UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2007

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

For the transition period from                                          to                                         .

CITIZENS & NORTHERN CORPORATION

(Exact name of Registrant as specified in its charter)

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

90-92 MAIN STREET, WELLSBORO, PA 16901
(Address of principal executive offices) (Zip code)
570-724-3411
(Registrant’s telephone number including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to section 12(g) of the Act:
COMMON STOCK Par Value $1.00

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 þ No o

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

Large accelerated filer o     Accelerated filer þ     Non-accelerated filer o

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

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)		8,921,909 Shares Outstanding on May 4, 2007

 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

CITIZENS & NORTHERN CORPORATION
Index

Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheet — March 31, 2007 and December 31, 2006		Page 3
Consolidated Statement of Income — Three Months Ended March 31, 2007 and 2006		Page 4
Consolidated Statement of Cash Flows — Three Months Ended March 31, 2007 and 2006		Page 5
Notes to Consolidated Financial Statements		Pages 6 through 10
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		Pages 10 through 24
Item 3. Quantitative and Qualitative Disclosures About Market Risk		Pages 25 through 27
Item 4. Controls and Procedures		Page 27
Part II. Other Information		Pages 27 through 29
Signatures		Page 30
Exhibit 31.1. Rule 13a-14(a)/15d-14(a) Certification — Chief Executive Officer		Page 31
Exhibit 31.2. Rule 13a-14(a)/15d-14(a) Certification — Chief Financial Officer		Page 32
Exhibit 32. Section 1350 Certifications		Page 33
EX-31.1
EX-31.2
EX-32

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

ITEM 1. FINANCIAL STATEMENTS

		March 31,				December 31,
		2007				2006
(In Thousands Except Share Data)		(Unaudited)				(Note)
ASSETS
Cash and due from banks:
Noninterest-bearing		$	19,545			$	18,676
Interest-bearing			4,003				8,483
Total cash and cash equivalents			23,548				27,159
Trading securities			1,528				—
Available-for-sale securities			342,780				356,665
Held-to-maturity securities			413				414
Loans, net			687,661				679,300
Bank-owned life insurance			16,533				16,388
Accrued interest receivable			4,900				5,046
Bank premises and equipment, net			23,087				23,129
Foreclosed assets held for sale			388				264
Intangible asset — Core deposit intangible			315				336
Intangible asset — Goodwill			2,809				2,809
Other assets			16,997				15,858
TOTAL ASSETS		$	1,120,959			$	1,127,368
LIABILITIES
Deposits:
Noninterest-bearing		$	108,379			$	105,675
Interest-bearing			661,779				654,674
Total deposits			770,158				760,349
Dividends payable			1,988				1,969
Short-term borrowings			58,967				49,258
Long-term borrowings			151,302				179,182
Accrued interest and other liabilities			8,779				6,722
TOTAL LIABILITIES			991,194				997,480
STOCKHOLDERS’ EQUITY
Common stock, par value $1.00 per share; authorized 20,000,000 shares in 2007 and 2006; issued 8,556,225 in 2007 and 8,472,382 in 2006			8,556				8,472
Stock dividend distributable			—				1,806
Paid-in capital			28,909				27,077
Retained earnings			96,547				96,077
Total			134,012				133,432
Accumulated other comprehensive income			265				613
Unamortized stock compensation			(131	)			(11	)
Treasury stock, at cost:
272,573 shares at March 31, 2007			(4,381	)
262,598 shares at December 31, 2006							(4,146	)
TOTAL STOCKHOLDERS’ EQUITY			129,765				129,888
TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY		$	1,120,959			$	1,127,368

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

Note: The balance sheet at December 31, 2006 has been derived from the audited financial statements at that date but does not include all the information and notes required by U.S. generally accepted accounting principles for complete financial statements.

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

CONSOLIDATED STATEMENT OF INCOME

		3 Months Ended
		March 31,				March 31,
		2007				2006
INTEREST INCOME
Interest and fees on loans		$	11,281			$	10,166
Interest on balances with depository institutions			26				12
Interest on loans to political subdivisions			344				311
Interest on federal funds sold			101				43
Interest on trading securities			3				—
Income from available-for-sale and held-to-maturity securities:
Taxable			3,497				3,727
Tax-exempt			727				1,336
Dividends			264				268
Total interest and dividend income			16,243				15,863
INTEREST EXPENSE
Interest on deposits			5,890				5,009
Interest on short-term borrowings			475				426
Interest on long-term borrowings			1,635				1,843
Total interest expense			8,000				7,278
Interest margin			8,243				8,585
Provision for loan losses			229				600
Interest margin after provision for loan losses			8,014				7,985
OTHER INCOME
Service charges on deposit accounts			482				450
Service charges and fees			142				65
Trust and financial management revenue			682				511
Insurance commissions, fees and premiums			116				139
Increase in cash surrender value of life insurance			145				147
Other operating income			521				477
Total other income before realized gains on available-for-sale securities, net			2,088				1,789
Realized gains on available-for-sale securities, net			1,161				1,315
Total other income			3,249				3,104
OTHER EXPENSES
Salaries and wages			3,595				3,322
Pensions and other employee benefits			1,185				1,143
Occupancy expense, net			626				546
Furniture and equipment expense			645				650
Pennsylvania shares tax			236				244
Other operating expense			1,960				1,938
Total other expenses			8,247				7,843
Income before income tax provision			3,016				3,246
Income tax provision			558				426
NET INCOME		$	2,458			$	2,820
PER SHARE DATA:
Net income — basic		$	0.30			$	0.34
Net income — diluted		$	0.30			$	0.33
Dividend per share		$	0.24			$	0.24
Number of shares used in computation — basic			8,293,207				8,379,891
Number of shares used in computation — diluted			8,311,233				8,417,978

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

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

Consolidated Statement of Cash Flows

		3 Months Ended
		March 31,				March 31,
(In Thousands)		2007				2006
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	2,458			$	2,820
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses			229				600
Realized gains on available-for-sale securities, net			(1,161	)			(1,315	)
Gain on sale of foreclosed assets, net			(10	)			(14	)
Depreciation expense			642				605
Accretion and amortization of securities, net			114				86
Increase in cash surrender value of life insurance			(145	)			(147	)
Stock-based compensation			103				10
Amortization of core deposit intangible			21				62
Increase in accrued interest receivable and other assets			(1,712	)			(2,472	)
Increase in accrued interest payable and other liabilities			567				2,529
Net Cash Provided by Operating Activities			1,106				2,764
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturity of held-to-maturity securities			1				2
Proceeds from sales of available-for-sale securities			16,709				10,566
Proceeds from calls and maturities of available-for-sale securities			8,557				8,291
Purchase of available-for-sale securities			(10,871	)			(21,893	)
Purchase of Federal Home Loan Bank of Pittsburgh stock			(312	)			(327	)
Redemption of Federal Home Loan Bank of Pittsburgh stock			1,182				1,162
Net (increase) decrease in loans			(8,779	)			126
Purchase of premises and equipment			(600	)			(1,652	)
Proceeds from sale of foreclosed assets			75				32
Net Cash Provided by (Used in) Investing Activities			5,962				(3,693	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits			9,809				(4,351	)
Net increase in short-term borrowings			9,709				39,780
Repayments of long-term borrowings			(27,880	)			(37,116	)
Purchase of treasury stock			(404	)			(409	)
Sale of treasury stock			75				29
Tax benefit from compensation plans			—				7
Dividends paid			(1,988	)			(1,995	)
Net Cash Used in Financing Activities			(10,679	)			(4,055	)
DECREASE IN CASH AND CASH EQUIVALENTS			(3,611	)			(4,984	)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR			27,159				26,446
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	23,548			$	21,462
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Assets acquired through foreclosure of real estate loans		$	189			$	141
Interest paid		$	8,078			$	6,184
Income taxes paid		$	10			$	—

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

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

Notes to Consolidated Financial Statements

1. BASIS OF INTERIM PRESENTATION

The financial information included herein, with the exception of the consolidated balance sheet dated December 31, 2006, is unaudited; however, 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 and cash flows for the interim periods.

Results reported for the three months ended March 31, 2007 might not be indicative of the results for the year ending December 31, 2007.

This document has not been reviewed or confirmed for accuracy or relevance by the Federal Deposit Insurance Corporation or any other regulatory agency.

2. PER SHARE DATA

Net income per share is based on the weighted-average number of shares of common stock outstanding. The number of shares used in calculating net income and cash dividends per share reflect the retroactive effect of stock dividends for all periods presented. The following data show the amounts used in computing net income per share and the weighted average number of shares of dilutive stock options. 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
Quarter Ended March 31, 2007
Earnings per share – basic		$	2,458,000				8,293,207			$	0.30
Dilutive effect of potential common stock Arising from stock options:
Exercise of outstanding stock options							111,900
Hypothetical share repurchase at $21.87							(93,874	)
Earnings per share — diluted		$	2,458,000				8,311,233			$	0.30
Quarter Ended March 31, 2006
Earnings per share — basic		$	2,820,000				8,379,891			$	0.34
Dilutive effect of potential common stock Arising from stock options:
Exercise of outstanding stock options							141,849
Hypothetical share repurchase at $26.21							(103,762	)
Earnings per share — diluted		$	2,820,000				8,417,978			$	0.33

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

3. COMPREHENSIVE INCOME

U.S. generally accepted accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although unrealized gains and losses on available-for-sale securities are reported as a separate component of the equity section of the balance sheet, changes in unrealized gains and losses on available-for-sale securities, along with net income, are components of comprehensive income. Also, effective December 31, 2006, the Corporation applied Statement of Financial Accounting Standards (SFAS) No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. SFAS No. 158 requires the Corporation to recognize the underfunded or overfunded status of defined benefit postretirement plans as a liability or asset in the balance sheet. Beginning in 2007, changes in accumulated other comprehensive income attributable to the impact of SFAS No. 158 on defined benefit plans are included in other comprehensive income.

The components of comprehensive income, and the related tax effects, are as follows:

		3 Months Ended
		March 31,
(In Thousands)		2007				2006
Net income		$	2,458			$	2,820
Unrealized gains (losses) on available-for-sale securities:
Unrealized holding gains (losses) on available-for-sale securities			624				(2,265	)
Less: Reclassification adjustment for gains realized in income			(1,161	)			(1,315	)
Other comprehensive loss before income tax			(537	)			(3,580	)
Income tax related to unrealized loss on securities			183				1,214
Other comprehensive loss on securities			(354	)			(2,366	)
Unfunded pension and postretirement obligations:
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost			11				—
Income tax related to other comprehensive gain			(5	)			—
Other comprehensive gain on unfunded pension/retirement obligations			6				—
Total comprehensive income		$	2,110			$	454

4. SECURITIES

The Corporation’s trading asset at March 31, 2007 was a municipal bond with an estimated fair value of $1,528,000. In the first quarter 2007, the gain on trading activities included in earnings totaled $6,000. There was no trading activity in the first quarter 2006.

Amortized cost and fair value of available-for-sale and held-to-maturity securities at March 31, 2007 are summarized as follows:

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

						Gross				Gross
						Unrealized				Unrealized
		Amortized				Holding				Holding				Fair
(In Thousands)		Cost				Gains				Losses				Value
AVAILABLE-FOR-SALE SECURITIES:
Obligations of other U.S. Government agencies		$	26,200			$	—			$	(230	)		$	25,970
Obligations of states and political subdivisions			63,297				706				(268	)			63,735
Mortgage-backed securities			106,605				126				(2,349	)			104,382
Collateralized mortgage obligations			37,859				27				(771	)			37,115
Other securities			84,544				1,003				(636	)			84,911
Total debt securities			318,505				1,862				(4,254	)			316,113
Marketable equity securities			22,097				5,028				(458	)			26,667
Total		$	340,602			$	6,890			$	(4,712	)		$	342,780
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury		$	310			$	6			$	—			$	316
Obligations of other U.S. Government agencies			99				5				—				104
Mortgage-backed securities			4				—				—				4
Total		$	413			$	11			$	—			$	424

The following table presents gross unrealized losses and fair value of investments aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2007.

		Less Than 12 Months								12 Months or More								Total
March 31, 2007		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
(In Thousands)		Value				Losses				Value				Losses				Value				Losses
AVAILABLE-FOR-SALE SECURITIES:
Obligations of other U.S. Government agencies		$	1,197			$	(3	)		$	24,772			$	(227	)		$	25,969			$	(230	)
Obligations of states and political subdivisions			10,597				(91	)			13,510				(177	)			24,107				(268	)
Mortgage-backed securities			7,944				(40	)			86,979				(2,309	)			94,923				(2,349	)
Collateralized mortgage obligations			—				—				31,470				(771	)			31,470				(771	)
Other securities			13,028				(153	)			25,940				(483	)			38,968				(636	)
Total debt securities			32,766				(287	)			182,671				(3,967	)			215,437				(4,254	)
Marketable equity securities			5,424				(333	)			1,373				(125	)			6,797				(458	)
Total temporarily impaired available-for-sale securities		$	38,190			$	(620	)		$	184,044			$	(4,092	)		$	222,234			$	(4,712	)

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns 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) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

The unrealized losses on debt securities are primarily the result of volatility in interest rates. Based on the credit worthiness of the issuers, which are almost exclusively U.S. Government agencies or state and political subdivisions, management believes the Corporation’s debt securities at March 31, 2007 were not other-than-temporarily impaired.

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

5. DEFINED BENEFIT PLANS

The Corporation has a noncontributory defined benefit pension plan for all employees meeting certain age and length of service requirements. Benefits are based primarily on years of service and the average annual compensation during the highest five consecutive years.

In addition, 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. 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 affect the liability balance at March 31, 2007 and December 31, 2006, and will not affect the Corporation’s future expenses.

The Corporation uses a December 31 measurement date for its plans.

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

		Pension								Postretirement
		Three Months Ended								Three Months Ended
		March 31,								March 31,
(In Thousands)		2007				2006				2007				2006
Service cost		$	171			$	152			$	18			$	16
Interest cost			175				157				17				15
Expected return on plan assets			(230	)			(208	)			—				—
Amortization of transition (asset) obligation			(6	)			(6	)			9				9
Amortization of prior service cost			2				2
Recognized net actuarial loss			11				18				1				1
Net periodic benefit cost (benefit)		$	123			$	115			$	45			$	41

For the defined benefit pension plan, the Corporation has a minimum required employer contribution of $156,000 for the year ended December 31, 2007. The Corporation has not yet made its defined benefit pension plan for contribution for 2007, and management has not yet determined the amount of its defined benefit pension plan contribution for 2007; however, the contribution will equal or exceed the minimum contribution disclosed above based, in part, on the allowable contribution level under current IRS regulations. In the first quarter 2007, the Corporation funded postretirement contributions totaling $14,000, with estimated annual postretirement contributions of $42,000 expected in 2007 for the full year.

6. STOCK-BASED COMPENSATION PLANS

In January 2007, the Corporation granted options to purchase a total of 43,385 shares of common stock through its Stock Incentive and Independent Directors Stock Incentive Plans. The exercise price for these options is $22.325 per share, which was the market price as of the date of grant. SFAS No. 123R requires the Corporation to record stock option expense based on estimated fair value calculated using an option valuation model. In the first quarter 2007, the Corporation recorded total stock option expense of $79,000. The Corporation expects total stock option expense for the year ending December 31, 2007 to be approximately $158,000. The Corporation neither modified, nor issued, any new options in 2006, and all options issued prior to December 31, 2005 were fully vested prior to that date. Accordingly, the Corporation had no stock option expense in 2006.

The fair value of each option granted in 2007 was estimated to be $4.46 per share as of the grant date. In calculating the fair value, the Corporation utilized the Black-Scholes option-pricing model with the following assumptions:

	•		Volatility – 23%
	•		Expected option lives – 8 years

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

	•		Risk-free interest rate – 4.69%
	•		Dividend yield – 3.61%

In calculating the estimated fair value of the 2007 stock option awards, the Corporation utilized its historical volatility and dividend yield over the immediately prior 8-year period to estimate future levels of volatility and dividend yield. The risk-free interest rate was based on the published yield of zero-coupon U.S. Treasury strips with an 8-year maturity as of the grant dates. The 8-year term was based on management’s estimate of the average term for all options issued under both plans.

In calculating stock expense, management assumed a 23% 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.

Also, effective in January 2007, the Corporation awarded a total of 5,835 shares of restricted stock under the Stock Incentive and Independent Directors Stock Incentive 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. Total restricted stock expense amounted to $24,000 in the first quarter 2007 and $10,000 in the first quarter 2006.

7. 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.

8. SUBSEQUENT EVENT — MERGER

On May 1, 2007, the Corporation completed its acquisition of Citizens Bancorp, Inc. (“Citizens.”) In accordance with the terms of the December 2006 merger agreement, the shareholders of Citizens are entitled to receive, for each share of Citizens common stock they own, (a) $28.57 cash; or (b) 1.297 shares of common stock of the Corporation. Citizens’ shareholder elections are subject to allocation procedures designed to ensure that in the aggregate, 50% of the shares of Citizens common stock will be exchanged for cash and 50% of the shares of Citizens common stock will be exchanged for shares of Corporation common stock. As a result of the transaction, the Corporation will issue approximately 637,555 shares of its common stock to former shareholders of Citizens. The total estimated purchase price of the transaction is valued at approximately $29 million.

In connection with the transaction, Citizens Trust Company, the banking subsidiary of Citizens, has merged with and into Citizens & Northern Bank (“C&N Bank”), a subsidiary of the Corporation.

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

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

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

•

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.

REFERENCES TO 2007 AND 2006

Unless otherwise noted, all references to “2007” in the following discussion of operating results are intended to mean the three months ended March 31, 2007, and similarly, references to “2006” relate to the three months ended March 31, 2006.

EARNINGS OVERVIEW

Net income in 2007 was $2,458,000, or $0.30 per share — basic and diluted. Net income per share was $0.34 (Basic) and $0.33 (diluted) in 2006. Return on average assets was 0.88% in 2007, down from 0.97% in 2006. Return on average equity was 7.50% for 2006, as compared to 8.51% in 2006.

The most significant income statement changes between 2007 and 2006 were as follows:

	•		The net interest margin decreased $342,000, or 4.0%, in 2007 as compared to 2006. The yield curve has been flat or inverted throughout 2006 and 2007, causing interest rates paid on liabilities (mainly deposits and borrowings) to increase more than the rates of interest earned on loans and investment securities. Further, the flat or inverted yield curve has limited opportunities to earn a positive spread from maintaining borrowed funds and holding investment securities. Accordingly, the Corporation has sold securities and repaid borrowings throughout much of 2007 and 2006.
	•		The provision for loan losses was $229,000 in 2007, down from $600,000 in 2006. The higher loan loss provision in the first quarter 2006 reflected management’s concerns at that time about possible charge-offs related to a few large commercial loans. In the second quarter 2006, settlements were reached on those loans, resulting in charge-offs that were significantly less than the estimated allowances that had been previously established.
	•		Noninterest revenue increased $293,000 in 2007 over 2006. The largest increases in noninterest revenue were from Trust and Financial Management services, which generated an increase of $171,000 (33.5%), and an increase of $59,000 in fees related to commercial letters of credit.
	•		Noninterest expense increased $404,000 (5.2%) in 2007 over 2006. Employee compensation-related expense increased $315,000, or 7.1% in the first quarter 2007 over the first quarter 2006. The increase in compensation-related expense included the effects of new positions added in late 2006 for lending and Trust and Financial Management services in New York State. Recently, regulatory permission has been received to offer Trust and Financial management services through the Canisteo and South Hornell, NY (First State Bank) locations, and management expects to begin offering Trust and Financial Management services at the New York State locations in the second quarter 2007. Noninterest expense for 2007 also included $79,000 of stock option expense. Stock option expense has been calculated using an option pricing model to estimate the fair value of stock options awarded. The Corporation expects total stock option expense for the year ending December 31, 2007 to be approximately $158,000. There was no stock option expense in the first quarter 2006. Occupancy expense increased $80,000, or 14.7%, in the first quarter 2007 over the first quarter 2006, mainly because of depreciation and other expenses associated with facilities that were constructed or expanded in 2006, including the Old Lycoming Township office and the Administration building in Wellsboro (both of which opened in March 2006) and the South Hornell office (renovations completed in October 2006).
	•		Net realized gains from sales of available-for-sale securities amounted to $1,161,000 in 2007, as compared to $1,315,000 in 2006. Most of the gains realized in both periods were from sales of bank stocks.

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

•

The income tax provision increased to $558,000, or 18.5% of pre-tax income, in 2007, from $426,000, or 13.1% of pre-tax income, in 2006. The higher income tax rate in 2007 reflects management’s decision to reduce the portion of assets held in municipal bonds, in an effort to reduce alternative minimum tax.

TABLE I — QUARTERLY FINANCIAL DATA

		Mar. 31,				Dec. 31,				Sept. 30,				June 30,				Mar. 31,
(In Thousands)		2007				2006				2006				2006				2006
Interest income		$	16,243			$	16,463			$	16,152			$	15,984			$	15,863
Interest expense			8,000				8,097				7,833				7,566				7,278
Interest margin			8,243				8,366				8,319				8,418				8,585
Provision for loan losses			229				181				191				(300	)			600
Interest margin after provision for loan losses			8,014				8,185				8,128				8,718				7,985
Other income			2,088				2,045				2,199				1,937				1,789
Available-for-sale securities gains			1,161				796				1,602				1,333				1,315
Gain from sale of credit card loans			—				340				—				—				—
Other expenses			8,247				8,155				7,640				7,976				7,843
Income before income tax provision			3,016				3,211				4,289				4,012				3,246
Income tax provision			558				517				1,016				813				426
Net income		$	2,458			$	2,694			$	3,273			$	3,199			$	2,820
Net income per share — basic		$	0.30			$	0.32			$	0.39			$	0.38			$	0.34
Net income per share — diluted		$	0.30			$	0.32			$	0.39			$	0.38			$	0.33

The number of shares used in calculating net income per share for each quarter presented in Table I reflects the retroactive effect of stock dividends.

Prospects for the Remainder of 2007

The flat or inverted yield curve continues to challenge the Corporation’s ability to achieve earnings growth. Over time, management hopes to use earnings from growth in loans and deposits, as well as revenues from Trust and Financial Management Services, to offset the impact of reduced (from historical norms) opportunities to generate net interest income from a positive spread between earnings on securities and interest costs on borrowings. The desire to reduce dependence on the yield curve for earnings contributions is one of the major reasons for management’s decisions to expand in recent years by building or acquiring banking facilities in Lycoming County, PA, New York State (First State Bank) and most recently, in the Citizens Trust Company locations (described in the next paragraph).

The merger of Citizens Bancorp, Inc. into Citizens & Northern Corporation closed on May 1, 2007. Citizens Bancorp, Inc., with total assets of approximately $144 million as of March 31, 2007, was the parent company of Citizens Trust Company, with offices in Coudersport, Port Allegany and Emporium, PA. These locations have become offices of C&N Bank, and are operating under the name, “Citizens Trust Company, a Division of Citizens & Northern Bank.” As a result of the transaction, the Corporation will issue approximately 637,555 shares of its common stock to former shareholders of Citizens Bancorp, Inc. The total purchase price of the transaction is estimated at approximately $29 million. The process of integrating Citizens Trust Company’s personnel and systems with the Corporation’s began before the merger closed. Management expects one key integration milestone, conversion of Citizens Trust Company’s core banking data into C&N Bank’s system, to be completed in the fourth quarter 2007. Including the impact of expenses related to the computer system conversion and other one-time and duplicative expenses that will be eliminated after 2007, management expects the addition of Citizens Trust Company to be approximately neutral to earnings per share in 2007 and accretive in 2008.

In April 2007, the Corporation completed the conversion of the New York State (First State Bank) branches’ core banking information into the same system used by C&N. Management expects to be able to offer more products and services, and to achieve certain administrative efficiencies, as a result of completing this conversion. Also, as reported above, new lending personnel were added to the New York State staff in the fourth quarter 2006, and Trust and Financial

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

Management services are expected to begin at the New York State locations in the second quarter 2007. While management expects these activities to result in positive contributions to earnings in the future, the net impact for the year ending December 31, 2007 cannot be determined.

Another major variable that affects the Corporation’s earnings is securities gains and losses, particularly from bank stocks and other equity securities. Management’s decisions regarding sales of securities are based on a variety of factors, with the overall goal of maximizing portfolio return over a long-term horizon. It is difficult to predict, with much precision, the amount of net securities gains and losses that will be realized throughout the remainder of 2007.

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 that the allowance for loan losses is adequate and reasonable. The Corporation’s methodology for determining the allowance for loan losses is described in a separate section later in Management’s Discussion and Analysis. Given the very subjective nature of identifying and valuing loan losses, it is likely that well-informed individuals could make materially different assumptions, and could, therefore, calculate a materially different allowance value. While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.

Another material estimate is the calculation of fair values of the Corporation’s debt securities. The Corporation receives estimated fair values of debt securities from an independent valuation service, or from brokers. In developing these 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. Accordingly, when selling debt securities, management typically obtains price quotes from more than one source. The large majority of the Corporation’s securities are classified as available-for-sale. Accordingly, these securities are carried at fair value on the consolidated balance sheet, with unrealized gains and losses excluded from earnings and reported separately through accumulated other comprehensive income (included in stockholders’ equity).

NET INTEREST MARGIN

The Corporation’s primary source of operating income is represented by the net interest margin. The net interest margin 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 margin for 2007 and 2006. 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 margin amounts reflected in these tables exceed the amounts presented in the consolidated financial statements. The discussion that follows is based on amounts in the Tables.

The net interest margin, on a tax-equivalent basis, of $8,724,000 in 2007 decreased $614,000, or 6.6% from 2006. As reflected in Table IV, interest rate changes had the effect of decreasing net interest income $498,000 in 2007 as compared to 2006, as rising short-term interest rates caused increases in interest expense. Table IV also shows that volume changes had the effect of decreasing net interest income $116,000 in 2007 over 2006. The major components of the net decrease in net interest income from volume changes in 2007 were lower interest income of $1,129,000 from available-for-sale securities, partially offset by an increase of $614,000 attributable to loan growth and a decrease in interest expense of $428,000 related to lower long-term borrowings. As presented in Table III, the “Interest Rate Spread” (excess of average rate of return on interest-bearing assets over average cost of funds on interest-bearing liabilities) shrunk to 2.80% in the first quarter 2007 from 2.90% for the year ended December 31, 2006 and 3.05% in the first quarter 2006.

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

INTEREST INCOME AND EARNING ASSETS

Interest income totaled $16,724,000 in 2007, less than 1% higher than in 2006. Interest and fees from loans increased $1,161,000, or 10.9%, while income from available-for-sale securities decreased $1,129,000, or 19.0%.

As indicated in Table III, total average available-for-sale securities in 2007 fell to $345,251,000, a decrease of $74,439,000 or 17.7% from 2006. Throughout the calendar year 2006, proceeds from sales and maturities of securities were used, in part, to help fund loans and pay off borrowings. Within the available-for-sale securities portfolio, the average balance of municipal bonds shrunk by $52,530,000 in 2007 as compared to 2006. Management decided to reduce the Corporation’s investment in municipal bonds in order to reduce the alternative minimum tax liability. Also, because short-term interest rates have been rising faster than long-term rates, there have been only limited opportunities to purchase mortgage-backed securities or other taxable bonds at spreads sufficient to justify the applicable interest rate risk. The average rate of return on available-for-sale securities was 5.65% for 2007, up from 5.55% for the year ended December 31, 2006 and down from 5.74% in the first quarter 2006.

The average balance of gross loans increased 5.6% to $685,418,000 in the first quarter 2007 from $648,872,000 in the first quarter 2006. The Corporation has experienced an increase in average balances of both residential mortgage and commercial loans in 2007. The average rate of return on loans was 6.97% in 2007, up from 6.81% for the year ended December 31, 2006 and 6.64% in the first quarter 2006.

INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES

Interest expense rose $722,000, or 9.9%, to $8,000,000 in 2007 from $7,278,000 in 2006. Table III shows that the overall cost of funds on interest-bearing liabilities rose to 3.72% in 2007, from 3.44% for the year ended December 31, 2006 and 3.22% in the first quarter 2006.

From Table III, you can calculate that total average deposits (interest-bearing and noninterest-bearing) increased 1.2%, to $758,466,000 in 2007 from $749,104,000 in the first three months of 2006. There has been some migration out of money market and savings accounts, for which the average balances have decreased in 2007, and into certificates of deposit. The average rate on certificates of deposit has increased significantly in 2007 over the first quarter 2006, to 4.40% from 3.56%.

The combined average total short-term and long-term borrowed funds decreased $46,004,000 to $217,343,000 in 2007 from $263,347,000 in the first quarter 2006. As discussed earlier in Management’s Discussion and Analysis, because the yield curve has been flat or inverted, the Corporation’s opportunities have been limited for earning a positive spread by purchasing or holding investment securities as compared to interest costs associated with maintaining borrowed funds. Accordingly, the Corporation has been paying off many borrowings as they mature. The average rate on short-term borrowings was 3.96% in 2007, up from 3.57% in the first quarter 2006. The average rate on long-term borrowings was 3.93% in 2007, up from 3.48% in the first quarter 2006.

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

TABLE II — ANALYSIS OF INTEREST INCOME AND EXPENSE

		Three Months Ended
		March 31,								Increase/
(In Thousands)		2007				2006				(Decrease)
INTEREST INCOME
Available-for-sale securities:
Taxable		$	3,755			$	3,989			$	(234	)
Tax-exempt			1,054				1,949				(895	)
Total available-for-sale securities			4,809				5,938				(1,129	)
Held-to-maturity securities,
Taxable			6				6				—
Trading securities			4				—				4
Interest-bearing due from banks			26				12				14
Federal funds sold			101				43				58
Loans:
Taxable			11,281				10,166				1,115
Tax-exempt			497				451				46
Total loans			11,778				10,617				1,161
Total Interest Income			16,724				16,616				108
INTEREST EXPENSE
Interest checking			568				452				116
Money market			1,411				1,362				49
Savings			78				87				(9	)
Certificates of deposit			2,442				1,900				542
Individual Retirement Accounts			1,390				1,207				183
Other time deposits			1				1				—
Short-term borrowings			475				426				49
Long-term borrowings			1,635				1,843				(208	)
Total Interest Expense			8,000				7,278				722
Net Interest Income		$	8,724			$	9,338			$	(614	)

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

Table III – Analysis of Average Daily Balances and Rates

		3 Months								Year								3 Months
		Ended				Rate of				Ended				Rate of				Ended				Rate of
		3/31/2007				Return/				12/31/2006				Return/				3/31/2006				Return/
		Average				Cost of				Average				Cost of				Average				Cost of
(Dollars in Thousands)		Balance				Funds %				Balance				Funds %				Balance				Funds %
EARNING ASSETS
Available-for-sale securities, at amortized cost:
Taxable		$	280,421				5.43	%		$	295,138				5.25	%		$	302,330				5.35	%
Tax-exempt			64,830				6.59	%			89,981				6.51	%			117,360				6.74	%
Total available-for-sale securities			345,251				5.65	%			385,119				5.55	%			419,690				5.74	%
Held-to-maturity securities,
Taxable			414				5.88	%			418				5.74	%			421				5.78	%
Trading securities			254				6.39	%			—				0.00	%			—				0.00	%
Interest-bearing due from banks			1,802				5.85	%			2,272				4.01	%			1,430				3.40	%
Federal funds sold			7,661				5.35	%			4,580				5.48	%			3,633				4.80	%
Loans,
Taxable			653,473				7.00	%			631,969				6.84	%			618,331				6.67	%
Tax-exempt			31,945				6.31	%			30,745				6.19	%			30,541				5.99	%
Total loans			685,418				6.97	%			662,714				6.81	%			648,872				6.64	%
Total Earning Assets			1,040,800				6.52	%			1,055,103				6.34	%			1,074,046				6.27	%
Cash			17,284								19,027								10,311
Unrealized gain/loss on securities			2,779								3,151								7,368
Allowance for loan losses			(8,318	)							(8,495	)							(8,540	)
Bank premises and equipment			23,242								23,491								23,385
Intangible Asset — Core Deposit Intangible			327								389								433
Intangible Asset — Goodwill			2,809								2,912								2,919
Other assets			37,104								39,111								43,281
Total Assets		$	1,116,027							$	1,134,689							$	1,153,203
INTEREST-BEARING LIABILITIES
Interest checking		$	73,350				3.14	%		$	68,369				2.61	%		$	72,530				2.53	%
Money market			174,968				3.27	%			179,288				3.24	%			179,348				3.08	%
Savings			58,135				0.54	%			62,030				0.54	%			63,809				0.55	%
Certificates of deposit			225,041				4.40	%			215,460				3.96	%			216,186				3.56	%
Individual Retirement Accounts			122,695				4.59	%			122,459				4.28	%			120,174				4.07	%
Other time deposits			900				0.45	%			1,116				0.63	%			908				0.45	%
Short-term borrowing			48,597				3.96	%			56,606				4.09	%			48,384				3.57	%
Long-term borrowing			168,746				3.93	%			188,077				3.59	%			214,963				3.48	%
Total Interest-bearing Liabilities			872,432				3.72	%			893,405				3.44	%			916,302				3.22	%
Demand deposits			103,377								102,260								96,149
Other liabilities			9,110								7,942								8,143
Total Liabilities			984,919								1,003,607								1,020,594
Stockholders’ equity, excluding other comprehensive income/loss			130,447								129,004								128,173
Other comprehensive income/loss			661								2,078								4,436
Total Stockholders’ Equity			131,108								131,082								132,609
Total Liabilities and Stockholders’ Equity		$	1,116,027							$	1,134,689							$	1,153,203
Interest Rate Spread							2.80	%							2.90	%							3.05	%
Net Interest Income/Earning Assets							3.40	%							3.42	%							3.53	%

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

TABLE IV — ANALYSIS OF VOLUME AND RATE CHANGES

		YTD Ended 3/31/07 vs. 3/31/06
		Change in				Change in				Total
(In Thousands)		Volume				Rate				Change
EARNING ASSETS
Available-for-sale securities:
Taxable		$	(292	)		$	58			$	(234	)
Tax-exempt			(855	)			(40	)			(895	)
Total available-for-sale securities			(1,147	)			18				(1,129	)
Held-to-maturity securities,
Taxable			—				—				—
Trading securities			4				—				4
Interest-bearing due from banks			4				10				14
Federal funds sold			53				5				58
Loans:
Taxable			593				522				1,115
Tax-exempt			21				25				46
Total loans			614				547				1,161
Total Interest Income			(472	)			580				108
INTEREST-BEARING LIABILITIES
Interest checking			5				111				116
Money market			(34	)			83				49
Savings			(8	)			(1	)			(9	)
Certificates of deposit			81				461				542
Individual Retirement Accounts			26				157				183
Other time deposits			—				—				—
Short-term borrowings			2				47				49
Long-term borrowings			(428	)			220				(208	)
Total Interest Expense			(356	)			1,078				722
Net Interest Income		$	(116	)		$	(498	)		$	(614	)

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

TABLE V — COMPARISON OF NONINTEREST INCOME

		3 Months Ended
		March 31,				March 31,
(In Thousands)		2007				2006
Service charges on deposit accounts		$	482			$	450
Service charges and fees			142				65
Trust and financial management revenue			682				511
Insurance commissions, fees and premiums			116				139
Increase in cash surrender value of life insurance			145				147
Other operating income			521				477
Total other operating income, before realized gains on securities, net			2,088				1,789
Realized gains on available-for-sale securities, net			1,161				1,315
Total Other Income		$	3,249			$	3,104

Total noninterest income increased $145,000, or 4.7%, in 2007 compared to 2006. Excluding realized gains on available-for-sale securities, which are discussed in the “Earnings Overview” section of Management’s Discussion and Analysis, the increase is 16.7% in 2007 over 2006. Items of significance are as follows:

	•		Service charges on deposit accounts increased $32,000, or 7.1%, in 2007 as compared to 2006. Within this category, the largest change was from overdraft fees, which increased $41,000 in 2007 over 2006.
	•		Service charges and fees increased $77,000 in 2007 over 2006. Among the types of fees included in this category are letter of credit fees, which increased $59,000 in 2007 because of a few large, commercial transactions, and ATM surcharge fees, which increased $12,000 in 2007 over 2006.
	•		Trust and financial management revenue increased $171,000, or 33.5%, in 2007 over 2006. Assets under management have increased 11.0% over the last 12 months, to $526,747,000 at March 31, 2007. The increase in assets under management is attributable to both appreciation in equity markets and an increase in volume of accounts. In addition to the impact of increased assets under management, 2007 revenues have also increased as a result of rate increases and from the resolution and final billings related to an estate.
	•		Other operating income increased $44,000, or 9.2%, in 2007 over 2006. Included in this category was an increase of $33,000 in fees from credit card agent bank activities. In the first quarter 2006, the Corporation was in the final stages of processing transactions for the credit card portfolio that was sold in the fourth quarter 2005. Accordingly, costs associated with processing and exiting that activity, net of interchange and other fees, were charged against a liability that had been established in 2005 for the estimated remaining servicing cost. Since the Corporation no longer services credit card transactions, fees received in 2007 have been included in other operating income.

TABLE VI- COMPARISON OF NONINTEREST EXPENSE

		3 Months Ended
		March 31,				March 31,
(In Thousands)		2007				2006
Salaries and wages		$	3,595			$	3,322
Pensions and other employee benefits			1,185				1,143
Occupancy expense, net			626				546
Furniture and equipment expense			645				650
Pennsylvania shares tax			236				244
Other operating expense			1,960				1,938
Total Other Expense		$	8,247			$	7,843

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Total noninterest expense increased $404,000, or 5.2%, in 2007 over 2006. The major changes in items of expense are described in the “Earnings Overview” section of Management’s Discussion and Analysis.

FINANCIAL CONDITION

Significant changes in the average balances of the Corporation’s earning assets and interest-bearing liabilities are described in the “Net Interest Margin” section of Management’s Discussion and Analysis. The allowance for loan losses and stockholders’ equity are discussed in separate sections of Management’s Discussion and Analysis.

As discussed in the “Prospects for the Remainder of 2007” section of Management’s Discussion and Analysis, the Corporation’s merger with Citizens Bancorp, Inc. closed on May 1, 2007. As a result of that merger, the Corporation’s reported amounts of assets, liabilities and stockholders’ equity will increase, but tangible assets as a percentage of equity will decrease slightly. Total capital purchases for 2007, excluding capital assets included in the Citizens Bancorp, Inc. acquisition, are estimated at approximately $2.5-$3 million. In light of the Corporation’s strong capital position and ample sources of liquidity, management does not expect the Citizens Bancorp, Inc. acquisition and other capital expenditures to have a material, detrimental effect on the Corporation’s financial condition in 2007. Management believes the overall impact on the Corporation’s earnings in 2007 and thereafter will depend on the Corporation’s ability to build market share and produce profitable results from its investments in new locations, technology and other capital assets, and how long that will take.

PROVISION AND ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s evaluation of the collectibility of the loan portfolio. In evaluating collectibility, management considers a number of factors, including the status of specific impaired loans, trends in historical loss experience, delinquency trends, credit concentrations, comparison of historical loan loss data to that of other financial institutions and economic conditions within the Corporation’s market area. Allowances for impaired loans are determined based on collateral values or the present value of estimated cash flows. The allowance is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries.

There are two major components of the allowance – (1) SFAS 114 allowances – on larger loans, mainly commercial purpose, determined on a loan-by-loan basis; and (2) SFAS 5 allowances – estimates of losses incurred on the remainder of the portfolio, determined based on collective evaluation of impairment for various categories of loans. SFAS 5 allowances include a portion based on historical net charge-off experience, and a portion based on evaluation of qualitative factors.

Each quarter, management performs a detailed assessment of the allowance and provision for loan losses. A management committee called the Watch List Committee performs this assessment. Quarterly, the Watch List Committee and the applicable Lenders discuss each loan relationship under review, and reach a consensus on the appropriate SFAS 114 estimated loss amount for the quarter. The Watch List Committee’s focus is on ensuring that all pertinent facts have been considered, and that the SFAS 114 loss amounts are reasonable. The assessment process includes review of certain loans reported on the “Watch List.” All loans, which Lenders or the Credit Administration staff has assigned a risk rating of Special Mention, Substandard, Doubtful or Loss, are included in the Watch List. The scope of loans evaluated individually for impairment (SFAS 114 evaluation) include all loan relationships greater than $200,000 for C&N Bank loans, and $50,000 for First State Bank, for which there is at least one extension of credit graded Substandard, Doubtful or Loss. Also, loan relationships less than $200,000 in the aggregate, but with an estimated loss of $100,000 or more, are individually evaluated for impairment.

The Banks also engage consulting firms, at least annually, to perform independent credit reviews of large credit relationships. Management gives substantial consideration to the classifications and recommendations of the independent credit reviewers in determining the allowance for loan losses.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

The SFAS 5 component of the allowance includes estimates of losses incurred on loans that have not been individually evaluated for impairment. Management uses loan categories included in the Call Report (a quarterly report filed by FDIC-insured banks) to identify categories of loans with similar risk characteristics, and multiplies the loan balances for each category as of each quarter-end by two different factors to determine the SFAS 5 allowance amounts. These two factors are based on: (1) historical net charge-off experience, and (2) qualitative factors. The sum of the allowance amounts calculated for each risk category, including both the amount based on historical net charge-off experience and the amount based on evaluation of qualitative factors, is equal to the total SFAS 5 component of the allowance.

The historical net charge-off portion of the SFAS 5 allowance component is calculated by the Accounting Department as of the end of the applicable quarter. For each loan classification category used in the Call Report, the Accounting Department multiplies the outstanding balance as of the quarter-end (excluding loans individually evaluated for impairment) by the ratio of net charge-offs to average quarterly loan balances for the previous three calendar years. Prior to the fourth quarter 2005, C&N Bank had utilized the ratio of net charge-offs to average balances over a five-year period in calculating the historical loan loss experience portion of the allowance portfolio. Management made the change to the three-year assumption, which had very little effect on the allowance valuation as of December 31, 2005, mainly because management believes net charge-off experience over a 3-year period may be more representative of losses existing in the portfolio as of the balance sheet date.

Effective in the second quarter 2005, management began to calculate the effects of specific qualitative factors criteria to determine a percentage increase or decrease in the SFAS 5 allowance, in relation to the historical net charge-off percentage. The qualitative factors analysis involves assessment of changes in factors affecting the portfolio, to provide for estimated differences between losses currently inherent in the portfolio and the amounts determined based on recent historical loss rates and from identification of losses on specific individual loans. A management committee called the Qualitative Factors Committee meets quarterly, near the end of the final month of each quarter. The Qualitative Factors Committee discusses several qualitative factors, including economic conditions, lending policies, changes in the portfolio, risk profile of the portfolio, competition and regulatory requirements, and other factors, with consideration given to how the factors affect three distinct parts of the loan portfolio: Commercial, Mortgage and Consumer. During or soon after completion of the meeting, each member of the Committee prepares an update to his or her recommended percentage adjustment for each qualitative factor, and average qualitative factor adjustments are calculated for Commercial, Mortgage and Consumer loans. The Accounting Department multiplies the outstanding balance as of the quarter-end (excluding loans individually evaluated for impairment) by the applicable qualitative factor percentages, to determine the portion of the SFAS 5 allowance attributable to qualitative factors.

The allocation of the allowance for loan losses table (Table VIII) includes the SFAS 114 component of the allowance on the line item called “Impaired Loans.” SFAS 5 estimated losses, including both the portion determined based on historical net charge-off results, as well as the portion based on management’s assessment of qualitative factors, are allocated in Table VIII to the applicable categories of commercial, consumer mortgage and consumer loans. In periods prior to 2005, the portion of the allowance determined by management’s subjective assessment of economic conditions and other factors (which is now calculated using the qualitative factors criteria described above) was reflected completely in the unallocated component of the allowance. The unallocated portion of the allowance grew to $538,000 at March 31, 2007 from $24,000 at December 31, 2006, mainly because of reductions in the portion of the SFAS 5 allowances related to qualitative factors. The Qualitative Factors Committee decided to lower some of its estimated allowance percentages, mainly in categories related to monitoring the portfolio, based on perceived improvement in identifying and evaluating problem loan relationships on a timely basis. The reductions in qualitative factors, along with updated information related to outstanding balances and identified impaired loans, will be considered in estimating the allowance for loan losses required as of June 30, 2007 and calculating the provision for loan losses for the second quarter 2007.

The allowance for loan losses totaled $8,338,000 at March 31, 2007, up from $8,201,000 at December 31, 2006. As shown in Table VII, net charge-offs in the first quarter 2007 totaled $92,000, which is relatively low compared to most quarters over the last several years (although higher than the first quarter 2006 total of $46,000). Table VII also shows the provision for loan losses totaled $229,000 in the first quarter 2007, down from $600,000 in the first quarter 2006. In total, the provision for loan losses for the year ended December 31, 2006 amounted to $672,000. In the second quarter 2006, settlements were reached related to two large commercial loan relationships that had previously been classified as impaired. Total second quarter 2006 charge-offs related to these two relationships were $568,000, or approximately $450,000 less than the estimated valuation allowance amounts that had been previously recorded. These lower-than-anticipated charge-off levels contributed to a very low (by the Corporation’s historical standards) provision for loan losses

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

total for the last three quarters of 2006. The total amount of the provision for loan losses in each period is determined based on the amount required to maintain an appropriate allowance in light of all of the factors described above.

Table IX presents information related to past due and impaired loans. Total impaired loans amounted to $7,943,000 at March 31, 2007, down slightly from $8,011,000 at December 31, 2006. Nonaccrual loans totaled $8,088,000 at March 31, 2007, down from $8,506,000 at December 31, 2006. The SFAS 114 valuation allowance on impaired loans totaled $1,615,000 at March 31, 2007, down from $1,726,000 at December 31, 2006. There were no significant changes to the loans identified for SFAS 114 analysis by the Watch List Committee in the first quarter 2007, and also no significant changes in estimated valuation allowances. The reduction in SFAS 114 valuation allowances that occurred in the first quarter 2007 resulted mainly from principal payments received on some of these loans. Management believes it has been conservative in its decisions concerning identification of impaired loans, estimates of loss and nonaccrual status. However, the actual losses realized from these relationships could vary materially from the allowances calculated as of March 31, 2007. Management continues to closely monitor its commercial loan relationships for possible credit losses, and will adjust its estimates of loss and decisions concerning nonaccrual status, if appropriate.

Tables VII, VIII, IX and X present an analysis of the allowance for loan losses, the allocation of the allowance, information concerning impaired and past due loans and a five-year summary of loans by type.

TABLE VII- ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES

		Quarter				Quarter
		Ended				Ended
		March 31,				March 31,				Years Ended December 31,
(In Thousands)		2007				2006				2006				2005				2004				2003				2002
Balance, beginning of year		$	8,201			$	8,361			$	8,361			$	6,787			$	6,097			$	5,789			$	5,265
Charge-offs:
Real estate loans			29				9				611				264				375				168				123
Installment loans			47				73				259				224				217				326				116
Credit cards and related plans			4				9				22				198				178				171				190
Commercial and other loans			34				8				200				298				16				303				123
Total charge-offs			114				99				1,092				984				786				968				552
Recoveries:
Real estate loans			4				—				27				14				3				75				30
Installment loans			11				15				65				61				32				52				30
Credit cards and related plans			5				12				25				30				23				17				18
Commercial and other loans			2				26				143				50				18				32				58
Total recoveries			22				53				260				155				76				176				136
Net charge-offs			92				46				832				829				710				792				416
Allowance for loan losses recorded in acquisition			—				—				—				377				—				—				—
Provision for loan losses			229				600				672				2,026				1,400				1,100				940
Balance, end of period		$	8,338			$	8,915			$	8,201			$	8,361			$	6,787			$	6,097			$	5,789

TABLE VIII – ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES BY TYPE

		As of
		March 31,				As of December 31,
(In Thousands)		2007				2006				2005				2004				2003				2002
Commercial		$	2,296			$	2,372			$	2,705			$	1,909			$	1,578			$	1,315
Consumer mortgage			3,348				3,556				2,806				513				456				460
Impaired loans			1,615				1,726				2,374				1,378				1,542				1,877
Consumer			541				523				476				409				404				378
Unallocated			538				24				—				2,578				2,117				1,759
Total Allowance		$	8,338			$	8,201			$	8,361			$	6,787			$	6,097			$	5,789

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

TABLE IX – PAST DUE AND IMPAIRED LOANS

		As of
		March 31,				As of December 31,
(In Thousands)		2007				2006				2005				2004				2003				2002
Impaired loans without a valuation allowance		$	2,578			$	2,674			$	910			$	3,552			$	114			$	675
Impaired loans with a valuation allowance			5,365				5,337				7,306				4,709				4,507				3,039
Total impaired loans		$	7,943			$	8,011			$	8,216			$	8,261			$	4,621			$	3,714
Valuation allowance related to impaired loans		$	1,615			$	1,726			$	2,374			$	1,378			$	1,542			$	1,877
Total nonaccrual loans		$	8,088			$	8,506			$	6,365			$	7,796			$	1,145			$	1,252
Total loans past due 90 days or more and still accruing		$	844			$	1,559			$	1,369			$	1,307			$	2,546			$	2,318

TABLE X – SUMMARY OF LOANS BY TYPE

		March 31,				As of December 31,
(In Thousands)		2007				2006				2005				2004				2003				2002
Real estate — construction		$	10,658			$	10,365			$	5,552			$	4,178			$	2,856			$	103
Real estate — residential mortgage			385,587				387,410				361,857				347,705				330,807				292,136
Real estate — commercial mortgage			174,450				178,260				153,661				128,073				100,240				78,317
Consumer			37,353				35,992				31,559				31,702				33,977				31,532
Agricultural			2,806				2,705				2,340				2,872				2,948				3,024
Commercial			38,692				39,135				69,396				43,566				34,967				30,874
Other			1,124				1,227				1,871				1,804				1,183				2,001
Political subdivisions			45,329				32,407				27,063				19,713				17,854				13,062
Lease receivables			—				—				—				—				65				96
Total			695,999				687,501				653,299				579,613				524,897				451,145
Less: allowance for loan losses			(8,338	)			(8,201	)			(8,361	)			(6,787	)			(6,097	)			(5,789	)
Loans, net		$	687,661			$	679,300			$	644,938			$	572,826			$	518,800			$	445,356