17,667   $20,970 
Interest-bearing   17,535    16,517 
Total cash and due from banks   35,202    37,487 
Available-for-sale debt securities, at fair value   346,723    363,273 
Marketable equity security   979    950 
Loans held for sale   767    213 
           
Loans receivable   1,182,222    827,563 
Allowance for loan losses   (9,836)   (9,309)
Loans, net   1,172,386    818,254 
           
Bank-owned life insurance   18,641    19,035 
Accrued interest receivable   5,001    3,968 
Bank premises and equipment, net   17,170    14,592 
Foreclosed assets held for sale   2,886    1,703 
Deferred tax asset, net   2,618    4,110 
Goodwill   28,388    11,942 
Core deposit intangibles   1,247    9 
Other assets   22,137    15,357 
TOTAL ASSETS  $1,654,145   $1,290,893 
           
LIABILITIES          
Deposits:          
Noninterest-bearing  $285,904   $272,520 
Interest-bearing   966,756    761,252 
Total deposits   1,252,660    1,033,772 
Short-term borrowings   86,220    12,853 
Long-term borrowings   52,127    35,915 
Subordinated debt   6,500    0 
Accrued interest and other liabilities   12,186    10,985 
TOTAL LIABILITIES   1,409,693    1,093,525 
           
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 13,934,996 and outstanding 13,716,445 at December 31, 2019; issued 12,655,171 and outstanding 12,319,330 at December 31, 2018   13,935    12,655 
Paid-in capital   104,519    72,602 
Retained earnings   126,480    122,643 
Treasury stock, at cost; 218,551 shares at December 31, 2019 and 335,841 shares at December 31, 2018   (4,173)   (6,362)
Accumulated other comprehensive income (loss)   3,691    (4,170)
TOTAL STOCKHOLDERS' EQUITY   244,452    197,368 
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY  $1,654,145   $1,290,893 

 

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

 

37

 

 

        
Consolidated Statements of Income   Years Ended December 31, 
(In Thousands Except Per Share Data)  2019   2018 
INTEREST INCOME          
Interest and fees on loans:          
Taxable  $53,086   $38,667 
Tax-exempt   2,104    2,242 
Interest on loans held for sale   22    14 
Interest on balances with depository institutions   514    415 
Income from available-for-sale debt securities:          
Taxable   7,008    6,189 
Tax-exempt   2,014    2,779 
Dividends on marketable equity security   23    22 
Total interest and dividend income   64,771    50,328 
INTEREST EXPENSE          
Interest on deposits   8,190    3,702 
Interest on short-term borrowings   733    366 
Interest on long-term borrowings   1,013    557 
Interest on subordinated debt   347    0 
Total interest expense   10,283    4,625 
Net interest income   54,488    45,703 
Provision for loan losses   849    584 
Net interest income after provision for loan losses   53,639    45,119 
NONINTEREST INCOME          
Trust and financial management revenue   6,106    5,838 
Brokerage revenue   1,266    1,018 
Insurance commissions, fees and premiums   167    105 
Service charges on deposit accounts   5,358    5,171 
Service charges and fees   332    343 
Interchange revenue from debit card transactions   2,754    2,546 
Net gains from sale of loans   924    682 
Loan servicing fees, net   100    347 
Increase in cash surrender value of bank-owned life insurance   402    394 
Other noninterest income   1,875    2,153 
Sub-total   19,284    18,597 
Gain on restricted equity security   0    2,321 
Realized gains (losses) on available-for-sale debt securities, net   23    (288)
Total noninterest income   19,307    20,630 
NONINTEREST EXPENSE          
Salaries and wages   20,644    17,191 
Pensions and other employee benefits   5,837    5,259 
Occupancy expense, net   2,629    2,497 
Furniture and equipment expense   1,289    1,196 
Data processing expenses   3,403    2,750 
Automated teller machine and interchange expense   1,103    1,304 
Pennsylvania shares tax   1,380    1,318 
Professional fees   1,069    976 
Telecommunications   744    748 
Directors' fees   673    706 
Merger-related expenses   4,099    328 
Other noninterest expense   6,667    5,213 
Total noninterest expense   49,537    39,486 
Income before income tax provision   23,409    26,263 
Income tax provision   3,905    4,250 
NET INCOME  $19,504   $22,013 
EARNINGS PER COMMON SHARE - BASIC  $1.46   $1.79 
EARNINGS PER COMMON SHARE - DILUTED  $1.46   $1.79 

 

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

 

38

 

    
Consolidated Statements of Comprehensive Income  Years Ended December 31, 
(In Thousands)  2019   2018 
Net income  $19,504   $22,013 
           
Unrealized gains (losses) on available-for-sale debt securities:          
Unrealized holding gains (losses) on available-for-sale debt securities   9,920    (3,392)
Reclassification adjustment for (gains) losses realized in income   (23)   288 
Other comprehensive gain (loss) on available-for-sale debt securities   9,897    (3,104)
           
Unfunded pension and postretirement obligations:          
Changes from plan amendments and actuarial gains and losses   87    101 
Amortization of prior service cost and net actuarial loss included in net periodic benefit cost   (32)   (17)
Other comprehensive gain on unfunded retirement obligations   55    84 
           
Other comprehensive income (loss) before income tax   9,952    (3,020)
Income tax related to other comprehensive (income) loss   (2,091)   634 
           
Net other comprehensive income (loss)   7,861    (2,386)
           
Comprehensive income  $27,365   $19,627 

 

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

 

39

 

 

Consolidated Statements of Changes in Stockholders' Equity                   
(In Thousands Except Share and Per Share Data)                      
                  Accumulated        
                  Other        
   Common  Treasury  Common  Paid-in  Retained  Comprehensive  Treasury     
   Shares  Shares  Stock  Capital  Earnings  (Loss) Income  Stock   Total 
Balance, January 1, 2018   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                   22,013           22,013 
Other comprehensive loss, net                       (2,386)      (2,386)
Cash dividends declared on common stock, $1.08 per share                   (13,255)          (13,255)
Shares issued for dividend reinvestment plan       (59,330)      385           1,124   1,509 
Shares issued from treasury and redeemed related to exercise of stock options       (18,862)      (166)          355   189 
Restricted stock granted       (34,552)      (655)          655   0 
Forfeiture of restricted stock       7,939       148           (148)  0 
Stock-based compensation expense               855               855 
Balance, December 31, 2018   12,655,171   335,841   12,655   72,602   122,643   (4,170)  (6,362)  197,368 
Net income                   19,504           19,504 
Other comprehensive income, net                       7,861       7,861 
Cash dividends declared on common stock, $1.18 per share                   (15,667)          (15,667)
Shares issued for dividend reinvestment plan       (62,232)      439           1,187   1,626 
Shares issued from treasury and redeemed related to exercise of stock options       (18,071)      (146)          344   198 
Restricted stock granted       (48,137)      (918)          918   0 
Forfeiture of restricted stock       3,758       71           (71)  0 
Stock-based compensation expense               798               798 
Purchase of restricted stock for tax withholding       7,392                   (189)  (189)
Shares issued for acquisition of Monument Bancorp, Inc., net of equity issuance costs   1,279,825       1,280   31,673               32,953 
Balance, December 31, 2019   13,934,996   218,551  $13,935  $104,519  $126,480  $3,691  $(4,173)  $ 244,452 

 

(a)As described in more detail in the Recent Accounting Pronouncements - Adopted section of Note 2, 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 2, 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 2, 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 the consolidated financial statements. 

 

40

 

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

    
  Years Ended December 31, 
(In Thousands)  2019   2018 
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net income  $19,504   $22,013 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for loan losses   849    584 
Realized (gains) losses on available-for-sale debt securities, net   (23)   288 
Gain on restricted equity security   0    (2,321)
Accretion and amortization on securities, net   1,341    1,044 
Increase in cash surrender value of bank-owned life insurance   (402)   (394)
Depreciation and amortization of bank premises and equipment   1,749    1,754 
Other accretion and amortization, net   (375)   (6)
Stock-based compensation   798    855 
Deferred income taxes   172    (187)
Decrease in fair value of servicing rights   331    83 
Gains on sales of loans, net   (924)   (682)
Origination of loans held for sale   (29,978)   (21,014)
Proceeds from sales of loans held for sale   30,144    22,060 
Decrease (increase) in accrued interest receivable and other assets   1,188    (413)
(Decrease) increase in accrued interest payable and other liabilities   (2,068)   1,957 
Other   155    271 
Net Cash Provided by Operating Activities   22,461    25,892 
CASH FLOWS FROM INVESTING ACTIVITIES:          
Net cash and cash equivalents used in business combination   (1,778)   0 
Proceeds from maturities of certificates of deposit   580    2,280 
Purchase of certificates of deposit   0    (3,700)
Proceeds from sales of available-for-sale debt securities   96,148    25,860 
Proceeds from calls and maturities of available-for-sale debt securities   81,204    52,383 
Purchase of available-for-sale debt securities   (57,655)   (90,015)
Redemption of Federal Home Loan Bank of Pittsburgh stock   10,137    6,145 
Purchase of Federal Home Loan Bank of Pittsburgh stock   (9,208)   (5,301)
Net increase in loans   (96,628)   (14,492)
Proceeds from sale of restricted equity security   0    2,321 
Proceeds from bank owned life insurance   796    1,442 
Purchase of premises and equipment   (2,870)   (1,167)
Proceeds from sale of foreclosed assets   1,768    2,418 
Other   174    178 
Net Cash Provided by (Used in) Investing Activities   22,668    (21,648)
CASH FLOWS FROM FINANCING ACTIVITIES:          
Net (decrease) increase in deposits   (4,822)   25,323 
Net decrease in short-term borrowings   (38,307)   (48,913)
Proceeds from long-term borrowings   48,500    33,000 
Repayments of long-term borrowings and subordinated debt   (38,173)   (6,274)
Sale of treasury stock   198    189 
Purchase of vested restricted stock   (189)   0 
Common dividends paid   (14,041)   (11,746)
Net Cash Used in Financing Activities   (46,834)   (8,421)
DECREASE IN CASH AND CASH EQUIVALENTS   (1,705)   (4,177)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR   32,827    37,004 
CASH AND CASH EQUIVALENTS, END OF YEAR  $31,122   $32,827 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:          
Right-of-use assets recognized at adoption of ASU 2016-02  $1,132   $0 
Leased assets obtained in exchange for new operating lease liabilities  $745   $0 
Assets acquired through foreclosure of real estate loans  $2,053   $2,520 
Interest paid  $9,601   $4,529 
Income taxes paid  $3,234   $4,277 

 

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

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

BASIS OF CONSOLIDATION - 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 2018, C&N Bank established a new entity, Northern Tier Holding LLC, for the purpose of acquiring, holding and disposing of real property acquired by C&N Bank. C&N Bank is the sole member of Northern Tier Holding LLC. All material intercompany balances and transactions have been eliminated in consolidation.

 

NATURE OF OPERATIONS - The Corporation provides banking and related services to individual and corporate customers. Lending products include commercial, mortgage and consumer loans, as well as specialized instruments such as commercial letters-of-credit. Deposit products include various types of checking accounts, passbook and statement savings, money market accounts, interest checking accounts, Individual Retirement Accounts and certificates of deposit. As discussed further in Note 3, in 2019 the Corporation expanded its primary market area from its historic concentration in northcentral Pennsylvania and southern New York State by acquiring Monument Bancorp, Inc. (“Monument”) with offices in Southeastern Pennsylvania. In 2019, the Corporation also expanded into south central Pennsylvania by opening a lending office in York.

 

The Corporation provides Trust and Financial Management services, including administration of trusts and estates, retirement plans, and other employee benefit plans, and investment management services. The Corporation offers a variety of personal and commercial insurance products through C&N Financial Services Corporation. C&N Financial Services Corporation also offers mutual funds, annuities, educational savings accounts and other investment products through registered agents.

 

Management has determined that the Corporation has one reportable segment, “Community Banking.” All of the Corporation’s activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Corporation supports the others.

 

The Corporation is subject to competition from other financial institutions. It is also subject to regulation by certain federal and state agencies and undergoes periodic examination by those regulatory authorities. As a consequence, the Corporation’s business is particularly susceptible to being affected by future federal and state legislation and regulations.

 

USE OF ESTIMATES - The financial information is presented in accordance with generally accepted accounting principles and general practice for financial institutions in the United States of America (“U.S. GAAP”). In preparing financial statements, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements. In addition, these estimates and assumptions affect revenues and expenses in the financial statements and as such, actual results could differ from those estimates.

 

Material estimates that are particularly susceptible to change include: (1) the allowance for loan losses, (2) fair values of debt securities based on estimates from independent valuation services or from brokers and (3) assessment of impaired securities to determine whether or not the securities are other-than-temporarily impaired.

 

INVESTMENT SECURITIES - Investment securities are accounted for as follows:

 

Available-for-sale debt securities - includes debt securities not classified as held-to-maturity or trading. Such securities are reported at fair value, with unrealized gains and losses excluded from earnings and reported separately through accumulated other comprehensive income (loss), net of tax. Premiums on non-amortizing available-for-sale debt securities are amortized using the level yield method to the earliest call date, while discounts on non-amortizing securities are amortized to the maturity date. Premiums and discounts on amortizing securities (mortgage-backed securities) are amortized using the level yield method over the remaining contractual life of the securities, adjusted for actual prepayments. Realized gains and losses on sales of available-for-sale securities are computed on the basis of specific identification of the adjusted cost of each security. Securities within the available-for-sale portfolio may be used as part of the Corporation’s asset and liability management strategy and may be sold in response to changes in interest rate risk, prepayment risk or other factors.

 

Other-than-temporary impairment – Credit-related declines in the fair value of available-for-sale debt securities that are deemed to be other-than-temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment (OTTI) losses, management considers (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, (3) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value, and (4) whether the Corporation intends to sell the security or if it is more likely than not that the Corporation will be required to sell the security before the recovery of its amortized cost basis. The credit-related impairment is recognized in earnings and is the difference between a security’s amortized cost basis and the present value of expected future cash flows discounted at the security’s effective interest rate. For debt securities classified as held-to-maturity, if any, the amount of noncredit-related impairment is recognized in other comprehensive income and accreted over the remaining life of the debt security as an increase in the carrying value of the security.

 

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Marketable equity security – The marketable equity security is carried at fair value with unrealized gains and losses included in other noninterest income in the consolidated statements of income.

 

Restricted equity securities - Restricted equity securities consist primarily of Federal Home Loan Bank of Pittsburgh stock, and are carried at cost and evaluated for impairment. Holdings of restricted equity securities are included in Other Assets in the consolidated balance sheets, and dividends received on restricted securities are included in Other Income in the consolidated statements of income.

 

LOANS HELD FOR SALE - Mortgage loans held for sale are reported at the lower of cost or market, determined in the aggregate.

 

LOANS RECEIVABLE - Loans originated by the Corporation which management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at unpaid principal balances, less the allowance for loan losses and net deferred loan fees. Interest income is accrued on the unpaid principal balance. Loan origination and commitment fees, as well as certain direct origination costs, are deferred and amortized as a yield adjustment over the lives of the related loans using the interest method.

 

The loans receivable portfolio is segmented into residential mortgage, commercial and consumer loans. The residential mortgage segment includes the following classes: first and junior lien residential mortgages, home equity lines of credit and residential construction loans. The most significant classes of commercial loans are commercial loans secured by real estate, non-real estate secured commercial and industrial loans, loans to political subdivisions, commercial construction, multi-family residential and loans secured by farmland.

 

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 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.

 

PURCHASED LOANS – The Corporation purchased loans in connection with its acquisition of Monument, some of which had, at the acquisition date of April 1, 2019, shown evidence of credit deterioration since origination. The Corporation considers several factors as indicators that an acquired loan has evidence of deterioration in credit quality. These factors include loans 90 days or more past due, loans with an internal risk rating of substandard or below, loans classified as nonaccrual by the acquired institution and loans that have been previously modified in a troubled debt restructuring. The purchased loans that showed evidence of credit impairment were designated as the purchased credit impaired (“PCI”) loans and were recorded at fair value, with no carryover of the allowance for loan losses. The PCI loans acquired are secured by real estate and the fair value of each loan at the acquisition date was determined based on the estimated proceeds to be derived from selling the collateral, net of selling costs. The PCI loans were placed into nonaccrual status upon acquisition (and remained in nonaccrual status at December 31, 2019) as the Corporation cannot reasonably estimate cash flows expected to be collected in order to compute yield on the loans.

 

For purchased loans that did not show evidence of credit deterioration at the acquisition date, the difference between the fair value of the loan at the acquisition date and the loan’s contractual amount is being amortized as a yield adjustment over the estimated remaining life of the loan using the effective interest method.

 

ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the collection of all, or part, of the principal balance is highly unlikely. Non-residential consumer loans are generally charged off no later than when they are 120 days past due on a contractual basis, or earlier in the event of bankruptcy or if there is an amount deemed uncollectible.

 

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 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. In the process of evaluating the loan portfolio, management also considers the Corporation’s exposure to losses from unfunded loan commitments. As of December 31, 2019 and 2018, management determined that no allowance for credit losses related to unfunded loan commitments was required.

 

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The allowance consists primarily of two major components – (1) a specific component based on a detailed assessment of certain larger loan relationships, mainly commercial purpose, determined on a loan-by-loan basis; and (2) a general component for the remainder of the portfolio, except for the performing loans purchased in 2019 from Monument, 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.

 

The specific component relates to loans that are classified as impaired based on a detailed assessment of certain larger loan relationships evaluated by a management committee referred to as the Watch List Committee. Specific loan relationships are identified for evaluation based on the related credit risk rating. For individual loans classified as impaired, an allowance is established when the collateral value less estimated selling costs, present value of discounted cash flows or observable market price of the impaired loan is lower than the carrying value of that loan.

 

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. All loans classified as troubled debt restructurings 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.

 

Loans acquired from Monument that did not show evidence of credit deterioration at the acquisition date (April 1, 2019) were initially recorded at fair value, including a discount for credit losses reflecting an estimate of the present value of credit losses based on market expectations. None of the performing loans purchased were impaired at December 31, 2019, and these purchased performing loans were excluded from the loan pools for which the general component of the allowance for loan losses was calculated. A provision for loan losses on purchased performing loans would be recognized only when the required allowance for loan losses or charge-off would exceed any remaining purchase discount at the loan level.

 

The general component covers pools of loans by loan class 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, (2) has an outstanding balance of $400,000 or more and a credit grade of Special Mention, Substandard or Doubtful, or (3) has an estimated loss of $100,000 or more. The pools of loans for each loan segment are evaluated for loss exposure based upon average historical net charge-off rates, adjusted for qualitative factors. 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. Qualitative risk factors (described in the following paragraph) are evaluated for the impact on each of the three distinct 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. Any adjustments to the factors are supported by a narrative documentation of changes in conditions accompanying the allowance for loan losses calculation.

 

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.

 

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

 

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For commercial loans secured by real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property. 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 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.

 

Loans whose terms are modified are classified as troubled debt restructurings if the Corporation grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a troubled debt restructuring generally involve reductions in required payments, an extension of a loan’s stated maturity date or a temporary reduction in interest rate. Loans classified as troubled debt restructurings are designated as impaired. Nonaccrual troubled debt restructurings may be restored to accrual status if the ultimate collectability of principal and interest payments under the modified terms is not in doubt, and there has been a period (generally, for at least six consecutive months) of satisfactory payment performance by the borrower either immediately before or after the restructuring.

 

BANK PREMISES AND EQUIPMENT - Bank premises and equipment are stated at cost less accumulated depreciation. Repair and maintenance expenditures which extend the useful lives of assets are capitalized, and other repair and maintenance expenditures are expensed as incurred. Depreciation expense is computed using the straight-line method.

 

IMPAIRMENT OF LONG-LIVED ASSETS - The Corporation reviews long-lived assets, such as premises and equipment and intangibles, for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. These changes in circumstances may include a significant decrease in the market value of an asset or the manner in which an asset is used. If there is an indication the carrying value of an asset may not be recoverable, future undiscounted cash flows expected to result from use of the asset are estimated. If the sum of the expected cash flows is less than the carrying value of the asset, a loss is recognized for the difference between the carrying value and fair market value of the asset.

 

FORECLOSED ASSETS HELD FOR SALE - Foreclosed assets held for sale consist of real estate acquired by foreclosure and are initially recorded at fair value, less estimated selling costs.

 

GOODWILL - Goodwill represents the excess of the cost of acquisitions over the fair value of the net assets acquired. Goodwill is tested at least annually at December 31 for impairment, or more often if events or circumstances indicate there may be impairment. The Corporation has the option of performing a qualitative assessment to determine whether any further quantitative testing for impairment is necessary. The option of whether or not to perform a qualitative assessment is made annually.

 

CORE DEPOSIT INTANGIBLES – Amortization of core deposit intangibles is calculated using an accelerated method. In determining amortization using the accelerated method for any given period, the amount of expected cash flows for that period that were used in determining the acquisition-date fair value is divided by the total amount of expected cash flows over the life of the asset. That percentage is multiplied by the initial carrying amount of the asset to arrive at amortization expense for that period. If the Corporation’s cash flow patterns differ significantly from the initial estimates, the amortization schedule would be adjusted prospectively.

 

SERVICING RIGHTS - The estimated fair value of servicing rights related to mortgage loans sold and serviced by the Corporation is recorded as an asset upon the sale of such loans. The valuation of servicing rights is adjusted quarterly, with changes in fair value included in Loan Servicing Fees, Net, in the consolidated statements of income. Significant inputs to the valuation include expected net servicing income to be received, the expected life of the underlying loans and the discount rate. The servicing rights asset is included in Other Assets in the consolidated balance sheets.

 

INCOME TAXES - Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases given the provisions of the enacted tax laws. Deferred tax assets are reduced, if necessary, by the amount of such benefits that are not expected to be realized based upon available evidence. Tax benefits from investments in limited partnerships that have qualified for federal low-income tax credits are recognized as a reduction in the provision for income tax over the term of the investment using the effective yield method. The Corporation includes income tax penalties in the provision for income tax. The Corporation has no accrued interest related to unrecognized tax benefits.

 

STOCK COMPENSATION PLANS - The Corporation’s stock-based compensation policy applies to all forms of stock-based compensation including stock options and restricted stock units. All stock-based compensation is accounted for under the fair value method as required by U.S. GAAP. The expense associated with stock-based compensation is recognized over the vesting period of each individual arrangement.

 

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The fair value of each stock option is estimated on the date of grant using the Black-Scholes-Merton option valuation model. The fair value of restricted stock is based on the current market price on the date of grant.

 

OFF-BALANCE SHEET FINANCIAL INSTRUMENTS - In the ordinary course of business, the Corporation has entered into off-balance sheet financial instruments consisting of commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they become payable.

 

CASH FLOWS - The Corporation utilizes the net reporting of cash receipts and cash payments for certain deposit and lending activities. Cash equivalents include federal funds sold and all cash and amounts due from depository institutions and interest-bearing deposits in other banks with original maturities of three months or less.

 

REVENUE RECOGNITION - As of January 1, 2018, the Corporation adopted Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606), as well as subsequent ASUs that modified Topic 606. The Company 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 Topic 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 $1,007,113,000 at December 31, 2019 and $862,517,000 at December 31, 2018. Trust and financial management revenue is included within noninterest income in the consolidated statements of income.

 

Trust revenue is recorded on a cash basis, which is not materially different from the accrual basis. The majority (approximately 82%, based on annual 2019 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.

 

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2. RECENT ACCOUNTING PRONOUNCEMENTS

 

The Financial Accounting Standards Board (FASB) issues 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 foreseeable future.

 

Recent Accounting Pronouncements - Adopted

 

Effective December 31, 2019, the Corporation elected early adoption of ASU 2017-04, Intangibles – Goodwill and Other (Topic 350), which simplified accounting for goodwill impairment by removing 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 is the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. Adoption of this ASU did not have a material impact on the Corporation’s consolidated financial statements.

 

Effective January 1, 2019, the Corporation adopted ASU 2016-02, Leases (Topic 842), as modified by subsequent ASUs, which changed U.S. GAAP by requiring that lease assets and liabilities arising from operating leases be recognized on the balance sheet. Topic 842, as modified, does not significantly change the recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee from prior U.S. GAAP. For leases with a term of 12 months or less, the Corporation made an accounting policy election by class of underlying asset not to recognize lease assets and liabilities. The Corporation elected to adopt this pronouncement using an optional transition method resulting in recognition of right-of-use assets and lease liabilities for operating leases of $1,132,000 on its consolidated balance sheets at January 1, 2019, with no adjustment to stockholders’ equity and no material impact to its consolidated statements of income. At December 31, 2019, right-of-use assets of $1,637,000 were included in other assets, and the related liabilities totaling the same amount were included in accrued interest and other liabilities, in the consolidated balance sheets.

 

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 debt 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).

 

Effective January 1, 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.

 

Effective January 1, 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 the following changes:

 

·A marketable equity security previously included in available-for-sale securities on the consolidated balance sheets is presented as a separate asset.

 

·Changes in the fair value of the marketable equity security are captured in the consolidated statements of income.

 

·Retained earnings was reduced and a corresponding increase in accumulated other comprehensive loss was recognized (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 marketable equity security.

 

·Adoption of ASU 2016-01 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 21.

 

Recently Issued But Not Yet Effective Accounting Pronouncements

 

ASU 2016-13, Financial Instruments-Credit Losses (Topic 326), as modified by subsequent ASUs, 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.

 

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In addition, ASU 2016-13 amends the accounting for credit losses on debt securities and purchased financial assets with credit deterioration. The effect of implementing this ASU is recorded through a cumulative-effect adjustment to retained earnings. The Corporation has formed a cross functional management team and is working with an outside vendor assessing alternative loss estimation methodologies and the Corporation’s data and system needs to evaluate the impact that adoption of this standard will have on the Corporation’s financial condition and results of operations. In November 2019, the FASB approved a delay of the required implementation date of ASU 2016-13 for smaller reporting companies, including the Corporation, resulting in a required implementation date for the Corporation of January 1, 2023.

 

ASU 2018-13, Fair Value Measurement (Topic 820) modifies disclosure requirements on fair value measurements. This ASU removes requirements to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for timing of transfers between levels and the valuation processes for Level 3 fair value measurements. ASU 2018-13 clarifies that disclosure regarding measurement uncertainty is intended to communicate information about the uncertainty in measurement as of the reporting date. ASU 2018-13 adds certain disclosure requirements, including disclosure of changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The amendments in this ASU are effective for the Corporation beginning in the first quarter 2020. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty should be applied prospectively, while all other amendments should be applied retrospectively for all periods presented. The Corporation does not expect adoption of this ASU to have a material impact on its consolidated financial position or results of operations.

 

ASU 2018-15, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40) was issued to help entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement (hosting arrangement) by providing guidance for determining when the arrangement includes a software license. The amendments align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by the amendments. This guidance will become effective for the Corporation beginning in the first quarter 2020, with early adoption permitted. The Corporation does not expect adoption of this ASU to have a material impact on its consolidated financial statements.

 

3. BUSINESS COMBINATION AND PENDING ACQUISITION

 

Business Combination – Acquisition of Monument Bancorp, Inc.

 

On April 1, 2019, the Corporation completed its acquisition of 100% of the common stock of Monument. Monument was the parent company of Monument Bank, a commercial bank which operated two community bank offices and one lending office in Bucks County, Pennsylvania. Pursuant to the merger, Monument was merged into Citizens & Northern Corporation and Monument Bank was merged into C&N Bank. Management believes the acquisition provides an opportunity to leverage the Corporation’s capital and deposits in a higher growth market and aligns with the Corporation’s focus to proactively deploy capital to enhance long-term shareholder value.

 

The consolidated financial statements include the formerly separate Monument operations from April 1, 2019 through December 31, 2019. Since the activities of the former Monument operations have been combined with those of the Corporation, separate disclosure of Monument-related financial information included in the consolidated financial statements is not practicable.

 

Total purchase consideration was $42,651,000, including cash paid to former Monument shareholders totaling $9,517,000 and 1,279,825 shares of Corporation common stock issued with a value of $32,953,000, (net of costs directly related to stock issuance of $181,000 included in the cash portion of merger consideration transferred in the table below).

 

The merger was accounted for using the acquisition method of accounting and, accordingly, purchased assets, including identifiable intangible assets, and assumed liabilities were recorded at their respective acquisition date fair values. The fair value measurements of assets acquired and liabilities assumed are subject to refinement for up to one year after the closing date of the acquisition as additional information relative to closing date fair values become available. In the fourth quarter 2019, the Corporation recorded an adjustment to the initial fair value measurements of miscellaneous receivables and accrued liabilities made as of April 1, 2019. The adjustment resulted in an increase in other assets of $216,000 and a decrease in other liabilities of $14,000, with a corresponding reduction in goodwill of $230,000.

 

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The fair value of assets acquired (as adjusted in the fourth quarter 2019), excluding goodwill, totaled $375,138,000, while the fair value of liabilities assumed totaled $348,933,000. Goodwill represents consideration transferred in excess of the fair value of the net assets acquired. At December 31, 2019, goodwill associated with the acquisition was $16,446,000. The goodwill resulting from the acquisition represents the value expected from the expansion of the Corporation’s market into Southeastern Pennsylvania. Goodwill acquired in the Monument merger is not deductible for tax purposes as the acquisition is accounted for as a tax-free exchange for tax purposes.

 

The following table summarizes the consideration paid for Monument and the estimated fair values of the assets acquired and liabilities assumed at the acquisition date:

 

(In Thousands)    
Fair value of consideration transferred:     
Cash  $9,698 
Common stock issued   32,953 
Total consideration transferred  $42,651 

 

Estimated fair values of assets acquired and (liabilities) assumed:
(In Thousands)
    
Cash and cash equivalents  $7,920 
Available-for-sale debt securities   94,568 
Loans receivable   259,295 
Accrued interest receivable   1,593 
Bank premises and equipment   1,465 
Foreclosed assets held for sale   1,064 
Deferred tax asset, net   771 
Core deposit intangible   1,461 
Goodwill   16,446 
Other assets   7,001 
Deposits   (223,303)
Short-term borrowings   (111,568)
Subordinated debt   (12,375)
Accrued interest and other liabilities   (1,687)
Estimated excess fair value of assets acquired over liabilities assumed  $42,651 

 

In the consolidated statements of cash flows, noncash investing and financing activities include the issuance of common stock as part of the merger consideration as well as the following categories of assets acquired and liabilities assumed from Monument as reflected in the table above: available-for-sale debt securities, loans receivable, bank premises and equipment, foreclosed assets held for sale, core deposit intangible, goodwill, Federal Home Loan Bank of Pittsburgh stock of $5,478,000 (included in other assets above), deposits, short-term borrowings and subordinated debt.

 

Acquisition date fair values for available-for-sale securities were determined using Level 1 inputs consistent with the methods discussed further in Note 21. The Corporation sold the acquired securities in April 2019 for approximately no realized gain or loss.

 

The determination of estimated fair values of the acquired loans required the Corporation to make certain estimates about discount rates, future expected cash flows, market conditions and other future events that are highly subjective in nature. Based on such factors as past due status, nonaccrual status, bankruptcy status, and credit risk ratings, the acquired loans were evaluated, and four loans (from three relationships) displayed evidence of credit quality deterioration. These loans are accounted for under ASC 310-30 (purchased credit impaired, or “PCI”). The majority of the purchased loans did not display evidence of impairment, and thus are accounted for under ASC 310-20. Expected cash flows, both principal and interest, were estimated based on key assumptions covering such factors as prepayments, default rates and severity of loss given default. These assumptions were developed based on the portfolio characteristics as of the acquisition date as well as available market research. The fair value estimates for acquired loans were based on the amount and timing of expected principal, interest and other cash flows, including expected prepayments, discounted at prevailing market interest rates applicable to the types of acquired loans, which the Corporation considers Level 3 fair value measurements.

 

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Loans acquired from Monument were measured at fair value at the acquisition date with no carryover of an allowance for loan losses. The following table presents performing and PCI loans acquired, by loan segment and class, at April 1, 2019:

 

(In Thousands)  Performing   PCI   Total 
Residential mortgage:               
Residential mortgage loans - first liens  $107,645   $77   $107,722 
Residential mortgage loans - junior liens   2,433    0    2,433 
Home equity lines of credit   2,674    0    2,674 
1-4 Family residential construction   510    0    510 
Total residential mortgage   113,262    77    113,339 
Commercial:               
Commercial loans secured by real estate   113,821    364    114,185 
Commercial and industrial   7,571    0    7,571 
Commercial construction and land   4,617    0    4,617 
Loans secured by farmland   267    0    267 
Multi-family (5 or more) residential   17,493    0    17,493 
Other commercial loans   835    0    835 
Total commercial   144,604    364    144,968 
Consumer   988    0    988 
Total  $258,854   $441   $259,295 

 

The following table presents the preliminary fair value adjustments made to the amortized cost basis of loans acquired at April 1, 2019:

 

(In Thousands)    
Gross amortized cost at acquisition  $263,334 
Market rate adjustment   (1,807)
Credit fair value adjustment on non-credit impaired loans (accretable)   (1,914)
Credit fair value adjustment on impaired loans (non-accretable)   (318)
Estimated fair value of acquired loans  $259,295 

 

The market rate adjustment represents the movement in interest rates, irrespective of credit adjustments, compared to the contractual rates of the acquired loans. The credit adjustment made on non-PCI loans represents changes in credit quality of the underlying borrowers from loan inception to the acquisition date.

 

The credit adjustment on PCI loans is derived in accordance with ASC 310-30 and represents the portion of the loan balances that have been deemed uncollectible for each loan. The PCI loans are secured by real estate and the fair value of each loan was determined based on the estimated proceeds to be derived from selling the collateral, net of selling costs. The PCI loans were placed into nonaccrual status upon acquisition (and remained in nonaccrual status at December 31, 2019) as the Corporation cannot reasonably estimate cash flows expected to be collected in order to compute yield on the loans.

 

The Corporation recognized a core deposit intangible of $1,461,000. The core deposit intangible represents the estimated value of lower-cost funding provided by the nonmaturity deposits assumed in comparison with the Corporation’s estimated cost of borrowing funds in the market. The core deposit intangible will be amortized over a weighted-average life of 4.4 years.

 

Deposit liabilities assumed were segregated into two categories: (1) nonmaturity deposits (checking, savings and money market), and (2) time deposits (deposit accounts with a stated maturity). The fair values of both categories of deposits were determined using level 2 fair value measurements. For nonmaturity deposits, the acquisition date outstanding balance of the assumed demand deposit accounts approximates fair value. In determining the fair value of time deposits, the Corporation discounted the contractual cash flows of the deposit accounts using prevailing market interest rates for time deposit accounts of similar type and duration.

 

Short-term borrowings assumed consisted of advances from the Federal Home Loan Bank of Pittsburgh. The fair value of short-term borrowings was determined using Level 2 measurements by discounting the contractual cash flows of the borrowings using Federal Home Loan Bank interest rates available April 1, 2019 for advances to the same maturities as those of the deposits assumed.

 

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Subordinated debt assumed included two issues: (1) agreements with par values totaling $5,375,000 which were redeemed on April 1, 2019; and (2) agreements with par values totaling $7,000,000, maturing April 1, 2027 and which may be redeemed at par beginning April 1, 2022. The fair value of subordinated debt was determined using Level 2 measurements by comparing the interest rates on the debt to the rates on similar recent issues of comparable size by other similar-sized banking companies. In the fourth quarter 2019, the Corporation redeemed subordinated debt with a par value of $500,000, resulting in a loss of $10,000 (included in other noninterest expense in the consolidated statements of income).

 

Merger-related expenses associated with the Monument transaction totaled of $3,812,000 in 2019 and $328,000 in 2018. Merger-related expenses include costs associated with termination of data processing contracts, conversion of Monument’s customer accounting data into the Corporation’s core system, severance and similar expenses, legal and other professional fees and various other costs.

 

The following table presents pro forma information as if the merger between the Corporation and Monument had been completed on January 1, 2018. The pro forma information does not necessarily reflect the results of operations that would have occurred had the merger taken place at the beginning of 2018. The supplemental pro forma information excludes the after-tax cost of merger-related expenses totaling $3,270,000 in 2019 and $305,000 in 2018. The pro forma information does not include the impact of possible business model changes nor does it consider any potential impacts of current market conditions or revenues, expense efficiencies or other factors.

 

   Year Ended 
   Dec. 31,   Dec. 31, 
(In Thousands Except Per Share Data)  2019   2018 
Interest income  $68,817   $66,528 
Interest expense   11,517    10,516 
Net interest income   57,300    56,012 
Provision for loan losses   894    1,059 
Net interest income after provision for loan losses   56,406    54,953 
Noninterest income   19,300    18,712 
Net gains on securities   23    2,763 
Other noninterest expenses   47,178    46,586 
Income before income tax provision   28,551    29,842 
Income tax provision   4,954    4,812 
Net income  $23,597   $25,030 
           
Earnings per common share - basic  $1.65   $1.84 
Earnings per common share - diluted  $1.64   $1.84 

 

Pending Acquisition of Covenant Financial, Inc.

 

In December 2019, the Corporation announced a plan of merger to acquire Covenant Financial, Inc. (“Covenant”) in a transaction valued on December 18, 2019 at approximately $77 million. Under the terms of the definitive agreement, the Corporation will pay cash for 25% of the Covenant shares and will convert 75% of Covenant shares to the Corporation’s common stock. Covenant is the holding company for Covenant Bank, which operates banking offices in Bucks and Chester Counties of PA. Covenant had total assets of $516 million, liabilities of $474 million and stockholders’ equity of $42 million at December 31, 2019. The merger is subject to satisfaction of customary closing conditions, including receipt of regulatory approvals and approval of Covenant’s shareholders. The merger is expected to close in the third quarter 2020. In 2019, the Corporation incurred merger-related expenses totaling $287,000 related to the planned acquisition of Covenant. Management estimates pre-tax merger-related expenses associated with the Covenant acquisition will total approximately $8 million ($6.6 million, net of tax), with most of the expenses expected to be incurred in the third quarter 2020.

 

4. 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.

 

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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.

 

   Years Ended 
   Dec. 31,   Dec. 31, 
   2019   2018 
Basic          
Net income  $19,504,000   $22,013,000 
Less: Dividends and undistributed earnings allocated to participating securities   (100,000)   (110,000)
Net income attributable to common shares  $19,404,000   $21,903,000 
Basic weighted-average common shares outstanding   13,298,736    12,219,209 
Basic earnings per common share (a)  $1.46   $1.79 
           
Diluted          
Net income attributable to common shares  $19,404,000   $21,903,000 
Basic weighted-average common shares outstanding   13,298,736    12,219,209 
Dilutive effect of potential common stock arising from stock options   22,823    38,159 
Diluted weighted-average common shares outstanding   13,321,559    12,257,368 
Diluted earnings per common share (a)  $1.46   $1.79 

 

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

 

The weighted-average number of nonvested restricted shares outstanding was 68,358 shares in 2019 and 61,778 shares in 2018.

 

Stock options that are anti-dilutive are excluded from net income per share calculations. There were no anti-dilutive instruments in 2019 or 2018.

 

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5. COMPREHENSIVE INCOME

 

Comprehensive income (loss) 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 (loss). The components of other comprehensive income (loss), and the related tax effects, are as follows:

 

  Before-Tax   Income Tax   Net-of-Tax 
(In Thousands)  Amount   Effect   Amount 
2019            
Unrealized gains on available-for-sale debt securities:               
Unrealized holding gains on available-for-sale securities  $9,920   ($2,084)  $7,836 
Reclassification adjustment for gains realized in income   (23)   5    (18)
Other comprehensive income on available-for-sale debt securities   9,897    (2,079)   7,818 
                
Unfunded pension and postretirement obligations:               
Changes from plan amendments and actuarial gains and losses               
included in other comprehensive income   87    (19)   68 
Amortization of prior service cost and net actuarial loss               
included in net periodic benefit cost   (32)   7    (25)
Other comprehensive income on unfunded retirement obligations   55    (12)   43 
                
Total other comprehensive income  $9,952   ($2,091)  $7,861 

 

  Before-Tax   Income Tax   Net-of-Tax 
(In Thousands)  Amount   Effect   Amount 
2018            
Unrealized losses on available-for-sale debt securities:                                                          
Unrealized holding losses on available-for-sale securities  ($3,392)  $712   ($2,680)
Reclassification adjustment for losses realized in income   288    (60)   228 
Other comprehensive loss on available-for-sale debt securities   (3,104)   652    (2,452)
                
Unfunded pension and postretirement obligations:               
Changes from plan amendments and actuarial gains and losses               
included in other comprehensive income   101    (21)   80 
Amortization of prior service cost and net actuarial loss               
included in net periodic benefit cost   (17)   3    (14)
Other comprehensive income on unfunded retirement obligations   84    (18)   66 
                
Total other comprehensive loss  ($3,020)  $634   ($2,386)

 

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Changes in the components of accumulated other comprehensive income (loss), included in stockholders’ equity, are as follows:

 

  Unrealized       Accumulated 
   Gains   Unfunded   Other 
   (Losses)   Retirement   Comprehensive 
(In Thousands)  on Securities   Obligations   Income (Loss) 
2019              
Balance, beginning of period  $(4,307)  $137   $(4,170)
Other comprehensive income during year ended December 31, 2019        7,818           43           7,861   
Balance, end of period  $3,511   $180   $3,691 
                                                                              
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 year ended December 31, 2018        (2,452  )        66           (2,386  )
Balance, end of period  $(4,307)  $137   $(4,170)

 

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

 

For the Year Ended December 31, 2019       
(In Thousands)      
   Reclassified from    
   Accumulated Other    
Details about Accumulated Other  Comprehensive   Affected Line Item in the Consolidated
Comprehensive Income (Loss) Components  Income (Loss)   Statements of Income
Unrealized gains and losses on available-for-sale debt securities    $ (23 )    Realized gains on available-for-sale debt securities, net
    5   Income tax provision
    (18)  Net of tax
Amortization of defined benefit pension and postretirement items:                               
Prior service cost   (31)  Other noninterest expense
Actuarial gain   (1)  Other noninterest expense
    (32)  Total before tax
    7   Income tax provision
    (25)  Net of tax
Total reclassifications for the period  $(43)   

 

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For the Year Ended December 31, 2018       
(In Thousands)       
   Reclassified from    
   Accumulated Other    
Details about Accumulated Other  Comprehensive   Affected Line Item in the Consolidated
Comprehensive Income (Loss) Components  Income (Loss)   Statements of Income
Unrealized gains and losses on available-for-sale debt securities     $  288       Realized losses on available-for-sale debt securities, net
    (60)  Income tax provision
    228   Net of tax
Amortization of defined benefit pension and postretirement items:                           
Prior service cost   (30)  Other noninterest expense
Actuarial loss   13   Other noninterest expense
    (17)  Total before tax
    3   Income tax provision
    (14)  Net of tax
Total reclassifications for the period  $214    

 

6. CASH AND DUE FROM BANKS

 

Cash and due from banks at December 31, 2019 and 2018 include the following:

 

  Dec. 31,   Dec. 31, 
(In thousands)  2019   2018 
Cash and cash equivalents  $31,122   $32,827 
Certificates of deposit   4,080    4,660 
Total cash and due from banks  $35,202   $37,487 

 

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. The reserves are based on deposit levels, account activity, and other services provided by the Federal Reserve Bank. Required reserves were $20,148,000 at December 31, 2019 and $18,141,000 at December 31, 2018.

 

7. SECURITIES

 

Amortized cost and fair value of available-for-sale debt securities at December 31, 2019 and 2018 are summarized as follows:

 

       December 31, 2019     
       Gross   Gross     
       Unrealized   Unrealized     
   Amortized   Holding   Holding   Fair 
(In Thousands)  Cost   Gains   Losses   Value 
Obligations of U.S. Government agencies  $16,380   $620   $0   $17,000 
Obligations of states and political subdivisions:                    
Tax-exempt   68,787    2,011    (38)   70,760 
Taxable   35,446    927    (70)   36,303 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                                                                
Residential pass-through securities   58,875    472    (137)   59,210 
Residential collateralized mortgage obligations   115,025    308    (610)   114,723 
Commercial mortgage-backed securities   47,765    1,069    (107)   48,727 
Total  $342,278   $5,407   ($962)  $346,723 

 

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December 31, 2018

     
       Gross   Gross     
       Unrealized   Unrealized     
   Amortized   Holding   Holding   Fair 
(In Thousands)  Cost   Gains   Losses   Value 
Obligations of U.S. Government agencies  $12,331   $169   $0   $12,500 
Obligations of states and political subdivisions:                    
Tax-exempt   84,204    949    (1,201)   83,952 
Taxable   27,618    208    (127)   27,699 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                                                                
Residential pass-through securities   54,827    48    (1,430)   53,445 
Residential collateralized mortgage obligations   148,964    238    (3,290)   145,912 
Commercial mortgage-backed securities   40,781    166    (1,182)   39,765 
Total  $368,725   $1,778   ($7,230)  $363,273 

 

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 December 31, 2019 and 2018:

 

  Less Than 12 Months   12 Months or More   Total 
December 31, 2019  Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
(In Thousands)  Value   Losses   Value   Losses   Value   Losses 
Obligations of states and political subdivisions:                              
Tax-exempt  $6,429   ($38)  $0   $0   $6,429   ($38)
Taxable   5,624    (68)   161    (2)   5,785    (70)
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                                                                               
Residential pass-through securities   9,771    (35)   14,787    (102)   24,558    (137)
Residential collateralized mortgage obligations   31,409    (195)   30,535    (415)   61,944    (610)
Commercial mortgage-backed securities   0    0    8,507    (107)   8,507    (107)
Total  $53,233   ($336)  $53,990   ($626)  $107,223   ($962)

 

  Less Than 12 Months   12 Months or More   Total 
December 31, 2018  Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
(In Thousands)  Value   Losses   Value   Losses   Value   Losses 
Obligations of states and political subdivisions:                              
Tax-exempt  $5,084   ($11)  $32,684   ($1,190)  $37,768   ($1,201)
Taxable   980    (2)   11,418    (125)   12,398    (127)
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                                                              
Residential pass-through securities   5,592    (4)   42,309    (1,426)   47,901    (1,430)
Residential collateralized mortgage obligations   1,892    (8)   101,662    (3,282)   103,554    (3,290)
Commercial mortgage-backed securities   0    0    32,552    (1,182)   32,552    (1,182)
Total  $13,548   ($25)  $220,625   ($7,205)  $234,173   ($7,230)

 

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Gross realized gains and losses from available-for-sale securities and the related income tax provision were as follows:

 

(In Thousands)  2019   2018 
Gross realized gains from sales  $24   $259 
Gross realized losses from sales   (1)   (547)
Net realized gains (losses)  $23   ($288)
Income tax (credit) provision related to net realized gains (losses)  $5   ($60)

 

The amortized cost and fair value of available-for-sale debt securities by contractual maturity are shown in the following table as of December 31, 2019. 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.

 

   December 31, 2019 
   Amortized   Fair 
(In Thousands)  Cost   Value 
Due in one year or less  $7,216   $7,247 
Due from one year through five years   31,627    32,408 
Due from five years through ten years   42,709    43,845 
Due after ten years   39,061    40,563 
Sub-total   120,613    124,063 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities   58,875    59,210 
Residential collateralized mortgage obligations   115,025    114,723 
Commercial mortgage-backed securities   47,765    48,727 
Total  $342,278   $346,723 

 

The Corporation’s mortgage-backed securities and collateralized mortgage obligations 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 $215,270,000 at December 31, 2019 and $229,418,000 at December 31, 2018 were pledged as collateral for public deposits, trusts and certain other deposits as provided by law. See Note 12 for information concerning securities pledged to secure borrowing arrangements.

 

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

 

A summary of information management considered in evaluating debt and equity securities for OTTI at December 31, 2019 and 2018 is provided below.

 

Debt Securities

 

At December 31, 2019 and 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 these debt securities at December 31, 2019 and 2018 to be temporary.

 

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Equity Securities

 

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 sheets, was $10,131,000 at December 31, 2019 and $5,582,000 at December 31, 2018. The Corporation evaluated its holding of FHLB-Pittsburgh stock for impairment and deemed the stock to not be impaired at December 31, 2019 and December 31, 2018. 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.

 

The Corporation’s marketable equity security, with carrying values of $979,000 at December 31, 2019 and $950,000 at December 31, 2018, consisted exclusively of one mutual fund. There was an unrealized loss on the mutual fund of $21,000 at December 31, 2019 and $50,000 at December 31, 2018. The decrease in the unrealized loss of $29,000 in 2019 and the increase in the unrealized loss of $21,000 in 2018 are included in other noninterest income in the consolidated statements of income.

 

In the year ended December 31, 2018, the Corporation recorded pre-tax gains from sales of a restricted equity security (Visa Class B stock) totaling $2,321,000. The Corporation had received 19,789 shares of Visa Class B stock pursuant to Visa’s 2007 initial public offering. Until the second quarter 2018, the carrying value of the shares was $0, which represented the Corporation’s cost basis. Class B shares are subject to restrictions on transfer, essentially limiting their transferability to other owners of Class B shares. In the second and third quarters of 2018, the Corporation sold all of its Visa Class B stock.

 

A summary of realized and unrealized gains and losses recognized on equity securities is as follows:

 

(In Thousands)  2019   2018 
Net gains recognized during the period on equity securities    $ 29 $ 2,300   
Less: net gains recognized during the period on equity securities sold during the period 0 (2,321 )
            
Unrealized gains (losses) recognized during the period on equity securities still held at the reporting date $ 29 $ (21 )

 

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8. LOANS

 

Loans outstanding at December 31, 2019 and 2018 are summarized as follows:

 

Summary of Loans by Type  Dec. 31,   Dec. 31, 
(In Thousands)  2019   2018 
Residential mortgage:          
Residential mortgage loans - first liens  $510,641   $372,339 
Residential mortgage loans - junior liens   27,503    25,450 
Home equity lines of credit   33,638    34,319 
1-4 Family residential construction   14,798    24,698 
Total residential mortgage   586,580    456,806 
Commercial:          
Commercial loans secured by real estate   301,227    162,611 
Commercial and industrial   126,374    91,856 
Political subdivisions   53,570    53,263 
Commercial construction and land   33,555    11,962 
Loans secured by farmland   12,251    7,146 
Multi-family (5 or more) residential   31,070    7,180 
Agricultural loans   4,319    5,659 
Other commercial loans   16,535    13,950 
Total commercial   578,901    353,627 
Consumer   16,741    17,130 
Total   1,182,222    827,563 
Less: allowance for loan losses   (9,836)   (9,309)
Loans, net  $1,172,386   $818,254 

 

In the table above, outstanding loan balances are presented net of deferred loan origination fees, net, of $2,482,000 at December 31, 2019 and $1,999,000 at December 31, 2018.

 

As described in Note 3, effective April 1, 2019, the Corporation acquired loans pursuant to the acquisition of Monument. The loans acquired from Monument were recorded at an initial fair value of $259,295,000. The gross amortized cost of loans acquired from Monument on April 1, 2019 was reduced $1,807,000 based on movements in interest rates (market rate adjustment) and was also reduced $1,914,000 based on a credit fair value adjustment on non-impaired loans and by $318,000 based on a credit fair value adjustment on impaired loans. In 2019, adjustments to these initial discounts to the carrying amounts of loans were recognized as follows:

 

       Credit     
   Market   Adjustment on   Credit 
   Rate   Non-impaired   Adjustment on 
(In Thousands)  Adjustment   Loans   PCI Loans 
Adjustments to gross amortized cost of loans at acquisition  $(1,807)  $(1,914)  $(318)
Accretion recognized in interest income   392    698      
Recovery from PCI loan pay-off             10 
Adjustments to gross amortized cost of loans at December 31, 2019  $(1,415)  $(1,216)  $(308)

 

 

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 northcentral Pennsylvania, the southern tier of New York State, southeastern Pennsylvania and southcentral Pennsylvania. 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 December 31, 2019.

 

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Transactions within the allowance for loan losses, summarized by segment and class, were as follows:

 

Year Ended December 31, 2019  Dec. 31,               Dec. 31, 
(In Thousands)  2018
Balance
   Charge-offs   Recoveries   Provision (Credit)   2019
Balance
 
Allowance for Loan Losses:                         
Residential mortgage:                         
Residential mortgage loans - first liens  $3,156   $(166)  $4   $411   $3,405 
Residential mortgage loans - junior liens   325    (24)   2    81    384 
Home equity lines of credit   302    0    5    (31)   276 
1-4 Family residential construction   203    0    1    (87)   117 
Total residential mortgage   3,986    (190)   12    374    4,182 
Commercial:                         
Commercial loans secured by real estate   2,538    0    0    (617)   1,921 
Commercial and industrial   1,553    (6)   6    (162)   1,391 
Commercial construction and land   110    0    0    856    966 
Loans secured by farmland   102    0    0    56    158 
Multi-family (5 or more) residential   114    0    0    42    156 
Agricultural loans   46    0    0    (5)   41 
Other commercial loans   128    0    0    27    155 
Total commercial   4,591    (6)   6    197    4,788 
Consumer   233    (183)   39    192    281 
Unallocated   499    0    0    86    585 
Total Allowance for Loan Losses  $9,309   $(379)  $57   $849   $9,836 

 

 

Year Ended December 31, 2018  Dec. 31,               Dec. 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   $(108)  $4   $60   $3,156 
Residential mortgage loans - junior liens   224    0    4    97    325 
Home equity lines of credit   296    (50)   0    56    302 
1-4 Family residential construction   243    0    0    (40)   203 
Total residential mortgage   3,963    (158)   8    173    3,986 
Commercial:                         
Commercial loans secured by real estate   2,584    (21)   0    (25)   2,538 
Commercial and industrial   1,065    (144)   6    626    1,553 
Commercial construction and land   150    0    0    (40)   110 
Loans secured by farmland   105    0    0    (3)   102 
Multi-family (5 or more) residential   172    0    311    (369)   114 
Agricultural loans   57    0    0    (11)   46 
Other commercial loans   102    0    0    26    128 
Total commercial   4,235    (165)   317    204    4,591 
Consumer   159    (174)   41    207    233 
Unallocated   499    0    0    0    499 
Total Allowance for Loan Losses  $8,856   $(497)  $366   $584   $9,309 

 

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, except for performing loans purchased in 2019 from Monument, based on a collective evaluation of pools of loans with similar risk characteristics. The general component is assigned to each pool of loans based on both historical net charge-off experience, and an evaluation of certain qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the above methodologies for estimating specific and general losses in the portfolio.

 

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Loans acquired from Monument that were identified as having a deterioration in credit quality (purchased credit impaired, or PCI) were valued at $441,000 at April 1, 2019 and December 31, 2019. The remainder of the portfolio was deemed to be the performing component of the portfolio. None of the performing loans purchased were found to be impaired at December 31, 2019, and the performing loans purchased in 2019 were excluded from the loan pools for which the general component of the allowance for loan losses was calculated.

 

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. 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. 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. Risk ratings are updated any time that conditions or the situation warrants. Loans not classified are included in the “Pass” column in the table below.

 

The following tables summarize the aggregate credit quality classification of outstanding loans by risk rating as of December 31, 2019 and 2018:

 

                   Purchased     
December 31, 2019      Special           Credit     
(In Thousands)  Pass   Mention   Substandard   Doubtful   Impaired   Total 
Residential Mortgage:                              
Residential Mortgage loans - first liens  $500,963   $193   $9,324   $84   $77   $510,641 
Residential Mortgage loans - junior liens   26,953    79    471    0    0    27,503 
Home Equity lines of credit   33,170    59    409    0    0    33,638 
1-4 Family residential construction   14,798    0    0    0    0    14,798 
Total residential mortgage   575,884    331    10,204    84    77    586,580 
Commercial:                              
Commercial loans secured by real estate   294,397    4,773    1,693    0    364    301,227 
Commercial and Industrial   114,293    9,538    2,543    0    0    126,374 
Political subdivisions   53,570    0    0    0    0    53,570 
Commercial construction and land   32,224    0    1,331    0    0    33,555 
Loans secured by farmland   6,528    4,681    1,042    0    0    12,251 
Multi-family (5 or more) residential   30,160    0    910    0    0    31,070 
Agricultural loans   3,343    335    641    0    0    4,319 
Other commercial loans   16,416    0    119    0    0    16,535 
Total commercial   550,931    19,327    8,279    0    364    578,901 
Consumer   16,720    0    21    0    0    16,741 
Totals  $1,143,535   $19,658   $18,504   $84   $441   $1,182,222 

 

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December 31, 2018      Special             
(In Thousands)  Pass   Mention   Substandard   Doubtful   Total 
Residential Mortgage:                         
Residential mortgage loans - first liens  $363,407   $937   $7,944   $51   $372,339 
Residential mortgage loans - junior liens   24,841    176    433    0    25,450 
Home equity lines of credit   33,659    59    601    0    34,319 
1-4 Family residential construction   24,698    0    0    0    24,698 
Total residential mortgage   446,605    1,172    8,978    51    456,806 
Commercial:                         
Commercial loans secured by real estate   156,308    740    5,563    0    162,611 
Commercial and Industrial   84,232    5,230    2,394    0    91,856 
Political subdivisions   53,263    0    0    0    53,263 
Commercial construction and land   11,887    0    75    0    11,962 
Loans secured by farmland   5,171    168    1,796    11    7,146 
Multi-family (5 or more) residential   7,180    0    0    0    7,180 
Agricultural loans   4,910    84    665    0    5,659 
Other commercial loans   13,879    0    71    0    13,950 
Total commercial   336,830    6,222    10,564    11    353,627 
Consumer   17,116    0    14    0    17,130 
Totals  $800,551   $7,394   $19,556   $62   $827,563 

 

As shown in the tables immediately above, total loans classified as special mention increased to $19,658,000 at December 31, 2019 from $7,394,000 at December 31, 2018. At December 31, 2019, there were 60 loans classified as special mention, with an average balance of $328,000. In comparison, at December 31, 2018, there were 53 loans classified as special mention, with an average balance of $140,000. Of the total balance of special mention loans at December 31, 2019, loans of $500,000 or more totaled $15,357,000, or 78% of the total. Special mention loans with balances of $500,000 or more at December 31, 2019 included 9 commercial loans to 7 different borrowers, summarized with comparative December 31, 2018 (if applicable) as follows:

 

           Risk 
   Balance,   Balance,   Rating 
   December 31,   December 31,   December 31, 
(In Thousands)  2019   2018   2018 
4 loans downgraded in 2019  $6,668   $7,043    Pass 
1 loan with no change in rating in 2019   984    1,098    Special Mention 
2 loans upgraded in 2019   3,570    3,781    Substandard 
2 loans originated in 2019   4,135    0    N/A 
Total Special Mention Loans of $500,000 or  More at December 31, 2019     $  15,357        $  11,922               

 

There was no specific allowance for loan losses recorded on any loans classified as special mention at December 31, 2019. At December 31, 2018, there were specific allowances totaling $1,365,000 on the 2 loans in the table above that were upgraded from substandard at December 31, 2018 to special mention at December 31, 2019. These loans were no longer considered impaired in 2019 and the specific allowances were eliminated in 2019. One of the loans originated in 2019 and classified as special mention at December 31, 2019, with an outstanding balance of $3,500,000 at December 31, 2019, was made on a partially unsecured basis. The Corporation estimates the liquidation value of the related collateral, net of selling costs, would be approximately $1,500,000, with a shortfall of $2,000,000. Despite the shortfall from the estimated value of the collateral, based on available information, the Corporation believes the loan should be repaid in full due to the high reported value of the borrower’s net worth.

 

At December 31, 2019, total loans classified as substandard amounted to $18,504,000, down from $19,556,000 at December 31, 2018. At December 31, 2019, there were 225 loans classified as substandard, with an average balance of $82,000. In comparison, at December 31, 2018, there were 215 loans classified as substandard, with an average balance of $91,000. Of the total balance of substandard loans at December 31, 2019, loans of $500,000 or more totaled $4,185,000, or 23% of the total, with the largest balance from one commercial construction loan with an outstanding balance of $1,261,000 and a specific allowance for loan losses of $678,000.

 

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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 December 31, 2019 and 2018:

 

   Loans:   Allowance for Loan Losses: 
           Purchased                 
December 31, 2019  Individually   Collectively   Performing       Individually   Collectively     
(In Thousands)  Evaluated   Evaluated   Loans   Totals   Evaluated   Evaluated   Totals 
Residential mortgage:                                   
Residential mortgage loans - first liens  $1,023   $405,186   $104,432   $510,641   $0   $3,405   $3,405 
Residential mortgage loans - junior liens   368    24,730    2,405    27,503    176    208    384 
Home equity lines of credit   0    32,147    1,491    33,638    0    276    276 
1-4 Family residential construction   0    14,640    158    14,798    0    117    117 
Total residential mortgage   1,391    476,703    108,486    586,580    176    4,006    4,182 
Commercial:                                   
Commercial loans secured by real estate   684    198,532    102,011    301,227    0    1,921    1,921 
Commercial and industrial   1,467    122,313    2,594    126,374    149    1,242    1,391 
Political subdivisions   0    53,570    0    53,570    0    0    0 
Commercial construction and land   1,261    29,710    2,584    33,555    678    288    966 
Loans secured by farmland   607    11,386    258    12,251    48    110    158 
Multi-family (5 or more) residential   0    10,617    20,453    31,070    0    156    156 
Agricultural loans   76    4,243    0    4,319    0    41    41 
Other commercial loans   0    15,947    588    16,535    0    155    155 
Total commercial   4,095    446,318    128,488    578,901    875    3,913    4,788 
Consumer   0    16,741    0    16,741    0    281    281 
Unallocated                                 585 
                                    
Total  $5,486   $939,762   $236,974   $1,182,222   $1,051   $8,200   $9,836 

 

  Loans:   Allowance for Loan Losses: 
December 31, 2018  Individually   Collectively       Individually   Collectively     
(In Thousands)  Evaluated   Evaluated   Totals   Evaluated   Evaluated   Totals 
Residential mortgage:                              
Residential mortgage loans - first liens  $991   $371,348   $372,339   $0   $3,156   $3,156 
Residential mortgage loans - junior liens   293    25,157    25,450    116    209    325 
Home equity lines of credit   0    34,319    34,319    0    302    302 
1-4 Family residential construction   0    24,698    24,698    0    203    203 
Total residential mortgage   1,284    455,522    456,806    116    3,870    3,986 
Commercial:                              
Commercial loans secured by real estate   4,302    158,309    162,611    781    1,757    2,538 
Commercial and industrial   2,157    89,699    91,856    659    894    1,553 
Political subdivisions   0    53,263    53,263    0    0    0 
Commercial construction and land   0    11,962    11,962    0    110    110 
Loans secured by farmland   1,349    5,797    7,146    49    53    102 
Multi-family (5 or more) residential   0    7,180    7,180    0    114    114 
Agricultural loans   665    4,994    5,659    0    46    46 
Other commercial loans   0    13,950    13,950    0    128    128 
Total commercial   8,473    345,154    353,627    1,489    3,102    4,591 
Consumer   17    17,113    17,130    0    233    233 
Unallocated                            499 
Total  $9,774   $817,789   $827,563   $1,605   $7,205   $9,309 

 

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Summary information related to impaired loans as of December 31, 2019 and 2018 is as follows:

 

  December 31, 2019   December 31, 2018 
   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  $645   $617   $0   $750   $721   $0 
Residential mortgage loans - junior liens   42    42    0    54    54    0 
Commercial loans secured by real estate   684    684    0    1,787    1,787    0 
Commercial and industrial   563    563    0    817    817    0 
Loans secured by farmland   129    129    0    862    862    0 
Agricultural loans   76    76    0    665    665    0 
Consumer   0    0    0    17    17    0 
Total with no related allowance recorded   2,139    2,111    0    4,952    4,923    0 
                               
With a related allowance recorded:                              
Residential mortgage loans - first liens   406    406    0    270    270    0 
Residential mortgage loans - junior liens   326    326    176    239    239    116 
Commercial loans secured by real estate   0    0    0    2,515    2,515    781 
Commercial and industrial   904    904    149    1,340    1,340    659 
Construction and other land loans   1,261    1,261    678    0    0    0 
Loans secured by farmland   478    478    48    487    487    49 
Total with a related allowance recorded   3,375    3,375    1,051    4,851    4,851    1,605 
Total  $5,514   $5,486   $1,051   $9,803   $9,774   $1,605 

 

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 
   Average Investment in   on Impaired Loans 
   Impaired Loans   on a Cash Basis 
  Year Ended December 31,   Year Ended December 31, 
(In Thousands)  2019   2018   2019   2018 
Residential mortgage:                    
Residential mortgage loans - first lien  $1,440   $980   $87   $52 
Residential mortgage loans - junior lien   288    297    12    11 
Home equity lines of credit   26    0    4    0 
Total residential mortgage   1,754    1,277    103    63 
Commercial:                    
Commercial loans secured by real estate   1,562    4,897    19    141 
Commercial and industrial   1,186    708    25    47 
Commercial construction and land   556    0    71    0 
Loans secured by farmland   1,276    1,357    49    35 
Multi-family (5 or more) residential   0    314    0    0 
Agricultural loans   399    542    31    46 
Other commercial loans   20    0    4    0 
Total commercial   4,999    7,818    199    269 
Consumer   3    18    0    1 
Total  $6,756   $9,113   $302   $333 

  

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

 

   December 31, 2019   December 31, 2018 
   Past Due       Past Due     
   90+ Days and       90+ Days and     
(In Thousands)  Accruing   Nonaccrual   Accruing   Nonaccrual 
Residential mortgage:                    
Residential mortgage loans - first liens  $878   $4,679   $1,633   $4,750 
Residential mortgage loans - junior liens   53    326    151    239 
Home equity lines of credit   71    73    219    27 
Total residential mortgage   1,002    5,078    2,003    5,016 
Commercial:                    
Commercial loans secured by real estate   107    1,148    394    3,958 
Commercial and industrial   15    1,051    18    2,111 
Commercial construction and land   0    1,311    0    52 
Loans secured by farmland   43    565    459    1,297 
Agricultural loans   0    0    0    665 
Other commercial   0    49    0    0 
Total commercial   165    4,124    871    8,083 
Consumer   40    16    32    14 
                     
Totals  $1,207   $9,218   $2,906   $13,113 

 

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

 

The tables below present a summary of the contractual aging of loans as of December 31, 2019 and 2018:

 

   As of December 31, 2019   As of December 31, 2018 
   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  $499,024   $7,839   $3,778   $510,641   $361,362   $6,414  $4,563   $372,339 
Residential mortgage loans - junior liens   27,041    83    379    27,503    24,876    184   390    25,450 
Home equity lines of credit   33,115    452    71    33,638    33,611    480   228    34,319 
1-4 Family residential construction   14,758    40    0    14,798    24,531    167   0    24,698 
Total residential mortgage   573,938    8,414    4,228    586,580    444,380    7,245   5,181    456,806 
                                        
Commercial:                                       
Commercial loans secured by real estate   299,640    737    850    301,227    160,668    226   1,717    162,611 
Commercial and industrial   126,221    16    137    126,374    90,915    152   789    91,856 
Political subdivisions   53,570    0    0    53,570    53,263    0   0    53,263 
Commercial construction and land   33,505    0    50    33,555    11,910    0   52    11,962 
Loans secured by farmland   11,455    666    130    12,251    5,390    487   1,269    7,146 
Multi-family (5 or more) residential   31,070    0    0    31,070    7,104    76   0    7,180 
Agricultural loans   4,318    1    0    4,319    5,624    29   6    5,659 
Other commercial loans   16,535    0    0    16,535    13,950    0   0    13,950 
Total commercial   576,314    1,420    1,167    578,901    348,824    970   3,833    353,627 
Consumer   16,496    189    56    16,741    16,991    93   46    17,130 
                                        
Totals  $1,166,748   $10,023   $5,451   $1,182,222   $810,195   $8,308  $9,060   $827,563 

 

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Nonaccrual loans are included in the contractual aging immediately above. A summary of the contractual aging of nonaccrual loans at December 31, 2019 and 2018 is as follows:

 

   Current &             
   Past Due   Past Due   Past Due     
   Less than   30-89   90+     
(In Thousands)  30 Days   Days   Days   Total 
December 31, 2019 Nonaccrual Totals  $3,840   $1,134   $4,244   $9,218 
December 31, 2018 Nonaccrual Totals  $5,793   $1,166   $6,154   $13,113 

 

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 and reviewed each quarter to determine if a specific allowance for loan losses is required. The outstanding balance of loans subject to TDRs, as well as the contractual aging information at December 31, 2019 and 2018 is as follows:

 

Troubled Debt Restructurings (TDRs):

 

   Current &                 
   Past Due   Past Due   Past Due         
   Less than   30-89   90+         
(In Thousands)  30 Days   Days   Days   Nonaccrual   Total 
December 31, 2019 Totals  $889   $0   $0   $1,737   $2,626 
December 31, 2018 Totals  $612   $43   $0   $2,884   $3,539 

 

At December 31, 2019 and 2018, there were no commitments to loan additional funds to borrowers whose loans have been classified as TDRs.

 

A summary of TDRs that occurred during 2019 and 2018 is as follows:

 

(Balances in Thousands)        
   2019   2018 
       Post-       Post- 
   Number   Modification   Number   Modification 
   of   Recorded   of   Recorded 
   Loans   Investment   Loans   Investment 
Residential mortgage - first liens:                    
Reduced monthly payments and extended maturity date   1   $271    0   $0 
Reduced monthly payments for a six-month period   0    0    1    80 
Residential mortgage - junior liens,                    
Reduced monthly payments and extended maturity date   1    18    0    0 
Commercial loans secured by real estate,                    
Extended interest only payments for a six-month period   0    0    2    36 
Commercial and industrial:                    
Extended interest only payments for a six-month period   0    0    1    46 
Reduced monthly payments and extended maturity date   8    177    0    0 
Commercial construction and land,                    
Extended interest only payments and reduced monthly                    
payments with a balloon payment at maturity   1    1,261    0    0 
Agricultural loans,                    
Reduced monthly payments and extended maturity date   1    84    0    0 
Total   12   $1,811    4   $162 

 

There were no differences between the outstanding contractual amounts and the recorded investments in receivables resulting from TDRs that occurred in 2019 and 2018. At December 31, 2019, the Corporation maintained a specific allowance for loan losses of $678,000 related to the commercial construction loan for which a TDR occurred in 2019. The other loans for which TDRs were granted in 2019 are associated with one relationship for which payment defaults occurred in 2019 as described below.

 

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In 2019 and 2018, payment defaults on loans for which modifications considered to be TDRs were entered into within the previous 12 months are summarized as follows:

 

   2019   2018 
   Number       Number     
   of   Recorded   of   Recorded 
(Balances in Thousands)  Loans   Investment   Loans   Investment 
Residential mortgage - first liens   1   $261    0    0 
Residential mortgage - junior liens   1    18    0    0 
Commercial and industrial   8    170    0    0 
Agricultural loans   1    81    0    0 
Total   11   $530    0   $0 

 

All of the TDRs for which payment defaults occurred in 2019 were related to one commercial relationship. These loans were individually evaluated for impairment at December 31, 2019 and 2018, and no specific allowance for loan losses was recognized because the estimated values of collateral and U.S. Government (Small Business Administration) guarantees exceeded the outstanding balances of the loans.

 

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 consolidated balance sheets) is as follows:

 

   Dec. 31,   Dec. 31, 
(In Thousands)  2019   2018 
Foreclosed residential real estate  $292   $64 

 

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

 

   Dec. 31,   Dec. 31, 
(In Thousands)  2019   2018 
Residential real estate in process of foreclosure  $1,717   $1,097 

 

9. BANK PREMISES AND EQUIPMENT

 

   December 31, 
(In Thousands)  2019   2018 
Land  $3,199   $2,803 
Buildings and improvements   28,403    27,343 
Furniture and equipment   13,618    16,577 
Construction in progress   1,655    2 
Total   46,875    46,725 
Less: accumulated depreciation   (29,705)   (32,133)
Net  $17,170   $14,592 

 

Depreciation expense is included in the following line items of the consolidated statements of income:

 

(In Thousands)  2019   2018 
Occupancy expense  $775   $849 
Furniture and equipment expense   692    684 
Data processing expenses   239    183 
Telecommunications expenses   43    38 
Total  $1,749   $1,754 

 

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10. GOODWILL AND OTHER INTANGIBLE ASSETS, NET

 

Information related to the core deposit intangibles is as follows:

 

   December 31, 
(In Thousands)  2019   2018 
Gross amount  $3,495   $2,034 
Accumulated amortization   (2,248)   (2,025)
Net  $1,247   $9 

 

Amortization expense was $223,000 in 2019, including $214,000 related to the Monument transaction described in Note 3, and $3,000 in 2018. The amount of amortization expense to be recognized in each of the ensuing five years is as follows:

 

(In Thousands)    
2020  $249 
2021   193 
2022   160 
2023   133 
2024   125 

 

Changes in the carrying amount of goodwill are summarized in the following table:

 

   December 31, 
(In Thousands)  2019   2018 
Balance, beginning of period  $11,942   $11,942 
Goodwill arising in business combination   16,446    0 
Balance, end of period  $28,388   $11,942 

 

In testing goodwill for impairment as of December 31, 2019, the Corporation by-passed performing a qualitative assessment and performed a quantitative assessment based on comparison of the Corporation’s market capitalization to its stockholders’ equity, resulting in the determination that the fair value of its reporting unit, its community banking operation, exceeded its carrying value. Accordingly, there was no goodwill impairment at December 31, 2019.

 

The Corporation’s assessment of goodwill for impairment at December 31, 2018 was based on assessment of qualitative factors to determine whether it was more likely than not that the fair value of its community banking operation was less than its carrying amount. The qualitative factors assessed included the Corporation’s recent financial performance, economic conditions in the Corporation’s market area, macroeconomic conditions and other factors. Based on the assessment of qualitative factors, the Corporation determined that it was not more likely than not that the fair value of the community banking operation had fallen below its carrying value, and therefore, the Corporation did not perform a more detailed, two-step goodwill impairment test and concluded there was no goodwill impairment as of December 31, 2018.

 

11. DEPOSITS

 

At December 31, 2019, the scheduled maturities of time deposits are as follows:

 

(In Thousands)    
2020  $238,887 
2021   83,197 
2022   28,968 
2023   12,003 
2024   11,610 
2025   30 
Total  $374,695 

 

Time deposits of more than $250,000 totaled $84,476,000 at December 31, 2019 and $36,094,000 at December 31, 2018. As of December 31, 2019, the remaining maturities or time to next re-pricing of time deposits more than $250,000 was as follows:

 

(In Thousands)    
Three months or less  $19,176 
Over 3 months through 12 months   52,093 
Over 1 year through 3 years   6,601 
Over 3 years   6,606 
Total  $84,476 

 

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12. BORROWED FUNDS AND SUBORDINATED DEBT

 

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

 

  Dec. 31,   Dec. 31, 
(In Thousands)  2019   2018 
FHLB-Pittsburgh borrowings  $84,292   $7,000 
Customer repurchase agreements   1,928    5,853 
Total short-term borrowings  $86,220   $12,853 

 

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

 

   Dec. 31,   Dec. 31 
(In Thousands)  2019   2018 
Overnight borrowing  $64,000   $7,000 
Other short-term advances   20,292    0 
Total short-term FHLB-Pittsburgh borrowings  $84,292   $7,000 

 

Overnight borrowings from FHLB-Pittsburgh had an interest rate of 1.81% at December 31, 2019 and 2.62% at December 31, 2018. At December 31, 2019, other short-term advances included seven advances totaling $20,297,000 which are presented in the table net of the unamortized purchase accounting adjustment, with a weighted-average effective rate of 2.28%.

 

The weighted average interest rate on total short-term borrowings outstanding was 1.88% at December 31, 2019 and 1.47% at December 31, 2018. The maximum amount of total short-term borrowings outstanding at any month-end was $86,220,000 in 2019 and $74,646,000 in 2018.

 

The Corporation had available credit with other correspondent banks totaling $45,000,000 at December 31, 2019 and 2018. These lines of credit are primarily unsecured. No amounts were outstanding at December 31, 2019 or 2018.

 

The Corporation has a line of credit with the Federal Reserve Bank of Philadelphia’s Discount Window. At December 31, 2019, the Corporation had available credit in the amount of $14,244,000 on this line with no outstanding advances. At December 31, 2018, the Corporation had available credit in the amount of $15,262,000 on this line with no outstanding advances. As collateral for this line, the Corporation has pledged available-for-sale securities with a carrying value of $14,728,000 at December 31, 2019 and $15,710,000 at December 31, 2018.

 

The FHLB-Pittsburgh loan facility is collateralized by qualifying loans secured by real estate with a book value totaling $778,877,000 at December 31, 2019 and $495,143,000 at December 31, 2018. Also, the FHLB-Pittsburgh loan facility requires 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 $10,131,000 at December 31, 2019 and $5,582,000 at December 31, 2018. The Corporation’s total credit facility with FHLB-Pittsburgh was $552,546,000 at December 31, 2019, including an unused (available) amount of $416,127,000. At December 31, 2018, the Corporation’s total credit facility with FHLB-Pittsburgh was $361,614,000, including an unused (available) amount of $318,699,000.

 

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 rate paid by the Corporation on customer repurchase agreements was 0.10% at December 31, 2019 and December 31, 2017. The carrying value of the underlying securities was $1,951,000 at December 31, 2019 and $5,890,000 at December 31, 2018.

 

LONG-TERM BORROWINGS

 

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

 

  Dec. 31,   Dec. 31, 
(In Thousands)  2019   2018 
Loans matured in 2019 with a weighted-average rate of 2.36%  $0   $32,000 
Loans maturing in 2020 with a weighted-average rate of 2.73%   5,069    3,271 
Loans maturing in 2021 with a weighted-average rate of 1.54%   6,000    0 
Loans maturing in 2022 with a weighted-average rate of 2.03%   20,000    0 
Loans maturing in 2023 with a weighted-average rate of 1.70%   20,500    0 
Loan maturing in 2025 with a rate of 4.91%   558    644 
Total long-term FHLB-Pittsburgh borrowings  $52,127   $35,915 

 

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In connection with the Monument acquisition, the Corporation assumed subordinated debt agreements with par values totaling $7,000,000, maturing April 1, 2027, which may be redeemed at par beginning April 1, 2022. The agreements have fixed annual interest rates of 6.50%. The subordinated debt was recorded at fair value, which was deemed to be equal to par value. In the fourth quarter 2019, the Corporation redeemed subordinated debt with a par value of $500,000, resulting in a loss of $10,000 (included in other noninterest expense in the consolidated statements of income). At December 31, 2019, the carrying value of the subordinated debt on the consolidated balance sheet is $6,500,000.

 

13. EMPLOYEE AND POSTRETIREMENT BENEFIT PLANS

 

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 December 31, 2019 and December 31, 2018 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 following table shows the funded status of the defined benefit plans:

 

   Pension   Postretirement 
(In Thousands)  2019   2018   2019   2018 
CHANGE IN BENEFIT OBLIGATION:                    
Benefit obligation at beginning of year  $870   $850   $1,349   $1,497 
Service cost   0    0    33    40 
Interest cost   28    25    50    51 
Plan participants' contributions   0    0    184    206 
Actuarial (gain) loss   91    11    (63)   (192)
Benefits paid   (13)   (16)   (227)   (253)
Benefit obligation at end of year  $976   $870   $1,326   $1,349 
                     
CHANGE IN PLAN ASSETS:                    
Fair value of plan assets at beginning of year  $847   $923   $0   $0 
Actual return on plan assets   137    (60)   0    0 
Employer contribution   0    0    43    47 
Plan participants' contributions   0    0    184    206 
Benefits paid   (13)   (16)   (227)   (253)
Fair value of plan assets at end of year  $971   $847   $0   $0 
                     
Funded status at end of year  $(5)  $(23)  $(1,326)  $(1,349)

 

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At December 31, 2019 and 2018, the following pension plan and postretirement plan liability amounts were recognized in the consolidated balance sheets:

 

  Pension   Postretirement 
(In Thousands)  2019   2018   2019   2018 
Accrued interest and other liabilities  $5   $23   $1,326   $1,349 

 

At December 31, 2019 and 2018, the following items included in accumulated other comprehensive income had not been recognized as components of expense:

 

Items not yet recognized as a component of net periodic benefit cost:

 

  Pension   Postretirement 
(In Thousands)  2019   2018   2019   2018 
Prior service cost  $0   $0   $(248)  $(279)
Net actuarial loss (gain)   255    299    (236)   (194)
Total  $255   $299   $(484)  $(473)

 

For the defined benefit pension plan, amortization of the net actuarial loss is expected to be $16,000 in 2020. For the postretirement plan, the estimated amount of prior service cost that will be amortized from accumulated other comprehensive income into net periodic benefit cost in 2020 is a reduction in expense of $31,000, and net actuarial gain of $7,000 is expected to be amortized in 2020.

 

The accumulated benefit obligation for the defined benefit pension plan was $976,000 at December 31, 2019 and $870,000 at December 31, 2018.

 

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

 

  Pension   Postretirement 
(In Thousands)  2019   2018   2019   2018 
Service cost  $0   $0   $33   $40 
Interest cost   28    25    50    51 
Expected return on plan assets   (22)   (20)   0    0 
Amortization of prior service cost   0    0    (31)   (30)
Recognized net actuarial loss (gain)   20    13    (21)   0 
Total net periodic benefit cost  $26   $18   $31   $61 

 

The weighted-average assumptions used to determine net periodic benefit cost are as follows:

 

   Pension   Postretirement 
   2019   2018   2019   2018 
Citizens Trust Company Retirement Plan and postretirement plan:                    
Discount rate   4.10%   3.55%   4.50%   3.75%
Expected return on plan assets   4.68%   4.32%   N/A    N/A 
Rate of compensation increase   N/A    N/A    N/A    N/A 

 

The weighted-average assumptions used to determine benefit obligations as of December 31, 2019 and 2018 are as follows:

 

   Pension   Postretirement 
   2019   2018   2019   2018 
Discount rate   3.55%   4.10%   3.25%   4.50%
Rate of compensation increase   N/A    N/A    N/A    N/A 

 

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Estimated future benefit payments, including only estimated employer contributions for the postretirement plan, which reflect expected future service, are as follows:

 

(In Thousands)  Pension   Postretirement 
2020  $431   $81 
2021   11    85 
2022   13    89 
2023   181    81 
2024   11    84 
2025-2029   349    478 

 

No estimated minimum contribution to the defined benefit pension plan is required in 2020, though the Corporation may make discretionary contributions.

 

The expected return on pension plan assets is a significant assumption used in the calculation of net periodic benefit cost. This assumption reflects the average long-term rate of earnings expected on the funds invested or to be invested to provide for the benefits included in the projected benefit obligation.

 

The fair values of pension plan assets at December 31, 2019 and 2018 are as follows:

 

   2019   2018 
Mutual funds invested principally in:          
Cash and cash equivalents   3%   3%
Debt securities   38%   40%
Equity securities   49%   45%
Alternative funds   10%   12%
Total   100%   100%

 

C&N Bank’s Trust and Financial Management Department manages the investment of the pension plan assets. The Plan’s securities include mutual funds invested principally in debt securities, a diversified mix of large, mid- and small-capitalization U.S. stocks, foreign stocks and alternative asset classes such as real estate, commodities, and inflation-protected securities. The fair values of plan assets are determined based on Level 1 inputs (as described in Note 21). The Plan’s assets do not include any shares of the Corporation’s common stock.

 

PROFIT SHARING AND DEFERRED COMPENSATION PLANS

 

The Corporation has a profit sharing plan that incorporates the deferred salary savings provisions of Section 401(k) of the Internal Revenue Code. The Corporation’s matching contributions to the Plan depend upon the tax deferred contributions of employees. The Corporation’s total basic and matching contributions were $891,000 in 2019 and $717,000 in 2018.

 

The Corporation has an Employee Stock Ownership Plan (ESOP). Contributions to the ESOP are discretionary, and the ESOP uses funds contributed to purchase Corporation stock for the accounts of ESOP participants. These purchases are made on the market (not directly from the Corporation), and employees are not permitted to purchase Corporation stock under the ESOP. The ESOP includes a diversification feature, which allows participants, upon reaching age 55 and 10 years of service (as defined), to sell up to 50% of their Corporation shares over a period of 6 years. As of December 31, 2019, and 2018, there were no shares allocated for repurchase by the ESOP.

 

Dividends paid on shares held by the ESOP are charged to retained earnings. All Corporation shares owned through the ESOP are included in the calculation of weighted-average shares outstanding for purposes of calculating earnings per share - basic and diluted. The ESOP held 473,171 shares of Corporation stock at December 31, 2019 and 444,843 shares at December 31, 2018, all of which had been allocated to Plan participants. The Corporation’s contributions to the ESOP totaled $718,000 in 2019 and $605,000 in 2018.

 

The Corporation has a nonqualified supplemental deferred compensation arrangement with its key officers. Charges to operating expense for officers’ supplemental deferred compensation were $251,000 in 2019 and $242,000 in 2018.

 

The Corporation also has a nonqualified deferred compensation plan that allows selected officers the option to defer receipt of cash compensation, including base salary and any cash bonuses or other cash incentives. This nonqualified deferred compensation plan does not provide for Corporation contributions.

 

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STOCK-BASED COMPENSATION PLANS

 

The Corporation has a Stock Incentive Plan for a selected group of senior officers. A total of 850,000 shares of common stock may be issued under the Stock Incentive Plan. Awards may be made under the Stock Incentive Plan in the form of qualified options (“Incentive Stock Options,” as defined in the Internal Revenue Code), nonqualified options, stock appreciation rights or restricted stock. Historically through December 31, 2019, all awards made under this Plan have consisted of Incentive Stock Options or restricted stock. Incentive Stock Options have an exercise price equal to the market value of the stock at the date of grant, vest after 6 months and expire after 10 years. There are 223,867 shares available for issuance under the Stock Incentive Plan as of December 31, 2019.

 

Also, the Corporation has an Independent Directors Stock Incentive Plan. This plan permits awards of nonqualified stock options and/or restricted stock to non-employee directors. A total of 235,000 shares of common stock may be issued under the Independent Directors Stock Incentive Plan. The recipients’ rights to exercise stock options under this plan expire 10 years from the date of grant. The exercise prices of all stock options awarded under the Independent Directors Stock Incentive Plan are equal to market value as of the dates of grant. There are 109,965 shares available for issuance under the Independent Directors Stock Incentive Plan as of December 31, 2019.

 

Total stock-based compensation expense is as follows:

 

(In Thousands)  2019   2018 
Restricted stock  $798   $855 
Stock options   0    0 
Total  $798   $855 

 

The following summarizes non-vested restricted stock activity for the year ended December 31, 2019:

 

       Weighted 
       Average 
   Number   Grant Date 
   of Shares   Fair Value 
Outstanding, December 31, 2018   60,345   $23.81 
Granted   48,137   $24.47 
Vested   (36,524)  $23.21 
Forfeited   (3,758)  $25.08 
Outstanding, December 31, 2019   68,200   $24.53 

 

Compensation cost related to restricted stock is recognized based on the market price of the stock at the grant date over the vesting period, adjusted for estimated and actual forfeitures. As of December 31, 2019, there was $822,000 total unrecognized compensation cost related to restricted stock, which is expected to be recognized over a weighted average period of 1.4 years.

 

In 2019 and 2018, the Corporation awarded shares of restricted stock under the Stock Incentive Plan, as follows:

 

   2019   2018 
Time-based awards to independent directors   7,620    9,086 
Time-based awards to employees   26,827    17,147 
Performance-based awards to employees   13,690    8,289 
Total   48,137    34,522 

 

Time-based restricted stock awards granted under the Independent Directors Stock Incentive Plan in 2019 and 2018 vest over one-year terms. Time-based restricted stock awards granted to employees in 2019 and 2018 vest ratably over three-year terms, subject to continued employment and satisfactory job performance. Performance-based restricted stock awards granted in 2019 and 2018 vest ratably over three-year terms, with vesting contingent upon meeting conditions based on the Corporation’s earnings as specified in the agreements.

 

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There were no stock options granted in 2019 or 2018. A summary of stock option activity is presented below:

 

   2019   2018 
       Weighted       Weighted 
       Average       Average 
       Exercise       Exercise 
   Shares   Price   Shares   Price 
Outstanding, beginning of year   115,714   $18.49    165,660   $18.49 
Granted   0         0      
Exercised   (31,304)  $17.65    (41,210)  $18.69 
Forfeited   0         0      
Expired   (8,513)  $19.88    (8,736)  $17.50 
Outstanding, end of year   75,897   $18.69    115,714   $18.49 
Options exercisable at year-end   75,897   $18.69    115,714   $18.49 
Weighted-average fair value of options forfeited        N/A         N/A 

 

The weighted-average remaining contractual term of outstanding stock options at December 31, 2019 was 2.7 years. The aggregate intrinsic value of stock options outstanding was $726,000 at December 31, 2019. The total intrinsic value of options exercised was $276,000 in 2019 and $291,000 in 2018.

 

The Corporation has issued shares from treasury stock for almost all stock option exercises through December 31, 2019. Management does not anticipate that stock repurchases will be necessary to accommodate stock option exercises in 2020.

 

In January 2020, the Corporation awarded 30,381 shares of restricted stock under the Stock Incentive Plan and 7,580 shares of restricted stock under the Independent Directors Stock Incentive Plans. The January 2020 restricted stock awards under the Stock Incentive Plan vest ratably over three years. The 2020 restricted stock issued under the Independent Directors Stock Incentive Plan vests over one year. Total estimated stock-based compensation for 2020 is $920,000. The restricted stock awards made in January 2020 are not included in the tables above.

 

14. INCOME TAXES

 

The net deferred tax asset at December 31, 2019 and 2018 represents the following temporary difference components:

 

   December 31,   December 31, 
(In Thousands)  2019   2018 
Deferred tax assets:          
Unrealized holding losses on securities  $0   $1,145 
Allowance for loan losses   2,080    2,005 
Purchase accounting adjustments on loans   640    0 
Other deferred tax assets   2,173    2,049 
Total deferred tax assets   4,893    5,199 
           
Deferred tax liabilities:          
Unrealized holding gains on securities   934    0 
Defined benefit plans - ASC 835   49    37 
Bank premises and equipment   763    907 
Core deposit intangibles   272    2 
Other deferred tax liabilities   257    143 
Total deferred tax liabilities   2,275    1,089 
Deferred tax asset, net  $2,618   $4,110 

 

The provision for income taxes includes the following:

 

(In thousands)  2019   2018 
Currently payable  $3,618   $4,350 
Tax expense resulting from allocations of certain tax benefits to equity or as a reduction in other assets   115    87 
Deferred   172    (187)
Total provision  $3,905   $4,250 

 

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A reconciliation of income tax at the statutory rate to the Corporation’s effective rate is as follows (amounts in thousands):

 

   2019       2018     
(Amounts in thousands)  Amount   %   Amount   % 
Statutory provision  $4,916    21.00   $5,515    21.00 
Tax-exempt interest income   (853)   (3.64)   (1,046)   (3.98)
Increase in cash surrender value and other income from life insurance, net   (91)   (0.39)   (170)   (0.65)
ESOP Dividends   (113)   (0.48)   (98)   (0.37)
State income tax, net of Federal benefit   122    0.52    125    0.48 
Other, net   (76)   (0.32)   (76)   (0.29)
Effective income tax provision  $3,905    16.68   $4,250    16.18 

 

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 2, 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 (no net change in stockholders’ equity).

 

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 2016.

 

15. RELATED PARTY TRANSACTIONS

 

Loans to executive officers, directors of the Corporation and its subsidiaries and any associates of the foregoing persons are as follows:

 

   Beginning   New       Other   Ending 
(In Thousands)  Balance   Loans   Repayments   Changes   Balance 
11 directors, 8 executive officers 2019  $15,144   $1,027   $(1,850)  $134   $14,455 
11 directors, 8 executive officers 2018  $14,412   $3,553   $(1,417)  $(1,404)  $15,144 

 

In the table above, other changes represent net changes in the balance of existing lines of credit and transfers in and out of the related party category.

 

Deposits from related parties held by the Corporation amounted to $8,828,000 at December 31, 2019 and $9,622,000 at December 31, 2018.

 

16. OFF-BALANCE SHEET RISK

 

The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit, interest rate or liquidity risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of these instruments express the extent of involvement the Corporation has in particular classes of financial instruments.

 

The Corporation’s exposure to credit loss from nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

 

Financial instruments whose contract amounts represent credit risk at December 31, 2019 and 2018 are as follows:

 

(In Thousands)  2019   2018 
Commitments to extend credit  $256,896   $191,672 
Standby letters of credit   8,446    7,227 

 

Commitments to extend credit are legally binding agreements to lend to customers. Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future liquidity requirements. The Corporation evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation, for extensions of credit is based on management’s credit assessment of the counterparty.

 

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Standby letters of credit are conditional commitments issued by the Corporation guaranteeing performance by a customer to a third party. Those guarantees are issued primarily to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Some of the standby letters of credit are collateralized by real estate or other assets, and others are unsecured. The extent to which proceeds from liquidation of collateral would be expected to cover the maximum potential amount of future payments related to standby letters of credit is not estimable. The Corporation has recorded no liability associated with standby letters of credit as of December 31, 2019 and 2018.

 

Standby letters of credit as of December 31, 2019 expire as follows:

 

Year of Expiration   (In Thousands) 
2020   $7,809 
2021    523 
2022    114 
Total   $8,446 

 

17. OPERATING LEASE COMMITMENTS AND CONTINGENCIES

 

The Corporation leases certain branch locations, office space and equipment. All leases are classified as operating leases. Leases with an initial term of 12 months or less are not recorded on the balance sheet and the related lease expense is recognized on a straight-line basis over the lease term.

 

Certain leases include options to renew, with renewal terms that can extend the lease term from one to eight years that are reasonably certain of being exercised. The discount rate used in determining the lease liability for each individual lease was the FHLB fixed advance rate which corresponded with the remaining lease term as of January 1, 2019 for leases that existed at adoption and as of the lease commencement date for leases subsequently entered into after January 1, 2019. At December 31, 2019, discount rates ranged from 2.77% to 3.50% with a weighted-average discount rate of 3.23%.

 

At December 31, 2019, right-of-use assets of $1,637,000 were included in other assets, and the related liabilities totaling the same amount were included in accrued interest and other liabilities, in the unaudited consolidated balance sheets. In 2019, right-of-use assets obtained in exchange for lease liabilities totaled $745,000. In 2019, operating lease expenses totaling $214,000 are included in occupancy expense, net, and $37,000 are included in furniture and equipment expense.

 

A maturity analysis of the Corporation’s lease liabilities at December 31, 2019 is as follows:

 

(In Thousands)

 

Lease Payments Due

 

2020   $265 
2021    265 
2022    241 
2023    229 
2024    239 
Thereafter    625 
Total lease payments    1,864 
Discount on cash flows    (227)
Total lease liabilities   $1,637 

 

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

 

18. REGULATORY MATTERS

 

As required by the Economic Growth, Regulatory Relief, and Consumer Protection Act, in August 2018, the Federal Reserve Board issued an interim final rule that expanded applicability of the Board’s small bank holding company policy statement. The interim final rule raised the policy statement’s asset threshold from $1 billion to $3 billion in total consolidated assets for a bank holding company or savings and loan holding company that: (1) is not engaged in significant nonbanking activities; (2) does not conduct significant off-balance sheet activities; and (3) does not have a material amount of debt or equity securities, other than trust-preferred securities, outstanding. The interim final rule provides that, if warranted for supervisory purposes, the Federal Reserve may exclude a company from the threshold increase. Management believes the Corporation meets the conditions of the Federal Reserve’s small bank holding company policy statement and is therefore excluded from consolidated capital requirements at December 31, 2019; however, C&N Bank remains subject to regulatory capital requirements administered by the federal banking agencies.

 

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Details concerning capital ratios at December 31, 2019 and December 31, 2018 are presented below. Management believes, as of December 31, 2019, that C&N Bank meets all capital adequacy requirements to which it is subject and maintains a capital conservation buffer (described in more detail below) that allows the 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 December 31, 2019 and December 31, 2018 exceed the Corporation’s Board policy threshold levels.

 

                           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 
(Dollars in Thousands)  Amount   Ratio   Amount   Ratio   Amount   Ratio   Amount   Ratio   Amount   Ratio 
December 31, 2019:                                                  
Total capital to risk-weighted assets:                                                  
Consolidated  $228,057    20.70%   N/A    N/A    N/A    N/A    N/A    N/A   $115,689    ³10.5% 
C&N Bank   205,863    18.75%   87,817    ³8%    115,260    ³10.5%    109,771    ³10%    115,260    ³10.5% 
Tier 1 capital to risk-weighted assets:                                                  
Consolidated   211,388    19.19%   N/A    N/A    N/A    N/A    N/A    N/A    93,653    ³8.5% 
C&N Bank   195,694    17.83%   65,863    ³6%    93,306    ³8.5%    87,817    ³8%    93,306    ³8.5% 
Common equity tier 1 capital to risk-weighted assets:                                                  
Consolidated   211,388    19.19%   N/A    N/A    N/A    N/A    N/A    N/A    77,126    ³7% 
C&N Bank   195,694    17.83%   49,397    ³4.5%    76,840    ³7.0%    71,351    ³6.5%    76,840    ³7% 
Tier 1 capital to average assets:                                                  
Consolidated   211,388    13.10%   N/A    N/A    N/A    N/A    N/A    N/A    129,126    ³8% 
C&N Bank   195,694    12.24%   63,940    ³4%    N/A    N/A    79,925    ³5%    127,879    ³8% 
                                                   
December 31, 2018:                                                  
Total capital to risk-weighted assets:                                                  
Consolidated  $199,226    24.42%   N/A    N/A    N/A    N/A    N/A    N/A   $85,653    ³10.5% 
C&N Bank   176,499    21.75%   64,916    ³8%    80,130    ³9.875%    81,145    ³10%    85,202    ³10.5% 
Tier 1 capital to risk-weighted assets:                                                  
Consolidated   189,589    23.24%   N/A    N/A    N/A    N/A    N/A    N/A    69,338    ³8.5% 
C&N Bank   166,862    20.56%   48,687    ³6%    63,901    ³7.875%    64,916    ³8%    68,976    ³8.5% 
Common equity tier 1 capital to risk-weighted assets:                                                  
Consolidated   189,589    23.24%   N/A    N/A    N/A    N/A    N/A    N/A    57,102    ³7% 
C&N Bank   166,862    20.56%   36,515    ³4.5%    51,730    ³6.375%    52,744    ³6.5%    56,801    ³7% 
Tier 1 capital to average assets:                                                  
Consolidated   189,589    14.78%   N/A    N/A    N/A    N/A    N/A    N/A    102,634    ³8% 
C&N Bank   166,862    13.16%   50,715    ³4%    N/A    N/A    63,394    ³5%    101,430    ³8% 

 

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). This capital rule provides that, to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization subject to the rule 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. In 2019, the minimum risk-based capital ratios, and the capital ratios including the capital conservation buffer, are as follows:

 

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Minimum common equity tier 1 capital ratio   4.5%
Minimum common equity tier 1 capital ratio plus capital conservation buffer   7.0%
Minimum tier 1 capital ratio   6.0%
Minimum tier 1 capital ratio plus capital conservation buffer   8.5%
Minimum total capital ratio   8.0%
Minimum total capital ratio plus capital conservation buffer   10.5%

 

A banking organization with a buffer greater than 2.5% over the minimum risk-based capital ratios 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. Also, a banking organization is prohibited 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 December 30, 2019, C&N Bank’s Capital Conservation Buffer, determined based on the minimum total capital ratio, was 10.75%.

 

Banking regulators limit the amount of dividends that may be paid by C&N Bank to the Corporation. Retained earnings against which dividends may be paid without prior approval of the banking regulators amounted to approximately $94,628,000 at December 31, 2019, subject to the minimum capital ratio requirements noted above.

 

Restrictions imposed by federal law prohibit the Corporation from borrowing from C&N Bank unless the loans are secured in specific amounts. Such secured loans to the Corporation are generally limited to 10% of C&N Bank’s tangible stockholder’s equity (excluding accumulated other comprehensive income) or $19,543,000 at December 31, 2019.

 

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19. PARENT COMPANY ONLY

 

The following is condensed financial information for Citizens & Northern Corporation:

 

CONDENSED BALANCE SHEET  Dec. 31,   Dec. 31, 
(In Thousands)  2019   2018 
ASSETS          
Cash  $6,485   $7,389 
Investment in subsidiaries:          
Citizens & Northern Bank   228,413    174,795 
Citizens & Northern Investment Corporation   12,353    11,697 
Bucktail Life Insurance Company   3,669    3,525 
Other assets   109    6 
TOTAL ASSETS  $251,029   $197,412 
           
LIABILITIES AND STOCKHOLDERS' EQUITY          
Subordinated debt  $6,500   $0 
Other liabilities   77    44 
Stockholders' equity   244,452    197,368 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY  $251,029   $197,412 

 

CONDENSED INCOME STATEMENT        
(In Thousands)  2019   2018 
Dividends from Citizens & Northern Bank  $24,600   $12,800 
Expenses   (1,086)   (681)
Income before equity in (excess distributions)/undistributed income of subsidiaries   23,514    12,119 
Equity in (excess distributions)/undistributed income of subsidiaries   (4,010)   9,894 
NET INCOME  $19,504   $22,013 

 

CONDENSED STATEMENT OF CASH FLOWS        
(In Thousands)  2019   2018 
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net income  $19,504   $22,013 
Adjustments to reconcile net income to net cash provided by operating activities:          
Loss on repayment of subordinated debt   10    0 
Equity in (excess distributions)/undistributed income of subsidiaries   4,010    (9,894)
(Increase) decrease in other assets   (107)   7 
(Decrease) increase in other liabilities   (81)   30 
Net Cash Provided by Operating Activities   23,336    12,156 
           
CASH FLOWS FROM INVESTING ACTIVITIES,          
Net cash used in business combination   (9,698)   0 
           
CASH FLOWS FROM FINANCING ACTIVITIES:          
Repayment of subordinated debt   (510)   0 
Proceeds from sale of treasury stock   198    189 
Purchase of treasury stock   (189)   0 
Dividends paid   (14,041)   (11,746)
Net Cash Used in Financing Activities   (14,542)   (11,557)
          
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS   (904)   599 
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR   7,389    6,790 
CASH AND CASH EQUIVALENTS, END OF YEAR  $6,485   $7,389 
           
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:          
Investment of net assets acquired in business combination in Citizens & Northern Bank  $49,765   $0 
Common equity issued in business combination  $32,953   $0 
Subordinated debt assumed in business combination  $7,000   $0 
Other liabilities assumed in business combination  $114   $0 
Interest paid  $461   $0 

 

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20. SUMMARY OF QUARTERLY CONSOLIDATED FINANCIAL DATA (Unaudited)

 

The following table presents summarized quarterly financial data for 2019 and 2018:

 

SUMMARY OF QUARTERLY CONSOLIDATED FINANCIAL DATA

 

  2019 Quarter Ended 
   Mar. 31,   June 30,   Sept. 30,   Dec. 31, 
(In Thousands Except Per Share Data) (Unaudited)  2019   2019   2019   2019 
Interest income  $13,065   $17,139   $17,277   $17,290 
Interest expense   1,350    2,934    3,000    2,999 
Net interest income   11,715    14,205    14,277    14,291 
(Credit) provision for loan losses   (957)   (4)   1,158    652 
Net interest income after (credit) provision for loan losses   12,672    14,209    13,119    13,639 
Other income   4,406    4,849    4,963    5,066 
Net gains on available-for-sale debt securities   0    7    13    3 
Merger-related expenses   311    3,301    206    281 
Other expenses   10,696    11,422    11,486    11,834 
Income before income tax provision   6,071    4,342    6,403    6,593 
Income tax provision   981    693    1,096    1,135 
Net income  $5,090   $3,649   $5,307   $5,458 
Net income attributable to common shares  $5,063   $3,630   $5,281   $5,431 
Net income per share – basic  $0.41   $0.27   $0.39   $0.40 
Net income per share – diluted  $0.41   $0.27   $0.39   $0.40 

 

   2018 Quarter Ended 
   Mar. 31,   June 30,   Sept. 30,   Dec. 31, 
   2018   2018   2018   2018 
Interest income  $11,890   $12,334   $12,800   $13,304 
Interest expense   993    1,079    1,241    1,312 
Net interest income   10,897    11,255    11,559    11,992 
Provision (credit) for loan losses   292    (20)   60    252 
Net interest income after provision (credit) for loan losses   10,605    11,275    11,499    11,740 
Other income   4,406    4,689    4,462    5,040 
Gain on restricted equity security   0    1,750    571    0 
Net losses on available-for-sale debt securities   0    (282)   (2)   (4)
Merger-related expenses   0    0    200    128 
Other expenses   9,895    9,684    9,633    9,946 
Income before income tax provision   5,116    7,748    6,697    6,702 
Income tax provision   741    1,377    1,111    1,021 
Net income  $4,375   $6,371   $5,586   $5,681 
Net income attributable to common shares  $4,352   $6,339   $5,558   $5,654 
Net income per share – basic  $0.36   $0.52   $0.45   $0.46 
Net income per share – diluted  $0.36   $0.52   $0.45   $0.46 

 

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21. FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS

 

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

 

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

 

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

 

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

 

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

 

At December 31, 2019 and 2018, assets measured at fair value and the valuation methods used are as follows:

 

       December 31, 2019     
   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   $17,000   $0   $17,000 
Obligations of states and political subdivisions:                    
Tax-exempt   0    70,760    0    70,760 
Taxable   0    36,303    0    36,303 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                    
Residential pass-through securities   0    59,210    0    59,210 
Residential collateralized mortgage obligations   0    114,723    0    114,723 
Commercial mortgage-backed securities   0    48,727    0    48,727 
Total available-for-sale debt securities   0    346,723    0    346,723 
Marketable equity security   979    0    0    979 
Servicing rights   0    0    1,277    1,277 
Total recurring fair value measurements  $979   $346,723   $1,277   $348,979 
                     

Nonrecurring fair value measurements

                    
Impaired loans with a valuation allowance  $0   $0   $3,375   $3,375 
Valuation allowance   0    0    (1,051)   (1,051)
Impaired loans, net   0    0    2,324    2,324 
Foreclosed assets held for sale   0    0    2,886    2,886 
Total nonrecurring fair value measurements  $0   $0   $5,210   $5,210 

 

81

 

 

       December 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   $12,500   $0   $15,500 
Obligations of states and political subdivisions:                    
Tax-exempt   0    83,952    0    83,952 
Taxable   0    27,699    0    27,699 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                    
Residential pass-through securities   0    53,445    0    53,445 
Residential collateralized mortgage obligations   0    145,912    0    145,912 
Commercial mortgage-backed securities   0    39,765    0    39,765 
Total available-for-sale debt securities   0    363,273    0    363,273 
Marketable equity security   950    0    0    950 
Servicing rights   0    0    1,404    1,404 
Total recurring fair value measurements  $950   $363,273   $1,404   $365,627 
                     
Nonrecurring fair value measurements                    
Impaired loans with a valuation allowance  $0   $0   $4,851   $4,851 
Valuation allowance   0    0    (1,605)   (1,605)
Impaired loans, net   0    0    3,246    3,246 
Foreclosed assets held for sale   0    0    1,703    1,703 
Total nonrecurring fair value measurements  $0   $0   $4,949   $4,949 

 

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. The following table shows quantitative information regarding significant techniques and inputs used at December 31, 2019 and 2018 for servicing rights assets measured using unobservable inputs (Level 3 methodologies) on a recurring basis:

 

   Fair Value at              
   12/31/19   Valuation  Unobservable      Method or Value As of
Asset  (In Thousands)   Technique  Input(s)      12/31/19
Servicing rights  $1,277   Discounted cash flow  Discount rate   12.50%  Rate used through modeling period
           Loan prepayment speeds    183.00%  Weighted-average PSA of loan balances of payments are late late fees assessed
           Servicing fees   0.25%   
               4.00%   
               5.00%   
              $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 of loans more than 30 days delinquent annual increase in servicing costs
               1.50%   
               3.00%   

 

82

 

 

   Fair Value at              
   12/31/18   Valuation  Unobservable      Method or Value As of
Asset  (In Thousands)   Technique  Input(s)      12/31/18
Servicing rights  $1,404   Discounted cash flow  Discount rate   12.50%  Rate used through modeling period
           Loan prepayment speeds   114.00%  Weighted-average PSA of loan balances of payments are late late fees assessed
           Servicing fees   0.25%   
               4.00%   
               5.00%   
              $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 of loans more than 30 days delinquent annual increase in servicing costs
               1.50%   
               3.00%   

 

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

 

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

 

   Years Ended December 31, 
(In Thousands)  2019   2018 
Balance, beginning of period  $1,404   $1,299 
Issuances of servicing rights   204    188 
Unrealized losses included in earnings   (331)   (83)
Balance, end of period  $1,277   $1,404 

 

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

 

At December 31, 2019 and 2018, 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 Percentages)
Asset
  Balance at
12/31/19
   Valuation
Allowance at
12/31/19
   Fair Value at
12/31/19
   Valuation
Technique
  Unobservable
Inputs
  Weighted-
Average
Discount at
12/31/19
 
Impaired loans:                          
Residential mortgage loans - first and junior liens  $732   $176   $556   Sales comparison  Discount to appraised value   30%
Commercial:                          
Commercial and industrial   106    89    17   Sales comparison  Discount to appraised value   69%
Commercial and industrial   798    60    738   Liquidation of accounts receivable  Discount to borrower's financial statement value   15%
Commercial construction and land   1,261    678    583   Sales comparison  Discount to appraised value   47%
Loans secured by farmland   478    48    430   Sales comparison  Discount to appraised value   46%
Total impaired loans  $3,375   $1,051   $2,324            
Foreclosed assets held for sale - real estate:                          
                           
Residential (1-4 family)  $292   $0   $292   Sales comparison  Discount to appraised value   46%
Land   70    0    70   Sales comparison  Discount to appraised value   53%
Commercial real estate   2,524    0    2,524   Sales comparison  Discount to appraised value   39%
Total foreclosed assets held for sale  $2,886   $0   $2,886            

 

83

 

 

(In Thousands, Except Percentages)
Asset
  Balance at
12/31/18
   Valuation
Allowance at
12/31/18
   Fair Value at
12/31/18
   Valuation
Technique
  Unobservable
Inputs
  Weighted-
Average
Discount at

12/31/18
 
Impaired loans:                          
Residential mortgage loans - first liens                          
   $509   $116   $393   Sales comparison  Discount to appraised value   26%
Commercial:                          
Commercial loans secured by real estate   2,515    781    1,734   Sales comparison  Discount to appraised value   16%
Commercial and industrial   75    75    0   Sales comparison  Discount to appraised value   100%
Commercial and industrial   1,265    584    681   Sales comparison  Discount to borrower's financial statement value   36%
Loans secured by farmland   487    49    438   Sales comparison  Discount to appraised value   56%
Total impaired loans  $4,851   $1,605   $3,246            
Foreclosed assets held for sale - real estate:                          
Residential (1-4 family)  $64   $0   $64   Sales comparison  Discount to appraised value   68%
Land   110    0    110   Sales comparison  Discount to appraised value   61%
Commercial real estate   1,529    0    1,529   Sales comparison  Discount to appraised value   20%
Total foreclosed assets held for sale  $1,703   $0   $1,703            

 

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

 

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

 

   Valuation   December 31, 2019   December 31, 2018 
   Method(s)   Carrying   Fair   Carrying   Fair 
(In Thousands)  Used   Amount   Value   Amount   Value 
Financial assets:                         
Cash and cash equivalents   Level 1   $31,122   $31,122   $32,827   $32,827 
Certificates of deposit   Level 2    4,080    4,227    4,660    4,634 
Restricted equity securities (included in Other Assets)   Level 2    10,321    10,321    5,712    5,712 
Loans, net   Level 3    1,172,386    1,181,000    818,254    825,809 
Accrued interest receivable   Level 2    5,001    5,001    3,968    3,968 
                          
Financial liabilities:                         
Deposits with no stated maturity   Level 2    877,965    877,965    804,207    804,207 
Time deposits   Level 2    374,695    376,738    229,565    229,751 
Short-term borrowings   Level 2    86,220    86,166    12,853    12,617 
Long-term borrowings   Level 2    52,127    52,040    35,915    35,902 
Accrued interest payable   Level 2    311    311    142    142 

 

84

 

 

Report of Independent Registered Public Accounting Firm

 

Stockholders and Board of Directors of
Citizens & Northern Corporation

 

Opinions on the Financial Statements and Internal Control over Financial Reporting

 

We have audited the accompanying consolidated balance sheets of Citizens & Northern Corporation and subsidiaries (collectively the "Corporation") as of December 31, 2019 and 2018, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows, for the years then ended, and the related notes (collectively referred to as the "consolidated financial statements"). We also have audited the Corporation’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).

 

In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Corporation as of December 31, 2019 and 2018, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control – Integrated Framework: (2013) issued by COSO.

 

Basis for Opinions

 

The Corporation’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Corporation's consolidated financial statements and an opinion on the Corporation’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud and whether effective internal control over financial reporting was maintained in all material respects.

 

Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

As described in Management’s Report on Internal Control over Financial Reporting, management excluded from its assessment of internal control over financial reporting Monument Bancorp, Inc., which was acquired on April 1, 2019, and whose financial statements constitute assets of approximately 19.8% of the Corporation’s consolidated total assets, and interest income and noninterest income of approximately 14.3% of the Corporation’s consolidated total interest income and noninterest income, as of and for the year ended December 31, 2019. Accordingly, our audit did not include the internal control over financial reporting of Monument Bancorp, Inc.

 

85 

 

 

Definition and Limitations of Internal Control Over Financial Reporting

 

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

We have served as the Corporation’s auditor since 1979.

 

Williamsport, Pennsylvania

February 20, 2020

 

86 

 

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None

 

ITEM 9A. CONTROLS AND PROCEDURES

 

EVALUATION OF DISCLOSURE 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. This evaluation did not include an assessment of those disclosure controls and procedures that are involved in, and did not include an assessment of, internal control over financial reporting as it relates to Monument Bancorp, Inc. 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.

 

Except as described in the following paragraph, 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.

 

The Monument Bancorp, Inc. acquisition was completed April 1, 2019, and during the last three quarters of 2019 the Corporation has been engaged in integrating processes and internal control over financial reporting for the former Monument locations into those of the Corporation. In late June 2019, the integration of Monument’s core customer data system into the Corporation’s system was completed. Though completion of the Monument core system conversion was a significant milestone, at December 31, 2019, the Corporation’s management had not yet completed changes to processes, information technology systems and other components of internal control over financial reporting as part of integration activities.

 

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

 

The Corporation’s management is responsible for establishing and maintaining effective internal control over financial reporting, as that term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). The Corporation’s system of internal control over financial reporting has been designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation and fair presentation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. The Corporation’s internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Corporation’s assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Corporation are being made only in accordance with authorizations of the Corporation’s management and directors; and (3) provide reasonable assurance regarding prevention, or timely detection and correction of unauthorized acquisition, use or disposition of the Corporation’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect and correct misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.

 

The Corporation’s management assessed the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2019, based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control – Integrated Framework (2013). Based on that assessment, we concluded that, as of December 31, 2019, the Corporation’s internal control over financial reporting is effective based on the criteria established in Internal Control – Integrated Framework (2013).

 

The Corporation acquired Monument Bancorp, Inc. (“Monument”) effective April 1, 2019. Management excluded from its assessment of the Corporation’s internal control over financial reporting, as of December 31, 2019, Monument’s internal control over financial reporting associated with assets of approximately 19.8% of the Corporation’s consolidated total assets, and interest income and noninterest income of approximately 14.3% of the Corporation’s consolidated total interest income and noninterest income, as of and for the year ended December 31, 2019.

 

87 

 

 

Baker Tilly Virchow Krause, LLP, the independent registered public accounting firm that audited the Corporation’s consolidated financial statements, has issued an audit report on the Corporation’s internal control over financial reporting as of December 31, 2019. That report appears immediately prior to this report.

 

February 20, 2020 By: /s/ J. Bradley Scovill
Date   President and Chief Executive Officer
     
     
February 20, 2020 By: /s/ Mark A. Hughes
Date   Treasurer and Chief Financial Officer

 

ITEM 9B. OTHER INFORMATION

 

There was no information the Corporation was required to disclose in a report on Form 8-K during the fourth quarter 2019 that was not disclosed.

 

PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

Information concerning Directors and Executive Officers is incorporated herein by reference to disclosure under the captions “Proposal 1 - Election of Directors,” “Executive Officers,” “Information Concerning Security Ownership” and “Meetings and Committees of the Board of Directors” of the Corporation’s proxy statement dated March 6, 2020 for the annual meeting of stockholders to be held on April 16, 2020.

 

The Corporation’s Board of Directors has adopted a Code of Ethics, available on the Corporation’s web site at www.cnbankpa.com for the Corporation’s employees, officers and directors. (The provisions of the Code of Ethics are also included in the Corporation’s employee handbook.)

 

ITEM 11. EXECUTIVE COMPENSATION

 

Information concerning executive compensation is incorporated herein by reference to disclosure under the captions “Compensation Discussion and Analysis” and “Executive Compensation Tables” of the Corporation’s proxy statement dated March 6, 2020 for the annual meeting of stockholders to be held on April 16, 2020.

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference to disclosure under the caption “Beneficial Ownership of Executive Officers and Directors” of the Corporation’s proxy statement dated March 6, 2020 for the annual meeting of stockholders to be held on April 16, 2020.

 

“Equity Compensation Plan Information” as required by Item 201(d) of Regulation S-K is incorporated by reference herein from Item 5 (Market for Registrant’s Common Equity and Related Stockholder Matters) of this Form 10-K.

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

Information concerning loans and deposit balances with Directors and Executive Officers is provided in Note 15 to the Consolidated Financial Statements, which is included in Part II, Item 8 of this Annual Report on Form 10-K. Additional information, including information concerning director independence, is incorporated herein by reference to disclosure appearing under the captions “Director Independence” and "Related Person Transaction and Policies" of the Corporation's proxy statement dated March 6, 2020 for the annual meeting of stockholders to be held on April 16, 2020.

 

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

Information concerning services provided by the Corporation’s independent auditor Baker Tilly Virchow Krause, LLP, the audit committee’s pre-approval policies and procedures for such services, and fees paid by the Corporation to that firm, is incorporated herein by reference to disclosure under the caption “Fees of Independent Public Accountants” of the Corporation’s proxy statement dated March 6, 2020 for the annual meeting of stockholders to be held on April 16, 2020.

 

88 

 

 

PART IV

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

(a) (1). The following consolidated financial statements are set forth in Part II, Item 8:

 

  Page
Report of Independent Registered Public Accounting Firm 85-86
 
Financial Statements:  
Consolidated Balance Sheets - December 31, 2019 and 2018 37
Consolidated Statements of Income - Years Ended December 31, 2019 and 2018 38
Consolidated Statements of Comprehensive Income - Years Ended December 31, 2019 and 2018 39
Consolidated Statements of Changes in Stockholders' Equity - Years Ended December 31, 2019 and 2018 40
Consolidated Statements of Cash Flows - Years Ended December 31, 2019 and 2018 41
Notes to Consolidated Financial Statements 42-84

 

(a)(2) Financial statement schedules are not applicable or included in the financial statements or related notes.

 

 2. Plan of acquisition, reorganization, arrangement, liquidation or succession:    
     
2.1 Agreement and Plan of Merger dated September 27, 2018, between the Corporation and Monument Bancorp, Inc. Incorporated by reference to Exhibit 2.1 of the Corporation’s Form 8-K filed September 28, 2018  
   
       
2.2 Agreement and Plan of Merger dated December 18, 2019, between the Corporation and Covenant Financial, Inc. Incorporated by reference to Exhibit 2.1 of the Corporation’s Form 8-K filed December 18, 2019    
       
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. (i) through (v) Instruments defining the rights

Of securities holders, including indentures

Not applicable
   
4. (vi) Description of registrant’s securities Filed herewith
   
9. Voting trust agreement Not applicable    
       
10. Material contracts:      
       

10.1 Form of Time-Based Restricted Stock agreement dated January 31, 2020 between the Corporation and Executive Officers pursuant to the Citizens & Northern Corporation Stock Incentive Plan

Filed herewith

   
       

10.2 Form of Restricted Stock agreement dated January 31, 2020 between the Corporation and its independent directors pursuant to the Citizens & Northern Corporation Independent Directors Stock Incentive Plan

Filed herewith

 

   
       
10.3 2020 Annual Performance Incentive Award Plan Filed herewith    
       

10.4 2020 Annual Performance Incentive Award Plan - Mortgage Lenders

 

Filed herewith

   

 

89

 

 

10.5 Deferred Compensation Agreement dated December 17, 2015 Incorporated by reference to Exhibit 10.8 filed with Corporation’s 10-K on February 15, 2018  
 
     
10.6 Second Amendment to Employment Agreement dated August 24, 2018 between the Corporation and J. Bradley Scovill Incorporated by reference to Exhibit 10.1 filed with Corporation’s Form 8-K on August 24, 2018  
 
 
     
10.7 First Amendment to Employment Agreement dated June 26, 2017 between the Corporation and J. Bradley Scovill Incorporated by reference to Exhibit 10.1 filed with Corporation’s Form 8-K on June 27, 2017  
 
 
     
10.8 Employment agreement dated March 2, 2015 between the Corporation and J. Bradley Scovill Incorporated by reference to Exhibit 10.1 filed with Corporation’s Form 8-K on February 9, 2015  
     
     
10.9 Employment agreement dated September 19, 2013 Corporation’s Form 8-K on September 19, 2013 between the Corporation and Mark A. Hughes Incorporated by reference to Exhibit 10.2 filed with  
     
10.10 Employment agreement dated September 19, 2013 Corporation’s Form 8-K on September 19, 2013 between the Corporation and Harold F. Hoose, III Incorporated by reference to Exhibit 10.3 filed with  
     

10.11 Employment agreement dated September 19, 2013 Corporation’s Form 8-K on September 19, 2013 between the Corporation and Deborah E. Scott

Incorporated by reference to Exhibit 10.4 filed with  
     

10.12 Form of Indemnification Agreement dated September 20, 2018 between the Corporation and J. Bradley Scovill

Incorporated by reference to Exhibit 10.1 filed with Corporation’s Form 10-Q on November 1, 2018

     

10.13 Form of Indemnification Agreement dated January 9, 2018 between the Corporation and Tracy E. Watkins

Incorporated by reference to Exhibit 10.6 filed with Corporation’s 10-K on February 15, 2018

 
     

10.14 Form of Indemnification Agreement dated February 11, 2015 between the Corporation and Stan R. Dunsmore

Incorporated by reference to Exhibit 10.9 filed with Corporation’s 10-K on February 26, 2015

 
     

10.15 Form of Indemnification Agreement dated January 2, 2013 between the Corporation and Shelley L. D'Haene

Incorporated by reference to Exhibit 10.5 filed with Corporation’s Form 10-K on February 21, 2013

 
     

10.16 Form of Indemnification Agreement dated January 19, 2011 between the Corporation and John M. Reber

Incorporated by reference to Exhibit 10.6 filed with Corporation's Form 10-K on Feb. 28, 2011

 
     

10.17 Form of Indemnification Agreements dated May 2004 between the Corporation and the Directors and certain officers

Incorporated by reference to Exhibit 10.1 filed with Corporation’s 10-K on March 14, 2005

 
     

10.18 Change in Control Agreement dated January 9, 2018 between the Corporation and Tracy E. Watkins

Incorporated by reference to Exhibit 10.7 filed with Corporation’s 10-K on February 15, 2018

 
     

10.19 Change in Control Agreement dated March 17, 2015 between the Corporation and Stan R. Dunsmore

Incorporated by reference to Exhibit 10.1 filed with Corporation’s Form 10-Q on May 8, 2015

 
     

10.20 Change in Control Agreement dated January 2, 2013 between the Corporation and Shelley L. D'Haene

Incorporated by reference to Exhibit 10.7 filed with Corporation’s Form 10-K on February 21, 2013

 
     

10.21 Change in Control Agreement dated January 20, 2005 between the Corporation and John M. Reber

Incorporated by reference to Exhibit 10.18 filed with Corporation’s Form 10-K on February 18, 2016

 

  

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10.22 Change in Control Agreement dated December 31, 2003 between the Corporation and Thomas L. Rudy, Jr.

Incorporated by reference to Exhibit 10.2 filed with the Corporation's Form 10-K on March 14, 2005

 
 
     

10.23 Executive Compensation Recoupment Policy dated September 19, 2013

Incorporated by reference to Exhibit 10.5 filed with Corporation’s Form 8-K on September 19, 2013

 
     

10.24 Fifth Amendment to Citizens & Northern Corporation Stock Incentive Plan

Incorporated by reference to Exhibit 10.1 filed with Form 8-K on December 21, 2018

 
     
10.25 Fourth Amendment to Citizens & Northern Corporation Stock Incentive Plan and Annual Incentive Plan

Incorporated by reference to Exhibit 10.6 filed with Corporation's Form 8-K on September 19, 2013

 
     

10.26 Third Amendment to Citizens & Northern Corporation Stock Incentive Plan

Incorporated by reference to Exhibit A to the Corporation's proxy statement dated March 18, 2008 for the annual meeting of stockholders held on April 15, 2008

 
     

10.27 Second Amendment to Citizens & Northern Corporation Stock Incentive Plan

Incorporated by reference to Exhibit 10.5 filed with the Corporation's Form 10-K on March 10, 2004

 
     

10.28 First Amendment to Citizens & Northern Corporation Stock Incentive Plan

Incorporated by reference to Exhibit 10.6 filed with the Corporation's Form 10-K on March 10, 2004

 
     

10.29 Citizens & Northern Corporation Stock Incentive Plan 

Incorporated by reference to Exhibit 10.7 filed with the Corporation's Form 10-K on March 10, 2004

 
     

10.30 Second Amendment to Citizens & Northern Independent Directors Stock incentive Plan

Incorporated by reference to Exhibit 10.2 filed with Form 8-K on December 21, 2018

 
     

10.31 First Amendment to Citizens & Northern Corporation Independent Directors Stock Incentive Plan

Incorporated by reference to Exhibit B to the Corporation's proxy statement dated March 18, 2008 for the annual meeting of stockholders held on April 15, 2008

 
     
10.32 Citizens & Northern Corporation Independent Directors Stock Incentive Plan

Incorporated by reference to Exhibit A to the Corporation's proxy statement dated March 19, 2001 for the annual meeting of stockholders held on April 17, 2001.

 
     

10.33 Citizens & Northern Corporation Supplemental Executive Retirement Plan (as amended and restated)

Incorporated by reference to Exhibit 10.21 filed with the Corporation's Form 10-K on March 6, 2009

 
     
10.34 Form of Indemnification Agreements dated May 24, 2018 between the Corporation and Directors Bobbi J. Kilmer, Terry L. Lehman, Frank G. Pellegrino and Aaron K. Singer

Incorporated by reference to Exhibit 10.1 of the Corporation’s Form 10-Q filed August 6, 2018

 

 
     

11. Statement re: computation of per share earnings 

Information concerning the computation of earnings per share is provided in Note 4 to the Consolidated Financial Statements, which is included in Part II, Item 8 of Form 10-K

 
     
12. Statements re: computation of ratios Not applicable  
     

13. Annual report to security holders, Form 10-Q or quarterly report to security holders

Not applicable

 
     

14. Code of ethics

The Code of Ethics is available through the Corporation's website at www.cnbankpa.com. To access the Code of Ethics, click on “About,” “Investor Relations,” “Corporate Governance Policies,” and “Code of Ethics.”

 

 

91

 

 

16. Letter re: change in certifying accountant Not applicable  
     
18. Letter re: change in accounting principles Not applicable  
     
21. Subsidiaries of the registrant Filed herewith  
     

22. Published report regarding matters submitted to

vote of security holders

Not applicable    

 

 
 
     
23. Consent of Independent Registered Public Accounting Firm Filed herewith  
     
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  
     

33. Report on assessment of compliance with servicing criteria for

asset-backed securities

 

Not applicable

 
     

34. Attestation report on assessment of compliance with servicing

criteria for asset-backed securities

 

Not applicable

 
     
35. Service compliance statement Not applicable  
     
99. Additional exhibits:    
     

99.1 Additional information mailed or made available online to

shareholders with proxy statement and Form 10-K on

March 6, 2020

Filed herewith

 

 

 
     
100. XBRL-related documents Not applicable  
     
101. Interactive data file Filed herewith  
     
104. Cover page interactive data file Not applicable  

 

92

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated.

 

By: /s/ J. Bradley Scovill  
President and Chief Executive Officer  
   
Date: February 20, 2020  
   
By: /s/ Mark A. Hughes  
Treasurer and Principal Accounting Officer  
   
Date: February 20, 2020  
   

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

BOARD OF DIRECTORS

 

/s/ Dennis F. Beardslee /s/ Frank G. Pellegrino
  Dennis F. Beardslee   Frank G. Pellegrino
  Date: February 20, 2020   Date: February 20, 2020
       
/s/ Clark S. Frame /s/ Timothy E. Schoener
  Clark S. Frame   Timothy E. Schoener
  Date: February 20, 2020   Date: February 20, 2020
       
/s/ Susan E. Hartley /s/ J. Bradley Scovill
  Susan E. Hartley   J. Bradley Scovill
  Date: February 20, 2020   Date: February 20, 2020
       
/s/ Bobbi J. Kilmer /s/ Leonard Simpson
  Bobbi J. Kilmer   Leonard Simpson
  Date: February 20, 2020   Date: February 20, 2020
       
/s/ Leo F. Lambert /s/ Aaron K. Singer
  Leo F. Lambert   Aaron K. Singer
  Date: February 20, 2020   Date: February 20, 2020
       
/s/ Terry L. Lehman    
  Terry L. Lehman    
  Date: February 20, 2020    

 

93