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 June 30, 2014

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, or a smaller reporting company. See definition of “large accelerated filer,” accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

 

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) 12,377,394 Shares Outstanding on August 5, 2014

 

 
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

CITIZENS & NORTHERN CORPORATION

Index

 

 

Part I. Financial Information  
   
Item 1. Financial Statements  
   
Consolidated Balance Sheets (Unaudited) – June 30, 2014 and
December 31, 2013
Page 3
   
Consolidated Statements of Income (Unaudited) – Three-Month and
Six-Month Periods Ended June 30, 2014 and 2013
Page 4
   
Consolidated Statements of Comprehensive Income
(Unaudited) – Three-Month and Six-Month Periods Ended June 30,
2014 and 2013
Page 5
   
Consolidated Statements of Cash Flows (Unaudited) –
Six Months Ended June 30, 2014 and 2013
Page 6
   
Consolidated Statements of Changes in Stockholders’ Equity
(Unaudited) - Six Months Ended June 30, 2014 and 2013
Page 7
   
Notes to Unaudited Consolidated Financial Statements Pages 8 – 39
   
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Pages 40 – 59
   
Item 3. Quantitative and Qualitative Disclosures About
Market Risk
Pages 60 – 62
   
Item 4. Controls and Procedures Page 62
   
Part II. Other Information Pages 63 – 65
   
Signatures Page 66
   
Exhibit 31.1. Rule 13a-14(a)/15d-14(a) Certification -
Chief Executive Officer
Page 67
   
Exhibit 31.2. Rule 13a-14(a)/15d-14(a) Certification -
Chief Financial Officer
Page 68
   
Exhibit 32. Section 1350 Certifications Page 69

 

2
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

ITEM 1. FINANCIAL STATEMENTS    
CONSOLIDATED BALANCE SHEETS    
(In Thousands, Except Share and Per Share Data) (Unaudited) June 30, December 31,
  2014 2013
ASSETS    
Cash and due from banks:    
Noninterest-bearing $28,316 $15,917
Interest-bearing 31,632 28,702
Total cash and due from banks 59,948 44,619
Available-for-sale securities, at fair value 512,748 482,658
Loans held for sale 0 54
     
Loans receivable 621,614 644,303
Allowance for loan losses (7,267) (8,663)
Loans, net 614,347 635,640
Bank-owned life insurance 21,922 21,743
Accrued interest receivable 3,813 4,146
Bank premises and equipment, net 16,647 17,430
Foreclosed assets held for sale 1,419 892
Deferred tax asset, net 1,837 6,344
Intangible asset - Core deposit intangibles 70 87
Intangible asset - Goodwill 11,942 11,942
Other assets 11,512 12,140
TOTAL ASSETS $1,256,205 $1,237,695
     
LIABILITIES    
Deposits:    
Noninterest-bearing $208,849 $191,245
Interest-bearing 770,390 763,271
Total deposits 979,239 954,516
Short-term borrowings 4,637 23,385
Long-term borrowings 73,201 73,338
Accrued interest and other liabilities 9,955 6,984
TOTAL LIABILITIES 1,067,032 1,058,223
     
STOCKHOLDERS' EQUITY    
Preferred stock, $1,000 par value; authorized 30,000 shares; $1,000 liquidation preference per share; no shares issued at June 30, 2014 and December 31, 2013 0 0
Common stock, par value $1.00 per share; authorized 20,000,000 shares in 2014 and 2013; issued 12,636,549 at June 30, 2014 and 12,596,540 at December 31, 2013 12,636 12,596
Paid-in capital 70,964 70,105
Retained earnings 103,276 101,216
Treasury stock, at cost; 186,544 shares at June 30, 2014    
and 206,477 shares at December 31, 2013 (3,119) (3,452)
Sub-total 183,757 180,465
Accumulated other comprehensive income (loss):    
Unrealized gain (loss) on available-for-sale securities 5,316 (1,004)
Defined benefit plans gain 100 11
  Total accumulated other comprehensive income (loss) 5,416 (993)
  TOTAL STOCKHOLDERS' EQUITY 189,173 179,472
  TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $1,256,205 $1,237,695

 

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

 

3
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Consolidated Statements of Income  3 Months Ended  Fiscal Year To Date
(In Thousands Except Per Share Data) (Unaudited) June 30, June 30, 6 Months Ended June 30,
INTEREST INCOME 2014 2013 2014 2013
Interest and fees on loans $8,085 $9,028 $16,083 $18,253
Interest on balances with depository institutions 32 23 62 51
Interest on loans to political subdivisions 334 323 707 685
Interest on mortgages held for sale 5 12 8 33
Income from available-for-sale securities:        
Taxable 1,961 1,663 3,763 3,380
Tax-exempt 1,080 1,243 2,191 2,455
Dividends 66 63 155 145
Total interest and dividend income 11,563 12,355 22,969 25,002
INTEREST EXPENSE        
Interest on deposits 553 673 1,107 1,451
Interest on short-term borrowings 1 2 6 3
Interest on long-term borrowings 736 740 1,465 1,561
Total interest expense 1,290 1,415 2,578 3,015
Net interest income 10,273 10,940 20,391 21,987
Provision for loan losses 446 66 135 249
Net interest income after provision for loan losses 9,827 10,874 20,256 21,738
OTHER INCOME        
Service charges on deposit accounts 1,314 1,242 2,537 2,468
Service charges and fees 134 145 261 279
Trust and financial management revenue 1,138 1,045 2,185 1,989
Brokerage revenue 242 237 469 381
Insurance commissions, fees and premiums 27 59 59 104
Interchange revenue from debit card transactions 517 505 970 969
Net gains from sale of loans 265 552 416 1,056
(Decrease) increase in fair value of servicing rights (53) (3) 52 5
Increase in cash surrender value of life insurance 91 99 179 192
Net loss from premises and equipment (1) 0 (1) 0
Other operating income 306 310 604 591
Sub-total 3,980 4,191 7,731 8,034
Total other-than-temporary impairment losses on available-for-sale securities 0 0 0 (25)
Portion of (gain) recognized in other comprehensive loss (before taxes) 0 0 0 0
Net impairment losses recognized in earnings 0 0 0 (25)
Realized gains on available-for-sale securities, net 103 100 134 1,284
Total other income 4,083 4,291 7,865 9,293
OTHER EXPENSES        
Salaries and wages 3,646 3,635 7,211 7,235
Pensions and other employee benefits 1,153 1,034 2,472 2,289
Occupancy expense, net 641 599 1,356 1,233
Furniture and equipment expense 466 483 938 977
FDIC Assessments 146 147 293 299
Pennsylvania shares tax 337 351 678 701
Professional fees 144 461 292 618
Automated teller machine and interchange expense 218 312 429 584
Software subscriptions 201 209 391 432
Loss on prepayment of debt 0 0 0 1,023
Other operating expense 1,395 1,289 2,811 2,705
Total other expenses 8,347 8,520 16,871 18,096
Income before income tax provision 5,563 6,645 11,250 12,935
Income tax provision 1,400 1,671 2,799 3,255
NET INCOME $4,163 $4,974 $8,451 $9,680
NET INCOME PER SHARE - BASIC $0.33 $0.40 $0.68 $0.78
NET INCOME PER SHARE - DILUTED $0.33 $0.40 $0.68 $0.78

 

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

 

4
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Consolidated Statements of Comprehensive Income        
(In Thousands) (Unaudited) Three Months Ended Six Months Ended
  June 30, June 30,
  2014 2013 2014 2013
Net income $4,163 $4,974 $8,451 $9,680
         
Unrealized gains (losses) on available-for-sale securities:        
Unrealized holding gains (losses) on available-for-sale securities 4,523 (9,732) 9,857 (12,179)
Reclassification adjustment for gains realized in income (103) (100) (134) (1,259)
Other comprehensive gain (loss) on available-for-sale securities 4,420 (9,832) 9,723 (13,438)
         
Unfunded pension and postretirement obligations:        
Changes from plan amendments and actuarial gains and losses included in accumulated other comprehensive gain 3 0 144 636
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost (4) 0 (8) 0
Other comprehensive (loss) gain on unfunded retirement obligations (1) 0 136 636
         
Other comprehensive income (loss) before income tax 4,419 (9,832) 9,859 (12,802)
Income tax related to other comprehensive (income) loss (1,545) 3,441 (3,450) 4,479
         
Net other comprehensive income (loss) 2,874 (6,391) 6,409 (8,323)
         
Comprehensive income (loss) $7,037 ($1,417) $14,860 $1,357

 

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

 

5
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended June 30,
(In Thousands) (Unaudited) 2014 2013
 CASH FLOWS FROM OPERATING ACTIVITIES:    
   Net income   $8,451 $9,680
  Adjustments to reconcile net income to net cash provided by operating activities:    
     Provision for loan losses 135 249
     Realized gains on available-for-sale securities, net (134) (1,259)
     Loss on prepayment of debt 0 1,023
     Realized loss on foreclosed assets 19 53
     Loss on disposition of premises and equipment 1 0
     Depreciation expense 988 1,021
     Accretion and amortization on securities, net 674 952
     Accretion and amortization on loans and deposits, net (14) (16)
     Decrease in fair value of servicing rights (52) (5)
     Increase in cash surrender value of life insurance (179) (192)
     Stock-based compensation 384 492
     Amortization of core deposit intangibles 17 25
     Deferred income taxes 1,057 1,573
     Gains on sales of loans, net (416) (1,056)
     Origination of loans for sale (12,443) (32,709)
     Proceeds from sales of loans 12,807 35,345
     Decrease in accrued interest receivable and other assets 179 2,705
     Increase in accrued interest payable and other liabilities 1,795 398
       Net Cash Provided by Operating Activities 13,269 18,279
 CASH FLOWS FROM INVESTING ACTIVITIES:    
   Proceeds from maturities of certificates of deposit 480 0
   Proceeds from sales of available-for-sale securities 28,831 23,402
   Proceeds from calls and maturities of available-for-sale securities 35,340 51,651
   Purchase of available-for-sale securities (83,766) (85,675)
   Redemption of Federal Home Loan Bank of Pittsburgh stock 976 1,773
   Purchase of Federal Home Loan Bank of Pittsburgh stock (123) (825)
   Net decrease in loans 20,248 28,970
   Purchase of premises and equipment (206) (423)
   Purchase of investment in limited liability entity 0 (147)
   Return of principal on limited liability entity investments 87 75
   Proceeds from sale of foreclosed assets 378 14
        Net Cash Provided by Investing Activities 2,245 18,815
 CASH FLOWS FROM FINANCING ACTIVITIES:    
   Net increase (decrease) in deposits 24,723 (55,337)
   Net (decrease) increase in short-term borrowings (18,748) 10,820
   Repayments of long-term borrowings (137) (11,363)
   Sale of treasury stock 86 119
   Tax benefit from compensation plans 74 55
   Common dividends paid (5,703) (5,448)
        Net Cash Provided by (Used in) Financing Activities 295 (61,154)
 INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 15,809 (24,060)
 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 38,591 55,016
 CASH AND CASH EQUIVALENTS, END OF PERIOD $54,400 $30,956
     
 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:    
   Assets acquired through foreclosure of real estate loans $924 $78
   Accrued purchase of available-for-sale securities $1,312 $0
   Interest paid $2,587 $3,040
   Income taxes paid $1,834 $986

 

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

 

6
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Consolidated Statements of Changes in Stockholders' Equity            
Six Months Ended June 30, 2014 and 2013              
(In Thousands Except Share and Per Share Data)         Accum. Other    
(Unaudited) Common Treasury Common Paid-in Retained Comprehensive Treasury  
  Shares Shares Stock Capital Earnings (Loss) Stock Total
Six Months Ended June 30, 2014:           Income    
Balance, December 31, 2013 12,596,540 206,477 $12,596 $70,105 $101,216 ($993) ($3,452) $179,472
Net income         8,451     8,451
Other comprehensive income, net           6,409   6,409
Cash dividends declared on common                
  stock, $.52 per share         (6,459)     (6,459)
Shares issued for dividend reinvestment                
     Plan 40,009   40 716       756
Shares issued from treasury related to                
     exercise of stock options   (5,577)   (7)     93 86
Restricted stock granted   (16,711)   (279)     279 0
Forfeiture of restricted stock   2,355   39     (39) 0
Stock-based compensation expense       384       384
Tax effect of stock option exercises       1       1
Tax benefit from dividends on restricted stock       5       5
Tax benefit from employee benefit plan         68     68
Balance, June 30, 2014 12,636,549 186,544 $12,636 $70,964 $103,276 $5,416 ($3,119) $189,173
                 
Six Months Ended June 30, 2013:                
Balance, December 31, 2012 12,525,411 251,376 $12,525 $68,622 $94,839 $11,003 ($4,203) $182,786
Net income         9,680     9,680
Other comprehensive loss, net           (8,323)   (8,323)
Cash dividends declared on common                
  stock, $.50 per share         (6,161)     (6,161)
Shares issued for dividend reinvestment                
     Plan 36,266   36 677       713
Shares issued from treasury related to                
     exercise of stock options   (6,568)   8     111 119
Restricted stock granted   (37,886)   (633)     633 0
Forfeiture of restricted stock   3,233   54     (54) 0
Stock-based compensation expense       492       492
Tax effect of stock option exercises       (6)       (6)
Tax benefit from employee benefit plan         61     61
Balance, June 30, 2013 12,561,677 210,155 $12,561 $69,214 $98,419 $2,680 ($3,513) $179,361

 

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

 

7
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Notes to Unaudited Consolidated Financial Statements

 

1. BASIS OF INTERIM PRESENTATION

 

The consolidated financial information included herein, with the exception of the consolidated balance sheet dated December 31, 2013, 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 2013 information has been reclassified for consistency with the 2014 presentation.

 

Operating results reported for the three-month and six-month periods ended June 30, 2014 might not be indicative of the results for the year ending December 31, 2014. The Corporation evaluates subsequent events through the date of filing with the Securities and Exchange Commission.

 

2. PER SHARE DATA

 

Net income per share is based on the weighted-average number of shares of common stock outstanding. The following data show the amounts used in computing basic and diluted net income per share. As shown in the table that follows, diluted earnings per 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.

 

    Weighted-  
    Average Earnings
  Net Common Per
  Income Shares Share
Six Months Ended June 30, 2014      
Earnings per share – basic $8,451,000 12,429,717 $0.68
Dilutive effect of potential common stock      
  arising from stock options:      
  Exercise of outstanding stock options   239,291  
  Hypothetical share repurchase at $19.25   (217,549)  
Earnings per share – diluted $8,451,000 12,451,459 $0.68
       
Six Months Ended June 30, 2013      
Earnings per share – basic $9,680,000 12,331,943 $0.78
Dilutive effect of potential common stock      
  arising from stock options:      
  Exercise of outstanding stock options   254,900  
  Hypothetical share repurchase at $19.53   (227,559)  
Earnings per share – diluted $9,680,000 12,359,284 $0.78

 

8
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

    Weighted-  
    Average Earnings
  Net Common Per
  Income Shares Share
Quarter Ended June 30, 2014      
Earnings per share – basic $4,163,000 12,441,679 $0.33
Dilutive effect of potential common stock      
  arising from stock options:      
  Exercise of outstanding stock options   174,840  
  Hypothetical share repurchase at $18.81   (157,135)  
Earnings per share – diluted $4,163,000 12,459,384 $0.33
       
Quarter Ended June 30, 2013      
Earnings per share – basic $4,974,000 12,342,755 $0.40
Dilutive effect of potential common stock      
  arising from stock options:      
  Exercise of outstanding stock options   252,380  
  Hypothetical share repurchase at $19.49   (225,824)  
Earnings per share – diluted $4,974,000 12,369,311 $0.40

 

Stock options that were anti-dilutive were excluded from net income per share calculations. Weighted-average common shares available from anti-dilutive instruments totaled 169,448 shares in the six-month period ended June 30, 2014, 119,385 shares in the six-month period ended June 30, 2013, 200,672 shares in the second quarter 2014 and 116,891 shares in the second quarter 2013.

 

3. COMPREHENSIVE INCOME

 

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

 

(In Thousands) Before-Tax Income Tax Net-of-Tax
  Amount Effect Amount
Six Months Ended June 30, 2014:      
Unrealized gains on available-for-sale securities:      
  Unrealized holding gains on available-for-sale securities $9,857 ($3,450) $6,407
  Reclassification adjustment for (gains) realized in income (134) 47 (87)
Other comprehensive gain on available-for-sale securities 9,723 (3,403) 6,320
       
Unfunded pension and postretirement obligations:      
  Changes from plan amendments and actuarial gains and losses      
    included in other comprehensive income 144 (50) 94
  Amortization of net transition obligation, prior service cost and net      
    actuarial loss included in net periodic benefit cost (8) 3 (5)
Other comprehensive gain on unfunded retirement obligations 136 (47) 89
       
Total other comprehensive gain $9,859 ($3,450) $6,409

 

9
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

(In Thousands) Before-Tax Income Tax Net-of-Tax
  Amount Effect Amount
Six Months Ended June 30, 2013:      
Unrealized gains on available-for-sale securities:      
  Unrealized holding losses on available-for-sale securities ($12,179) $4,261 ($7,918)
  Reclassification adjustment for (gains) realized in income (1,259) 441 (818)
Other comprehensive loss on available-for-sale securities (13,438) 4,702 (8,736)
       
Unfunded pension and postretirement obligations:      
  Changes from plan amendments and actuarial gains and losses      
    included in other comprehensive income 636 (223) 413
  Amortization of net transition obligation, prior service cost and net      
    actuarial loss included in net periodic benefit cost 0 0 0
Other comprehensive gain on unfunded retirement obligations 636 (223) 413
       
Total other comprehensive loss ($12,802) $4,479 ($8,323)
       
(In Thousands) Before-Tax Income Tax Net-of-Tax
  Amount Effect Amount
Three Months Ended June 30, 2014:      
Unrealized gains on available-for-sale securities:      
  Unrealized holding gains on available-for-sale securities $4,523 ($1,582) $2,941
  Reclassification adjustment for (gains) realized in income (103) 36 (67)
Other comprehensive gain on available-for-sale securities 4,420 (1,546) 2,874
       
Unfunded pension and postretirement obligations:      
  Changes from plan amendments and actuarial gains and losses      
    included in other comprehensive income 3 (1) 2
  Amortization of net transition obligation, prior service cost and net      
    actuarial loss included in net periodic benefit cost (4) 2 (2)
Other comprehensive loss on unfunded retirement obligations (1) 1 0
       
Total other comprehensive gain $4,419 ($1,545) $2,874
       
(In Thousands) Before-Tax Income Tax Net-of-Tax
  Amount Effect Amount
Three Months Ended June 30, 2013:      
Unrealized gains on available-for-sale securities:      
  Unrealized holding losses on available-for-sale securities ($9,732) $3,406 ($6,326)
  Reclassification adjustment for (gains) realized in income (100) 35 (65)
Other comprehensive loss on available-for-sale securities (9,832) 3,441 (6,391)
       
Unfunded pension and postretirement obligations:      
  Changes from plan amendments and actuarial gains and losses      
    included in other comprehensive income 0 0 0
  Amortization of net transition obligation, prior service cost and net      
    actuarial loss included in net periodic benefit cost 0 0 0
Other comprehensive gain on unfunded retirement obligations 0 0 0
       
Total other comprehensive loss ($9,832) $3,441 ($6,391)

 

10
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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

 

(In Thousands) Unrealized Unfunded Accumulated
  Holding Gains Pension and Other
  (Losses) Postretirement Comprehensive
  on Securities Obligations Income
Six Months Ended June 30, 2014      
Balance, beginning of period ($1,004) $11 ($993)
Other comprehensive income before reclassifications 6,407 94 6,501
Amounts reclassified from accumulated other      
   comprehensive income (87) (5) (92)
Other comprehensive income 6,320 89 6,409
Balance, end of period $5,316 $100 $5,416
       
Six Months Ended June 30, 2013      
Balance, beginning of period $11,568 ($565) $11,003
Other comprehensive (loss) income before reclassifications (7,918) 413 (7,505)
Amounts reclassified from accumulated other      
   comprehensive income (818) 0 (818)
Other comprehensive (loss) income (8,736) 413 (8,323)
Balance, end of period $2,832 ($152) $2,680

 

Three Months Ended June 30, 2014      
Balance, beginning of period $2,442 $100 $2,542
Other comprehensive income before reclassifications 2,941 2 2,943
Amounts reclassified from accumulated other      
   comprehensive income (67) (2) (69)
Other comprehensive income 2,874 0 2,874
Balance, end of period $5,316 $100 $5,416
       
Three Months Ended June 30, 2013      
Balance, beginning of period $9,223 ($152) $9,071
Other comprehensive loss before reclassifications (6,326) 0 (6,326)
Amounts reclassified from accumulated other      
   comprehensive income (65) 0 (65)
Other comprehensive loss (6,391) 0 (6,391)
Balance, end of period $2,832 ($152) $2,680

 

11
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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

 

For the Six Months Ended June 30, 2014    
(In Thousands)    
  Reclassified from  
Details about Accumulated Other Accumulated Other Affected Line Item in the Consolidated
Comprehensive Income Components Comprehensive Income Statements of Income
Unrealized gains and losses on available-for-sale    
   securities ($134) Realized gains on available-for-sale securities, net
  47 Income tax provision
  (87) Net of tax
Amortization of defined benefit pension and postretirement items:    
    Prior service cost (16) Pensions and other employee benefits
    Actuarial loss 8 Pensions and other employee benefits
  (8) Total before tax
  3 Income tax provision
  (5) Net of tax
Total reclassifications for the period ($92)  

 

For the Six Months Ended June 30, 2013    
(In Thousands)    
  Reclassified from  
Details about Accumulated Other Accumulated Other Affected Line Item in the Consolidated
Comprehensive Income Components Comprehensive Income Statements of Income
Unrealized gains and losses on available-for-sale    
   securities $25 Total other-than-temporary impairment losses on
     available-for-sale securities
  (1,284) Realized gains on available-for-sale securities, net
  (1,259) Total before tax
  441 Income tax provision
  (818) Net of tax
Amortization of defined benefit pension and postretirement items:    
    Prior service cost (16) Pensions and other employee benefits
    Actuarial loss 16 Pensions and other employee benefits
  0 Total before tax
  0 Income tax provision
  0 Net of tax
Total reclassifications for the period ($818)  

 

12
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 


For the Three Months Ended June 30, 2014
   
(In Thousands)    
  Reclassified from  
Details about Accumulated Other Accumulated Other Affected Line Item in the Consolidated
Comprehensive Income Components Comprehensive Income Statements of Income
Unrealized gains and losses on available-for-sale    
   securities ($103) Realized gains on available-for-sale securities, net
  36 Income tax provision
  (67) Net of tax
Amortization of defined benefit pension and postretirement items:    
    Prior service cost (8) Pensions and other employee benefits
    Actuarial loss 4 Pensions and other employee benefits
  (4) Total before tax
  2 Income tax provision
  (2) Net of tax
Total reclassifications for the period ($69)  

 

For the Three Months Ended June 30, 2013    
(In Thousands)    
  Reclassified from  
Details about Accumulated Other Accumulated Other Affected Line Item in the Consolidated
Comprehensive Income Components Comprehensive Income Statements of Income
Unrealized gains and losses on available-for-sale    
   securities $0 Total other-than-temporary impairment losses on
     available-for-sale securities
  (100) Realized gains on available-for-sale securities, net
  (100) Total before tax
  35 Income tax provision
  (65) Net of tax
Amortization of defined benefit pension and postretirement items:    
    Prior service cost (8) Pensions and other employee benefits
    Actuarial loss 8 Pensions and other employee benefits
  0 Total before tax
  0 Income tax provision
  0 Net of tax
Total reclassifications for the period ($65)  

 

13
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

4. CASH AND DUE FROM BANKS

 

Cash and due from banks at June 30, 2014 and December 31, 2013 include the following:

 

(In thousands) June 30, Dec. 31,
  2014 2013
Cash and cash equivalents $54,400 $38,591
Certificates of deposit 5,548 6,028
Total cash and due from banks $59,948 $44,619

 

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 $14,714,000 at June 30, 2014 and $15,318,000 at December 31, 2013.

 

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 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.

 

14
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

At June 30, 2014 and December 31, 2013, assets measured at fair value and the valuation methods used are as follows:

 

    June 30, 2014  
  Quoted Prices Other    
  in Active Observable Unobservable Total
  Markets Inputs Inputs Fair
(In Thousands) (Level 1) (Level 2) (Level 3) Value
         
Recurring fair value measurements        
AVAILABLE-FOR-SALE SECURITIES:        
Obligations of U.S. Government agencies $0 $28,452 $0 $28,452
Obligations of states and political subdivisions:        
     Tax-exempt 0 127,593 0 127,593
     Taxable 0 34,717 0 34,717
Mortgage-backed securities 0 93,613 0 93,613
Collateralized mortgage obligations,        
     Issued by U.S. Government agencies 0 218,506 0 218,506
Collateralized debt obligations 0 660 0 660
Total debt securities 0 503,541 0 503,541
Marketable equity securities 9,207 0 0 9,207
Total available-for-sale securities 9,207 503,541 0 512,748
Servicing rights 0 0 1,281 1,281
Total recurring fair value measurements $9,207 $503,541 $1,281 $514,029
         
Nonrecurring fair value measurements        
Impaired loans with a valuation allowance $0 $0 $3,804 $3,804
Valuation allowance 0 0 (754) (754)
Impaired loans, net 0 0 3,050 3,050
Foreclosed assets held for sale 0 0 1,419 1,419
Total nonrecurring fair value measurements $0 $0 $4,469 $4,469

 

15
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

    December 31, 2013  
  Quoted Prices Other    
  in Active Observable Unobservable Total
  Markets Inputs Inputs Fair
(In Thousands) (Level 1) (Level 2) (Level 3) Value
         
Recurring fair value measurements        
AVAILABLE-FOR-SALE SECURITIES:        
Obligations of U.S. Government agencies $0 $45,877 $0 $45,877
Obligations of states and political subdivisions:        
     Tax-exempt 0 128,426 0 128,426
     Taxable 0 34,471 0 34,471
Mortgage-backed securities 0 86,208 0 86,208
Collateralized mortgage obligations,        
     Issued by U.S. Government agencies 0 178,092 0 178,092
Collateralized debt obligations 0 660 0 660
Total debt securities 0 473,734 0 473,734
Marketable equity securities 8,924 0 0 8,924
Total available-for-sale securities 8,924 473,734 0 482,658
Servicing rights 0 0 1,123 1,123
Total recurring fair value measurements $8,924 $473,734 $1,123 $483,781
         
Nonrecurring fair value measurements        
Impaired loans with a valuation allowance $0 $0 $9,889 $9,889
Valuation allowance 0 0 (2,333) (2,333)
Impaired loans, net 0 0 7,556 7,556
Foreclosed assets held for sale 0 0 892 892
Total nonrecurring fair value measurements $0 $0 $8,448 $8,448

 

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 less estimated selling costs.

 

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 June 30, 2014 and December 31, 2013, 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        
  6/30/14 Valuation Unobservable Method or Value As of
Asset (In Thousands) Technique Input(s) 6/30/14
Servicing rights $1,281 Discounted cash flow Discount rate 10.00% Rate used through modeling period
      Loan prepayment speeds 150.00% 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

 

16
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

  Fair Value at        
  12/31/13 Valuation Unobservable Method or Value As of
Asset (In Thousands) Technique Input(s) 12/31/13
Servicing rights $1,123 Discounted cash flow Discount rate 12.00% Rate used through modeling period
      Loan prepayment speeds 152.00% 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.

 

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

 

  Three Months
Ended June 30,
2014
Six Months
Ended June 30,
2014
(In Thousands) Servicing Servicing
  Rights Rights
Balance, beginning of period $1,268 $1,123
Issuances of servicing rights 66 106
Unrealized (losses) gains included in earnings (53) 52
Balance, end of period $1,281 $1,281

 

  Three Months Ended June 30, 2013 Six Months Ended June 30, 2013
  Pooled Trust Pooled Trust     Pooled Trust Pooled Trust    
   Preferred  Preferred      Preferred  Preferred    
  Securities - Securities -     Securities - Securities -    
(In Thousands) Senior Mezzanine Servicing   Senior Mezzanine Servicing  
  Tranches Tranches Rights Total Tranches Tranches Rights Total
Balance, beginning of period $1,659 $0 $738 $2,397 $1,613 $0 $605 $2,218
Issuances of servicing rights 0 0 115 115 0 0 240 240
Accretion and amortization, net (1) 0 0 (1) (2) 0 0 (2)
Proceeds from sales and calls (1,636) 0 0 (1,636) (1,636) (571) 0 (2,207)
Realized gains, net 23 0 0 23 23 571 0 594
Unrealized (losses) gains included in                
   earnings 0 0 (3) (3) 0 0 5 5
Unrealized (losses) gains included in                
   other comprehensive income (45) 0 0 (45) 2 0 0 2
Balance, end of period $0 $0 $850 $850 $0 $0 $850 $850

 

No other-than-temporary impairment losses (OTTI) on securities valued using Level 3 methodologies were recorded in 2014 or 2013.

 

17
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

DEPOSITS - The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, money market and interest checking accounts, is (by definition) equal to the amount payable on demand at June 30, 2014 and December 31, 2013. The fair value of time deposits, such as certificates of deposit and Individual Retirement Accounts, is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value estimates of deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market, commonly referred to as the core deposit intangible.

 

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

 

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

 

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

 

18
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

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

 

(In Thousands) Valuation June 30, 2014 December 31, 2013
  Method(s) Carrying Fair Carrying Fair
  Used Amount Value Amount Value
Financial assets:          
Cash and cash equivalents Level 1 $54,400 $54,400 $38,591 $38,591
Certificates of deposit Level 2 5,548 5,577 6,028 6,057
Available-for-sale securities See Above 512,748 512,748 482,658 482,658
Restricted equity securities (included in Other Assets) Level 2 2,933 2,933 3,786 3,786
Loans held for sale Level 1 0 0 54 54
Loans, net Level 3 614,347 618,673 635,640 634,937
Accrued interest receivable Level 1 3,813 3,813 4,146 4,146
Servicing rights Level 3 1,281 1,281 1,123 1,123
           
Financial liabilities:          
Deposits with no stated maturity Level 1 717,491 717,491 693,479 693,479
Time deposits Level 3 261,748 262,732 261,037 262,376
Short-term borrowings Level 3 4,637 4,601 23,385 23,356
Long-term borrowings Level 3 73,201 80,015 73,338 79,400
Accrued interest payable Level 1 111 111 120 120

 

6. SECURITIES

 

Amortized cost and fair value of available-for-sale securities at June 30, 2014 and December 31, 2013 are summarized as follows:

    June 30, 2014  
    Gross Gross  
    Unrealized Unrealized  
  Amortized Holding Holding Fair
(In Thousands) Cost Gains Losses Value
         
Obligations of U.S. Government agencies $29,162 $59 ($769) $28,452
Obligations of states and political subdivisions:        
Tax-exempt 123,140 4,780 (327) 127,593
Taxable 34,577 366 (226) 34,717
Mortgage-backed securities 91,051 2,672 (110) 93,613
Collateralized mortgage obligations,        
Issued by U.S. Government agencies 219,858 1,195 (2,547) 218,506
Collateralized debt obligations 660 0 0 660
Total debt securities 498,448 9,072 (3,979) 503,541
Marketable equity securities 6,122 3,086 (1) 9,207
Total $504,570 $12,158 ($3,980) $512,748

 

19
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

    December 31, 2013  
    Gross Gross  
    Unrealized Unrealized  
  Amortized Holding Holding Fair
(In Thousands) Cost Gains Losses Value
         
Obligations of U.S. Government agencies $47,382 $282 ($1,787) $45,877
Obligations of states and political subdivisions:        
Tax-exempt 127,748 2,766 (2,088) 128,426
Taxable 35,154 206 (889) 34,471
Mortgage-backed securities 84,849 1,819 (460) 86,208
Collateralized mortgage obligations,        
Issued by U.S. Government agencies 182,372 761 (5,041) 178,092
Collateralized debt obligations: 660 0 0 660
Total debt securities 478,165 5,834 (10,265) 473,734
Marketable equity securities 6,038 2,886 0 8,924
Total $484,203 $8,720 ($10,265) $482,658

 

The following table presents gross unrealized losses and fair value of available-for-sale securities with unrealized loss positions that are not deemed to be other-than-temporarily impaired, aggregated by length of time that individual securities have been in a continuous unrealized loss position at June 30, 2014 and December 31, 2013:

 

June 30, 2014 Less Than 12 Months 12 Months or More Total
(In Thousands) Fair Unrealized Fair Unrealized Fair Unrealized
  Value Losses Value Losses Value Losses
             
Obligations of U.S. Government agencies $0 $0 $23,867 ($769) $23,867 ($769)
Obligations of states and political subdivisions:            
Tax-exempt 3,463 (33) 11,309 (294) 14,772 (327)
Taxable 2,541 (5) 11,008 (221) 13,549 (226)
Mortgage-backed securities 4,543 (5) 4,372 (105) 8,915 (110)
Collateralized mortgage obligations,            
Issued by U.S. Government agencies 68,200 (562) 67,946 (1,985) 136,146 (2,547)
Total debt securities 78,747 (605) 118,502 (3,374) 197,249 (3,979)
Marketable equity securities 73 (1) 0 0 73 (1)
Total temporarily impaired available-for-sale securities $78,820 ($606) $118,502 ($3,374) $197,322 ($3,980)

 

December 31, 2013 Less Than 12 Months 12 Months or More Total
(In Thousands) Fair Unrealized Fair Unrealized Fair Unrealized
  Value Losses Value Losses Value Losses
             
Obligations of U.S. Government agencies $22,489 ($1,337) $4,598 ($450) $27,087 ($1,787)
Obligations of states and political subdivisions:            
Tax-exempt 44,285 (1,425) 5,808 (663) 50,093 (2,088)
Taxable 20,873 (766) 2,378 (123) 23,251 (889)
Mortgage-backed securities 34,377 (460) 0 0 34,377 (460)
Collateralized mortgage obligations,            
Issued by U.S. Government agencies 113,204 (4,608) 7,399 (433) 120,603 (5,041)
Total temporarily impaired available-for-sale securities $235,228 ($8,596) $20,183 ($1,669) $255,411 ($10,265)

 

20
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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

 

(In Thousands)  3 Months Ended 6 Months Ended
  June 30, June 30, June 30, June 30,
  2014 2013 2014 2013
Gross realized gains from sales $140 $100 $342 $1,402
Gross realized losses from sales (37) 0 (208) (118)
Losses from OTTI impairment 0 0 0 (25)
Net realized gains $103 $100 $134 $1,259

 

The amortized cost and fair value of available-for-sale debt securities by contractual maturity are shown in the following table as of June 30, 2014. Actual maturities may differ from contractual maturities because counterparties may have the right to call or prepay obligations with or without call or prepayment penalties.

 

  Amortized Fair
(In Thousands) Cost Value
     
Due in one year or less $12,797 $12,926
Due from one year through five years 50,717 51,121
Due from five years through ten years 65,550 65,706
Due after ten years 58,475 61,669
Subtotal 187,539 191,422
Mortgage-backed securities 91,051 93,613
Collateralized mortgage obligations,    
     Issued by U.S. Government agencies 219,858 218,506
Total $498,448 $503,541

 

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

 

Investment securities carried at $362,809,000 at June 30, 2014 and $323,613,000 at December 31, 2013 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 OTTI at least on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether the Corporation intends to sell the security or more likely than not will be required to sell the security before its anticipated recovery.

 

A summary of information management considered in evaluating debt and equity securities for OTTI at June 30, 2014 is provided below.

 

Debt Securities

 

At June 30, 2014, 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, including municipal bonds with no external ratings, at June 30, 2014 to be temporary.

 

21
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

The credit rating agencies have withdrawn their ratings on numerous municipal bonds held by the Corporation. At June 30, 2014, the total amortized cost basis of municipal bonds with no external credit ratings was $17,509,000, with an aggregate unrealized gain of $75,000. At the time of purchase, each of these bonds was considered investment grade and had been rated by at least one credit rating agency. Most of the bonds for which credit rating agencies have withdrawn their ratings were insured by an entity that has reported significant financial problems and declines in its regulatory capital ratios, and most of the ratings were removed in the fourth quarter 2009. However, the insurance remains in effect on the bonds. In the third quarter 2013, a credit rating agency withdrew its ratings on several bonds due to changes in its rating methodology related to credit enhancement programs provided by issuers’ state governments. However, the credit enhancement remains in effect on the bonds. None of the unrated municipal bonds has failed to make a scheduled payment.

 

Equity Securities

 

The Corporation’s marketable equity securities at June 30, 2014 and December 31, 2013 consisted exclusively of stocks of banking companies. At June 30, 2014, the Corporation held one stock with an unrealized loss of $1,000 for which management determined an OTTI charge was not required.

 

Realized gains from sales of bank stocks totaled $74,000 in the three-month and six-month period ended June 30, 2014. The Corporation realized gains from sales of bank stocks totaling $57,000 in the three-month period ended June 30, 2013 and $578,000 during the first six months of 2013.

 

C&N Bank is a member of the Federal Home Loan Bank of Pittsburgh (FHLB-Pittsburgh), which is one of 12 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 $2,803,000 at June 30, 2014 and $3,656,000 at December 31, 2013. The Corporation evaluated its holding of FHLB-Pittsburgh stock for impairment and deemed the stock to not be impaired at June 30, 2014 and December 31, 2013. 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.

 

22
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

7. LOANS

 

The loans receivable portfolio is segmented into residential mortgage, commercial and consumer loans. Loans outstanding at June 30, 2014 and December 31, 2013 are summarized by segment, and by classes within each segment, as follows:

 

Summary of Loans by Type        
(In Thousands) June 30,     Dec. 31,
  2014     2013
Residential mortgage:        
Residential mortgage loans - first liens $291,690     $299,831
Residential mortgage loans - junior liens 22,401     23,040
Home equity lines of credit 34,633     34,530
1-4 Family residential construction 13,948     13,909
Total residential mortgage 362,672     371,310
Commercial:        
Commercial loans secured by real estate 145,934     147,215
Commercial and industrial 46,778     42,387
Political subdivisions 11,617     16,291
Commercial construction and land 8,550     17,003
Loans secured by farmland 8,380     10,468
Multi-family (5 or more) residential 10,548     10,985
Agricultural loans 3,116     3,251
Other commercial loans 13,816     14,631
Total commercial 248,739     262,231
Consumer 10,203     10,762
Total 621,614     644,303
Less: allowance for loan losses (7,267)     (8,663)
Loans, net $614,347     $635,640

 

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 June 30, 2014 or December 31, 2013.

 

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 June 30, 2014 and December 31, 2013, management determined that no allowance for credit losses related to unfunded loan commitments was required.

 

23
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Transactions within the allowance for loan losses, summarized by segment and class, for the three-month and six-month periods ended June 30, 2014 and 2013 were as follows:

 

Three Months Ended June 30, 2014 March 31,        June 30,
(In Thousands) 2014
Balance 
 Charge-offs   Recoveries   Provision
(Credit) 
2014
Balance 
Allowance for Loan Losses:          
Residential mortgage:          
Residential mortgage loans - first liens $2,863 ($40) $1 $142           $2,966
Residential mortgage loans - junior liens 280 0 0 0               280
Home equity lines of credit 271 0 0 6               277
1-4 Family residential construction 153 0 0 20               173
Total residential mortgage 3,567 (40) 1 168             3,696
Commercial:          
Commercial loans secured by real estate 3,081 (1,486) 0 301             1,896
Commercial and industrial 555 0 7 64                626
Political subdivisions 0 0 0 0                 0
Commercial construction and land 247 0 5 (89)                163
Loans secured by farmland 98 0 0 (2)                  96
Multi-family (5 or more) residential 105 0 0 (2)                103
Agricultural loans 30 0 0 0                  30
Other commercial loans 138 0 0 (3)                135
Total commercial 4,254 (1,486) 12 269           3,049
Consumer 128 (20) 11 8                127
Unallocated 394 0 0 1                 395
           
Total Allowance for Loan Losses $8,343 ($1,546) $24 $446 $7,267

 

Three Months Ended June 30, 2013 March 31,        June 30, 
(In Thousands) 2013
Balance 
 Charge-offs   Recoveries   Provision
(Credit) 
2013 
Balance 
Allowance for Loan Losses:          
Residential mortgage:          
Residential mortgage loans - first liens $2,786 ($13) $11 $87 $2,871
Residential mortgage loans - junior liens 236 0 0 (7) 229
Home equity lines of credit 251 0 0 7 258
1-4 Family residential construction 145 (11) 0 45 179
Total residential mortgage 3,418 (24) 11 132 3,537
Commercial:          
Commercial loans secured by real estate 1,906 0 43 (5) 1,944
Commercial and industrial 597 (2) 1 32 628
Political subdivisions 0 0 0 0 0
Commercial construction and land 368 (4) 0 (106) 258
Loans secured by farmland 127 0 0 (6) 121
Multi-family (5 or more) residential 65 0 0 (1) 64
Agricultural loans 26 0 0 2 28
Other commercial loans 2 0 0 3 5
Total commercial 3,091 (6) 44 (81) 3,048
Consumer 211 (22) 11 15 215
Unallocated 398 0 0 0 398
           
Total Allowance for Loan Losses $7,118 ($52) $66 $66 $7,198

 

24
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Six Months Ended June 30, 2014 December 31,         June 30, 
(In Thousands)  2013
Balance 
Charge-offs   Recoveries   Provision
(Credit) 
 2014 
Balance 
Allowance for Loan Losses:          
Residential mortgage:          
Residential mortgage loans - first liens $2,974 ($59) $1 $50 $2,966
Residential mortgage loans - junior liens 294 0 0 (14) 280
Home equity lines of credit 269 0 0 8 277
1-4 Family residential construction 168 0 0 5 173
Total residential mortgage 3,705 (59) 1 49 3,696
Commercial:          
Commercial loans secured by real estate 3,123 (1,521) 250 44 1,896
Commercial and industrial 591 (24) 8 51 626
Political subdivisions 0 0 0 0 0
Commercial construction and land 267 (170) 5 61 163
Loans secured by farmland 115 0 0 (19) 96
Multi-family (5 or more) residential 103 0 0 0 103
Agricultural loans 30 0 0 0 30
Other commercial loans 138 0 0 (3) 135
Total commercial 4,367 (1,715) 263 134 3,049
Consumer 193 (46) 25 (45) 127
Unallocated 398 0 0 (3) 395
           
Total Allowance for Loan Losses $8,663 ($1,820) $289 $135 $7,267

 

Six Months Ended June 30, 2013 December 31,         June 30, 
(In Thousands) 2012
Balance 
Charge-offs  Recoveries  Provision
(Credit) 
 2013
Balance 
Allowance for Loan Losses:          
Residential mortgage:          
Residential mortgage loans - first liens $2,619 ($65) $11 $306 $2,871
Residential mortgage loans - junior liens 247 0 0 (18) 229
Home equity lines of credit 255 0 0 3 258
1-4 Family residential construction 96 (11) 0 94 179
Total residential mortgage 3,217 (76) 11 385 3,537
Commercial:          
Commercial loans secured by real estate 1,930 0 293 (279) 1,944
Commercial and industrial 581 (110) 2 155 628
Political subdivisions 0 0 0 0 0
Commercial construction and land 234 (4) 0 28 258
Loans secured by farmland 129 0 0 (8) 121
Multi-family (5 or more) residential 67 0 0 (3) 64
Agricultural loans 27 0 0 1 28
Other commercial loans 3 0 0 2 5
Total commercial 2,971 (114) 295 (104) 3,048
Consumer 228 (55) 31 11 215
Unallocated 441 0 0 (43) 398
           
Total Allowance for Loan Losses $6,857 ($245) $337 $249 $7,198

 

25
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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 below.

 

The following tables summarize the aggregate credit quality classification of outstanding loans by risk rating as of June 30, 2014 and December 31, 2013:

 

June 30, 2014   Special      
(In Thousands) Pass Mention Substandard Doubtful Total
Residential Mortgage:          
Residential Mortgage loans - first liens $278,486 $1,825 $11,297 $82 $291,690
Residential Mortgage loans - junior liens 21,245 371 785 0 22,401
Home Equity lines of credit 33,902 292 439 0 34,633
1-4 Family residential construction 13,948 0 0 0 13,948
Total residential mortgage 347,581 2,488 12,521 82 362,672
Commercial:          
Commercial loans secured by real estate 132,823 3,376 9,735 0 145,934
Commercial and Industrial 38,348 5,173 3,022 235 46,778
Political subdivisions 11,617 0 0 0 11,617
Commercial construction and land 6,047 306 2,111 86 8,550
Loans secured by farmland 5,952 512 1,889 27 8,380
Multi-family (5 or more) residential 10,244 302 2 0 10,548
Agricultural loans 3,072 0 44 0 3,116
Other commercial loans 13,724 92 0 0 13,816
Total Commercial 221,827 9,761 16,803 348 248,739
Consumer 10,070 1 131 1 10,203
Totals $579,478 $12,250 $29,455 $431 $621,614

 

26
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

December 31, 2013   Special      
(In Thousands) Pass Mention Substandard Doubtful Total
Residential Mortgage:          
Residential mortgage loans - first liens $286,144 $1,876 $11,629 $182 $299,831
Residential mortgage loans - junior liens 21,694 351 995 0 23,040
Home equity lines of credit 33,821 295 414 0 34,530
1-4 Family residential construction 13,837 0 72 0 13,909
Total residential mortgage 355,496 2,522 13,110 182 371,310
Commercial:          
Commercial loans secured by real estate 129,834 5,866 11,368 147 147,215
Commercial and Industrial 32,317 6,697 3,138 235 42,387
Political subdivisions 16,291 0 0 0 16,291
Commercial construction and land 13,792 427 2,036 748 17,003
Loans secured by farmland 8,279 758 1,402 29 10,468
Multi-family (5 or more) residential 10,665 316 4 0 10,985
Agricultural loans 3,169 34 48 0 3,251
Other commercial loans 14,532 99 0 0 14,631
Total commercial 228,879 14,197 17,996 1,159 262,231
Consumer 10,587 6 169 0 10,762
Totals $594,962 $16,725 $31,275 $1,341 $644,303

 

The general component of the allowance for loan losses covers pools of loans including commercial loans not considered individually impaired, as well as smaller balance homogeneous classes of loans, such as residential real estate, home equity lines of credit and other consumer loans. Accordingly, the Corporation generally does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are subject to a restructuring agreement. The pools of loans are evaluated for loss exposure based upon three-year average historical net charge-off rates for each loan class, adjusted for qualitative factors. Qualitative risk factors (described in the following paragraph) 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 three-year average net charge-off rate to 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 71% at June 30, 2014) 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.

 

27
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

The scope of loans evaluated individually for impairment include all loan relationships greater than $200,000 for which there is at least one extension of credit graded Special Mention, Substandard or Doubtful. Also, all loans classified as troubled debt restructurings (discussed in more detail below) and all loan relationships less than $200,000 in the aggregate, but with an estimated loss of $100,000 or more, are individually evaluated for impairment. Loans that are individually evaluated for impairment, but which are not determined to 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 evaluated, but which have not been determined to be impaired, are included in the “Collectively Evaluated” column in the tables summarizing the allowance and associated loan balances as of June 30, 2014 and December 31, 2013.

 

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 June 30, 2014 and December 31, 2013:

 

June 30, 2014 Loans:   Allowance for Loan Losses:
(In Thousands)      
  Individually Collectively     Individually Collectively  
  Evaluated Evaluated Totals   Evaluated Evaluated Totals
Residential mortgage:              
Residential mortgage loans - first liens $2,652 $289,038 $291,690   $452 $2,514 $2,966
Residential mortgage loans - junior liens 181 22,220 22,401   100 180 280
Home equity lines of credit 0 34,633 34,633   0 277 277
1-4 Family residential construction 0 13,948 13,948   0 173 173
Total residential mortgage 2,833 359,839 362,672   552 3,144 3,696
Commercial:              
Commercial loans secured by real estate 7,003 138,931 145,934   20 1,876 1,896
Commercial and industrial 776 46,002 46,778   83 543 626
Political subdivisions 0 11,617 11,617   0 0 0
Commercial construction and land 2,113 6,437 8,550   72 91 163
Loans secured by farmland 1,294 7,086 8,380   27 69 96
Multi-family (5 or more) residential 0 10,548 10,548   0 103 103
Agricultural loans 43 3,073 3,116   0 30 30
Other commercial loans 0 13,816 13,816   0 135 135
Total commercial 11,229 237,510 248,739   202 2,847 3,049
Consumer 0 10,203 10,203   0 127 127
Unallocated             395
               
Total $14,062 $607,552 $621,614   $754 $6,118 $7,267

 

28
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

December 31, 2013 Loans:   Allowance for Loan Losses:
(In Thousands)      
  Individually Collectively     Individually Collectively  
  Evaluated Evaluated Totals   Evaluated Evaluated Totals
Residential mortgage:              
Residential mortgage loans - first liens $2,727 $297,104 $299,831   $449 $2,525 $2,974
Residential mortgage loans - junior liens 183 22,857 23,040   100 194 294
Home equity lines of credit 0 34,530 34,530   0 269 269
1-4 Family residential construction 0 13,909 13,909   0 168 168
Total residential mortgage 2,910 368,400 371,310   549 3,156 3,705
Commercial:              
Commercial loans secured by real estate 7,988 139,227 147,215   1,577 1,546 3,123
Commercial and industrial 1,276 41,111 42,387   106 485 591
Political subdivisions 0 16,291 16,291   0 0 0
Commercial construction 2,776 14,227 17,003   72 195 267
Loans secured by farmland 1,318 9,150 10,468   29 86 115
Multi-family (5 or more) residential 0 10,985 10,985   0 103 103
Agricultural loans 48 3,203 3,251   0 30 30
Other commercial loans 0 14,631 14,631   0 138 138
Total commercial 13,406 248,825 262,231   1,784 2,583 4,367
Consumer 5 10,757 10,762   0 193 193
Unallocated             398
               
Total $16,321 $627,982 $644,303   $2,333 $5,932 $8,663

 

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

 

(In Thousands)  3 Months Ended   6 Months Ended 
   June 30,   June 30, 
  2014 2013 2014 2013
Average investment in impaired loans $14,595 $7,131 $15,129 $7,291
Interest income recognized on impaired loans 210 58 373 128
Interest income recognized on a cash basis on impaired loans 210 58 373 128

 

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

 

29
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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

 

(In Thousands) June 30, 2014   December 31, 2013
  Past Due     Past Due  
  90+ Days and     90+ Days and  
  Accruing Nonaccrual   Accruing Nonaccrual
Residential mortgage:          
Residential mortgage loans - first liens $1,698 $3,613   $2,016 $3,533
Residential mortgage loans - junior liens 137 197   187 110
Home equity lines of credit 38 100   87 62
1-4 Family residential construction 0 0   0 72
Total residential mortgage 1,873 3,910   2,290 3,777
Commercial:          
Commercial loans secured by real estate 660 6,253   744 7,096
Commercial and industrial 5 475   17 434
Commercial construction and land 0 2,001   5 2,663
Loans secured by farmland 508 890   0 902
Agricultural loans 0 43   0 35
Total commercial 1,173 9,662   766 11,130
Consumer 4 26   75 27
           
Totals $3,050 $13,598   $3,131 $14,934

 

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 June 30, 2014 and December 31, 2013:

 

  As of June 30, 2014   As of December 31, 2013
  Current &         Current &      
(In Thousands) Past Due Past Due Past Due     Past Due Past Due Past Due  
  Less than 30-89 90+     Less than 30-89 90+  
  30 Days Days Days Total   30 Days Days Days Total
Residential mortgage:                  
Residential mortgage loans - first liens $284,531 $3,919 $3,240 $291,690   $289,483 $6,776 $3,572 $299,831
Residential mortgage loans - junior liens 21,781 295 325 22,401   22,247 506 287 23,040
Home equity lines of credit 34,386 109 138 34,633   34,263 118 149 34,530
1-4 Family residential construction 13,948 0 0 13,948   13,837 0 72 13,909
Total residential mortgage 354,646 4,323 3,703 362,672   359,830 7,400 4,080 371,310
                   
Commercial:                  
Commercial loans secured by real estate 143,622 809 1,503 145,934   145,055 405 1,755 147,215
Commercial and industrial 46,568 69 141 46,778   41,730 434 223 42,387
Political subdivisions 11,617 0 0 11,617   16,291 0 0 16,291
Commercial construction and land 6,392 157 2,001 8,550   14,303 32 2,668 17,003
Loans secured by farmland 6,943 66 1,371 8,380   9,267 329 872 10,468
Multi-family (5 or more) residential 10,548 0 0 10,548   10,985 0 0 10,985
Agricultural loans 3,073 0 43 3,116   3,203 13 35 3,251
Other commercial loans 13,816 0 0 13,816   14,631 0 0 14,631
Total commercial 242,579 1,101 5,059 248,739   255,465 1,213 5,553 262,231
Consumer 10,118 81 4 10,203   10,516 171 75 10,762
                   
Totals $607,343 $5,505 $8,766 $621,614   $625,811 $8,784 $9,708 $644,303

 

30
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Nonaccrual loans are included in the contractual aging in the immediately preceding table. A summary of the contractual aging of nonaccrual loans at June 30, 2014 and December 31, 2013 is as follows:

 

  Current &      
(In Thousands) Past Due Past Due Past Due  
  Less than 30-89 90+  
  30 Days Days Days Total
June 30, 2014 Nonaccrual Totals $7,214 $668 $5,716 $13,598
December 31, 2013 Nonaccrual Totals $7,878 $479 $6,577 $14,934

 

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 June 30, 2014 and December 31, 2013 is as follows:

 

  Current &        
(In Thousands) Past Due Past Due Past Due    
  Less than 30-89 90+    
  30 Days Days Days Nonaccrual Total
June 30, 2014 Totals $1,811 $258 $619 $5,419 $8,107
December 31, 2013 Totals $3,254 $13 $0 $908 $4,175

 

TDRs that occurred during the three-month periods ended June 30, 2014 and 2013 are as follows:

 

Three Months Ended June 30, 2014   Pre- Post-
(Balances in Thousands)   Modification Modification
  Number Outstanding Outstanding
  of Recorded Recorded
  Contracts Investment Investment
Residential mortgage,      
Residential mortgage loans - first liens 2 $67 $67
Commercial:      
Commercial loans secured by real estate 5 6,679 5,193
Commercial and industrial 1 80 80
       
Three Months Ended June 30, 2013   Pre- Post-
(Balances in Thousands)   Modification Modification
  Number Outstanding Outstanding
  Of Recorded Recorded
  Contracts Investment Investment
Residential mortgage:      
Residential mortgage loans - first liens 1 $143 $143
Residential mortgage loans - junior liens 1 65 65
Commercial:      
Commercial loans secured by real estate 1 440 440
Loans secured by farmland 4 512 512
Agricultural loans 1 13 13
Consumer 1 6 6

 

31
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

The TDRs related to residential mortgage loans in the three-month period ended June 30, 2014 included a reduction in payment amount on one contract and an interest only period allowed on one contract. The TDRs related to commercial loans in the three-month period ended June 30, 2014 relate to six contracts associated with one relationship. The Corporation entered into a forbearance agreement with this commercial borrower which includes a reduction in monthly payment amounts over a fifteen-month period. At the end of the fifteen-month period, the monthly payment amounts would revert to the original amounts, unless the forbearance agreement is extended or the payment requirements are otherwise modified. The Corporation recorded a charge-off of $1,486,000 in the second quarter 2014 as a result of these modifications, as the payment amounts based on the forbearance agreement are not sufficient to fully amortize the contractual amount of principal outstanding on the loans. The amount of the charge-off was determined based on the excess of the contractual principal due over the present value of the payment amounts provided for in the forbearance agreement, assuming the revised payment amounts would continue until maturity, at the contractual interest rates. After the effect of the charge-off, the total recorded investment in loans to this borrower amounted to $5,273,000, with no related allowance for loan losses on these loans at June 30, 2014, while the allowance on the loans amounted to $1,503,000 at March 31, 2014. There were no other changes in the allowance for loan losses related to TDRs that occurred in the second quarter 2014.

 

All of the TDRs in the three-month period ended June 30, 2013 were situations in which the Corporation agreed to permit the borrowers to pay interest only for an extended period of time, and all of the contracts included in the table above were associated with one relationship, except for the commercial loan secured by real estate. There were no changes in the allowance for loan losses in the second quarter 2013 as a result of TDRs that occurred in that period.

 

TDRs that occurred during the six-month periods ended June 30, 2014 and 2013 were as follows:

 

Six Months Ended June 30, 2014   Pre- Post-
(Balances in Thousands)   Modification Modification
  Number Outstanding Outstanding
  of Recorded Recorded
  Contracts Investment Investment
Residential mortgage,      
Residential mortgage loans - first liens 3 $150 $150
Commercial:      
Commercial loans secured by real estate 5                   6,679                     5,193
Commercial and industrial 1                         80                           80

 

Six Months Ended June 30, 2013   Pre- Post-
(Balances in Thousands)   Modification Modification
  Number Outstanding Outstanding
  of Recorded Recorded
  Contracts Investment Investment
Residential mortgage:      
Residential mortgage loans - first liens 6 $677 $677
Residential mortgage loans - junior liens 3 102 102
Commercial:      
Commercial loans secured by real estate 1 440 440
Loans secured by farmland 4 512 512
Agricultural loans 1 13 13
Consumer 1 6 6

 

In addition to the TDRs that occurred in the second quarter 2014, which are described above, earlier in 2014 the Corporation agreed to a reduction in interest rate and payment amount on one residential mortgage loan. After the effect of the $1,486,000 charge-off related to loans to one commercial borrower described above, there was no allowance for loan losses on loans to that borrower at June 30, 2014, while the allowance on the loans amounted to $1,552,000 at December 31, 2013. There were no other changes in the allowance for loan losses related to TDRs that occurred during the six-month period ended June 30, 2014.

 

The TDRs in the six-month period ended June 30, 2013 included interest only payments for an extended period of time (10 contracts), extensions of the final maturity date (3 contracts), reduction in interest rate (2 contracts) and reduction in payment amount for one year (1 contract). There was no allowance for loan losses on these loans at June 30, 2013 and no change in the allowance for loan losses resulting from these TDRs during the six-month period ended June 30, 2013.

 

32
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

In the three-month and six-month periods ended June 30, 2014 and 2013, defaults on loans for which modifications considered to be TDRs were entered into within the previous 12 months were as follows:

 

  Number  
  of Recorded
  Contracts Investment
Three Months Ended June 30, 2014    
(Balances in Thousands)    
Residential mortgage:    
Residential mortgage loans - first liens 1 $83
Residential mortgage loans - junior liens 1 62
Commercial:    
Commercial loans secured by real estate 1 429
Agricultural 1 13

 

  Number  
  of Recorded
  Contracts Investment
Three Months Ended June 30, 2013    
(Balances in Thousands)    
Commercial,    
Commercial loans secured by real estate 1 $440

 

  Number  
  of Recorded
  Contracts Investment
Six Months Ended June 30, 2014    
(Balances in Thousands)    
Residential mortgage:    
Residential mortgage loans - first liens 2 $223
Residential mortgage loans - junior liens 1 62
Commercial:    
Commercial loans secured by real estate 1 429
Loans secured by farmland 4 490
Agricultural 1 13

 

  Number  
  of Recorded
  Contracts Investment
Six Months  Ended June 30, 2013    
(Balances in Thousands)    
Commercial,    
Commercial loans secured by real estate 1 $440

 

In the second quarter 2014, the events of default in the table listed above included a borrower’s failure to make the reduced payments provided for at a reduced interest rate on a first lien residential mortgage. The other events of default listed above in the three-month and six-month periods ended June 30, 2014 resulted from the borrowers’ failure to make interest only monthly payments. There were no allowances for loan losses recorded on these loans at June 30, 2014.

 

In the three-month and six-month periods ended June 30, 2013, the event of default listed in the table resulted from the borrower’s failure to make interest only monthly payments. There was no allowance for loan losses recorded on this loan at June 30, 2013.

 

33
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

8. BORROWED FUNDS

 

SHORT-TERM BORROWINGS

 

Short-term borrowings include the following:

 

(In Thousands) June 30, Dec. 31,
  2014 2013
FHLB-Pittsburgh borrowings $0 $20,000
Customer repurchase agreements 4,637 3,385
Total short-term borrowings $4,637 $23,385

 

The FHLB-Pittsburgh loan facilities are collateralized by qualifying loans secured by real estate with a book value totaling $447,927,000 at June 30, 2014 and $453,792,000 at December 31, 2013. 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 $2,803,000 at June 30, 2014 and $3,656,000 at December 31, 2013.

 

The short-term borrowing from the FHLB-Pittsburgh matured in January 2014 and had an interest rate of 0.24%.

 

The Corporation engages in repurchase agreements with certain commercial customers. These agreements provide that the Corporation sells specified investment securities to the customers on an overnight basis and repurchases them on the following business day. The weighted average rate paid by the Corporation on customer repurchase agreements was 0.10% at June 30, 2014 and December 31, 2013. The carrying value of the underlying securities was $11,121,000 at June 30, 2014 and $11,269,000 at December 31, 2013.

 

LONG-TERM BORROWINGS    
     
Long-term borrowings are as follows:    
(In Thousands) June 30, Dec. 31,
  2014 2013
FHLB-Pittsburgh borrowings $12,201 $12,338
Repurchase agreements 61,000 61,000
Total long-term borrowings $73,201 $73,338

 

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

(In Thousands) June 30, Dec. 31,
  2014 2013
Loan maturing in 2016 with a rate of 6.86% $130 $153
Loan maturing in 2017 with a rate of 6.83% 19 22
Loan maturing in 2017 with a rate of 3.81% 10,000 10,000
Loan maturing in 2020 with a rate of 4.79% 1,068 1,146
Loan maturing in 2025 with a rate of 4.91% 984 1,017
Total long-term FHLB-Pittsburgh borrowings $12,201 $12,338

 

Repurchase agreements included in long-term borrowings are as follows:

 

(In Thousands) June 30, Dec. 31,
  2014 2013
Agreement maturing in 2017 with a rate of 3.595% $27,000 $27,000
Agreement maturing in 2017 with a rate of 4.265% 34,000 34,000
Total long-term repurchase agreements $61,000 $61,000

 

The Corporation incurred a loss of $1,023,000 in the first quarter of 2013 on prepayment of $7,000,000 of the agreement with an interest rate of 3.595%. Each of these borrowings is putable by the issuer at quarterly intervals.

 

34
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Securities sold under repurchase agreements were delivered to the broker-dealer who is the counter-party to the transactions. The broker-dealer may have sold, loaned or otherwise disposed of such securities to other parties in the normal course of their operations, and has agreed to resell to the Corporation substantially identical securities at the maturities of the agreements. The Master Repurchase Agreement between the Corporation and the broker-dealer provides that the Agreement constitutes a “netting contract,” as defined; however, the Corporation and the broker-dealer have no other obligations to one another and accordingly, no netting has occurred. The carrying value of the underlying securities was $73,843,000 at June 30, 2014 and $79,814,000 at December 31, 2013.

 

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. Effective January 1, 2013, this plan was amended so that full-time employees no longer accrue service time toward the Corporation-subsidized portion of the medical benefits. The plan was also amended effective January 1, 2013 to change some of the age and length-of-service requirements for participants to receive some of the benefits provided under the plan. This 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 June 30, 2014 and December 31, 2013, 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:

 

 (In Thousands) Pension   Postretirement
  Six Months Ended   Six Months Ended
  June 30,   June 30,
  2014 2013   2014 2013
Service cost $0 $0   $17 $21
Interest cost 37 36   29 28
Expected return on plan assets (44) (45)   0 0
Amortization of prior service cost 0 0   (16) (16)
Recognized net actuarial loss 8 16   0 0
Net periodic benefit cost $1 $7   $30 $33

 

(In Thousands) Pension   Postretirement
  Three Months Ended   Three Months Ended
  June 30,   June 30,
  2014 2013   2014 2013
Service cost $0 $0   $8 $11
Interest cost 19 18   15 14
Expected return on plan assets (22) (22)   0 0
Amortization of prior service cost 0 0   (8) (8)
Recognized net actuarial loss 4 8   0 0
Net periodic benefit cost $1 $4   $15 $17

 

In the first six months of 2014, the Corporation funded postretirement contributions totaling $29,000, with estimated annual postretirement contributions of $60,000 expected in 2014 for the full year. The Corporation made no contribution to the defined benefit pension plan in the first six months of 2014. Based upon the related actuarial reports, no defined benefit pension contributions are required in 2014, though the Corporation may make discretionary contributions.

 

35
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

10. STOCK-BASED COMPENSATION PLANS

 

In January 2014, the Corporation granted options to purchase a total of 39,027 shares of common stock through its Stock Incentive and Independent Directors Stock Incentive Plans. In January 2013, the Corporation granted options to purchase a total of 64,050 shares of common stock. The exercise price for the 2014 awards is $20.45 per share, and the exercise price for the 2013 awards is $19.21 per share, based on the market price as of the date of grant. Stock option expense is recognized over the vesting period of each option. The Corporation expects total stock option expense for the year ending December 31, 2014 will be $154,000, and total stock option expense for the year ended December 31, 2013 was $242,000.

 

The Corporation records stock option expense based on estimated fair value calculated using an option valuation model. In calculating the 2014 and 2013 fair values, the Corporation utilized the Black-Scholes-Merton option-pricing model. The calculated fair value of each option granted, and significant assumptions used in the calculations, are as follows:

 

  2014 2013
Fair value of each option granted $5.50 $5.56
Volatility 39% 41%
Expected option lives 8 Years 8 Years
Risk-free interest rate 2.85% 1.60%
Dividend yield 4.33% 3.69%

 

In calculating the estimated fair value of stock option awards, management based its estimates of volatility and dividend yield on the Corporation’s experience over the immediately prior period of time consistent with the estimated lives of the options. The risk-free interest rate was based on the published yield of zero-coupon U.S. Treasury strips with an applicable maturity as of the grant dates. The expected option lives were based on management’s estimates of the average term for all options issued under both plans. In 2014, management assumed a 34% forfeiture rate for options granted under the Stock Incentive Plan, and a 3% forfeiture rate for the Directors Stock Incentive Plan. In 2013, management assumed a 33% forfeiture rate for options granted under the Stock Incentive Plan, and a 0% forfeiture rate for the Directors Stock Incentive Plan. These estimated forfeiture rates were determined based on the Corporation’s historical experience.

 

In January 2014, the Corporation awarded a total of 16,711 shares of restricted stock under the Stock Incentive and Independent Directors Stock Incentive Plans. In January 2013, a total of 37,886 shares of restricted stock were awarded under the Plans. Compensation cost related to restricted stock is recognized based on the market price of the stock at the grant date over the vesting period. For most of the restricted stock awards granted under the Stock Incentive Plan, the Corporation must meet an annual targeted return on average equity (“ROAE”) performance ratio, as defined, in order for participants to vest. Management has estimated restricted stock expense in the first six months of 2014 based on an assumption that the ROAE target for 2014 will be met. For 2014 restricted stock awards under the Stock Incentive Plan to individuals who are substantially involved in mortgage lending, and for restricted stock awards under the Independent Directors Stock Incentive Plan, vesting is not dependent on the Corporation’s ROAE.

 

Total stock-based compensation expense is as follows:

 

(In Thousands) 3 Months Ended 6 Months Ended
  June 30, June 30, June 30, June 30,
  2014 2013 2014 2013
 Stock options $59 $96 $154 $262
 Restricted stock 113 109 230 230
         
 Total $172 $205 $384 $492

 

36
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

11. INCOME TAXES

 

The net deferred tax asset at June 30, 2014 and December 31, 2013 represents the following temporary difference components:

 

  June 30, December 31,
 (In Thousands) 2014 2013
Deferred tax assets:    
Unrealized holding losses on securities $0 $541
Net realized losses on securities 94 91
Allowance for loan losses 2,543 3,032
Credit for alternative minimum tax paid 1,387 1,905
Other deferred tax assets 2,231 2,332
Total deferred tax assets 6,255 7,901
Deferred tax liabilities:    
Unrealized holding gains on securities 2,862 0
Defined benefit plans - ASC 835 53 6
Bank premises and equipment 1,269 1,314
Core deposit intangibles 24 30
Other deferred tax liabilities 210 207
Total deferred tax liabilities 4,418 1,557
Deferred tax asset, net $1,837 $6,344

 

The provision for income tax for the three-month and six-month periods ended June 30, 2014 and 2013 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 Six Months Ended
(In thousands) June 30, June 30,
  2014 2013 2014 2013
Income before income tax provision $5,563 $6,645 $11,250 $12,935
Income tax provision 1,400 1,671 2,799 3,255
Effective tax rate 25.17% 25.15% 24.88% 25.16%

 

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

 

The Corporation has investments in three limited partnerships that manage affordable housing projects that have qualified for the federal low-income housing tax credit. The Corporation’s expected return from these investments is based on the receipt of tax credits and tax benefits from deductions of operating losses. The Corporation uses the effective yield method to account for these investments, with the benefits recognized as a reduction of the provision for income taxes. For two of the three limited partnership investments, the tax credits have been received in full in prior years, and the Corporation has fully realized the benefits of the credits and amortized its initial investments in the partnerships. The most recent affordable housing project was completed in 2013, and the Corporation received tax credits in 2013 and expects to continue to receive tax credits annually through 2022. The carrying amount of the Corporation’s investment is $951,000 at June 30, 2014 and $996,000 at December 31, 2013 (included in Other Assets in the consolidated balance sheets). For the year ending December 31, 2014, the estimated amount of tax credits and other tax benefits to be received is $159,000 and the estimated amount to be recognized as a reduction of the provision for income taxes is $83,000. For the year ended December 31, 2013, tax credits and other tax benefits totaled $160,000 and the amount recognized as a reduction of the provision for income taxes for 2013 was $85,000. The reduction in the provision for income taxes resulting from this investment totaled $20,000 in the second quarter 2014 and $41,000 for the first six months of 2014, and $43,000 in the three-month and six-month periods ended June 30, 2013.

 

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 2010.

 

37
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

12. CONTINGENCIES

 

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

 

13. RECENT ACCOUNTING PRONOUNCEMENTS

 

The FASB issues Accounting Standards Updates (ASUs) to the FASB 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.

 

In July 2013, the FASB issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. The amendments in this standard clarify that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. For the Corporation, the amendments in this Update are effective beginning in the first quarter 2014. The Corporation will be affected by these amendments if unrecognized tax benefits arise in future periods.

 

In December 2013, the FASB issued ASU 2013-12, Definition of a Public Business Entity. The amendment in this Update provides a single definition of public business entity for use in future financial accounting and reporting guidance. The amendment does not affect existing requirements and does not have an effective date. The amendment specifies the following: (1) an entity that is required by the Securities and Exchange Commission (SEC) to file or furnish financial statements with the SEC, or does file or furnish financial statements with the SEC, is considered a public entity, (2) a consolidated subsidiary of a public company is not considered a public business entity for purposes of its standalone financial statements other than those included in an SEC filing by its parent or by other registrants or those that are issuers and are required to file or furnish financial statements with the SEC, and (3) a business entity that has securities that are not subject to contractual restrictions on transfer and that is by law, contract or regulation required to prepare U.S. GAAP financial statements (including footnotes) and make them publicly available on a periodic basis is considered a public business entity. Based on this definition, Citizens & Northern Corporation is considered a public business entity, while the individual subsidiaries are not considered to be public business entities for purposes of their standalone financial statements.

 

In January 2014, the FASB issued ASU 2014-01, Accounting for Investments in Qualified Affordable Housing Projects. This Update provides guidance on accounting for investments in flow-through limited liability entities that qualify for the federal low-income housing tax credit. Currently, under U.S. GAAP, a reporting entity that invests in a qualified affordable housing project may elect to account for that investment using the effective yield method if certain conditions are met, or alternatively, the investment would be accounted for under either the equity method or the cost method. Generally, investors in qualified affordable housing project investments expect to receive all of their return through the receipt of tax credits and tax deductions from operating losses, and use of the effective yield method results in recognition of the return as a reduction of income tax expense over the period of the investment. The amendments in this Update modify the conditions that a reporting entity must meet to be eligible to use a method other than the equity or cost methods to account for investments in qualified affordable housing projects. Additionally, the amendments introduce new recurring disclosure requirements about investments in qualified affordable housing projects. The amendments in this Update are effective for the Corporation for annual and interim periods beginning in the first quarter 2015, and are to be applied retrospectively. Information concerning the Corporation’s investments in qualified affordable housing projects is provided in Note 11 to these unaudited consolidated financial statements.

 

In January 2014, the FASB issued ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. The objective of the amendments in this Update is to reduce diversity among reporting entities by clarifying when an in substance foreclosure occurs. The amendments in this Update clarify that an in substance foreclosure occurs, and a creditor is considered to have received physical possession of residential real property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to the requirements of the applicable jurisdiction. An entity can elect to adopt the amendments in this Update using either a modified retrospective transition method or a prospective transition method. Under the modified retrospective transition method, an entity would record a cumulative-effect adjustment to residential consumer mortgage loans and foreclosed residential real estate properties existing as of the beginning of the annual period for which the amendments are effective. For prospective transition, an entity would apply the amendments to all instances of an entity receiving physical possession of residential real estate property collateralizing consumer mortgage loans that occur after the date of adoption. Early adoption is permitted. The amendments in this Update are effective for the Corporation for annual and interim periods beginning in the first quarter 2015, and the Corporation is in the process of determining how it will apply the amendments to its accounting and reporting practices.

 

38
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which provides a principles-based framework for revenue recognition that supersedes virtually all previously issued revenue recognition guidance under U.S. GAAP. Additionally, the ASU requires improved disclosures to help users of financial statements better understand the nature, amount, timing, and uncertainty of revenue that is recognized. The core principle of the five-step revenue recognition framework is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU will be effective for all annual and interim periods beginning in the first quarter 2017. The amendments in the ASU should be applied either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying this ASU recognized at the date of initial application. The Corporation is in the process of evaluating the potential impact of adopting this ASU, including determining which transition method to apply.

 

In June 2014, the FASB issued ASU 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. In addition to various other amendments that will affect accounting and disclosures for transactions in which the Corporation has not engaged to date, this Update requires expanded disclosures for repurchase agreements that are accounted for as secured borrowings, including: (1) a disaggregation of the gross obligation by the class of collateral pledged, (2) the remaining contractual tenor of the agreements and (3) a discussion of the potential risks associated with the agreements and the related collateral pledged, including obligations arising from a decline in the fair value of the collateral pledged and how those risks are managed. The expanded disclosure requirements associated with repurchase agreements are effective for the Corporation for annual and interim periods beginning in the second quarter 2015. Information concerning the Corporation’s repurchase agreements is provided in Note 8 to these unaudited consolidated financial statements.

 

14. SUBSEQUENT EVENT

 

Effective July 17, 2014, the Corporation terminated its existing treasury stock repurchase programs and approved a new treasury stock repurchase program. Under the new program, the Corporation is authorized to repurchase up to 622,500 shares of the Corporation’s common stock, or approximately 5% of the Corporation’s issued and outstanding shares at July 16, 2014. As permitted by securities laws and other legal requirements and subject to market conditions and other factors, purchases under the new program may be made from time to time in the open market at prevailing prices, or through privately negotiated transactions.

 

Consistent with previous programs, the Board of Directors’ July 17, 2014 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.

 

39
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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

 

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

 

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

 

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

 

EARNINGS OVERVIEW

 

Second quarter 2014 net income of $4,163,000, or $0.33 per basic and diluted share, was down slightly from $0.35 per basic share and $0.34 per diluted share in the first quarter 2014 and down from $0.40 per basic and diluted share in the second quarter 2013. Net income for the six months ended June 30, 2014 totaled $8,451,000, or $0.68 per basic and diluted share, representing an annualized return on average assets of 1.38% and an annualized return on average equity of 9.16%. Net income for the first six months of 2014 was down from $0.78 per share for the first six months of 2013.

 

Some of the more significant fluctuations in the components of earnings between the second quarter and first quarter of 2014, and between the three-month and six-month periods ended June 30, 2014 and the corresponding periods in 2013 are as follows:

 

·Net interest income totaled $10,273,000 in the second quarter 2014, up from $10,118,000 in the first quarter 2014 and down 6.1% from $10,940,000 in the second quarter 2013. For the first six months of 2014, net interest income of $20,391,000 was down $1,596,000 (7.3%) from the first six months of 2013. In 2013 and the first six months of 2014, yields earned on securities and loans have fallen by more than interest rates paid on deposits and borrowings. Also, the average balance of loans outstanding was $38.2 million (5.7%) lower in the first six months of 2014 as compared to the first six months of 2013. The net interest margin was 3.84% in the second quarter 2014, down from 3.89% in the first quarter 2014. For the first six months of 2014, the net interest margin was 3.86% as compared to 4.16% for the first six months of 2013.

 

·The provision for loan losses was $446,000 in the second quarter 2014 as compared to a credit (reduction in expense) of ($311,000) in the first quarter 2014 and a provision of $66,000 in the second quarter 2013. For the first six months of 2014, the provision for loan losses totaled $135,000 as compared to a provision of $249,000 for the first six months of 2013. The higher provision for loan losses in the second quarter 2014 included an increase in the collectively determined portion of the allowance for loan losses as a result of an increased level of net charge-offs. C&N recorded net charge-offs totaling $1,522,000 in the second quarter 2014, including a charge-off of $1,486,000 related to one commercial loan relationship for which a specific allowance had been established in previous quarters.

 

·Noninterest revenue totaled $3,980,000 in the second quarter 2014, up $229,000 from the first quarter 2014 but $211,000 lower than in the second quarter 2013. For the first six months of 2014, noninterest revenue was $303,000 (3.8%) lower than in the first six months of 2013. Gains from sales of residential mortgage loans totaled $416,000 in the first six months of 2014, down from $1,056,000 in the first six months of 2013, as volume fell mainly because of higher interest rates. Total Trust and brokerage revenue of $2,654,000 in the first six months of 2014 was $284,000 (12.0%) higher than the total in the first six months of 2013.

 

40
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

·Realized gains from available-for-sale securities totaled $103,000 in the second quarter 2014 as compared to $31,000 in the first quarter 2014 and $100,000 in the second quarter 2013. In the first six months of 2014, realized gains from securities totaled $134,000. In comparison, in the first six months of 2013, C&N generated gains from sales of securities totaling $1,259,000 and also incurred losses from prepayment of borrowings of $1,023,000.

 

·Noninterest expenses, excluding losses from prepayment of borrowings, totaled $8,347,000 in the second quarter 2014, down from $8,524,000 in the first quarter 2014 and $8,520,000 in the second quarter 2013. Pensions and other employee benefit costs were $166,000 lower in the second quarter 2014 than in the first quarter 2013, mainly due to the timing of payroll taxes and other payroll-related expenses that are typically highest in the first quarter of each year. In the first six months of 2014, total noninterest expenses, excluding losses from prepayment of borrowings, were $202,000 (1.2%) lower than in the first six months of 2013. The reduction in noninterest expenses in the first six months of 2014 included decreases in professional fees of $326,000 and ATM and interchange processing expense of $155,000, while pensions and other employee benefit expenses increased $183,000, mainly due to higher health care costs, and occupancy expenses increased $123,000 due to higher weather-related maintenance expenses.

 

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

 

TABLE I - QUARTERLY FINANCIAL DATA

(In Thousands)

 

  June 30, Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31,
  2014 2014 2013 2013 2013 2013
Interest income $11,563 $11,406 $11,885 $12,027 $12,355 $12,647
Interest expense 1,290 1,288 1,354 1,396 1,415 1,600
Net interest income 10,273 10,118 10,531 10,631 10,940 11,047
Provision (credit) for loan losses 446 (311) 1,559 239 66 183
Net Interest income after provision (credit) for loan losses 9,827 10,429 8,972 10,392 10,874 10,864
Other income 3,980 3,751 4,124 4,293 4,191 3,843
Net gains on available-for-sale securities 103 31 266 193 100 1,159
Loss on prepayment of debt 0 0 0 0 0 1,023
Other expenses 8,347 8,524 7,788 8,610 8,520 8,553
Income before income tax provision 5,563 5,687 5,574 6,268 6,645 6,290
Income tax provision 1,400 1,399 1,349 1,579 1,671 1,584
Net income $4,163 $4,288 $4,225 $4,689 $4,974 $4,706
Net income per share – basic $0.33 $0.35 $0.34 $0.38 $0.40 $0.38
Net income per share – diluted $0.33 $0.34 $0.34 $0.38 $0.40 $0.38

 

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.

 

41
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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

 

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

 

NET INTEREST INCOME

 

The Corporation’s primary source of operating income is net interest income, which is equal to the difference between the amounts of interest income and interest expense. Tables II, III and IV include information regarding the Corporation’s net interest income for the three-month and six-month periods ended June 30, 2014 and June 30, 2013. 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.

 

Six-Month Periods Ended June 30, 2014 and 2013

 

For the six-month periods, fully taxable equivalent net interest income was $21,915,000 in 2014, $1,720,000 (7.3%) lower than in 2013. As shown in Table IV, interest rate changes had the effect of decreasing net interest income $1,089,000 and changes in volume had the effect of decreasing net interest income $631,000 in 2014 compared to 2013. The most significant components of the rate-related change in net interest income in 2014 were a decrease in interest income of $1,064,000 attributable to lower rates earned on loans receivable and a decrease in interest income of $264,000 attributable to lower rates earned on available-for-sale securities, partially offset by a decrease in interest expense of $232,000 due to lower rates paid on interest-bearing deposits. The most significant components of the volume-related change in net interest income in 2014 were a decrease in interest income of $1,072,000 attributable to a decline in the balance of loans receivable, partially offset by an increase in interest income of $257,000 from an increase in available-for-sale securities, a decrease in interest expense of $112,000 attributable to a reduction in the balance of interest-bearing deposits (primarily certificates of deposit) and a decrease in interest expense of $103,000 attributable to a reduction in the balance of borrowed funds. As presented in Table III, the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) was 3.70% in 2014, as compared to 3.99% in 2013.

 

INTEREST INCOME AND EARNING ASSETS

 

Interest income totaled $24,493,000 in 2014, a decrease of 8.1% from 2013. Interest and fees on loans receivable decreased $2,136,000, or 11.1%. The average balance of gross loans receivable decreased 5.7% to $628,559,000 in 2014 from $666,793,000 in 2013. The Corporation experienced contraction in the balance of loans receivable due to borrowers prepaying or refinancing existing loans combined with modest demand for new loans. The decline in the balance of the residential mortgage portfolio was also affected by management’s decision to sell a significant portion of newly originated residential mortgages on the secondary market. The Corporation’s average rate of return on loans receivable declined to 5.51% in 2014 from 5.84% in 2013 as rates on new loans have decreased.

 

As indicated in Table III, average available-for-sale securities (at amortized cost) totaled $484,031,000 in 2014, an increase of $33,414,000 (7.4%) from 2013. The net increase in the Corporation’s available-for-sale securities portfolio was primarily made up of mortgage-backed securities and collateralized mortgage obligations issued or guaranteed by U.S. Government agencies. The Corporation’s yield on securities was lower in 2014 than in 2013, primarily because of lower market interest rates. The average rate of return on available-for-sale securities was 3.03% for 2014 and 3.25% in 2013.

 

42
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES

 

Interest expense fell $437,000, or 14.5%, to $2,578,000 in 2014 from $3,015,000 in 2013. Table III shows that the overall cost of funds on interest-bearing liabilities fell to 0.62% in 2014 from 0.70% in 2013.

 

Total average deposits (interest-bearing and noninterest-bearing) decreased 1.4%, to $954,918,000 in 2014 from $968,333,000 in 2013. Decreases in the average balances of certificates of deposit, Individual Retirement Accounts, and money market accounts were partially offset by increases in average balances of demand deposits, interest checking and savings accounts. Consistent with continuing low short-term market interest rates, the average rates incurred on certificates of deposit and Individual Retirement Accounts have decreased significantly in 2014 as compared to 2013.

 

Total average borrowed funds decreased $2,748,000 to $80,659,000 in 2014 from $83,407,000 in 2013.

 

Three-Month Periods Ended June 30, 2014 and 2013

 

For the three-month periods, fully taxable equivalent net interest income was $11,018,000 in 2014, which was $747,000 (6.3%) lower than in 2013. As shown in Table IV, interest rate changes had the effect of decreasing net interest income $416,000 and net changes in volume had the effect of decreasing net interest income $331,000 in 2014 compared to 2013. As presented in Table III, the “Interest Rate Spread” was 3.67% in 2014, as compared to 3.97% in 2013.

 

Interest income totaled $12,308,000 in 2014, a decrease of $872,000 (6.6%) from 2013. Income from available-for-sale securities increased $53,000 (1.5%), while interest and fees from loans receivable decreased $927,000, or 9.7%. As indicated in Table III, total average available-for-sale securities (at amortized cost) in 2014 increased to $496,234,000 from $455,446,000 in 2013. The average rate of return on available-for-sale securities was 2.97% for 2014, down from 3.19% in 2013. For the three-month period, the average balance of gross loans receivable decreased 5.6% to $622,015,000 in 2014 from $658,905,000 in 2013. The average rate of return on loans was 5.54% in 2014, down from 5.80% in 2013.

 

For the three-month period, interest expense fell $125,000, or 8.8%, to $1,290,000 in 2014 from $1,415,000 in 2013. Total average deposits (interest-bearing and noninterest-bearing) saw little change at $964,551,000 in 2014 and $964,074,000 in 2013. The average interest rate on interest-bearing liabilities was 0.62% in the second quarter 2014 as compared to 0.67% in the second quarter 2013.

 

43
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

TABLE II - ANALYSIS OF INTEREST INCOME AND EXPENSE

 

  Three Months Ended     Six Months Ended  
  June 30, Increase/   June 30, Increase/
(In Thousands) 2014 2013 (Decrease)   2014 2013 (Decrease)
               
INTEREST INCOME              
Available-for-sale securities:              
Taxable $2,027 $1,726 $301   $3,918 $3,525 $393
Tax-exempt 1,649 1,897 (248)   3,343 3,743 (400)
Total available-for-sale securities 3,676 3,623 53   7,261 7,268 (7)
Interest-bearing due from banks 32 23 9   62 51 11
Federal funds sold 0 0 0   0 0 0
Loans held for sale 5 12 (7)   8 33 (25)
Loans receivable:              
Taxable 8,085 9,028 (943)   16,083 18,253 (2,170)
Tax-exempt 510 494 16   1,079 1,045 34
Total loans receivable 8,595 9,522 (927)   17,162 19,298 (2,136)
Total Interest Income 12,308 13,180 (872)   24,493 26,650 (2,157)
               
INTEREST EXPENSE              
Interest-bearing deposits:              
Interest checking 54 51 3   106 103 3
Money market 72 74 (2)   141 146 (5)
Savings 30 29 1   59 58 1
Certificates of deposit 280 375 (95)   569 836 (267)
Individual Retirement Accounts 117 144 (27)   232 308 (76)
Other time deposits 0 0 0   0 0 0
Total interest-bearing deposits 553 673 (120)   1,107 1,451 (344)
Borrowed funds:              
Short-term 1 2 (1)   6 3 3
Long-term 736 740 (4)   1,465 1,561 (96)
Total borrowed funds 737 742 (5)   1,471 1,564 (93)
Total Interest Expense 1,290 1,415 (125)   2,578 3,015 (437)
               
Net Interest Income $11,018 $11,765 ($747)   $21,915 $23,635 ($1,720)

 

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

 

44
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

TABLE III - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES

(Dollars in Thousands)

 

  3 Months   3 Months   6 Months   6 Months  
  Ended Rate of Ended Rate of Ended Rate of Ended Rate of
  6/30/2014 Return/ 6/30/2013 Return/ 6/30/2014 Return/ 6/30/2013 Return/
  Average Cost of Average Cost of Average Cost of Average Cost of
  Balance Funds % Balance Funds % Balance Funds % Balance Funds %
EARNING ASSETS                
Available-for-sale securities,                
at amortized cost:                
Taxable $372,666 2.18% $323,248 2.14% $359,239 2.20% $319,451 2.23%
Tax-exempt 123,568 5.35% 132,198 5.76% 124,792 5.40% 131,166 5.75%
Total available-for-sale securities 496,234 2.97% 455,446 3.19% 484,031 3.03% 450,617 3.25%
Interest-bearing due from banks 33,106 0.39% 23,044 0.40% 31,611 0.40% 26,323 0.39%
Federal funds sold 0 0.00% 3 0.00% 0 0.00% 9 0.00%
Loans held for sale 282 7.11% 787 6.12% 201 8.03% 1,486 4.48%
Loans receivable:                
Taxable 585,593 5.54% 625,215 5.79% 590,526 5.49% 630,716 5.84%
Tax-exempt 36,422 5.62% 33,690 5.88% 38,033 5.72% 36,077 5.84%
Total loans receivable 622,015 5.54% 658,905 5.80% 628,559 5.51% 666,793 5.84%
Total Earning Assets 1,151,637 4.29% 1,138,185 4.64% 1,144,402 4.32% 1,145,228 4.69%
Cash 17,484   16,961   16,895   16,523  
Unrealized gain/loss on securities 6,539   13,820   4,656   15,038  
Allowance for loan losses (8,402)   (7,229)   (8,590)   (7,178)  
Bank premises and equipment 16,889   18,351   17,085   18,502  
Intangible Asset - Core Deposit Intangible 75   120   79   126  
Intangible Asset - Goodwill 11,942   11,942   11,942   11,942  
Other assets 40,965   43,127   41,642   43,252  
Total Assets $1,237,129   $1,235,277   $1,228,111   $1,243,433  
                 
INTEREST-BEARING LIABILITIES                
Interest-bearing deposits:                
Interest checking $179,018 0.12% $167,404 0.12% $179,316 0.12% $170,758 0.12%
Money market 198,753 0.15% 204,444 0.15% 197,183 0.14% 203,293 0.14%
Savings 121,741 0.10% 117,224 0.10% 120,144 0.10% 116,883 0.10%
Certificates of deposit 138,250 0.81% 150,358 1.00% 136,551 0.84% 155,158 1.09%
Individual Retirement Accounts 120,987 0.39% 130,368 0.44% 121,684 0.38% 132,212 0.47%
Other time deposits 1,138 0.00% 1,161 0.00% 976 0.00% 1,004 0.00%
Total interest-bearing deposits 759,887 0.29% 770,959 0.35% 755,854 0.30% 779,308 0.38%
Borrowed funds:                
Short-term 4,766 0.08% 5,684 0.14% 7,393 0.16% 4,956 0.12%
Long-term 73,232 4.03% 73,615 4.03% 73,266 4.03% 78,451 4.01%
Total borrowed funds 77,998 3.79% 79,299 3.75% 80,659 3.68% 83,407 3.78%
Total Interest-bearing Liabilities 837,885 0.62% 850,258 0.67% 836,513 0.62% 862,715 0.70%
Demand deposits 204,664   193,115   199,064   189,025  
Other liabilities 7,971   8,292   8,064   8,582  
Total Liabilities 1,050,520   1,051,665   1,043,641   1,060,322  
Stockholders' equity, excluding                
other comprehensive income/loss 182,258   174,782   181,354   173,686  
Other comprehensive income/loss 4,351   8,830   3,116   9,425  
Total Stockholders' Equity 186,609   183,612   184,470   183,111  
Total Liabilities and Stockholders' Equity $1,237,129   $1,235,277   $1,228,111   $1,243,433  
Interest Rate Spread   3.67%   3.97%   3.70%   3.99%
Net Interest Income/Earning Assets   3.84%   4.15%   3.86%   4.16%
                 
Total Deposits (Interest-bearing                
and Demand) $964,551   $964,074   $954,918   $968,333  

 

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

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

 

45
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

TABLE IV - ANALYSIS OF VOLUME AND RATE CHANGES 

(In Thousands) 3 Months Ended 6/30/14 vs. 6/30/13 6 Months Ended 6/30/14 vs. 6/30/13
  Change in Change in Total Change in Change in Total
  Volume Rate Change Volume Rate Change
EARNING ASSETS            
Available-for-sale securities:            
Taxable $268 $33 $301 $434 ($41) $393
Tax-exempt (120) (128) (248) (177) (223) (400)
Total available-for-sale securities 148 (95) 53 257 (264) (7)
Interest-bearing due from banks 10 (1) 9 10 1 11
Federal funds sold 0 0 0 0 0 0
Loans held for sale (9) 2 (7) (41) 16 (25)
Loans receivable:            
Taxable (557) (386) (943) (1,128) (1,042) (2,170)
Tax-exempt 39 (23) 16 56 (22) 34
Total loans receivable (518) (409) (927) (1,072) (1,064) (2,136)
Total Interest Income (369) (503) (872) (846) (1,311) (2,157)
             
INTEREST-BEARING LIABILITIES            
Interest-bearing deposits:            
Interest checking 3 0 3 5 (2) 3
Money market (2) 0 (2) (4) (1) (5)
Savings 2 (1) 1 2 (1) 1
Certificates of deposit (26) (69) (95) (92) (175) (267)
Individual Retirement Accounts (10) (17) (27) (23) (53) (76)
Other time deposits 0 0 0 0 0 0
Total interest-bearing deposits (33) (87) (120) (112) (232) (344)
Borrowed funds:            
Short-term (1) 0 (1) 1 2 3
Long-term (4) 0 (4) (104) 8 (96)
Total borrowed funds (5) 0 (5) (103) 10 (93)
Total Interest Expense (38) (87) (125) (215) (222) (437)
             
Net Interest Income ($331) ($416) ($747) ($631) ($1,089) ($1,720)

 

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

 

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

 

46
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

TABLE V - COMPARISON OF NONINTEREST INCOME      
 (In Thousands)        
   6 Months Ended    
   June 30, $ %
  2014 2013  Change  Change
Service charges on deposit accounts $2,537 $2,468 $69 2.8
Service charges and fees 261 279 (18) (6.5)
Trust and financial management revenue 2,185 1,989 196 9.9
Brokerage revenue 469 381 88 23.1
Insurance commissions, fees and premiums 59 104 (45) (43.3)
Interchange revenue from debit card transactions 970 969 1 0.1
Net gains from sales of loans 416 1,056 (640) (60.6)
Increase in fair value of servicing rights 52 5 47 940.0
Increase in cash surrender value of life insurance 179 192 (13) (6.8)
Net loss from premises and equipment (1) 0 (1)  
Other operating income 604 591 13 2.2
Total other operating income before realized gains        
on available-for-sale securities, net $7,731 $8,034 ($303) (3.8)

 

Table V excludes realized gains on available-for-sale securities, which are discussed in the “Earnings Overview” section of Management’s Discussion and Analysis. Total noninterest income shown in Table V decreased $303,000 or 3.8%, in the first six months of 2014 as compared to the first six months of 2013. The most significant variances include the following:

 

·Net gains from sales of loans decreased $640,000, or 60.6%. Since December 2009, the Corporation has sold a significant amount of residential mortgage loans into the secondary market through the MPF programs administered by the Federal Home Loan Banks of Pittsburgh and Chicago. The decrease in revenue in 2014 reflects decreases in volume, including the impact of less refinancing activity.

 

·Trust and financial management revenue increased $196,000, or 9.9%, as a result of growth in assets under management resulting from market appreciation as well as new business.

 

·Brokerage revenue increased $88,000, or 23.1%, as a result of increased annuity sales.

 

·Service charges on deposit accounts increased $69,000, or 2.8%, as the result of new fees implemented in the fourth quarter 2013.

 

·The fair value of servicing rights associated with residential mortgage loans increased $52,000 in the first six months of 2014, as compared to an increase of $5,000 in the first six months of 2013. The larger increase in fair value in 2014 resulted mainly from slower prepayment assumptions driven by market assumptions of higher interest rates.

 

·Insurance commissions, fees and premiums decreased $45,000 or 43.3%, as a result of decreased volume, including group insurance as well as credit related insurance.

 

47
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

TABLE VI - COMPARISON OF NONINTEREST INCOME      
 (In Thousands)        
   3 Months Ended    
   June 30, $ %
  2014 2013  Change  Change
Service charges on deposit accounts $1,314 $1,242 $72 5.8
Service charges and fees 134 145 (11) (7.6)
Trust and financial management revenue 1,138 1,045 93 8.9
Brokerage revenue 242 237 5 2.1
Insurance commissions, fees and premiums 27 59 (32) (54.2)
Interchange revenue from debit card transactions 517 505 12 2.4
Net gains from sales of loans 265 552 (287) (52.0)
Decrease in fair value of servicing rights (53) (3) (50) 1666.7
Increase in cash surrender value of life insurance 91 99 (8) (8.1)
Net loss from premises and equipment (1) 0 (1)  
Other operating income 306 310 (4) (1.3)
Total other operating income before realized gains        
(losses) on available-for-sale securities, net $3,980 $4,191 ($211) (5.0)

 

Table VI excludes realized gains on available-for-sale securities, which are discussed in the “Earnings Overview” section of Management’s Discussion and Analysis. Total noninterest income shown in Table VI decreased $211,000 or 5.0%, in the three months ended June 30, 2014 as compared to the three months ended June 30, 2013. The most significant variances include the following:

 

·Net gains from sales of loans decreased $287,000, or 52.0%. Since December 2009, the Corporation has sold a significant amount of residential mortgage loans into the secondary market through the MPF programs administered by the Federal Home Loan Banks of Pittsburgh and Chicago. The decrease in revenue in 2014 reflects decreases in volume, including the impact of less refinancing activity.

 

·The fair value of servicing rights associated with residential mortgage loans decreased $53,000 in the three months ended June 30, 2014, as compared to a decrease of $3,000 in the same period of 2013. The decrease in 2014 resulted from a slight decrease in the estimated fair value of mortgage servicing rights as well as principal pay downs during the quarter.

 

·Insurance commissions, fees and premiums decreased $32,000 or 54.2%, as a result of decreased volume, including group insurance as well as credit related insurance.

 

·Trust and financial management revenue increased $93,000, or 8.9%, as a result of growth in assets under management resulting from market appreciation as well as new business.

 

·Service charges on deposit accounts increased $72,000, or 5.8%, as the result of new fees implemented in the fourth quarter 2013.

 

48
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

TABLE VII- COMPARISON OF NONINTEREST EXPENSE    
 (In Thousands)        
   6 Months Ended    
   June 30,  $  %
  2014 2013  Change  Change
Salaries and wages $7,211 $7,235 ($24) (0.3)
Pensions and other employee benefits 2,472 2,289 183 8.0
Occupancy expense, net 1,356 1,233 123 10.0
Furniture and equipment expense 938 977 (39) (4.0)
FDIC Assessments 293 299 (6) (2.0)
Pennsylvania shares tax 678 701 (23) (3.3)
Professional fees 292 618 (326) (52.8)
Automated teller machine and interchange expense 429 584 (155) (26.5)
Software subscriptions 391 432 (41) (9.5)
Loss on prepayment of debt 0 1,023 (1,023) (100.0)
Other operating expense 2,811 2,705 106 3.9
Total Other Expense $16,871 $18,096 ($1,225) (6.8)

 

As shown in Table VII, total noninterest expense decreased $1,225,000 or 6.8% in the first six months of 2014 as compared to the first six months of 2013. The decrease in expense included the loss on prepayment of debt of $1,023,000 in 2013 compared to no loss in 2014. Excluding the loss on prepayment of debt in 2013, total noninterest expense decreased $202,000, or 1.2%. Other significant variances include the following:

 

·Professional fees decreased $326,000, or 52.8%, in the first six months of 2014 as compared to the same period in 2013. The Corporation incurred professional fee expense of $315,000 in 2013 for a consulting project related to debit card operations and electronic funds processing. There were no costs related to this project in 2014.

 

·Automated teller machine and interchange expenses decreased $155,000, or 26.5%, mainly from benefits derived from the consulting project referred to above in 2013.

 

·Pensions and other employee benefits increased $183,000, or 8.0%. Health care expense increased $148,000, as the amount of claims incurred during the first six months of 2014 was higher than in the same period in 2013. The Corporation is self-insured for health insurance, up to a cap for catastrophic levels of losses, which are insured by a third party.

 

·Occupancy expense increased $123,000, or 10.0%. This increase related primarily to weather related expenses such as snow removal and maintenance.

 

49
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

TABLE VIII- COMPARISON OF NONINTEREST EXPENSE

 (In Thousands)        
   3 Months Ended    
   June 30,  $  %
  2014 2013  Change  Change
Salaries and wages $3,646 $3,635 $11 0.3
Pensions and other employee benefits 1,153 1,034 119 11.5
Occupancy expense, net 641 599 42 7.0
Furniture and equipment expense 466 483 (17) (3.5)
FDIC Assessments 146 147 (1) (0.7)
Pennsylvania shares tax 337 351 (14) (4.0)
Professional fees 144 461 (317) (68.8)
Automated teller machine and interchange expense 218 312 (94) (30.1)
Software subscriptions 201 209 (8) (3.8)
Other operating expense 1,395 1,289 106 8.2
Total Other Expense $8,347 $8,520 ($173) (2.0)

 

As shown in Table VIII, total noninterest expense decreased $173,000 or 2.0% in the three months ended June 30, 2014 as compared to the same period of 2013. Significant variances include the following:

 

·Professional fees decreased $317,000, or 68.8%, in the three months ended June 30, 2014 as compared to the same period in 2013, as the second quarter 2013 included professional fee expense of $315,000 for a consulting project related to debit card operations and electronic funds processing. There were no costs related to this project in 2014.

 

·Automated teller machine and interchange expenses decreased $94,000, or 30.1%, mainly from benefits derived from the consulting project in 2013.

 

·Pensions and other employee benefits increased $119,000, or 11.5%. Health care expense increased $101,000, as the amount of claims incurred during the three months ended June 30, 2014 was higher than in the same period in 2013. The Corporation is self-insured for health insurance, up to a cap for catastrophic levels of losses, which are insured by a third party.

 

·Within other expenses, collection expense increased $105,000 during the three months ended June 30, 2014 over the same period in 2013 as a result of increased real estate tax payments and building repair costs associated with loans.

 

FINANCIAL CONDITION

 

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.

 

Management does not expect capital expenditures to have a material, detrimental effect on the Corporation’s financial condition in 2014.

 

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 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.

 

50
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

The allowance for loan losses was $7,267,000 at June 30, 2014, down from $8,663,000 at December 31, 2013. As shown in Table XI, the specific allowance on impaired loans totaled $754,000 at June 30, 2014, which was $1,579,000 lower than the total specific allowance at December 31, 2013. The decrease in the specific allowances on impaired loans includes a charge-off of $1,486,000 related to one commercial loan relationship for which a specific allowance of $1,552,000 had been established at December 31, 2013. Table XI also shows the collectively determined component of the allowance for commercial loans was $264,000 higher at June 30, 2014 than at December 31, 2013. The collectively determined allowance for the commercial segment increased mainly because the net charge-off percentage used to determine a portion of the collectively determined allowance was higher at June 30, 2014 as compared to the percentage used throughout 2013. (The Corporation used net charge-offs as a percentage of average outstanding loans for the previous thirty-six months to estimate a portion of the collectively determined allowance at both June 30, 2014 and December 31, 2013.) This increase was partially offset by the effects on collectively determined allowances of lower loan balances at June 30, 2014 as compared to December 31, 2013.

 

The provision (credit) for loan losses by segment in the three-month and six-month periods ended June 30, 2014 and 2013 is as follows:

 

(In Thousands) 3 Months Ended 6 Months Ended
  June 30, June 30, June 30, June 30,
  2014 2013 2014 2013
Residential mortgage $168 $132 $49 $385
Commercial 269           (81) 134 (104)
Consumer 8            15 (45) 11
Unallocated 1              0   (3) (43)
         
Total $446 $66 $135 $249

 

The provision for loan losses for commercial loans in the second quarter 2014 included the effect of net charge-offs of $1,474,000 during the quarter increasing the net charge-off percentage used to determine a portion of the collectively determined allowance at June 30, 2014. The provision for loan losses for residential mortgages in the second quarter 2014 included a net increase in the allowance for loan losses on impaired loans of $81,000. The provision for loan losses in the second quarter 2013 included a net increase in the allowance for loan losses on impaired loans of $171,000, including an increase in the allowance on impaired residential mortgage loans of $97,000 and an increase in the allowance on impaired commercial loans of $77,000. The net credit for loan losses from the commercial segment in the second quarter 2013 included a reduction in the collectively evaluated portion of the allowance of $120,000, mainly due to a reduction in outstanding commercial loans.

 

The provision for loan losses related to the residential mortgage segment for the six months ended June 30, 2014 totaled $49,000, and reflected a slight increase in the qualitative factors applied in calculating the collectively evaluated portion of the allowance for loan losses at June 30, 2014 in comparison to the qualitative factors applied at December 31, 2013. In comparison, the $385,000 provision for loan losses for the residential mortgage segment in the first six months of 2013 included an increase in the collectively evaluated portion of the allowance of $258,000, reflecting an increase in the net charge-off percentage used in the calculations for that period, and a $62,000 increase in the allowance on impaired loans. The provision for loan losses for commercial loans for the six months ended June 30, 2014 of $134,000 reflected an increase in the collectively determined portion of the allowance for loan losses, as described above, while the credit of $104,000 in the six months ended June 30, 2013 included the benefit of net recoveries of previously charged-off loans of $181,000. The $45,000 credit for the consumer segment in the six months ended June 30, 2014 resulted from a reduction in the collectively evaluated portion of the allowance, mainly due to a lower ratio of net charge-offs as a percentage of average loans.

 

Table XI presents information related to past due and impaired loans, and loans that have been modified under terms that are considered troubled debt restructurings (TDRs). Table XI shows total impaired loans of $14,062,000 at June 30, 2014, down from the corresponding amount at December 31, 2013 of $16,321,000. Though down from year-end 2013, the amount of impaired loans (as well as nonperforming loans as reflected in the table) at June 30, 2014 is significantly higher than it was from 2009 through 2012. The increase in impaired and nonperforming loans at June 30, 2014 and December 31, 2013 as compared to the other periods presented reflected the classification as nonperforming of two large commercial loan relationships with outstanding balances totaling $7,088,000 at June 30, 2014 and $7,599,000 at December 31, 2013. The total of the specific allowance for loan losses on those two relationships amounted to $72,000 at June 30, 2014 and $1,624,000 at December 31, 2013. As described in the following paragraph, during the second quarter 2014, a charge-off of $1,486,000 was made related to one of these commercial loan relationships resulting in the decrease in the specific allowance as well as total impaired loans with a valuation allowance.

 

51
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

As shown in Table XI, loans classified as TDRs increased to $8,107,000 at June 30, 2014 from $4,175,000 at December 31, 2013. This increase relates mainly to one commercial borrower. The Corporation entered into a forbearance agreement with this commercial borrower which includes a reduction in monthly payment amounts over a fifteen-month period. At the end of the fifteen-month period, the monthly payment amounts would revert to the original amounts, unless the forbearance agreement is extended or the payment requirements are otherwise modified. The Corporation recorded a charge-off of $1,486,000 in the second quarter 2014 as a result of these modifications, as the payment amounts based on the forbearance agreement are not sufficient to fully amortize the contractual amount of principal outstanding on the loans. The amount of the charge-off was determined based on the excess of the contractual principal due over the present value of the payment amounts provided for in the forbearance agreement, assuming the revised payment amounts would continue until maturity, at the contractual interest rates.

 

Table XI reflects a lower amount of total loans past due 30-89 days and still accruing interest at June 30, 2014 of $4,837,000 as compared to the December 31, 2013 total of $8,305,000, mainly due to a lower amount of past due residential mortgage loans. Also, total loans past due 90 days or more and still accruing interest was down slightly at June 30, 2014 to $3,050,000 from $3,131,000. As part of its normal quarterly procedures, management reviewed loans past due 90 days or more at June 30, 2014, and determined the loans remaining in accrual status to be well secured and in the process of collection. Each period presented in Table XI 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 June 30, 2014. Management continues to closely monitor its commercial loan relationships for possible credit losses, and will adjust its estimates of loss and decisions concerning nonaccrual status, if appropriate.

 

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

 

TABLE IX - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES        
(In Thousands)              
  6 Months Ended          
  June 30, June 30,    Years Ended December 31,
  2014 2013 2013 2012 2011 2010 2009
Balance, beginning of year $8,663 $6,857 $6,857 $7,705 $9,107 $8,265 $7,857
Charge-offs:              
Residential mortgage           (59)           (76) (95) (552) (100) (340) (146)
Commercial      (1,715)         (114) (459) (498) (1,189) (91) (39)
Consumer           (46)           (55) (117) (171) (157) (188) (293)
Total charge-offs (1,820) (245) (671) (1,221) (1,446) (619) (478)
Recoveries:              
Residential mortgage 1 11 24 18 3 55 8
Commercial 263 295 348 8 255 113 77
Consumer 25 31 58 59 71 102 121
Total recoveries 289 337 430 85 329 270 206
Net (charge-offs) recoveries (1,531) 92 (241) (1,136) (1,117) (349) (272)
Provision (credit) for loan losses          135 249 2,047 288 (285) 1,191 680
Balance, end of period $7,267 $7,198 $8,663 $6,857 $7,705 $9,107 $8,265
               
Net charge-offs (recoveries) as a % of              
average loans 0.24% -0.01% 0.04% 0.16% 0.16% 0.05% 0.04%

 

52
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

TABLE X - COMPONENTS OF THE ALLOWANCE FOR LOAN LOSSES

(In Thousands)

 

  June 30, As of December 31,
  2014 2013 2012 2011 2010 2009
ASC 310 - Impaired loans $754 $2,333 $623 $1,126 $2,288 $1,126
ASC 450 - Collective segments:            
Commercial 2,847 2,583 2,594 2,811 3,047 2,677
Residential mortgage 3,144 3,156 3,011 3,130 3,227 3,859
Consumer 127 193 188 204 232 281
Unallocated 395 398 441 434 313 322
Total Allowance $7,267 $8,663 $6,857 $7,705 $9,107 $8,265

 

The above allocation is based on estimates and subjective judgments and is not necessarily indicative of the specific amounts or loan categories in which losses may occur.

 

TABLE XI - PAST DUE AND IMPAIRED LOANS, NONPERFORMING ASSETS

AND TROUBLED DEBT RESTRUCTURINGS (TDRs)

(In Thousands) As of          
  June 30, As of December 31,
  2014 2013 2012 2011 2010 2009
Impaired loans with a valuation allowance $3,804 $9,889 $2,710 $3,433 $5,457 $2,690
Impaired loans without a valuation allowance 10,258 6,432 4,719 4,431 3,191 3,257
Total impaired loans $14,062 $16,321 $7,429 $7,864 $8,648 $5,947
             
Total loans past due 30-89 days and still accruing $4,837 $8,305 $7,756 $7,898 $7,125 $9,445
             
Nonperforming assets:            
Total nonaccrual loans $13,598 $14,934 $7,353 $7,197 $10,809 $9,092
Total loans past due 90 days or more and still accruing 3,050 3,131 2,311 1,267 727 31
Total nonperforming loans 16,648 18,065 9,664 8,464 11,536 9,123
Foreclosed assets held for sale (real estate) 1,419 892 879 1,235 537 873
Total nonperforming assets $18,067 $18,957 $10,543 $9,699 $12,073 $9,996
             
Loans subject to troubled debt restructurings (TDRs):            
Performing $2,069 $3,267 $906 $1,064 $645 $326
Nonperforming 6,038 908 1,155 2,413 0 0
Total TDRs $8,107 $4,175 $2,061 $3,477 $645 $326
             
Total nonperforming loans as a % of loans 2.68% 2.80% 1.41% 1.19% 1.58% 1.27%
Total nonperforming assets as a % of assets 1.44% 1.53% 0.82% 0.73% 0.92% 0.76%
Allowance for loan losses as a % of total loans 1.17% 1.34% 1.00% 1.09% 1.25% 1.15%
Allowance for loan losses as a % of nonperforming loans 43.65% 47.95% 70.95% 91.03% 78.94% 90.60%
               

 

53
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

TABLE XII - SUMMARY OF LOANS BY TYPE          
Summary of Loans by Type          
(In Thousands) June  30, As of December 31,
  2014 2013 2012 2011 2010 2009
Residential mortgage:            
Residential mortgage loans - first liens $291,690 $299,831 $311,627 $331,015 $333,012 $340,268
Residential mortgage loans - junior liens 22,401 23,040 26,748 28,851 31,590 35,734
Home equity lines of credit 34,633 34,530 33,017 30,037 26,853 23,577
1-4 Family residential construction 13,948 13,909 12,842 9,959 14,379 11,452
Total residential mortgage 362,672 371,310 384,234 399,862 405,834 411,031
Commercial:            
Commercial loans secured by real estate 145,934 147,215 158,413 156,388 167,094 163,483
Commercial and industrial 46,778 42,387 48,442 57,191 59,005 49,753
Political subdivisions 11,617 16,291 31,789 37,620 36,480 37,598
Commercial construction and land 8,550 17,003 28,200 23,518 24,004 15,264
Loans secured by farmland 8,380 10,468 11,403 10,949 11,353 11,856
Multi-family (5 or more) residential 10,548 10,985 6,745 6,583 7,781 8,338
Agricultural loans 3,116 3,251 3,053 2,987 3,472 3,848
Other commercial loans 13,816 14,631 362 552 392 638
Total commercial 248,739 262,231 288,407 295,788 309,581 290,778
Consumer 10,203 10,762 11,269 12,665 14,996 19,202
Total 621,614 644,303 683,910 708,315 730,411 721,011
Less: allowance for loan losses (7,267) (8,663) (6,857) (7,705) (9,107) (8,265)
Loans, net $614,347 $635,640 $677,053 $700,610 $721,304 $712,746
                 

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 June 30, 2014, the Corporation maintained overnight interest-bearing deposits with the Federal Reserve Bank of Philadelphia and other correspondent banks totaling $26,084,000.

 

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 $26,206,000 at June 30, 2014.

 

The Corporation’s outstanding, available, and total credit facilities at June 30, 2014 and December 31, 2013 are as follows:

 

   Outstanding  Available  Total Credit
(In Thousands)  June 30,  Dec. 31, June 30,  Dec. 31, June 30,  Dec. 31,
  2014 2013 2014 2013 2014 2013
Federal Home Loan Bank of Pittsburgh $12,201 $34,335 $314,286 $304,875 $326,487 $339,210
Federal Reserve Bank Discount Window 0 0 24,831 26,078 24,831 26,078
Other correspondent banks 0 0 45,000 45,000 45,000 45,000
Total credit facilities $12,201 $34,335 $384,117 $375,953 $396,318 $410,288

 

54
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

At June 30, 2014, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of long-term borrowings with a total amount of $12,201,000. At December 31, 2013, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh included a short-term borrowing of $20,000,000, long-term borrowings with a total amount of $12,338,000 and a letter of credit in the amount of $1,997,000. Additional information regarding borrowed funds is included in Note 8 of the unaudited consolidated financial statements.

 

Additionally, the Corporation uses repurchase agreements placed with brokers to borrow funds secured by investment assets and “RepoSweep” arrangements to borrow funds from commercial banking customers on an overnight basis. If required to raise cash in an emergency situation, the Corporation could sell available-for-sale securities to meet its obligations. At June 30, 2014, the carrying value of available-for-sale securities in excess of amounts required to meet pledging or repurchase agreement obligations was $275,922,000.

 

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 June 30, 2014 and December 31, 2013 are presented below. Management believes, as of June 30, 2014 and December 31, 2013, that the Corporation and C&N Bank meet all capital adequacy requirements to which they are subject.

 

          Minimum To Be Well
(Dollars in Thousands)     Minimum Capitalized Under
      Capital Prompt Corrective
  Actual Requirement Action Provisions
  Amount Ratio Amount Ratio Amount Ratio
June 30, 2014:            
Total capital to risk-weighted assets:            
Consolidated $180,272 27.82% $51,843 ³8%      n/a  n/a
C&N Bank 164,602 25.74% 51,164 ³8% $63,955 ³10%
Tier 1 capital to risk-weighted assets:            
Consolidated 171,617 26.48% 25,922 ³4%  n/a  n/a
C&N Bank 157,307 24.60% 25,582 ³4%          38,373 ³6%
Tier 1 capital to average assets:            
Consolidated 171,617 14.07% 48,806 ³4%  n/a  n/a
C&N Bank 157,307 13.01% 48,379 ³4%          60,474 ³5%
             
December 31, 2013:            
Total capital to risk-weighted assets:            
Consolidated $177,693 26.60% $53,449 ³8%      n/a  n/a
C&N Bank 162,610 24.65% 52,783 ³8% $65,979 ³10%
Tier 1 capital to risk-weighted assets:            
Consolidated 168,039 25.15% 26,724 ³4%  n/a  n/a
C&N Bank 154,323 23.39% 26,392 ³4%          39,588 ³6%
Tier 1 capital to average assets:            
Consolidated 168,039 13.78% 48,783 ³4%  n/a  n/a
C&N Bank 154,323 12.77% 48,348 ³4%          60,435 ³5%

 

Effective July 17, 2014, the Corporation terminated its existing treasury stock repurchase programs and approved a new treasury stock repurchase program. Under the new program, the Corporation is authorized to repurchase up to 622,500 shares of the Corporation’s common stock, or approximately 5% of the Corporation’s issued and outstanding shares at July 16, 2014. As permitted by securities laws and other legal requirements and subject to market conditions and other factors, purchases under the new program may be made from time to time in the open market at prevailing prices, or through privately negotiated transactions.

 

55
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

Consistent with previous programs, the Board of Directors’ July 17, 2014 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.

 

Repurchases of common stock under the new treasury stock repurchase program would have the effect of reducing the Corporation’s regulatory capital ratios. Further, C&N Bank’s capital ratios will be affected by declaration of a dividend of $11 million in July 2014 for the purpose of providing funds to the Corporation for repurchases of common stock. Despite the expected effects of the common stock repurchase program and C&N Bank’s $11 million dividend, management expects the Corporation and C&N Bank to maintain capital levels that exceed the regulatory standards for well-capitalized institutions for the next 12 months and for the foreseeable future. Planned capital expenditures are not expected to have a significantly detrimental effect on capital ratios.

 

Future dividend payments will depend upon maintenance of a strong financial condition, future earnings and capital and regulatory requirements. 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.

 

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 on available-for-sale securities, net of deferred income tax, amounted to $5,316,000 at June 30, 2014 and ($1,004,000) at December 31, 2013. 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 June 30, 2014.

 

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 $100,000 at June 30, 2014 and $11,000 at December 31, 2013.

 

NEW CAPITAL RULE

 

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 are subject to the new rule on January 1, 2015. Generally, the new rule implements higher minimum capital requirements, revises the definition of regulatory capital components and related calculations, adds a new common equity tier 1 capital ratio, implements a new capital conservation buffer, increases the risk weighting for past due loans and provides a transition period for several aspects of the new rule.

 

56
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

A summarized comparison of the existing capital requirements with requirements under the new rule is as follows:

 

  Current General  
  Risk-Based  
  Capital Rule New Capital Rule
Minimum regulatory capital ratios:    
Common equity tier 1 capital/    
risk-weighted assets (RWA) N/A 4.5%
Tier 1 capital / RWA 4% 6%
Total capital / RWA 8% 8%
Tier 1 capital / Average assets    
(Leverage ratio) 4% 4%
     
Capital buffers:    
Capital conservation buffer N/A 2.5% of RWA; composed of
    common equity tier 1 capital
     
Prompt correction action levels -    
Common equity tier 1 capital ratio:    
Well capitalized N/A ³6.5%
Adequately capitalized N/A ³4.5%
Undercapitalized N/A <4.5%
Significantly undercapitalized N/A <3%
     
Prompt correction action levels -    
Tier 1 capital ratio:    
Well capitalized ³6% ³8%
Adequately capitalized ³4% ³6%
Undercapitalized <4% <6%
Significantly undercapitalized <3% <4%
     
Prompt correction action levels -    
Total capital ratio:    
Well capitalized ³10% ³10%
Adequately capitalized ³8% ³8%
Undercapitalized <8% <8%
Significantly undercapitalized <6% <6%
     
Prompt correction action levels -    
Leverage ratio:    
Well capitalized ³5% ³5%
Adequately capitalized ³4% ³4%
Undercapitalized <4% <4%
Significantly undercapitalized <3% <3%
     
Prompt correction action levels -    
Critically undercapitalized:    
Tangible equity to total assets 2% 2%

 

57
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

  

The 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. Phase-in of the capital conservation buffer requirements will begin January 1, 2016. The transition schedule for new ratios, including the capital conservation buffer, is as follows:

 

  As of January 1:      
  2015 2016 2017 2018 2019
Minimum common equity tier 1 capital ratio 4.5% 4.5% 4.5% 4.5% 4.5%
Common equity tier 1 capital conservation buffer N/A 0.625% 1.25% 1.875% 2.5%
Minimum common equity tier 1 capital ratio plus          
  capital conservation buffer 4.5% 5.125% 5.75% 6.375% 7.0%
Phase-in of most deductions from common equity          
  tier 1 capital 40% 60% 80% 100% 100%
Minimum tier 1 capital ratio 6.0% 6.0% 6.0% 6.0% 6.0%
Minimum tier 1 capital ratio plus capital          
  conservation buffer N/A 6.625% 7.25% 7.875% 8.5%
Minimum total capital ratio 8.0% 8.0% 8.0% 8.0% 8.0%
Minimum total capital ratio plus capital          
  conservation buffer N/A 8.625% 9.25% 9.875% 10.5%

 

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

 

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

 

COMPREHENSIVE INCOME

 

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

 

Comprehensive Income totaled $7,037,000 for the three months ended June 30, 2014 as compared to a Comprehensive Loss of $1,417,000 in the second quarter 2013. In the second quarter 2014, Comprehensive Income included: (1) Net Income of $4,163,000, which was $811,000 lower than in the second quarter 2013; and (2) Other Comprehensive Income from unrealized gains on available-for-sale securities, net of deferred income tax, of $2,874,000 as compared to Other Comprehensive Loss of $6,391,000 in the second quarter 2013. For the six months ended June 30, 2014, Comprehensive income totaled $14,863,000 as compared to $1,357,000 for the six months ended June 30, 2013. In the six months ended June 30, 2014, Comprehensive Income included: (1) Net Income of $8,451,000, which was $1,229,000 lower than in the first six months of 2013; (2) Other Comprehensive Income from unrealized gains on available-for-sale securities, net of deferred income tax, of $6,320,000 as compared to Other Comprehensive Loss of $8,736,000 in the first six months of 2013; and (3) Other Comprehensive Income from defined benefit plans of $89,000 as compared to $413,000 in the first six months of 2013. Fluctuations in interest rates significantly affect fair values of available-for-sale securities, and accordingly reductions in interest rates resulted in positive amounts of Other Comprehensive Income in the second quarter and first six months of 2014, while increases in interest rates resulted in Other Comprehensive Loss in the second quarter and first six months of 2013.

 

58
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

INCOME TAXES

 

The effective income tax rate was approximately 25% of pre-tax income for the three-month and six-month periods ended June 30, 2014 and 2013. The provision for income tax for interim periods is based on the Corporation’s estimate of the effective tax rate expected to be applicable for the full year. The Corporation’s effective tax rates differ from the statutory rate of 35% principally because of the effects of tax-exempt interest income.

 

The Corporation recognizes deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax basis of assets and liabilities. At June 30, 2014, the net deferred tax asset was $1,837,000, down from $6,344,000 at December 31, 2013. At June 30, 2014, the deferred tax liability associated with unrealized gains on available-for-sale securities was $2,862,000 as compared to a deferred tax asset on the unrealized loss on available-for-sale securities at December 31, 2013 of $541,000. Also, the deferred tax assets related to the credit for alternative minimum tax paid and the allowance for loan losses decreased by a total of $1,007,000 based on activity in the first six months of 2014.

 

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 June 30, 2014 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.

 

INFLATION

 

The Corporation is significantly affected by the Federal Reserve Board’s efforts to control inflation through changes in short-term interest rates. Beginning in September 2007, in response to concerns about weakness in the U.S. economy, the Federal Reserve lowered the fed funds target rate numerous times; in December 2008, it established a target range of 0% to 0.25%, which it has maintained through the first several months of 2014. Also, the Federal Reserve has injected massive amounts of liquidity into the nation’s monetary system through a variety of programs. The Federal Reserve has purchased large amounts of securities in an effort to keep interest rates low and stimulate economic growth. Although the Federal Reserve reduced the amount of securities it purchased beginning in late 2013, highly accommodative monetary policy in the form of low short-term interest rates is expected until at least mid-2015.

 

Despite the current low short-term rate environment and liquidity injections, inflation statistics indicate that the overall rate of inflation is unlikely to significantly affect the Corporation’s operations within the near future. 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.

 

59
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

MARKET RISK

 

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

 

The Corporation’s two major categories of market risk are interest rate risk and equity securities risk, which are discussed in the following sections.

 

INTEREST RATE RISK

 

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

 

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 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 XIII, which follows this discussion, is based on the results of calculations performed using the simulation model as of April 30, 2014 and December 31, 2013. 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.

 

60
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

TABLE XIII - THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES

 

April 30, 2014 Data          
(In Thousands)   Period Ending April 30, 2015    
           
Basis Point Interest Interest Net Interest NII NII
Change in Rates Income Expense Income (NII)  % Change Risk Limit
+400 $52,450 $22,349 $30,101 -21.3% 25.0%
+300 50,210 17,635 32,575 -14.8% 20.0%
+200 47,940 13,234 34,706 -9.2% 15.0%
+100 45,582 9,130 36,452 -4.7% 10.0%
0 43,267 5,026 38,241 0.0% 0.0%
-100 40,781 4,835 35,946 -6.0% 10.0%
-200 39,223 4,834 34,389 -10.1% 15.0%
-300 38,346 4,834 33,512 -12.4% 20.0%
-400 38,238 4,834 33,404 -12.6% 25.0%
           
   Market Value of Portfolio Equity at January 31, 2013  
           
  Present Present Present    
Basis Point Value Value Value    
Change in Rates Equity  % Change Risk Limit    
+400 $172,120 -25.5% 50.0%    
+300 185,187 -19.8% 45.0%    
+200 200,081 -13.3% 35.0%    
+100 215,262 -6.8% 25.0%    
0 230,901 0.0% 0.0%    
-100 234,136 1.4% 25.0%    
-200 236,507 2.4% 35.0%    
-300 255,474 10.6% 45.0%    
-400 290,713 25.9% 50.0%    
           
December 31, 2013 Data        
(In Thousands)   Period Ending December 31, 2014  
           
Basis Point Interest Interest Net Interest NII NII
Change in Rates Income Expense Income (NII)  % Change Risk Limit
+400 $53,993 $23,975 $30,018 -24.4% 25.0%
+300 51,748 18,975 32,773 -17.4% 20.0%
+200 49,496 14,091 35,405 -10.8% 15.0%
+100 47,146 9,552 37,594 -5.3% 10.0%
0 44,821 5,123 39,698 0.0% 0.0%
-100 42,432 4,897 37,535 -5.4% 10.0%
-200 40,747 4,895 35,852 -9.7% 15.0%
-300 40,059 4,895 35,164 -11.4% 20.0%
-400 39,968 4,895 35,073 -11.7% 25.0%
           
   Market Value of Portfolio Equity at December 31, 2013  
           
  Present Present Present    
Basis Point Value Value Value    
Change in Rates Equity  % Change Risk Limit    
+400 $161,652 -28.5% 50.0%    
+300 175,176 -22.6% 45.0%    
+200 192,513 -14.9% 35.0%    
+100 209,428 -7.4% 25.0%    
0 226,204 0.0% 0.0%    
-100 230,189 1.8% 25.0%    
-200 233,902 3.4% 35.0%    
-300 250,451 10.7% 45.0%    
-400 282,994 25.1% 50.0%    

 

61
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

EQUITY SECURITIES RISK

 

The Corporation’s equity securities portfolio consists of investments in stocks of banks and bank holding companies. Investments in bank stocks are subject to risk factors that affect the banking industry in general, including credit risk, competition from non-bank entities, interest rate risk and other factors, which could result in a decline in market prices. Also, losses could occur in individual stocks held by the Corporation because of specific circumstances related to each bank.

 

Equity securities held as of June 30, 2014 and December 31, 2013 are presented in Table XIV. Table XIV presents quantitative data concerning the effects of a decline in fair value of the Corporation’s equity securities of 10% or 20%. The data in Table XIV does not reflect the effects of any appreciation in value that may occur, nor does it present the Corporation’s maximum exposure to loss on equity securities, which would be 100% of their fair value as of June 30, 2014.

 

TABLE XIV - EQUITY SECURITIES RISK    
(In Thousands)    
     
  June 30, Dec. 31,
  2014 2013
Cost $6,122 $6,038
Fair Value 9,207 8,924
Hypothetical 10% Decline In Market Value (921) (892)
Hypothetical 20% Decline In Market Value (1,841) (1,785)

  

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.

 

On May 14, 2013, the Committee of Sponsoring Organizations of the Treadway Commission (COSO) issued an updated version of its Internal Control – Integrated Framework (2013 Framework). Originally issued in 1992 (1992 Framework), the framework helps organizations design, implement and evaluate the effectiveness of internal control concepts and simplify their use and application. The 1992 Framework remains available during the transition period, which extends to December 15, 2014, after which time COSO will consider it as superseded by the 2013 Framework. As of June 30, 2014, the Corporation continued to utilize the 1992 Framework.

 

62
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

PART II – OTHER INFORMATION

 

Item 1.Legal Proceedings
The Corporation and C&N Bank are involved in various legal proceedings incidental to their business. Management believes the aggregate liability, if any, resulting from such pending and threatened legal proceedings will not have a material, adverse effect on the Corporation’s financial condition or results of operations.

 

Item 1A.Risk Factors
Except for the risk factor labeled “Biggert-Waters Flood Insurance Act,” which is discussed in the following paragraphs, there have been no material changes from the risk factors previously disclosed in Item 1A of the Corporation’s Form 10-K filed February 20, 2014.

 

The Corporation’s Form 10-K for the year ended December 31, 2013 included the description of a risk factor related to significantly increasing costs of flood insurance for borrowers as a result of changes in the National Flood Insurance Program resulting from the Biggert-Waters Flood Insurance Act. In March 2014, Congress passed, and President Obama signed, a new law titled the Homeowner Flood Insurance Affordability Act. The new law repeals and modifies certain provisions of the Biggert-Waters Flood Insurance Act, including (among other changes) provision of a limit on annual rate increases of 18% and elimination of a sales trigger that had required home buyers to pay the full risk rate for flood insurance when a home was sold.

 

Although the Homeowner Flood Insurance Affordability Act defers some of the rate increases, the intent of the new law remains consistent with the intent of the Biggert-Waters Flood Insurance Act to phase out or reduce the federal government’s subsidization of the cost of flood insurance policies. Accordingly, the risk continues to exist that reductions in collateral values associated with properties located in flood zones that secure some of the Corporation’s residential and commercial loans could occur, and some borrowers may become unable or unwilling to make their loan payments as a result of the increased costs of flood insurance. These potential results could have a material effect on the Corporation’s financial condition, results of operations or liquidity.

 

Item 2.Unregistered Sales of Equity Securities and Use of Proceeds

 

Issuer Purchases of Equity Securities

 

On May 19, 2011, the Corporation announced the Board of Directors had authorized repurchases of outstanding common stock, up to a total of $1 million, in open market or privately negotiated transactions. At its September 22, 2011 meeting, the Board of Directors authorized repurchases of outstanding common stock in open market or privately negotiated transactions, up to a total of $1 million, as an addition to the stock repurchase program previously announced on May 19, 2011. The Board of Directors’ authorizations provided that: (1) the treasury stock repurchase programs became effective when publicly announced and would 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 programs would 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. As of June 30, 2014, the maximum additional value available for purchases under this program was $980,694.

 

In the second quarter 2014, the Corporation made no purchases of its equity securities.

 

Effective July 17, 2014, the Corporation terminated its existing treasury stock repurchase programs (described immediately above) and approved a new treasury stock repurchase program. Under the new program, the Corporation is authorized to repurchase up to 622,500 shares of the Corporation’s common stock, or approximately 5% of the Corporation’s issued and outstanding shares at July 16, 2014. As permitted by securities laws and other legal requirements and subject to market conditions and other factors, purchases under the new program may be made from time to time in the open market at prevailing prices, or through privately negotiated transactions.

 

Consistent with previous programs, the Board of Directors’ July 17, 2014 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.

 

63
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Item 3.Defaults Upon Senior Securities

None

 

Item 4.Mine Safety Disclosures

Not applicable

 

Item 5.Other Information

None

 

64
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Item 6.Exhibits

 

2. Plan of acquisition, reorganization, arrangement,   Not applicable
    liquidation or succession                                                                
     
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   Not applicable    
     vote of security holders    
     
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

 

65
CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

SIGNATURES

 

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

 

  CITIZENS & NORTHERN CORPORATION
   
August 8, 2014 By:/s/ Charles H. Updegraff, Jr.
Date President and Chief Executive Officer
   
August 8, 2014 By: /s/ Mark A. Hughes
Date Treasurer and Chief Financial Officer

 

66