JUNIATA VALLEY FINANCIAL CORP - Quarter Report: 2008 March (Form 10-Q)

using derivative instruments and does not engage in hedging activities, but is evaluating the potential impact the new pronouncement will have on its consolidated financial statements.

In February 2008, the FASB issued a FASB Staff Position (FSP) FAS 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions.” This FSP addresses the issue of whether or not these transactions should be viewed as two separate transactions or as one “linked” transaction. The FSP includes a “rebuttable presumption” that presumes linkage of the two transactions unless the presumption can be overcome by meeting certain criteria. The FSP will be effective for fiscal years beginning after November 15, 2008 and will apply only to original transfers made after that date; early adoption will not be allowed. The Company does not believe that there will be an impact of the new pronouncement on its consolidated financial statements.

NOTE C — Comprehensive Income

U.S. generally accepted accounting principles require that recognized revenue, expenses, gains, and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the consolidated balance sheets, such items, along with net income, are components of comprehensive income.

The components of comprehensive income and related tax effects are as follows (in thousands):

		Three Months Ended March 31, 2008												Three Months Ended March 31, 2007
		Before				Tax Expense								Before				Tax Expense
		Tax				or				Net-of-Tax				Tax				or				Net-of-Tax
		Amount				(Benefit)				Amount				Amount				(Benefit)				Amount
Net income		$	1,941			$	539			$	1,402			$	1,782			$	503			$	1,279
Other comprehensive income:
Unrealized gains on available for sale securities:
Unrealized gains arising during the period			621				211				410				64				21				43
Unrealized gains from unconsolidated subsidiary			13								13												—
Less reclassification adjustment for:
gains included in net income			(13	)			(4	)			(9	)			—				—				—
Other comprehensive income			621				207				414				64				21				43
Total comprehensive income		$	2,562			$	746			$	1,816			$	1,846			$	524			$	1,322

NOTE D — Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per share:

(Amounts, except earnings per share, in thousands)
		Three Months				Three Months
		Ended				Ended
		March 31, 2008				March 31, 2007
Net income		$	1,402			$	1,279
Weighted-average common shares outstanding			4,403				4,450
Basic earnings per share		$	0.32			$	0.29
Weighted-average common shares outstanding			4,403				4,450
Common stock equivalents due to effect of stock options			10				10
Total weighted-average common shares and equivalents			4,413				4,460
Diluted earnings per share		$	0.32			$	0.29

NOTE E — Commitments, Contingent Liabilities and Guarantees

In the ordinary course of business, the Corporation makes commitments to extend credit to its customers through letters of credit, loan commitments and lines of credit. At March 31, 2008, the Corporation had $53,006,000 outstanding in loan commitments and other unused lines of credit extended to its customers as compared to $51,371,000 at December 31, 2007.

The Corporation does not issue any guarantees that would require liability recognition or disclosure, other than its letters of credit. Letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Generally, all letters of credit have expiration dates within one year of issuance. The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers. The Corporation generally holds collateral and/or personal guarantees supporting these commitments. The Corporation had $684,000 and $718,000 of letters of credit commitments as of March 31, 2008 and December 31, 2007, respectively. Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payments required under the corresponding guarantees. The current amount of the liability as of March 31, 2008 for payments under letters of credit issued was not material.

NOTE F — Defined Benefit Retirement Plan

The Corporation has a defined benefit retirement plan covering substantially all of its employees. The benefits are based on years of service and the employees’ compensation. The Corporation’s funding policy is to contribute annually the maximum amount that can be deducted for federal income taxes purposes. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. The Corporation has contributed $50,000 in the first three months of 2007 and expects to contribute a total of $200,000 to the defined benefit plan in 2008.

Pension expense included the following components for the three month periods ended March 31, 2008 and 2007:

		Three Months Ended
		March 31,
(Dollar amounts in thousands)		2008				2007
Components of net periodic pension cost
Service cost		$	45			$	74
Interest cost			110				99
Expected return on plan assets			(106	)			(90	)
Additional recognized amounts			9				13
Net periodic pension cost		$	58			$	96

On August 21, 2007, the Board of Directors of the Corporation (Board) approved a proposal to close the defined benefit retirement plan to new entrants as of January 1, 2008. The Board also approved changes to the Corporation’s defined contribution plan as of January 1, 2008 that allow for employer contributions. In the first three months of 2008, the Corporation recorded an expense of $38,000 as an accrual for such employer contributions.

NOTE G- Acquisition

In 2006, the Corporation acquired a branch office in Richfield, PA. The acquisition included real estate, deposits and loans. The assets and liabilities of the acquired business were recorded on the consolidated balance sheet at their estimated fair values as of September 8, 2006, and their results of operations have been included in the consolidated statements of income since such date.

Included in the purchase price of the branch was goodwill and core deposit intangible of $2,046,000 and $449,000, respectively. The core deposit intangible is being amortized over a ten-year period on a straight line basis. During the first three months of 2008 and 2007, amortization expense was $11,000. Accumulated amortization of core deposit intangible through March 31, 2008 was $71,000. The goodwill is not amortized, but is measured annually for impairment.

NOTE H — Investment in Unconsolidated Subsidiary

The Corporation owns 39.16% of the outstanding common stock of The First National Bank of Liverpool (FNBL), Liverpool, PA. This investment is accounted for under the equity method of accounting, as defined in Accounting Principles Board Opinion No. 18. The investment is being carried at $3,027,000 as of March 31, 2008, of which $2,018,000 represents the underlying equity in net assets of FNBL. The difference between the investment carrying amount and the amount of the underlying equity, $1,009,000, is considered to be goodwill and is being evaluated quarterly for impairment. A loss in value of the investment which is other than a temporary decline will be recognized. Evidence of a loss in value might include, but would not necessarily be limited to, absence of an ability to recover the carrying amount of the investment or inability of FNBL to sustain an earnings capacity which would justify the carrying amount of the investment.

NOTE I — Fair Value Measurements

Effective January 1, 2008, the Corporation adopted the provisions of SFAS No 157, “Fair Value Measurements” for financial assets and financial liabilities. In accordance with FASB Staff Position (FSP) No. 157-2, “Effective Date of FASB Statement No. 157”, the Corporation will delay application of SFAS 157 for non-financial assets and non-financial liabilities until January 1, 2009. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements.

SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

SFAS 157 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, SFAS 157 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

Level 1 Inputs — Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

Level 2 Inputs — Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities,

prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

Level 3 Inputs — Unobservable inputs for determining the fair values of assets or liabilities that reflect on entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Corporation’s financial assets and financial liabilities carried at fair value effective January 1, 2008.

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

Securities Available for Sale. Securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Corporation obtains fair value measurement from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data , market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

Impaired Loans. Certain impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using Level 3 inputs based on customized discounting criteria.

The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of March 31, 2008, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (in thousands).

		Level 1				Level 2				Level 3				Total Fair
		Inputs				Inputs				Inputs				Value
Securities available for sale			—			$	59,081				—			$	59,081

Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Financial assets and liabilities measured at fair value on a non-recurring basis were not significant at March 31, 2008.

Certain non-financial assets and non-financial liabilities measured at fair value on a recurring basis include reporting units measured at fair value in the first step of a goodwill impairment test. Certain non-financial assets measured at fair value on a non-recurring basis include non-financial assets and non-financial liabilities measured at fair value in the second step of a goodwill impairment test, as well as intangible assets and other non-financial long-lived assets measured at fair value for impairment assessment. As stated above, SFAS 157 will be applicable to these fair value measurements beginning January 1, 2009.

Effective January 1, 2008, the Corporation adopted the provisions of SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115.” SFAS 159 permits the Corporation to choose to measure eligible items at fair value at specified election dates. Unrealized gains and

Financial Condition:

As of March 31, 2008, total assets increased by $4,795,000, or 1.1%, as compared to December 31, 2007. The increase was primarily funded by a $4.2 million increase in deposits. Of the increase in deposits, 78% was interest-bearing in nature. The deposit increases were primarily used to fund loan growth, with the excess invested in federal funds.

The table below shows changes in deposit volumes by type of deposit (in thousands of dollars) between December 31, 2007 and March 31, 2008. Only the category of NOW and money market accounts had a decrease, and we believe that, in the recent declining rate environment, some of our customer base has chosen to lock in rates in savings and time deposit instruments to protect their yield.

		March 31,				December 31,				Change
		2008				2007				$				%
Deposits:
Demand, non-interest bearing		$	49,686			$	48,755			$	931				1.9	%
NOW and money market			70,202				74,821				(4,619	)			(6.2	%)
Savings			36,154				33,877				2,277				6.7	%
Time deposits, $100,000 and more			39,158				36,308				2,850				7.8	%
Other time deposits			168,457				165,696				2,761				1.7	%
Total deposits		$	363,657			$	359,457			$	4,200				1.2	%

Overall, loans, net of unearned interest, increased by $2,764,000, or 0.9%, between December 31, 2007 and March 31, 2008. As shown in the table below, the increase in outstanding loans since December 31, 2007 has been related to mortgage activity, supplemented by increases in loans made to local municipalities (in thousands of dollars).

		March 31,				December 31,				Change
		2008				2007				$				%
Loans:
Commercial		$	92,511			$	91,679			$	832				0.9	%
Mortgage			129,268				127,324				1,944				1.5	%
Home Equity , net of unearned			63,601				63,678				(77	)			(0.1	%)
Installment			15,384				15,319				65				0.4	%
Total loans		$	300,764			$	298,000			$	2,764				0.9	%

A summary of the transactions in the allowance for loan losses for each of the three months ended March 31, 2008 and 2007 (in thousands) are presented below.

		Periods Ended March 31,
		2008				2007
Balance of allowance — January 1		$	2,322			$	2,572
Loans charged off			(25	)			(56	)
Recoveries of loans previously charged off			11				15
Net charge-offs			(14	)			(41	)
Provision for loan losses			32				67
Balance of allowance — end of period		$	2,340			$	2,598
Ratio of net charge-offs during period to average loans outstanding			0.00	%			0.01	%

As of March 31, 2008, the Corporation had one large loan relationship, with a carrying balance of $341,000, considered to be impaired for which there is a specific allocation of $36,000 within the loan loss reserve; management believes that the reserve is adequate to cover potential future losses related to this relationship. There are two other

significant loan relationships considered to be impaired, totaling $1,111,000, but for which there is no specific allocation within the allowance for loan losses. Otherwise, there are no material loans classified for regulatory purposes as loss, doubtful, substandard, or special mention which management expects to significantly impact future operating results, liquidity or capital resources. Following is a summary of the Bank’s non-performing loans on March 31, 2008 as compared to December 31, 2007.

(Dollar amounts in thousands)		March 31, 2008				December 31, 2007
Non-performing loans
Nonaccrual loans		$	766			$	—
Accruing loans past due 90 days or more			659				837
Restructured loans			—				—
Total		$	1,425			$	837
Average loans outstanding		$	298,944			$	300,607
Ratio of non-performing loans to average loans outstanding			0.48	%			0.28	%

Stockholders’ equity increased by $253,000, or 0.5%, from December 31, 2007 to March 31, 2008. Net income of $1,402,000 was offset by dividends of $793,000 and net purchases of treasury stock of $302,000. The Corporation repurchased stock into treasury pursuant to its stock repurchase program. During the first three months of 2008, the Corporation purchased 14,525 shares. Securities available for sale increased in market value, representing an increase to equity of $414,000, net of taxes, during the period, which was offset by a reduction in equity of $480,000 as a result of the adoption of the post-retirement split-dollar accounting treatment prescribed under EITF 06-4.

Management is not aware of any current recommendations of applicable regulatory authorities that, if implemented, would have a material effect on the Corporation’s liquidity, capital resources, or operations.

Subsequent to March 31, 2008, the following events took place:

On April 15, 2008, the Board of Directors declared a regular cash dividend for the second quarter of 2008 of $0.18 per share to shareholders of record on May 15, 2008, payable on June 2, 2008.

Comparison of the Three Months Ended March 31, 2008 and 2007

Operations Overview:

Net income for the first quarter of 2008 was $1,402,000, an increase of $123,000, or 9.6%, compared to the first quarter of 2007. Basic and diluted earnings per share increased 10.3% over the 2007 quarter, from $0.29 to $0.32. Annualized return on average equity for the first quarter in 2008 was 11.60%, comparing favorably to the prior year’s ratio for the same period of 10.64%, an increase of 9.0%. For the quarter ended March 31, annualized return on average assets was 1.34% in 2008, versus 1.23% in 2007, reflecting an increase of 8.9%. The increase in net income was primarily a result of higher net interest income and non-interest income, partially offset by an increase in non-interest expense.

Presented below are selected key ratios for the two periods:

		Three Months Ended
		March 31
		2008				2007
Return on average assets (annualized)			1.34	%			1.23	%
Return on average equity (annualized)			11.60	%			10.64	%
Average equity to average assets			11.52	%			11.53	%
Non-interest income, excluding securities gains, as a percentage of average assets (annualized)			1.07	%			0.99	%
Non-interest expense as a percentage of average assets (annualized)			2.90	%			2.85	%

The discussion that follows further explains changes in the components of net income when comparing the first quarter of 2008 with the first quarter of 2007.

Net Interest Income:

Net interest income was $3,882,000 for the first quarter of 2008, as compared to $3,779,000 in the same quarter in 2007. Levels of average earning assets were similar in both quarters, but the 300 basis point reduction in the prime and federal funds rates between March 31, 2007 and March 31, 2008, affected the cost of funding to a greater extent than the yield on earning assets in the quarter to quarter comparison.

Interest on loans decreased $94,000, or 1.7%, in the first quarter of 2008 as compared to the same period in 2007. An average weighted interest rate decrease of 8 basis points, in conjunction with a decrease of $3.2 million in the average balance of the loan portfolio, was responsible for lower interest income in comparison to the 2007 period.

Interest earned on investment securities and money market investments increased $15,000 in the first quarter of 2008 as compared to 2007, with average balances increasing $2.7 million during the period. The yield on money market investments (federal funds and interest bearing deposits) decreased by 132 basis points in the first quarter of 2008 as compared to the first quarter of 2009, due to the reduction in the federal funds target rate from 5.25% in the first quarter of 2007 to 2.25% as of March 31, 2008. However, the overall pre-tax yield on the investment securities portfolio increased during that same timeframe by 19 basis points, as a result of maturities during 2007 being reinvested at more favorable rates.

Average interest-bearing deposits and securities sold under agreements to repurchase declined by $1,700,000, while average non-interest bearing deposits grew by $3,483,000. This change in the mix of deposits, in addition to the lower general rate environment, contributed to the reduction in the cost to fund earning assets, which was reduced by 21 basis points to 2.62% in the first quarter of 2008.

Total average earning assets during the first quarter of 2008 were $381,477,000, compared to $381,956,000 during the first quarter of 2007, yielding 6.69% in 2008 versus 6.80% in 2007. Funding costs for the earning assets were 2.62% and 2.83%, for the first quarters of 2008 and 2007, respectively. Net interest margin on a fully tax-equivalent basis for the first quarter of 2008 was 4.25%. For the same period in 2007, the fully-tax equivalent net interest margin was 4.09%.

Provision for Loan Losses:

In the first quarter of 2008, the provision for loan losses was $32,000. Management regularly reviews the adequacy of the loan loss reserve and makes assessments as to specific loan impairment, historical charge-off expectations, general economic conditions in the Bank’s market area, specific loan quality and other factors. In the first quarter of 2007, the recorded loan loss provision was $67,000.

Non-interest Income:

Non-interest income in the first quarter of 2008, exclusive of gains recorded on securities, exceeded non-interest income in the previous year’s first quarter by $81,000, or 7.8%. Fees for customer service on deposit accounts in the first quarter of 2008 increased compared to the same period in 2007 by $5,000, or 1.3%, due in part to the increased demand deposit activity. Fee income from the Bank’s alternative investment program decreased by $15,000, or 6.6%, due to slightly lower sales levels in the early part of 2008. Income from bank owned life insurance and annuities increased in the first quarter of 2008 compared to the first quarter of 2007 by $20,000, or 19.2%, as a result of additional insurance policies and higher earning rates. Income from trust services increased by $6,000, or 5.1%, in the first quarter of 2008 from the first quarter of 2007, due to higher fees from estate settlements. Income from our unconsolidated subsidiary was $42,000, representing earnings recorded under the equity method of accounting for the ownership of 39.16% of the First National Bank of Liverpool during the first quarter of 2008, maintaining essentially the same level of income as in the previous year’s first quarter. Other non-interest income increased by $70,000 in the first quarter of 2008 compared to the same period in 2007. Several factors were responsible for the increase, including increased debit card activity and increased fees from the sale of title insurance. In addition, the Corporation is a VISA member bank that received funds from VISA for the partial redemption of Class B shares that were created as a result of VISA’s IPO. The redemption amount was $38,000 and was recorded as other non-interest income. The Corporation holds the remaining Class B shares that are restricted from sale for three years. During that time, VISA may redeem some or all of the remaining shares from the member banks. We believe that, if the remaining shares are not redeemed by the end of the three year period, the Class B shares will all be converted into Class A common shares that are publicly traded.

The Corporation recognized a gain of $13,000 on securities transactions in the first quarter of 2008 as compared to no gains in the same quarter of 2007.

As a percentage of average assets, annualized non-interest income, exclusive of net gains on the sale of securities, was 1.07% in the first quarter of 2008 as compared to 0.99% in the same period of 2007.

Non-interest Expense:

Total non-interest expense increased $73,000, or 2.5%, in the first quarter of 2008 as compared to 2007. Employee compensation and benefits costs increased by $101,000, or 6.3%, in the first quarter of 2008 compared to the first quarter of 2007 due to a slight staffing increase and the addition of expense associated with post-retirement benefits in the form of split-dollar insurance. Professional fees in the first quarter of 2008 were $20,000, or 19.2% lower than in the first quarter of 2007, due to fewer consulting fees.

As a percentage of average assets, annualized noninterest expense was 2.90% in the first quarter of 2008 as compared to 2.85% in the same period of 2007.

Liquidity:

The objective of liquidity management is to ensure that sufficient funding is available, at a reasonable cost, to meet the ongoing operational cash needs of the Corporation and to take advantage of income producing opportunities as they arise. While the desired level of liquidity will vary depending upon a variety of factors, it is the primary goal of the Corporation to maintain a high level of liquidity in all economic environments. Principal sources of asset liquidity are provided by securities maturing in one year or less, other short-term investments such as federal funds sold and cash and due from banks. Liability liquidity, which is more difficult to measure, can be met by attracting deposits and maintaining the core deposit base. The Corporation is a member of the Federal Home Loan Bank of Pittsburgh for the purpose of providing short-term liquidity when other sources are unable to fill these needs. During the first three months of 2008, there were no short-term borrowings from the Federal Home Loan Bank. As of March 31, 2008, the Corporation had no long-term debt and had unused borrowing capacity with the Federal Home Loan Bank of $194 million.

Funding derived from securities sold under agreements to repurchase is available through corporate cash management accounts for business customers. This product gives the Corporation the ability to pay interest on corporate checking accounts.

consistent attractive after-tax yields from dividends. The carrying value of the financial institutions stocks accounted for only 0.4% of the Corporation’s total assets. As of March 31, 2008, the Corporation has not concluded that the declines in market value of the portfolio are “other-than-temporary”, but if values continue to decline and there is an indication that the declines are “other-than-temporary”, the Corporation may be required to write-down the values of financial institution stocks in the future, depending on facts and circumstances surrounding the decrease in the fair value of each individual financial institution’s stock.

In addition to its equity portfolio, the Corporation’s investment management and trust services revenue could be impacted by fluctuations in the securities markets. A portion of the Corporation’s trust revenue is based on the value of the underlying investment portfolios. If securities values decline, the Corporation’s revenue could be negatively impacted.

Interest rate risk creates exposure in two primary areas. First, changes in rates have an impact on the Corporation’s liquidity position and could affect its ability to meet obligations and continue to grow. Second, movements in interest rates can create fluctuations in the Corporation’s net interest income and changes in the economic value of equity.

The primary objective of the Corporation’s asset-liability management process is to maximize current and future net interest income within acceptable levels of interest rate risk while satisfying liquidity and capital requirements. Management recognizes that a certain amount of interest rate risk is inherent, appropriate and necessary to ensure profitability. A simulation analysis is used to assess earnings and capital at risk from movements in interest rates. The model considers three major factors of (1) volume differences, (2) repricing differences, and (3) timing in its income simulation. As of December 31, 2007, the model disseminated data into appropriate repricing buckets, based upon the static position at that time. The interest-earning assets and interest-bearing liabilities were assigned a multiplier to simulate how much that particular balance sheet item would re-price when interest rates change. Finally, the estimated timing effect of rate changes is applied, and the net interest income effect is determined on a static basis (as if no other factors were present). As the table below indicates, based upon rate shock simulations on a static basis, the Company appears to be in a neutral position, which is slightly asset sensitive. Over a one-year period, the effect of a 100 and 200 basis point rate increase would add about $15,000 and $29,000, respectively, to net interest income. Conversely, the effect of a 100 and 200 basis point decline would result in lower net interest income by approximately the same amounts. The modeling process is continued by further estimating the impact that imbedded options and probable internal strategies may have in the changing-rate environment. Examples of imbedded options are floor and ceiling features in adjustable rate mortgages and call features on securities in the investment portfolio. Probable internal strategies would include loan and deposit pricing methodologies employed to mitigate the negative effects that certain rate environments could have on the net interest margin. For example, rate changes on certain core transaction deposits may be more likely to occur in a declining rate environment than in a rising rate environment. Applying the likely results of all known imbedded options and likely internal pricing strategies to the simulation produces quite different results from the static position assumptions. The Company becomes liability sensitive in a declining rate environment and asset sensitive in the rising rate scenario. Over a one-year period, a 100 and 200 basis point rate increase would add about $52,000 and $134,000, respectively, to net interest income. The effect of a 100 and 200 basis point decline would likewise result in higher net interest income by approximately $262,000 and $556,000, respectively. Juniata’s rate risk policies provide for maximum limits on net interest income that can be at risk for 100 through 200 basis point changes in interest rates.