Form 10-Q CITIZENS & NORTHERN CORP For: Mar 31

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

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

 

For the quarterly period ended March 31, 2018

 

or

 

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

 

For the transition period from _______________ to _________________________.

 

Commission file number: 000-16084

 

CITIZENS & NORTHERN CORPORATION

(Exact name of Registrant as specified in its charter)

 

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

 

90-92 MAIN STREET, WELLSBORO, PA 16901

(Address of principal executive offices) (Zip code)

 

570-724-3411

(Registrant's telephone number including area code)

 

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

 

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

Yes x No ¨

 

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

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

Emerging growth company ¨

 

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

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

 

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

 

Common Stock ($1.00 par value)

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

 

 

 

CITIZENS & NORTHERN CORPORATION

Index

 

Part I. Financial Information
Item 1. Financial Statements		Page 3
Consolidated Balance Sheets (Unaudited) – March 31, 2018 and December 31, 2017		Page 3
Consolidated Statements of Income (Unaudited) – Three-month Periods Ended March 31, 2018 and 2017		Page 4
Consolidated Statements of Comprehensive Income (Unaudited) - Three-month Periods Ended March 31, 2018 and 2017		Page 5
Consolidated Statements of Cash Flows (Unaudited) – Three-month Periods Ended March 31, 2018 and 2017		Page 6
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) – Three-month Periods Ended March 31, 2018 and 2017		Page 7
Notes to Unaudited Consolidated Financial Statements		Pages 8 – 34
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations		Pages 35 – 54
Item 3. Quantitative and Qualitative Disclosures About Market Risk		Pages 55 – 56
Item 4. Controls and Procedures		Page 57
Part II. Other Information		Pages 58 – 59
Signatures		Page 60
Exhibit 31.1. Rule 13a-14(a)/15d-14(a) Certification - Chief Executive Officer
Exhibit 31.2. Rule 13a-14(a)/15d-14(a) Certification - Chief Financial Officer
Exhibit 32. Section 1350 Certifications

 

 

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

 

		March 31,				December 31,
		2018				2017
ASSETS
Cash and due from banks:
Noninterest-bearing		$	18,740			$	25,664
Interest-bearing			18,120				14,580
Total cash and due from banks			36,860				40,244
Available-for-sale debt securities, at fair value			341,133				355,937
Marketable equity security			956				971
Loans held for sale			225				765
Loans receivable			817,349				815,713
Allowance for loan losses			(9,049	)			(8,856	)
Loans, net			808,300				806,857
Bank-owned life insurance			20,180				20,083
Accrued interest receivable			3,899				4,048
Bank premises and equipment, net			15,482				15,432
Foreclosed assets held for sale			1,100				1,598
Deferred tax asset, net			4,120				3,289
Intangible assets - Goodwill and core deposit intangibles			11,953				11,954
Other assets			13,908				15,781
TOTAL ASSETS		$	1,258,116			$	1,276,959
LIABILITIES
Deposits:
Noninterest-bearing		$	250,839			$	241,214
Interest-bearing			767,242				767,235
Total deposits			1,018,081				1,008,449
Short-term borrowings			26,482				61,766
Long-term borrowings			18,122				9,189
Accrued interest and other liabilities			9,049				9,112
TOTAL LIABILITIES			1,071,734				1,088,516
STOCKHOLDERS' EQUITY
Preferred stock, $1,000 par value; authorized 30,000 shares; $1,000 liquidation preference per share; no shares issued			0				0
Common stock, par value $1.00 per share; authorized 20,000,000 shares; issued 12,655,171; outstanding 12,264,284 at March 31, 2018 and 12,214,525 December 31, 2017			12,655				12,655
Paid-in capital			71,716				72,035
Retained earnings			114,953				113,608
Treasury stock, at cost; 390,887 shares at March 31, 2018 and 440,646 shares at December 31, 2017			(7,404	)			(8,348	)
Accumulated other comprehensive loss			(5,538	)			(1,507	)
TOTAL STOCKHOLDERS' EQUITY			186,382				188,443
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY		$	1,258,116			$	1,276,959

 

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

 

 

Consolidated Statements of Income

(In Thousands Except Per Share Data) (Unaudited)

 

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

 

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

 

 

Consolidated Statements of Comprehensive Income

(In Thousands)

 

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

 

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

 

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands) (Unaudited)

 

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

 

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

 

 

Consolidated Statements of Changes in Stockholders' Equity

(In Thousands Except Share and Per Share Data)

(Unaudited)

 

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

 

(a)

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

 

(b)

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

 

(c)

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

 

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

 

 

Notes to Unaudited Consolidated Financial Statements

 

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

 

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

 

The consolidated financial information included herein, with the exception of the consolidated balance sheet dated December 31, 2017, is unaudited. Such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations, comprehensive income, cash flows and changes in stockholders’ equity for the interim periods; however, the information does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for a complete set of financial statements. Certain 2017 information has been reclassified for consistency with the 2018 presentation.

 

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

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

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

 

Recent Accounting Pronouncements - Adopted

 

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

 

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

 

 

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

 

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

 

Recently Issued But Not Yet Effective Accounting Pronouncements

 

ASU 2016-02, Leases (Topic 842) changes current GAAP by requiring that lease assets and liabilities arising from operating leases be recognized on the balance sheet. Topic 842 would not significantly change the recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee from current U.S. GAAP. For leases with a term of 12 months or less, a lessee would be permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and liabilities. Topic 842 will become effective for the Corporation for annual and interim periods beginning in the first quarter 2019. Adoption of ASU 2016-02 is not expected to have a material impact on the Corporation’s consolidated financial statements. The Corporation leases certain properties and equipment under operating leases that will result in the recognition of lease assets and lease liabilities on the consolidated balance sheet under the ASU; however, the majority of the Corporation’s properties and equipment are owned, not leased.

 

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

 

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

 

 

2. PER SHARE DATA

 

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

 

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

 

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

 

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

 

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

 

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

 

  

3. COMPREHENSIVE INCOME

 

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

 

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

 

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

 

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

 

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

 

 

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

 

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

 

For the Three Months Ended March 31, 2018

(In Thousands)

 

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

 

For the Three Months Ended March 31, 2017

(In Thousands)

 

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

 

4. CASH AND DUE FROM BANKS

 

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

 

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

 

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

 

The Corporation is required to maintain reserves against deposit liabilities in the form of cash and balances with the Federal Reserve Bank of Philadelphia. The reserves are based on deposit levels, account activity, and other services provided by the Federal Reserve Bank. Required reserves were $16,376,000 at March 31, 2018 and $17,178,000 at December 31, 2017.

 

 

5. FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS

 

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

 

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

 

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

 

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

 

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

 

 

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

 

						March 31, 2018
		Quoted Prices				Other
		in Active				Observable				Unobservable				Total
		Markets				Inputs				Inputs				Fair
(In Thousands)		(Level 1)				(Level 2)				(Level 3)				Value
Recurring fair value measurements
AVAILABLE-FOR-SALE DEBT SECURITIES:
Obligations of U.S. Government agencies		$	0			$	7,803			$	0			$	7,803
Obligations of states and political subdivisions:
Tax-exempt			0				103,403				0				103,403
Taxable			0				24,038				0				24,038
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities			0				49,335				0				49,335
Residential collateralized mortgage obligations			0				124,008				0				124,008
Commercial mortgage-backed securities			0				32,546				0				32,546
Total available-for-sale debt securities			0				341,133				0				341,133
Marketable equity security			956				0				0				956
Servicing rights			0				0				1,369				1,369
Total recurring fair value measurements		$	956			$	341,133			$	1,369			$	343,458
Nonrecurring fair value measurements
Impaired loans with a valuation allowance		$	0			$	0			$	4,368			$	4,368
Valuation allowance			0				0				(1,289	)			(1,289	)
Impaired loans, net			0				0				3,079				3,079
Foreclosed assets held for sale			0				0				1,100				1,100
Total nonrecurring fair value measurements		$	0			$	0			$	4,179			$	4,179

 

 

						December 31, 2017
		Quoted Prices				Other
		in Active				Observable				Unobservable				Total
		Markets				Inputs				Inputs				Fair
(In Thousands)		(Level 1)				(Level 2)				(Level 3)				Value
Recurring fair value measurements
AVAILABLE-FOR-SALE DEBT SECURITIES:
Obligations of U.S. Government agencies		$	0			$	7,873			$	0			$	7,873
Obligations of states and political subdivisions:
Tax-exempt			0				105,111				0				105,111
Taxable			0				25,573				0				25,573
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities			0				52,347				0				52,347
Residential collateralized mortgage obligations			0				131,814				0				131,814
Commercial mortgage-backed securities			0				33,219				0				33,219
Total available-for-sale debt securities			0				355,937				0				355,937
Marketable equity security			971				0				0				971
Servicing rights			0				0				1,299				1,299
Total recurring fair value measurements		$	971			$	355,937			$	1,299			$	358,207
Nonrecurring fair value measurements
Impaired loans with a valuation allowance		$	0			$	0			$	3,776			$	3,776
Valuation allowance			0				0				(1,183	)			(1,183	)
Impaired loans, net			0				0				2,593				2,593
Foreclosed assets held for sale			0				0				1,598				1,598
Total nonrecurring fair value measurements		$	0			$	0			$	4,191			$	4,191

 

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

 

At March 31, 2018 and December 31, 2017, quantitative information regarding significant techniques and inputs used for assets measured on a recurring basis using unobservable inputs (Level 3 methodologies) are as follows:

 

		Fair Value at
		3/31/18				Valuation		Unobservable						Method or Value As of
Asset		(In Thousands)				Technique		Input(s)						3/31/18
Servicing rights		$	1,369			Discounted cash flow		Discount rate			13.00	%		Rate used through modeling period
								Loan prepayment speeds			118.00	%		Weighted-average PSA
								Servicing fees			0.25	%		of loan balances
											4.00	%		of payments are late
											5.00	%		late fees assessed
										$	1.94			Miscellaneous fees per account per month
								Servicing costs		$	6.00			Monthly servicing cost per account
										$	24.00			Additional monthly servicing cost per loan on loans more than 30 days delinquent
											1.50	%		of loans more than 30 days delinquent
											3.00	%		annual increase in servicing costs

 

 

		Fair Value at
		12/31/17				Valuation		Unobservable						Method or Value As of
Asset		(In Thousands)				Technique		Input(s)						12/31/17
Servicing rights		$	1,299			Discounted cash flow		Discount rate			13.00	%		Rate used through modeling period
								Loan prepayment speeds			140.00	%		Weighted-average PSA
								Servicing fees			0.25	%		of loan balances
											4.00	%		of payments are late
											5.00	%		late fees assessed
										$	1.94			Miscellaneous fees per account per month
								Servicing costs		$	6.00			Monthly servicing cost per account
										$	24.00			Additional monthly servicing cost per loan on loans more than 30 days delinquent
											1.50	%		of loans more than 30 days delinquent
											3.00	%		annual increase in servicing costs

 

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

 

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

 

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

 

Loans are classified as impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Foreclosed assets held for sale consist of real estate acquired by foreclosure. For impaired commercial loans secured by real estate and foreclosed assets held for sale, estimated fair values are determined primarily using values from third-party appraisals. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property. For commercial and industrial and agricultural loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging data or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.

 

 

At March 31, 2018 and December 31, 2017, quantitative information regarding significant techniques and inputs used for nonrecurring fair value measurements using unobservable inputs (Level 3 methodologies) are as follows:

 

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

 

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

 

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

 

  

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

 

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

 

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

 

6. SECURITIES

 

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

 

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

 

 

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

 

The following table presents gross unrealized losses and fair value of available-for-sale debt securities with unrealized loss positions that are not deemed to be other-than-temporarily impaired, aggregated by length of time that individual securities have been in a continuous unrealized loss position at March 31, 2018 and December 31, 2017:

 

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

  

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

 

 

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

 

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

 

The amortized cost and fair value of available-for-sale debt securities by contractual maturity are shown in the following table as of March 31, 2018. Actual maturities may differ from contractual maturities because counterparties may have the right to call or prepay obligations with or without call or prepayment penalties.

 

		Amortized				Fair
(In Thousands)		Cost				Value
Due in one year or less		$	18,713			$	18,844
Due from one year through five years			63,703				63,793
Due from five years through ten years			33,100				32,226
Due after ten years			20,245				20,381
Sub-total			135,761				135,244
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities			50,880				49,335
Residential collateralized mortgage obligations			127,886				124,008
Commercial mortgage-backed securities			33,793				32,546
Total		$	348,320			$	341,133

 

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

 

Investment securities carried at $209,321,000 at March 31, 2018 and $217,925,000 at December 31, 2017 were pledged as collateral for public deposits, trusts and certain other deposits as provided by law. See Note 8 for information concerning securities pledged to secure borrowing arrangements.

 

Management evaluates securities for other-than-temporary impairment (OTTI) at least on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether the Corporation intends to sell the security or more likely than not will be required to sell the security before its anticipated recovery. The Corporation recognized no net impairment losses in earnings in the three-month periods ended March 31, 2018 and 2017.

 

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

 

Debt Securities

 

At March 31, 2018, management performed an assessment for possible OTTI of the Corporation’s debt securities on an issue-by-issue basis, relying on information obtained from various sources, including publicly available financial data, ratings by external agencies, brokers and other sources. The extent of individual analysis applied to each security depended on the size of the Corporation’s investment, as well as management’s perception of the credit risk associated with each security. Based on the results of the assessment, management believes impairment of debt securities at March 31, 2018 and December 31, 2017 to be temporary.

 

 

Equity Securities

 

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

 

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

 

C&N Bank is a member of the Federal Home Loan Bank of Pittsburgh (FHLB-Pittsburgh), which is one of 11 regional Federal Home Loan Banks. As a member, C&N Bank is required to purchase and maintain stock in FHLB-Pittsburgh. There is no active market for FHLB-Pittsburgh stock, and it must ordinarily be redeemed by FHLB-Pittsburgh in order to be liquidated. C&N Bank’s investment in FHLB-Pittsburgh stock, included in Other Assets in the consolidated balance sheet, was $5,142,000 at March 31, 2018 and $6,426,000 at December 31, 2017. The Corporation evaluated its holding of FHLB-Pittsburgh stock for impairment and deemed the stock to not be impaired at March 31, 2018 and December 31, 2017. In making this determination, management concluded that recovery of total outstanding par value, which equals the carrying value, is expected. The decision was based on review of financial information that FHLB-Pittsburgh has made publicly available.

 

7. LOANS

 

The loans receivable portfolio is segmented into residential mortgage, commercial and consumer loans. Loans outstanding at March 31, 2018 and December 31, 2017 are summarized by segment, and by classes within each segment, as follows:

 

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

 

The Corporation grants loans to individuals as well as commercial and tax-exempt entities. Commercial, residential and personal loans are made to customers geographically concentrated in the Pennsylvania and New York counties that comprise the market serviced by Citizens & Northern Bank. Although the Corporation has a diversified loan portfolio, a significant portion of its debtors’ ability to honor their contracts is dependent on the local economic conditions within the region. There is no concentration of loans to borrowers engaged in similar businesses or activities that exceed 10% of total loans at either March 31, 2018 or December 31, 2017.

 

 

The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and recorded as a reduction of the investment in loans. The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Corporation’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available. In the process of evaluating the loan portfolio, management also considers the Corporation’s exposure to losses from unfunded loan commitments. As of March 31, 2018 and December 31, 2017, management determined that no allowance for credit losses related to unfunded loan commitments was required.

 

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

 

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

 

  

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

 

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

 

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

 

 

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

 

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

 

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

 

 

The general component of the allowance for loan losses covers pools of loans including commercial loans not considered individually impaired, as well as smaller balance homogeneous classes of loans, such as residential real estate, home equity lines of credit and other consumer loans. Accordingly, the Corporation generally does not separately identify individual consumer and residential loans for impairment disclosures, unless such a loan: (1) is subject to a restructuring agreement, or (2) has an outstanding balance of $400,000 or more and a credit grade of Special Mention, Substandard or Doubtful. The pools of loans are evaluated for loss exposure based upon average historical net charge-off rates for each loan class, adjusted for qualitative factors (described in the following paragraphs). The time period used in determining the average historical net charge-off rate for each loan class is based on management’s evaluation of an appropriate time period that captures an historical loss experience relevant to the current portfolio. At March 31, 2018 and December 31, 2017, a five-year average net charge-off rate was used for commercial loans secured by real estate and for multi-family residential loans, while a three-year average net charge-off rate was used for all other loan classes.

 

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

 

The qualitative factors used in the general component calculations are designed to address credit risk characteristics associated with each segment. The Corporation’s credit risk associated with all of the segments is significantly impacted by these factors, which include economic conditions within its market area, the Corporation’s lending policies, changes or trends in the portfolio, risk profile, competition, regulatory requirements and other factors. Further, the residential mortgage segment is significantly affected by the values of residential real estate that provide collateral for the loans. The majority of the Corporation’s commercial segment loans (approximately 53% at March 31, 2018) is secured by real estate, and accordingly, the Corporation’s risk for the commercial segment is significantly affected by commercial real estate values. The consumer segment includes a wide mix of loans for different purposes, primarily secured loans, including loans secured by motor vehicles, manufactured housing and other types of collateral.

 

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

 

The scope of loans reviewed individually each quarter to determine if they are impaired include all commercial loan relationships greater than $200,000 and any residential mortgage or consumer loans of $400,000 or more for which there is at least one extension of credit graded Special Mention, Substandard or Doubtful. Loans that are individually reviewed, but which are determined to not be impaired, are combined with all remaining loans that are not reviewed on a specific basis, and such loans are included within larger pools of loans based on similar risk and loss characteristics for purposes of determining the general component of the allowance. The loans that have been individually reviewed, but which have been determined to not be impaired, are included in the “Collectively Evaluated” column in the table summarizing the allowance and associated loan balances as of March 31, 2018 and December 31, 2017. All loans classified as troubled debt restructurings (discussed in more detail below) and all commercial loan relationships less than $200,000 or other loan relationships less than $400,000 in the aggregate, but with an estimated loss of $100,000 or more, are individually evaluated for impairment.

 

 

The following tables present a summary of loan balances and the related allowance for loan losses summarized by portfolio segment and class for each impairment method used as of March 31, 2018 and December 31, 2017:

 

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

 

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

 

 

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

 

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

 

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

 

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

 

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

 

 

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

 

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

 

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

 

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

 

 

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

 

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

 

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

 

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

 

Loans whose terms are modified are classified as Troubled Debt Restructurings (TDRs) if the Corporation grants such borrowers concessions, and it is deemed that those borrowers are experiencing financial difficulty. Loans classified as TDRs are designated as impaired. The outstanding balance of loans subject to TDRs, as well as contractual aging information at March 31, 2018 and December 31, 2017 is as follows:

 

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

 

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

 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

8. BORROWED FUNDS

 

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

 

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

 

The FHLB-Pittsburgh loan facilities are collateralized by qualifying loans secured by real estate with a book value totaling $494,290,000 at March 31, 2018 and $488,889,000 at December 31, 2017. Also, the FHLB-Pittsburgh loan facilities require the Corporation to invest in established amounts of FHLB-Pittsburgh stock. The carrying values of the Corporation’s holdings of FHLB-Pittsburgh stock (included in Other Assets) were $5,142,000 at March 31, 2018 and $6,426,000 at December 31, 2017.

 

 

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

 

The Corporation engages in repurchase agreements with certain commercial customers. These agreements provide that the Corporation sells specified investment securities to the customers on an overnight basis and repurchases them on the following business day. The weighted average interest rate paid by the Corporation on customer repurchase agreements was 0.10% at March 31, 2018 and December 31, 2017. The carrying value of the underlying securities was $11,417,000 at March 31, 2018 and $12,158,000 at December 31, 2017.

 

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

 

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

 

9. DEFINED BENEFIT PLANS

 

The Corporation sponsors a defined benefit health care plan that provides postretirement medical benefits and life insurance to employees who meet certain age and length of service requirements. Full-time employees no longer accrue service time toward the Corporation-subsidized portion of the medical benefits. The plan contains a cost-sharing feature which causes participants to pay for all future increases in costs related to benefit coverage. Accordingly, actuarial assumptions related to health care cost trend rates do not significantly affect the liability balance at March 31, 2018 and December 31, 2017, and are not expected to significantly affect the Corporation's future expenses. The Corporation uses a December 31 measurement date for the postretirement plan.

 

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

 

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

 

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

 

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

 

 

In the first three months of 2018, the Corporation funded postretirement contributions totaling $12,000, with estimated annual postretirement contributions of $60,000 expected in 2018 for the full year. No defined benefit pension contributions are required in 2018, though the Corporation may make discretionary contributions.

 

10. STOCK-BASED COMPENSATION PLANS

 

The Corporation has a Stock Incentive Plan for a selected group of officers and an Independent Directors Stock Incentive Plan. In the first quarter 2018, the Corporation awarded 25,466 shares of restricted stock under the Stock Incentive Plan and 9,086 shares of restricted stock under the Independent Directors Stock Incentive Plan. The 2018 restricted stock awards under the Stock Incentive Plan vest ratably over three years, and vesting for one-half of the 16,578 restricted shares awarded to Executive Officers depends on the Corporation meeting a return on average equity (“ROAE”) target each year. The 2018 restricted stock issued under the Independent Directors Stock Incentive Plan vests over one year.

 

Compensation cost related to restricted stock is recognized based on the fair value of the stock at the grant date over the vesting period, adjusted for estimated and actual forfeitures. Management has estimated restricted stock expense in the first three months of 2018 based on an assumption that the ROAE target for awards to Executive Officers in 2016, 2017 and 2018 will not be met, resulting in forfeiture of the restricted stock.

 

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

 

11. INCOME TAXES

 

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

 

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

 

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

 

 

 

The provision for income tax for the three-month periods ended March 31, 2018 and 2017 is based on the Corporation’s estimate of the effective tax rate expected to be applicable for the full year. The effective tax rates for the Corporation are as follows:

 

		Three Months Ended
(Dollars In thousands)		March 31,
		2018				2017
Income before income tax provision		$	5,116			$	4,418
Income tax provision			741				984
Effective tax rate			14.48	%			22.27	%

 

The effective tax rate for each period presented differs from the statutory rate of 21% for the period ended March 31, 2018 and 35% for the period ended March 31, 2017 principally because of the effects of tax-exempt interest income.

 

The Corporation has investments in three limited partnerships that manage affordable housing projects that have qualified for the federal low-income housing tax credit. The Corporation’s expected return from these investments is based on the receipt of tax credits and tax benefits from deductions of operating losses. The Corporation uses the effective yield method to account for these investments, with the benefits recognized as a reduction of the provision for income taxes. For two of the three limited partnership investments, the tax credits have been received in full in prior years, and the Corporation has fully realized the benefits of the credits and amortized its initial investments in the partnerships. The most recent affordable housing project was completed in 2013, and the Corporation received tax credits in 2013 through 2017 and expects to continue to receive tax credits annually through 2022. The carrying amount of the Corporation’s investment is $581,000 at March 31, 2018 and $608,000 at December 31, 2017 (included in Other Assets in the consolidated balance sheets). For the year ending December 31, 2018, the estimated amount of tax credits and other tax benefits to be received is $150,000 and the estimated amount to be recognized as a reduction of the provision for income taxes is $54,000. The total reduction in the provision for income taxes resulting from this investment is $14,000 in the first quarter 2018 and $18,000 in the first quarter 2017.

 

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

 

12. CONTINGENCIES

 

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

 

13.   REVENUE RECOGNITION

 

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

 

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

 

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

 

 

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

 

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

 

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

 

 

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

 

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

 

·

changes in monetary and fiscal policies of the Federal Reserve Board and the U. S. Government, particularly related to changes in interest rates

·

changes in general economic conditions

·

legislative or regulatory changes

·

downturn in demand for loan, deposit and other financial services in the Corporation’s market area

·

increased competition from other banks and non-bank providers of financial services

·

technological changes and increased technology-related costs

·

changes in accounting principles, or the application of generally accepted accounting principles.

 

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

 

EARNINGS OVERVIEW

 

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

 

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

 

·

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

 

 

·

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

 

·

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

 

·

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

 

·

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

 

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

 

Table I - QUARTERLY FINANCIAL DATA

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

 

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

 

CRITICAL ACCOUNTING POLICIES

 

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

 

 

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

 

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

 

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

 

NET INTEREST INCOME

 

The Corporation’s primary source of operating income is net interest income, which is equal to the difference between the amounts of interest income and interest expense. Tables II, III and IV include information regarding the Corporation’s net interest income for the three-month periods ended March 31, 2018 and March 31, 2017. In each of these tables, the amounts of interest income earned on tax-exempt securities and loans have been adjusted to a fully taxable-equivalent basis. Accordingly, the net interest income amounts reflected in these tables exceed the amounts presented in the consolidated financial statements. The discussion that follows is based on amounts in the related Tables.

 

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

 

INTEREST INCOME AND EARNING ASSETS

 

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

 

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

 

INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES

 

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

 

 

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

 

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

 

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

 

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

 

 

TABLE II - ANALYSIS OF INTEREST INCOME AND EXPENSE

 

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

 

Note: Interest income from tax-exempt securities and loans has been adjusted to a fully tax-equivalent basis, using the Corporation’s marginal federal income tax rate of 21% for 2018 and 35% for 2017.

 

 

TABLE III - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES

(Dollars in Thousands)

 

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

 

(1) Annualized rates of return on tax-exempt securities and loans are presented on a fully taxable-equivalent basis, using the Corporation’s marginal federal income tax rate of 21% in 2018 and 35% in 2017.

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

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

 

 

TABLE IV - ANALYSIS OF VOLUME AND RATE CHANGES

 

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

 

(1) Changes in income on tax-exempt securities and loans are presented on a fully tax-equivalent basis, using the Corporation’s marginal federal income tax rate of 21% for 2018 and 35% for 2017.

 

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

 

 

NONINTEREST INCOME

 

TABLE V - COMPARISON OF NONINTEREST INCOME

(In Thousands)

 

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

 

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

 

·

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

 

·

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

 

·

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

 

·

Loan servicing fees, net, increased $56,000. This category includes fees received from servicing residential mortgage loans that have been originated and sold, adjusted for changes in the fair value of servicing rights. The fair value of mortgage servicing rights increased by $20,000 in the first three months of 2018 as compared to a reduction of $30,000 in the same period of 2017.

 

·

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

 

 

NONINTEREST EXPENSE

 

TABLE VI - COMPARISON OF NONINTEREST EXPENSE

(Dollars In Thousands)

 

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

 

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

 

·

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

 

·

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

 

·

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

 

·

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

 

·

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

 

·

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

 

INCOME TAXES

 

The income tax provision in interim periods is based on the Corporation’s estimate of the effective tax rate expected to be applicable for the full year. The income tax provision for the first three months of 2018 was $741,000, or 14.5% of pre-tax earnings, which was $243,000 lower than the provision for the first three months of 2017 of $984,000, or 22.3% of pre-tax income. The Corporation benefited from the reduction in the federal corporate income tax rate to 21%, effective January 1, 2018, from the 35% marginal tax rate in effect throughout 2017. The Corporation’s effective tax rates differ from the statutory rate of 21% in the first three months of 2018 and 35% for the first three months of 2017 principally because of the effects of tax-exempt interest income.

 

The Corporation recognizes deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax basis of assets and liabilities. At March 31, 2018 the net deferred tax asset was $4,120,000, up from $3,289,000 at December 31, 2017. The most significant change in temporary difference components was a net increase of $1,002,000 related to unrealized losses on available-for-sale securities. At March 31, 2018, the net deferred tax asset associated with the unrealized loss was $1,508,000, while at December 31, 2017, the deferred tax asset associated with the unrealized loss was $506,000, including $843,000 recorded as an offset to the pre-tax unrealized loss within accumulated other comprehensive loss, partially offset by $337,000 charged against retained earnings.

 

 

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

 

Management believes the recorded net deferred tax asset at March 31, 2018 is fully realizable; however, if management determines the Corporation will be unable to realize all or part of the net deferred tax asset, the Corporation would adjust the deferred tax asset, which would negatively impact earnings.

 

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

 

FINANCIAL CONDITION

 

This section includes information regarding the Corporation’s lending activities or other significant changes or exposures that are not otherwise addressed in Management’s Discussion and Analysis. Significant changes in the average balances of the Corporation’s earning assets and interest-bearing liabilities are described in the “Net Interest Income” section of Management’s Discussion and Analysis. Other significant balance sheet items, including the allowance for loan losses and stockholders’ equity, are discussed in separate sections of Management’s Discussion and Analysis. There are no significant concerns that have arisen related to the Corporation’s off-balance sheet loan commitments or outstanding standby letters of credit at March 31, 2018, and management does not expect capital expenditures to have a material, detrimental effect on the Corporation’s financial condition in 2018.

 

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

 

While the Corporation’s lending activities are primarily concentrated in its market area, a portion of the Corporation’s commercial loan segment consists of participation loans. Participation loans represent portions of larger commercial transactions for which other institutions are the “lead banks”. Although not the lead bank, the Corporation conducts detailed underwriting and monitoring of participation loan opportunities. Participation loans are included in the “Commercial and industrial,” “Commercial loans secured by real estate”, “Political subdivisions” and “Other commercial” classes in the loan tables presented in this Form 10-Q. Total participation loans outstanding amounted to $62,788,000 at March 31, 2018, up from $61,245,000 at December 31, 2017 and $43,586,000 at March 31, 2017. At March 31, 2018, the balance of participation loans outstanding includes a total of $52,596,000 to businesses located outside of the Corporation’s market area, including $9,977,000 from participations in loans originated through the Corporation’s membership in a network that originates loans throughout the U.S. The Corporation’s participation loans originated through the network consist of loans to businesses that are larger than the Corporation’s typical commercial customer base. The loans originated through the network are considered “leveraged loans,” meaning the businesses typically have minimal tangible book equity and the extent of collateral available is limited, though at the time of origination the businesses have demonstrated strong cash flow performance in their recent histories. Total leveraged participation loans, including loans originated through the network and two loans originated through another lead institution, totaled $13,975,000 at March 31, 2018, and $15,328,000 at December 31, 2017.

 

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

 

 

For loan sales originated under the MPF Xtra and Original programs, the Corporation provides customary representations and warranties to investors that specify, among other things, that the loans have been underwritten to the standards established by the investor. The Corporation may be required to repurchase a loan and reimburse a portion of fees received, or reimburse the investor for a credit loss incurred on a loan, if it is determined that the representations and warranties have not been met. Such repurchases or reimbursements generally result from an underwriting or documentation deficiency. At March 31, 2018, the total outstanding balance of loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $1,791,000, and the corresponding total outstanding balance repurchased at December 31, 2017 was $1,805,000.

 

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

 

For loans sold under the Original program, the Corporation provides a credit enhancement whereby the Corporation would assume credit losses in excess of a defined First Loss Account (“FLA”) balance, up to specified amounts. The FLA is funded by the Federal Home Loan Bank of Pittsburgh based on a percentage of the outstanding balance of loans sold. At March 31, 2018, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $3,427,000, and the Corporation has recorded a related allowance for credit losses of $291,000 which is included in “Accrued interest and other liabilities” in the accompanying consolidated balance sheets. At December 31, 2017, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $5,742,000, and the related allowance for credit losses was $260,000. The Corporation does not provide a credit enhancement for loans sold through the Xtra program.

 

PROVISION AND ALLOWANCE FOR LOAN LOSSES

 

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

 

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

 

The allowance for loan losses was $9,049,000 at March 31, 2018, up from $8,856,000 at December 31, 2017. Table VIII shows total specific allowances on impaired loans increased $92,000 to $1,371,000 at March 31, 2018 from $1,279,000 at December 31, 2017. The largest individual loan balance for which a specific allowance has been recorded is a real estate secured commercial loan with an outstanding balance of $2,607,000 and a specific allowance of $884,000 at March 31, 2018, down from an outstanding balance of $2,641,000 and a specific allowance of $919,000 at December 31, 2017. The net increase in specific allowances in the first three months of 2018 included the addition of a specific allowance of $158,000 on a commercial loan relationship with outstanding balances totaling $677,000 at March 31, 2018.

 

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

 

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

 

 

The provision for loan losses is further detailed as follows:

 

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

 

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

 

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

 

 

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

 

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

 

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

 

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

 

Table IX presents information related to past due and impaired loans, and loans that have been modified under terms that are considered troubled debt restructurings (TDRs). Total nonperforming loans as a percentage of outstanding loans was 2.00% at March 31, 2018, down from 2.10% at December 31, 2017, and nonperforming assets as a percentage of total assets was 1.39% at March 31, 2018, down from 1.47% at December 31, 2017. Table IX presents data at March 31, 2018 and at the end of each of the years ended December 31, 2013 through 2017. For the range of dates presented in Table IX, total nonperforming loans as a percentage of loans has ranged from a low of 2.00% at March 31, 2018 to a high of 2.80% at December 31, 2013, and total nonperforming assets as a percentage of assets have ranged from a low of 1.31% at December 31, 2015 to a high of 1.53% at December 31, 2013.

 

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

 

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

 

·

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

 

·

Total loans past due 90 days or more and still accruing interest amounted to $2,795,000 at March 31, 2018, a decrease of $929,000 from the total at December 31, 2017. The reduction in loans past due 90 days or more included a reduction in residential mortgage loans of $568,000 and commercial loans of $360,000. The Corporation reviews the status of loans past due 90 days or more each quarter to determine if it is appropriate to continue to accrue interest, and has determined the loans included in this category are well secured and that ultimate collection of all principal and interest is probable.

 

 

·

Foreclosed assets held for sale consisted of real estate, and totaled $1,100,000 at March 31, 2018, a decrease of $498,000 from $1,598,000 at December 31, 2017. At March 31, 2018, the Corporation held 12 such properties for sale, with total carrying values of $396,000 related to residential real estate, $632,000 of land and $72,000 related to commercial real estate. At December 31, 2017, the Corporation held 16 such properties for sale, with total carrying values of $721,000 related to residential real estate, $632,000 of land and $245,000 related to commercial real estate. The Corporation evaluates the carrying values of foreclosed assets each quarter based on the most recent market activity or appraisals for each property.

 

Over the period 2013-2017 and the first three months of 2018, each period includes a few large commercial relationships that have required significant monitoring and workout efforts. As a result, a limited number of relationships may significantly impact the total amount of allowance required on impaired loans, and may significantly impact the amount of total charge-offs reported in any one period.

 

Management believes it has been conservative in its decisions concerning identification of impaired loans, estimates of loss, and nonaccrual status; however, the actual losses realized from these relationships could vary materially from the allowances calculated as of March 31, 2018. Management continues to closely monitor its commercial loan relationships for possible credit losses, and will adjust its estimates of loss and decisions concerning nonaccrual status, if appropriate.

 

Tables VII through X present historical data related to loans and the allowance for loan losses.

 

TABLE VII - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES

(Dollars In Thousands)

 

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

 

 

 

TABLE VIII - COMPONENTS OF THE ALLOWANCE FOR LOAN LOSSES

(In Thousands)

 

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

 

TABLE IX - PAST DUE AND IMPAIRED LOANS, NONPERFORMING ASSETS

AND TROUBLED DEBT RESTRUCTURINGS (TDRs)

(Dollars In Thousands)

 

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

 

 

TABLE X - SUMMARY OF LOANS BY TYPE

Summary of Loans by Type

(In Thousands)

 

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

 

LIQUIDITY

 

Liquidity is the ability to quickly raise cash at a reasonable cost. An adequate liquidity position permits the Corporation to pay creditors, compensate for unforeseen deposit fluctuations and fund unexpected loan demand. At March 31, 2018, the Corporation maintained overnight interest-bearing deposits with the Federal Reserve Bank of Philadelphia and other correspondent banks totaling $15,600,000.

 

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

 

The Corporation has a line of credit with the Federal Reserve Bank of Philadelphia’s Discount Window. Management intends to use this line of credit as a contingency funding source. As collateral for the line, the Corporation has pledged available-for-sale securities with a carrying value of $15,544,000 at March 31, 2018.

 

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

 

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

 

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

 

 

Additionally, the Corporation uses “RepoSweep” arrangements to borrow funds from commercial banking customers on an overnight basis. If required to raise cash in an emergency situation, the Corporation could sell available-for-sale securities to meet its obligations or use repurchase agreements placed with brokers to borrow funds secured by investment assets. At March 31, 2018, the carrying value of available-for-sale securities in excess of amounts required to meet pledging or repurchase agreement obligations was $188,290,000.

 

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

 

STOCKHOLDERS’ EQUITY AND CAPITAL ADEQUACY

 

The Corporation and C&N Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Details concerning capital ratios at March 31, 2018 and December 31, 2017 are presented below. Management believes, as of March 31, 2018 and December 31, 2017, that the Corporation and C&N Bank meet all capital adequacy requirements to which they are subject and maintain capital conservation buffers (described in more detail below) that allow the Corporation and C&N Bank to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. Further, as reflected in the table below, the Corporation’s and C&N Bank’s capital ratios at March 31, 2018 and December 31, 2017 exceed the Corporation’s policy threshold levels.

 

 

(Dollars in Thousands)																										Minimum To Be Well
										Minimum								Minimum To Maintain								Capitalized Under								Minimum To Meet
										Capital								Capital Conservation								Prompt Corrective								the Corporation's
		Actual								Requirement								Buffer at Reporting Date								Action Provisions								Policy Thresholds
		Amount				Ratio				Amount				Ratio				Amount				Ratio				Amount				Ratio				Amount				Ratio
March 31, 2018:
Total capital to risk-weighted assets:
Consolidated		$	189,309				23.49	%		$	64,470				³8	%		$	79,580				³9.875	%		$	80,587				³10	%		$	84,617				³10.5	%
C&N Bank			167,117				20.85	%			64,116				³8	%			79,143				³9.875	%			80,145				³10	%			84,152				³10.5	%
Tier 1 capital to risk-weighted assets:
Consolidated			179,969				22.33	%			48,352				³6	%			63,463				³7.875	%			64,470				³8	%			68,499				³8.5	%
C&N Bank			157,777				19.69	%			48,087				³6	%			63,114				³7.875	%			64,116				³8	%			68,123				³8.5	%
Common equity tier 1 capital to risk-weighted assets:
Consolidated			179,969				22.33	%			36,264				³4.5	%			51,374				³6.375	%			52,382				³6.5	%			56,411				³7	%
C&N Bank			157,777				19.69	%			36,065				³4.5	%			51,092				³6.375	%			52,094				³6.5	%			56,101				³7	%
Tier 1 capital to average assets:
Consolidated			179,969				14.33	%			50,239				³4	%			N/A				N/A				62,798				³5	%			62,798				³5	%
C&N Bank			157,777				12.75	%			49,480				³4	%			N/A				N/A				61,850				³5	%			61,850				³5	%
December 31, 2017:
Consolidated		$	187,097				23.07	%		$	64,872				³8	%		$	75,008				³9.25	%		$	81,090				³10	%		$	85,144				³10.5	%
C&N Bank			165,142				20.47	%			64,528				³8	%			74,611				³9.25	%			80,661				³10	%			84,694				³10.5	%
Tier 1 capital to risk-weighted assets:
Consolidated			177,981				21.95	%			48,654				³6	%			58,790				³7.25	%			64,872				³8	%			68,926				³8.5	%
C&N Bank			156,026				19.34	%			48,396				³6	%			58,479				³7.25	%			64,528				³8	%			68,561				³8.5	%
Common equity tier 1 capital to risk-weighted assets:
Consolidated			177,981				21.95	%			36,490				³4.5	%			46,626				³5.75	%			52,708				³6.5	%			56,763				³7	%
C&N Bank			156,026				19.34	%			36,297				³4.5	%			46,380				³5.75	%			52,429				³6.5	%			56,462				³7	%
Tier 1 capital to average assets:
Consolidated			177,981				14.23	%			50,023				³4	%			N/A				N/A				62,529				³5	%			62,529				³5	%
C&N Bank			156,026				12.63	%			49,418				³4	%			N/A				N/A				61,772				³5	%			61,772				³5	%

 

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

 

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

 

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

 

 

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

 

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

 

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

 

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

 

At March 31, 2018, the Corporation’s Capital Conservation Buffer, determined based on the minimum total capital ratio, was 15.49%. C&N Bank’s Capital Conservation Buffer (also determined based on the minimum total capital ratio) was 12.85%.

 

The Corporation’s total stockholders’ equity is affected by fluctuations in the fair values of available-for-sale securities. The difference between amortized cost and fair value of available-for-sale securities, net of deferred income tax, is included in Accumulated Other Comprehensive Income (Loss) within stockholders’ equity. The balance in Accumulated Other Comprehensive Income (Loss) related to unrealized gains (losses) on available-for-sale securities, net of deferred income tax, amounted to ($5,679,000) at March 31, 2018 and ($1,566,000) at December 31, 2017. Changes in accumulated other comprehensive income (loss) are excluded from earnings and directly increase or decrease stockholders’ equity. If available-for-sale securities are deemed to be other-than-temporarily impaired, unrealized losses are recorded as a charge against earnings, and amortized cost for the affected securities is reduced. Note 6 to the unaudited consolidated financial statements provides additional information concerning management’s evaluation of available-for-sale securities for other-than-temporary impairment at March 31, 2018.

 

 

Stockholders’ equity is also affected by the underfunded or overfunded status of defined benefit pension and postretirement plans. The balance in Accumulated Other Comprehensive Income related to defined benefit plans, net of deferred income tax, was $141,000 at March 31, 2018 and $59,000 at December 31, 2017.

 

COMPREHENSIVE INCOME

 

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

 

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

 

INFLATION

 

The Corporation is significantly affected by the Federal Reserve Board’s efforts to control inflation through changes in short-term interest rates. Since September 2007, the Federal Reserve has maintained the fed funds target rate at extremely low levels by historical standards. Further, throughout the period of low interest rates, the Federal Reserve has injected massive amounts of liquidity into the nation’s monetary system through a variety of programs. Since late 2015, the Federal Reserve has begun to move its fed funds target rate higher, in an effort to re-establish a more normalized level by historical standards, with six separate 0.25% increases from December 2015 through March 2018, resulting in the current range of 1.50% to 1.75%. Inflation has remained subdued, measured through 2017 and the first three months of 2018 at levels below the Federal Open Market Committee’s 2% longer run objective, though the FOMC noted in its latest statement that the labor market continues to strengthen and that economic activity continues to rise at a moderate rate. The Committee continues to suggest that as market conditions continue to improve, further gradual increases in the federal funds rate will be warranted.

 

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

 

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

MARKET RISK

 

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

 

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

 

INTEREST RATE RISK

 

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

 

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

 

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

 

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

 

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

 

 

TABLE XI - THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES

 

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

 

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

 

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

 

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

 

 

ITEM 4. CONTROLS AND PROCEDURES

 

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

 

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

 

 

PART II – OTHER INFORMATION

 

Item 1.

Legal Proceedings

The Corporation and C&N Bank are involved in various legal proceedings incidental to their business. Management believes the aggregate liability, if any, resulting from such pending and threatened legal proceedings will not have a material, adverse effect on the Corporation’s financial condition or results of operations.

 

Item 1A.

Risk Factors

There have been no material changes from the risk factors previously disclosed in Item 1A of the Corporation’s Form 10-K filed February 15, 2018.

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

Issuer Purchases of Equity Securities

 

The following table sets forth a summary of the purchases by the Corporation, on the open market, of its equity securities during the first quarter 2018:

 

Period		Total Number of Shares Purchased				Average Price Paid per Share				Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs				Maximum Number of Shares  that May Yet be Purchased Under the Plans or Programs
January 1 - 31, 2018			0			$	0				0				600,000
February 1 - 28, 2018			0			$	0				0				600,000
March 1 - 31, 2018			0			$	0				0				600,000

 

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

 

Item 3.

Defaults Upon Senior Securities

None

 

Item 4.

Mine Safety Disclosures

Not applicable

 

Item 5.

Other Information

None 

 

 

Item 6.

Exhibits

 

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

 

 

SIGNATURES

 

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

 

	CITIZENS & NORTHERN CORPORATION
May 3, 2018	By:	/s/ J. Bradley Scovill
Date	President and Chief Executive Officer
May 3, 2018	By:	/s/ Mark A. Hughes
Date	Treasurer and Chief Financial Officer

 

 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Exhibit 31.1

 

CERTIFICATION

 

I, J. Bradley Scovill, certify that:

 

1.

I have reviewed this quarterly report on Form 10-Q of Citizens & Northern Corporation;

 

2.

Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3.

Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4.

The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have:

 

a)

designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

b)

designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;

 

c)

evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

d)

disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a)

all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

b)

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

May 3, 2018	By:	/s/ J. Bradley Scovill
Date		President and Chief Executive Officer

 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Exhibit 31.2

 

CERTIFICATION

 

I, Mark A. Hughes, certify that:

 

1.

I have reviewed this quarterly report on Form 10-Q of Citizens & Northern Corporation;

 

2.

Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3.

Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4.

The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have:

 

a)

designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

b)

designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;

 

c)

evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

d)

disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a)

all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

b)

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

May 3, 2018	By:	/s/ Mark A. Hughes
Date		Treasurer and Chief Financial Officer

 

 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Exhibit 32

 

SECTION 1350 CERTIFICATIONS

 

In connection with the Quarterly Report of Citizens & Northern Corporation (the “Corporation”) on Form 10-Q for the quarterly period ended March 31, 2018, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned hereby certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to each of the undersigned’s best knowledge and belief:

 

(a) the Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 as amended; and

 

(b) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation.

 

May 3, 2018	By:	/s/ J. Bradley Scovill
Date		President and Chief Executive Officer
May 3, 2018	By:	/s/ Mark A. Hughes
Date		Treasurer and Chief Financial Officer

 

These certifications accompany this report on Form 10-Q pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by such Act, be deemed filed by the Corporation for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the Corporation specifically incorporates them by reference.

 

A signed original of this written statement required by Section 906 has been provided to the Corporation and will be retained by the Corporation and furnished to the Securities and Exchange Commission or its staff upon request.