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 June 30, 2008

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 incorporation or organization)		(I.R.S. Employer Identification No.)

90-92 MAIN STREET, WELLSBORO, PA 16901

570-724-3411

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

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer   o		Smaller Reporting Company o
	(Do not check if a 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 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)		8,969,540 Shares Outstanding on July 29, 2008

 

 

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

CITIZENS & NORTHERN CORPORATION
Index

Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheet – June 30, 2008 and December 31, 2007		Page 3
Consolidated Statement of Income – Three Months and Six Months Ended June 30, 2008 and 2007		Page 4
Consolidated Statement of Cash Flows — Six Months Ended June 30, 2008 and 2007		Pages 5 and 6
Notes to Consolidated Financial Statements		Pages 7 through 13
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		Pages 14 through 30
Item 3. Quantitative and Qualitative Disclosures About Market Risk		Pages 31 through 34
Item 4. Controls and Procedures		Page 34
Part II. Other Information		Pages 35 through 38
Signatures		Page 38
Exhibit 31.1. Rule 13a-14(a)/15d-14(a) Certification - Chief Executive Officer		Page 39
Exhibit 31.2. Rule 13a-14(a)/15d-14(a) Certification - Chief Financial Officer		Page 40
Exhibit 32. Section 1350 Certifications		Page 41
EX-31.1
EX-31.2
EX-32

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

PART I – FINANCIAL INFORMATION

		June 30,				December 31,
		2008				2007
(In Thousands Except Share Data)		(Unaudited)				(Note)
ASSETS
Cash and due from banks:
Noninterest-bearing		$	24,780			$	21,892
Interest-bearing			1,422				9,769
Total cash and cash equivalents			26,202				31,661
Trading securities			1,770				2,980
Available-for-sale securities			422,589				432,755
Held-to-maturity securities			407				409
Loans, net			741,377				727,082
Bank-owned life insurance			21,929				21,539
Accrued interest receivable			5,608				5,714
Bank premises and equipment, net			27,079				27,796
Foreclosed assets held for sale			202				258
Intangible asset — Core deposit intangibles			1,102				1,378
Intangible asset — Goodwill			12,014				12,032
Other assets			26,782				20,142
TOTAL ASSETS		$	1,287,061			$	1,283,746
LIABILITIES
Deposits:
Noninterest-bearing		$	129,624			$	125,485
Interest-bearing			718,769				713,018
Total deposits			848,393				838,503
Dividends payable			2,148				2,134
Short-term borrowings			42,159				40,678
Long-term borrowings			256,860				259,454
Accrued interest and other liabilities			7,027				5,196
TOTAL LIABILITIES			1,156,587				1,145,965
STOCKHOLDERS’ EQUITY
Common stock, par value $1.00 per share; authorized 20,000,000 shares in 2008 and 2007; issued 9,284,148 in 2008 and 9,193,192 in 2007			9,284				9,193
Stock dividend distributable			—				1,571
Paid-in capital			44,185				42,494
Retained earnings			98,860				96,628
Unamortized stock compensation			(95	)			(56	)
Treasury stock, at cost; 332,110 shares at June 30, 2008 and 303,058 shares at December 31, 2007			(5,570	)			(4,992	)
Sub-total			146,664				144,838
Accumulated other comprehensive loss:
Unrealized losses on available-for-sale securities			(15,796	)			(6,654	)
Defined benefit plans			(394	)			(403	)
Total accumulated other comprehensive loss			(16,190	)			(7,057	)
TOTAL STOCKHOLDERS’ EQUITY			130,474				137,781
TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY		$	1,287,061			$	1,283,746

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

Note: The balance sheet at December 31, 2007 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								Fiscal Year To Date
		June 30,				June 30,				6 Months Ended June 30,
		2008				2007				2008				2007
(In Thousands, Except Per Share Data) (Unaudited)		(Current)				(Prior Year)				(Current)				(Prior Year)
INTEREST INCOME
Interest and fees on loans		$	12,269			$	12,679			$	24,581			$	23,960
Interest on balances with depository institutions			5				32				18				58
Interest on loans to political subdivisions			345				359				710				703
Interest on federal funds sold			24				49				74				150
Interest on trading securities			10				16				43				19
Income from available-for-sale and held-to-maturity securities:
Taxable			4,768				3,643				9,759				7,140
Tax-exempt			736				700				1,439				1,427
Dividends			216				214				449				478
Total interest and dividend income			18,373				17,692				37,073				33,935
INTEREST EXPENSE
Interest on deposits			4,757				6,453				10,384				12,343
Interest on short-term borrowings			237				490				543				965
Interest on long-term borrowings			2,730				1,736				5,453				3,371
Total interest expense			7,724				8,679				16,380				16,679
Interest margin			10,649				9,013				20,693				17,256
(Credit) provision for loan losses			(376	)			—				528				229
Interest margin after (credit) provision for loan losses			11,025				9,013				20,165				17,027
OTHER INCOME
Trust and financial management revenue			975				939				1,852				1,621
Service charges on deposit accounts			1,103				633				2,049				1,115
Service charges and fees			187				182				361				324
Insurance commissions, fees and premiums			97				144				169				260
Increase in cash surrender value of life insurance			192				174				390				319
Other operating income			601				572				1,821				1,093
Total other income before net losses on available-for-sale securities			3,155				2,644				6,642				4,732
Net losses on available-for-sale securities			(867	)			(1,172	)			(977	)			(11	)
Total other income			2,288				1,472				5,665				4,721
OTHER EXPENSES
Salaries and wages			3,736				3,433				7,427				7,028
Pensions and other employee benefits			1,079				973				2,230				2,158
Occupancy expense, net			717				660				1,471				1,286
Furniture and equipment expense			642				751				1,290				1,396
Pennsylvania shares tax			292				235				584				471
Other operating expense			1,791				2,137				3,719				4,097
Total other expenses			8,257				8,189				16,721				16,436
Income before income tax provision			5,056				2,296				9,109				5,312
Income tax provision			1,303				360				2,240				918
NET INCOME		$	3,753			$	1,936			$	6,869			$	4,394
PER SHARE DATA:
Net income — basic		$	0.42			$	0.22			$	0.77			$	0.51
Net income — diluted		$	0.42			$	0.22			$	0.76			$	0.51
Dividend per share		$	0.24			$	0.24			$	0.48			$	0.48
Number of shares used in computation — basic			8,963,552				8,785,690				8,968,999				8,582,047
Number of shares used in computation — diluted			8,977,540				8,798,719				8,984,398				8,597,530

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

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

Consolidated Statement of Cash Flows

		6 Months Ended
		June 30,				June 30,
(In Thousands) (Unaudited)		2008				2007
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	6,869			$	4,394
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses			528				229
Realized losses on available-for-sale securities, net			977				11
Gain on sale of foreclosed assets, net			(39	)			(76	)
Depreciation expense			1,449				1,365
Accretion and amortization on securities, net			220				199
Accretion and amortization on loans, deposits and borrowings, net			(208	)			(63	)
Increase in cash surrender value of life insurance			(390	)			(319	)
Stock-based compensation			256				206
Amortization of core deposit intangibles			276				132
Net increase in trading securities			(1,862	)			(2,514	)
Increase in accrued interest receivable and other assets			(2,106	)			(1,708	)
Increase in accrued interest payable and other liabilities			1,587				118
Net Cash Provided by Operating Activities			7,557				1,974
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from acquisition of Citizens Bancorp, Inc., net			—				29,952
Proceeds from maturity of held-to-maturity securities			2				2
Proceeds from sales of available-for-sale securities			15,131				39,748
Proceeds from calls and maturities of available-for-sale securities			38,525				18,831
Purchase of available-for-sale securities			(55,473	)			(23,672	)
Purchase of Federal Home Loan Bank of Pittsburgh stock			(1,772	)			(1,846	)
Redemption of Federal Home Loan Bank of Pittsburgh stock			1,974				2,787
Net increase in loans			(14,913	)			(8,046	)
Purchase of premises and equipment			(732	)			(1,524	)
Return of principal on limited partnership investment			15				238
Proceeds from sale of foreclosed assets			299				421
Net Cash (Used in) Provided by Investing Activities			(16,944	)			56,891
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits			9,872				11,148
Net increase (decrease) in short-term borrowings			1,481				(15,680	)
Proceeds from long-term borrowings			24,703				15,000
Repayments of long-term borrowings			(27,185	)			(49,195	)
Purchase of treasury stock			(852	)			(593	)
Sale of treasury stock			—				88
Dividends paid			(4,091	)			(3,978	)
Net Cash Provided by (Used in) Financing Activities			3,928				(43,210	)
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS			(5,459	)			15,655
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR			31,661				27,159
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	26,202			$	42,814

Consolidated Statement of Cash Flows

		6 Months Ended
		June 30,				June 30,
(In Thousands) (Unaudited) (Continued)		2008				2007
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Assets acquired through foreclosure of real estate loans		$	204			$	189
Securities transferred from trading to available-for-sale		$	3,072			$	—
Interest paid		$	16,519			$	16,695
Income taxes paid		$	2,054			$	1,112
ACQUISITION OF CITIZENS BANCORP, INC.:
Cash and cash equivalents received		$	—			$	44,264
Cash paid for acquisition			—				(14,312	)
Net cash received on acquisition		$	—			$	29,952
NONCASH ASSETS RECEIVED, LIABILITIES ASSUMED AND EQUITY ISSUED FROM ACQUISITION OF CITIZENS BANCORP, INC.:
Assets received:
Available for sale securities		$	—			$	26,426
Loans			—				60,151
Bank-owned life insurance			—				4,433
Premises and equipment			—				5,243
Foreclosed assets			—				107
Intangible asset — core deposit intangible			—				1,487
Intangible asset — goodwill			—				9,258
Other assets			—				1,567
Total noncash assets received		$	—			$	108,672
Liabilities assumed and equity issued:
Deposits		$	—			$	99,636
Short-term borrowings			—				1,426
Long-term borrowings			—				22,753
Other liabilities			—				735
Equity issued, net			—				14,074
Total noncash liabilities assumed and equity issued		$	—			$	138,624

     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, 2007, 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-month and six-month periods ended June 30, 2008 might not be indicative of the results for the year ending December 31, 2008.

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 reflects the retroactive effect of stock dividends for all periods presented. The following data shows 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
Six Months Ended June 30, 2008
Earnings per share – basic		$	6,869,000				8,968,999			$	0.77
Dilutive effect of potential common stock arising from stock options:
Exercise of outstanding stock options							148,788
Hypothetical share repurchase at $19.09							(133,389	)
Earnings per share – diluted		$	6,869,000				8,984,398			$	0.76
Six Months Ended June 30, 2007
Earnings per share – basic		$	4,394,000				8,582,047			$	0.51
Dilutive effect of potential common stock arising from stock options:
Exercise of outstanding stock options							110,492
Hypothetical share repurchase at $21.29							(95,009	)
Earnings per share – diluted		$	4,394,000				8,597,530			$	0.51

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

Quarter Ended June 30, 2008
Earnings per share – basic		$	3,753,000				8,963,552			$	0.42
Dilutive effect of potential common stock arising from stock options:
Exercise of outstanding stock options							148,788
Hypothetical share repurchase at $18.89							(134,800	)
Earnings per share – diluted		$	3,753,000				8,977,540			$	0.42
Quarter Ended June 30, 2007
Earnings per share – basic		$	1,936,000				8,785,690			$	0.22
Dilutive effect of potential common stock arising from stock options:
Exercise of outstanding stock options							109,616
Hypothetical share repurchase at $20.73							(96,587	)
Earnings per share – diluted		$	1,936,000				8,798,719			$	0.22

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 comprehensive (loss) income, and the related tax effects, are as follows:

		3 Months Ended								6 Months Ended
		June 30,								June 30,
(In Thousands)		2008				2007				2008				2007
Net income		$	3,753			$	1,936			$	6,869			$	4,394
Unrealized losses on available-for-sale securities:
Unrealized holding losses on available-for-sale securities			(5,086	)			(4,317	)			(14,829	)			(3,693	)
Reclassification adjustment for losses realized in income			867				1,172				977				11
Other comprehensive loss on available-for-sale securities before income tax			(4,219	)			(3,145	)			(13,852	)			(3,682	)
Income tax related to unrealized loss on available-for-sale securities			1,434				1,069				4,710				1,252
Other comprehensive loss on available-for-sale securities			(2,785	)			(2,076	)			(9,142	)			(2,430	)
Unfunded pension and postretirement obligations:
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost			6				11				11				22
Income tax related to other comprehensive gain			(1	)			(4	)			(2	)			(9	)
Other comprehensive gain on unfunded retirement obligations			5				7				9				13
Total comprehensive (loss) income		$	973			$	(133	)		$	(2,264	)		$	1,977

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

4. SECURITIES

The Corporation’s trading assets at June 30, 2008 were composed exclusively of municipal bonds. Gains and losses from trading activities are included in Other Operating Income in the consolidated income statement as follows:

		3 Months Ended								Fiscal Year To Date
		June 30,				June 30,				6 Months Ended June 30,
		2008				2007				2008				2007
		(Current)				(Prior Year)				(Current)				(Prior Year)
Gross realized gains		$	5			$	—			$	40			$	6
Gross realized losses			(63	)			—				(63	)			—
Net change in unrealized gains/losses			15				(77	)			(1	)			(77	)
Net losses		$	(43	)		$	(77	)		$	(24	)		$	(71	)
Income tax provision related to net losses		$	(15	)		$	(26	)		$	(8	)		$	(24	)

Amortized cost and fair value of available-for-sale and held-to-maturity securities at June 30, 2008 are summarized as follows:

						June 30, 2008
						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		$	15,499			$	420			$	—			$	15,919
Obligations of states and political subdivisions			68,620				168				(3,175	)			65,613
Mortgage-backed securities			165,846				729				(698	)			165,877
Collateralized mortgage obligations			71,849				14				(2,561	)			69,302
Other securities			103,108				782				(18,929	)			84,961
Total debt securities			424,922				2,113				(25,363	)			401,672
Marketable equity securities			21,607				2,379				(3,069	)			20,917
Total		$	446,529			$	4,492			$	(28,432	)		$	422,589
HELD-TO-MATURITY SECURITIES:
Obligations of the U.S. Treasury		$	306			$	14			$	—			$	320
Obligations of other U.S. Government agencies			99				5				—				104
Mortgage-backed securities			2				—				—				2
Total		$	407			$	19			$	—			$	426

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

The following table presents gross unrealized losses and fair value of available-for-sale investments aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2008.

		Less Than 12 Months								12 Months or More								Total
June 30, 2008		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		$	—			$	—			$	—			$	—			$	—			$	—
Obligations of states and political subdivisions			27,569				(1,100	)			23,686				(2,075	)			51,255				(3,175	)
Mortgage-backed securities			56,080				(583	)			7,573				(115	)			63,653				(698	)
Collateralized mortgage obligations			48,855				(1,198	)			19,374				(1,363	)			68,229				(2,561	)
Other securities			30,550				(8,055	)			34,810				(10,874	)			65,360				(18,929	)
Total debt securities			163,054				(10,936	)			85,443				(14,427	)			248,497				(25,363	)
Marketable equity securities			7,119				(1,664	)			4,582				(1,405	)			11,701				(3,069	)
Total temporarily impaired available-for-sale Securities		$	170,173			$	(12,600	)		$	90,025			$	(15,832	)		$	260,198			$	(28,432	)

Management evaluates securities for other-than-temporary impairment 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) 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.

In addition to the effects of volatility in interest rates on individual debt securities, management believes valuations of debt securities at June 30, 2008 have been negatively impacted by events affecting the overall credit markets during the last quarter of 2007 and the first six months of 2008. There have been widespread disruptions to the normal operation of bond markets. Particularly with regard to trust-preferred securities (which comprise most of the balance in “Other securities” in the table above), trading volume has been limited and consisted almost entirely of sales by distressed sellers.

Trust-preferred securities are very long-term (usually 30-year maturity) instruments with characteristics of both debt and equity, mainly issued by banks. Most of the Corporation’s investments in trust-preferred securities are of pooled issues, each made up of 30 or more companies with geographic and size diversification. Almost all of the Corporation’s pooled trust-preferred securities are comprised of debt issued by banking companies, with lesser amounts issued by insurance companies and real estate investment trusts. Management believes trust-preferred valuations have been negatively affected by concerns that the underlying banks and other companies may have significant exposure to losses from sub-prime mortgages, defaulted collateralized debt obligations or other concerns. Although none of the Corporation’s trust-preferred securities has been downgraded, major ratings services (primarily Moody’s and Fitch) have put most of the pooled trust-preferred securities on “Ratings Watch Negative,” meaning that a downgrade may be possible in the foreseeable future. In the first half of 2008, some of the issuers of trust-preferred securities that are included in the Corporation’s pooled investments have elected to defer payment of interest on these obligations (trust-preferred securities typically permit deferral of quarterly interest payments for up to five years), and a few issuers have defaulted. Trust-preferred securities are structured so that the issuers pay more interest into the trusts than would be required for pass through to the investors in the rated notes (such as the Corporation), with the excess used to cover administrative and other expenses, and to provide a cushion for some protection against the risk of loss for investors in the rated notes. Although credit risk associated with some of the trust-preferred issuers has increased, management has reviewed the Corporation’s individual holdings of trust-preferred securities and the financial condition and near term prospects of the underlying issuers, and has concluded that based on events through June 30, 2008, the Corporation should expect to collect all principal and interest on essentially the same schedule as originally anticipated when they were purchased.

Based on the Corporation’s ability and intent to hold its debt securities for the foreseeable future, and management’s assessment of the creditworthiness of the issuers, management believes the Corporation’s debt securities at June 30, 2008 were not other-than-temporarily impaired.

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

Unrealized losses on marketable equity securities are mainly from investments in common stocks of banking corporations. Management evaluated equity securities held as of June 30, 2008. Upon evaluation, it was determined that equity securities issued by six banking corporations were other-than-temporarily impaired. Management’s assessment that these securities were other-than-temporarily impaired was based on a large (50% or more) amount of unrealized loss, poor and rapidly deteriorating financial conditions reflected in published financial reports for each entity, and in some cases, publicly announced endeavors to issue additional shares of stock that would dilute the Corporation’s ownership interest. These securities were written down to current market value at June 30, 2008, and the Corporation recognized a pretax loss in the second quarter 2008 of $1,171,000. As of June 30, 2008, management believes the impairment of the Corporation’s other marketable equity securities to be temporary. For the six months ended June 30, 2008, pretax losses from other-than-temporary impairment charges totaled $1,420,000.

5. ASSETS MEASURED AT FAIR VALUE ON A RECURRING BASIS

The Corporation measures certain assets at fair value on a recurring basis. 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. Statement of Financial Accounting Standards No. 157 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 would be 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.

At June 30, 2008, assets measured at fair value on a recurring basis and the valuation methods used are as follows:

						Market Values Based on:
		Quoted Prices				Other
		in Active				Observable				Unobservable				Total
		Markets				Inputs				Inputs				Fair
(In Thousands)		(Level 1)				(Level 2)				(Level 3)				Value
AVAILABLE-FOR-SALE SECURITIES:
Obligations of other U.S. Government agencies		$	—			$	15,919			$	—			$	15,919
Obligations of states and political subdivisions			3,934				61,679				—				65,613
Mortgage-backed securities			—				165,877				—				165,877
Collateralized mortgage obligations			—				69,302				—				69,302
Other securities			—				84,961				—				84,961
Total debt securities			3,934				397,738				—				401,672
Marketable equity securities			20,917				—				—				20,917
Total available-for-sale securities			24,851				397,738				—				422,589
TRADING SECURITIES,
Obligations of states and political subdivisions			963				807				—				1,770
Total		$	25,814			$	398,545			$	—			$	424,359

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

6. 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 within the final ten years of employment.

On October 18, 2007, the Corporation’s Board of Directors adopted amendments to the defined benefit pension plan to freeze and terminate the Plan, effective December 31, 2007. The Corporation expects to fund and settle its obligations under the Plan sometime in 2008.

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 June 30, 2008 and December 31, 2007, and will not affect the Corporation’s future expenses.

The Corporation uses a December 31 measurement date for its plans. In 2007, the Corporation assumed the Citizens Trust Company Retirement Plan, a defined benefit pension plan for which benefit accruals and participation were frozen in 2002. The Corporation used a September 30 measurement date for this plan in 2007, and will change to a December 31 measurement date in 2008. The Citizens Trust Company Retirement Plan is not significant in comparison to the other defined benefit plans, and information related to that plan is not included in the table that follows.

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

		Pension								Postretirement
		Six Months Ended								Six Months Ended
Defined Benefit Plans		June 30,								June 30,
(In Thousands)		2008				2007				2008				2007
Service cost		$	20			$	342			$	35			$	37
Interest cost			298				350				39				35
Expected return on plan assets			(153	)			(459	)			—				—
Amortization of transition (asset) obligation			(12	)			(12	)			18				18
Amortization of prior service cost			—				4				5				—
Recognized net actuarial loss			—				23				—				1
Net periodic benefit cost		$	153			$	248			$	97			$	91

		Pension								Postretirement
		Three Months Ended								Three Months Ended
		June 30,								June 30,
(In Thousands)		2008				2007				2008				2007
Service cost		$	10			$	171			$	18			$	19
Interest cost			149				175				19				18
Expected return on plan assets			(76	)			(229	)			—				—
Amortization of transition (asset) obligation			(6	)			(6	)			9				9
Amortization of prior service cost			—				2				3				—
Recognized net actuarial loss			—				12				—				—
Net periodic benefit cost		$	77			$	125			$	49			$	46

CITIZENS & NORTHERN CORPORATION — FORM 10-Q

The Corporation has not made a 2008 contribution to the defined benefit pension plan through June 2008, and the timing and amount of its contribution in 2008 will depend on requirements to fund its final obligations under the terminated plan. At this time, the Corporation cannot estimate the amount of contribution required for the defined benefit pension plan in 2008. In the first six months of 2008, the Corporation funded postretirement contributions totaling $29,000, with estimated annual postretirement contributions of $51,000 expected in 2008 for the full year.

7. STOCK-BASED COMPENSATION PLANS

In January 2008, the Corporation granted options to purchase a total of 83,257 shares of common stock through its Stock Incentive and Independent Directors Stock Incentive Plans. In January 2007, the Corporation granted options to purchase a total of 43,385 shares of common stock. The exercise price for the 2008 awards is $17.50 per share, and the exercise price for the 2007 awards is $22.325 per share, based on the market price as of the date of each grant. The Corporation records stock option expense based on estimated fair value calculated using an option valuation model.

In calculating the fair value, the Corporation utilized the Black-Scholes option-pricing model. The calculated fair value of each option granted, and significant assumptions used in the calculations, are as follows:

		2008				2007
Fair value of each option granted		$	3.15			$	4.46
Volatility			23	%			23	%
Expected option lives		9 Years				8 Years
Risk-free interest rate			4.05	%			4.69	%
Dividend yield			3.74	%			3.61	%

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 9-year expected option life used for 2008 awards, and 8-year expected option life used for 2007 awards, was based on management’s estimates of the average term for all options issued under both plans. For the 2008 and 2007 awards, 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, the Corporation awarded a total of 5,062 shares in January 2008 and 6,529 shares in January 2007 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 stock-based compensation expense is as follows:

		3 Months Ended								Fiscal Year To Date
		June 30,				June 30,				6 Months Ended June 30,
		2008				2007				2008				2007
(In Thousands)		(Current)				(Prior Year)				(Current)				(Prior Year)
Stock options		$	91			$	77			$	209			$	156
Restricted stock			23				26				47				50
Total		$	114			$	103			$	256			$	206

Stock option expense has been recognized over the six-month vesting period for both the 2008 and 2007 awards. Management expects no additional stock option expense in the last six months of 2008.

8. 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.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

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 management’s assessment regarding the realization of future cash flows on securities, as well as the determination of whether securities are other-than-temporarily impaired
•		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.

REFERENCES TO 2008 AND 2007

Unless otherwise noted, all references to “2008” in the following discussion of operating results are intended to mean the six months ended June 30, 2008, and similarly, references to “2007” relate to the six months ended June 30, 2007.

EARNINGS OVERVIEW

Net income in 2008 was $6,869,000 in the first six months of 2008, as compared to $4,394,000 in 2007. Net income per share was $0.77 basic, and $0.76 diluted, for the first six months of 2008 compared to $0.51 per share (basic and diluted) for 2007, an increase of 49.0% in net income per diluted share. Return on average assets was 1.08% in 2008, up from 0.76% in 2007. Return on average equity was 10.07% for 2008, up from 6.49% in 2007.

The most significant changes in the components of earnings for the first six months of 2008, as compared to the same period in 2007, were as follows:

	•		The interest margin increased by $3,437,000, or 19.9%. The improved interest margin includes the impact of the Citizens Bancorp, Inc. acquisition, which was effective May 1, 2007, for the full year-to-date period of 2008 compared to only 2 months of 2007. In addition, the interest margin has been positively impacted by lower short-term market interest rates, which have reduced interest rates paid on deposits and borrowings, and by higher earnings on the investment portfolio resulting from higher average total holdings of securities.
	•		Noninterest income, excluding securities gains (losses) increased $1,910,000, or 40.4%. Service charges on deposit accounts increased $934,000, or 83.8%, as a result of growth in deposit volumes from the Citizens Bancorp acquisition, as well as higher fees on overdrafts associated with a new overdraft privilege program. Also, in 2008, noninterest income included a gain of $533,000 from redemption of restricted shares of Visa, resulting from Visa’s initial public offering. Trust and Financial Management revenue increased $231,000, or 14.3%, mainly as a result of the addition of Citizens Bancorp.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

	•		In the first six months of 2008, net losses on available-for-sale securities amounted to $977,000, as compared to net losses of $11,000 in the first six months of 2007. In 2008, the Corporation recognized impairment charges of $1,420,000 for the first six months, including $1,171,000 in the second quarter, from investments in bank stocks. In the first six months of 2007, the small net losses on available-for-sale securities included the effects of an impairment charge of $1,780,000 on mortgage-backed securities that management decided to sell in July 2007 as part of a restructuring designed to improve future earnings. Also, gains from sales of bank stocks in 2007 almost fully offset the impact on earnings of that impairment charge for the period.
	•		The provision for income taxes in 2008 was $1,322,000 higher, mainly because of a higher level of pre-tax income.

Second Quarter 2008:

Net income per diluted share for the second quarter of 2008 was $0.42, which was $0.20 (90.9%) higher than the second quarter of 2007. The most significant changes in the components of earnings for the second quarter of 2008, as compared to 2007, were increases in the interest margin of $1,636,000 and noninterest income of $511,000. Also, the Corporation benefited from a negative provision for loan losses of $376,000 in the second quarter 2008, while the provision for loan losses was $0 in the second quarter 2007. The negative provision in the second quarter 2008 resulted mainly from reversing a previously established allowance on a large commercial loan relationship that paid off.

Second quarter 2008 net income per diluted share was $0.07, or 20%, higher than the first quarter 2008 results. The provision for loan losses was $1,280,000 lower than in the first quarter. Also, the interest margin increased $605,000. Offsetting some of the earnings increases were higher losses on available-for-sale securities of $757,000 as a result of the impairment charge on bank stocks described above, and lower noninterest income attributable to the gain from the Visa IPO that occurred in the first quarter.

TABLE I — QUARTERLY FINANCIAL DATA

		June 30,				Mar. 31,				Dec. 31,				Sept. 30,				June 30,				Mar. 31,
(In Thousands)		2008				2008				2007				2007				2007				2007
Interest income		$	18,373			$	18,700			$	18,228			$	18,058			$	17,692			$	16,243
Interest expense			7,724				8,656				8,679				8,551				8,679				8,000
Interest margin			10,649				10,044				9,549				9,507				9,013				8,243
(Credit) provision for loan losses			(376	)			904				300				—				—				229
Interest margin after (credit) provision for loan losses			11,025				9,140				9,249				9,507				9,013				8,014
Other income			3,155				3,487				2,831				2,877				2,644				2,088
Net (losses) gains on available-for-sale securities			(867	)			(110	)			206				(68	)			(1,172	)			1,161
Other expenses			8,257				8,464				8,156				8,691				8,189				8,247
Income before income tax provision			5,056				4,053				4,130				3,625				2,296				3,016
Income tax provision			1,303				937				948				777				360				558
Net income		$	3,753			$	3,116			$	3,182			$	2,848			$	1,936			$	2,458
Net income per share – basic		$	0.42			$	0.35			$	0.35			$	0.32			$	0.22			$	0.29
Net income per share – diluted		$	0.42			$	0.35			$	0.35			$	0.32			$	0.22			$	0.29

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.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Prospects for the Remainder of 2008

Earnings have increased significantly in the first half of 2008 over results from 2007, and there are many factors pointing to continued good results and improvement over the remainder of the year. The largest area of concern for the remainder of 2008 is the potential need to recognize realized losses in the securities portfolio, as described in more detail below.

As described in more detail in Item 3, Quantitative and Qualitative Disclosures About Market Risk, the Corporation is liability sensitive, meaning that its sources of funds (mainly deposits and borrowings) tend to re-price more quickly on average when interest rates change than do its earning assets (mainly loans and available-for-sale debt securities). Accordingly, the Corporation tends to generate lower earnings when short-term interest rates rise and higher earnings when short-term rates fall. Reductions in the Fed Funds target rate (which has fallen from 5.25% in August 2007 to its late-July 2008 level of 2%), the Corporation has experienced some recent reductions in its cost of funds and improvement in its net interest margin. In June 2008, a new “E-Z Money Checking” product was introduced. A relatively high rate of interest is paid on E-Z Money accounts (a 4.17% rate, or 4.25% average percentage yield, as of June 30, 2008), subject to several customer requirements. Management expects that transfers by existing customers to this new account may increase the Corporation’s aggregate cost of funds slightly in 2008, with the goal of increasing profitability in 2009 and future years by increasing total checking account balances from existing and new customers.

The addition of Citizens Bancorp, Inc. is expected to be accretive to earnings in 2008, and inclusion of those operations for the full year in 2008 (as opposed to eight months in 2007) will lead to higher reported levels of revenues and expenses. The addition of the Citizens Trust Company trust department has contributed significantly to growth in Trust and Financial Management revenue.

In January 2008, the Corporation implemented an overdraft privilege program. This program is designed to provide customers an opportunity to have checks paid that would otherwise have been returned, and to avoid charges from merchants and other payees. As described in the Earnings Overview section of Management’s Discussion and Analysis, the Corporation generated a significant increase in noninterest revenue as a result of implementing the overdraft privilege program in 2008, and management expects to continue that trend for the remainder of the year.

The provision for loan losses for the first six months of 2008 was $528,000, including a credit of $376,000 in the second quarter and a charge to earnings of $904,000 in the first quarter. Issues related to larger commercial borrowers significantly affect the Corporation’s provision for loan losses in any particular period. Accordingly, the amount of loan loss provision for the remainder of 2008 will depend substantially on the credit status of the commercial portfolio. Although management is concerned about reports that the national economy is in or near recessionary status, to date the Corporation has not experienced significant deterioration in loan delinquencies, nor a noticeable change in volume of activity related to troubled debts or foreclosures. The Corporation has not originated interest only mortgages, loans without documentation of the borrowers’ sources of income or net worth, or other types of subprime mortgage loans that have received negative publicity in 2007 and 2008.

Benefits under the Corporation’s defined benefit pension plan were frozen, and a decision was made to terminate the Plan, effective December 31, 2007. The Corporation will record a realized loss from settlement of the defined benefit pension plan at the time it funds the final amounts necessary to extinguish its obligations under the Plan. The amount of settlement loss, which management expects will be incurred in 2008, has not yet been finally determined; however, management estimates a settlement loss in the income statement from termination of the plan in 2008 in an amount ranging from $500,000 to $1,000,000. Management expects to settle at least a portion of its obligations under the Plan in the third quarter 2008, but it is not known how much of the settlement will occur in the third quarter, and how much (if any) will occur in the fourth quarter. As reflected in Note 6 to the consolidated financial statements, in the first six months of 2008, the Corporation recorded expense from the defined benefit plan of $153,000. For the year ended December 31, 2007, when a significant amount of service cost was still accruing, expense from the defined benefit plan (excluding a loss from curtailment of $77,000) totaled $495,000. Also in 2008, employer matching contributions under the Corporation’s Employee Savings & Retirement Plan (a 401(k) plan), were increased, which will result in an estimated increase in expense of $150,000 for the year. Going forward after termination and settlement of the Plan, management expects the net impact of terminating the defined benefit plan and increasing the Savings & Retirement Plan contributions to be lower ongoing employee benefit expenses.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Another major variable that affects the Corporation’s earnings is securities gains and losses. In the first six months of 2008, the Corporation reported net realized losses from available-for-sale securities of $977,000, including the effect of writing down impaired bank stocks by $1,420,000. Recently, market valuations of most financial stocks have been depressed, with some of the nation’s largest financial institutions reporting net losses in 2007 and the first half of 2008, triggered by write-offs of sub-prime mortgages, commercial and construction loans, collateralized debt obligations and other investments. Management believes this valuation issue to be cyclical; however, opportunities for realized gains from bank stocks are expected to be limited in 2008. Further, as discussed in more detail in Note 4 to the financial statements, the Corporation has significant unrealized losses on its holdings of trust-preferred securities as of June 30, 2008. Although credit risk associated with some of the trust-preferred issuers has increased, management has reviewed the Corporation’s individual holdings of trust-preferred securities and the financial condition and near-term prospects of the underlying issuers, and has concluded that based on events through June 30, 2008, the Corporation should expect to collect all principal and interest on essentially the same schedule as originally anticipated when they were purchased. Management has reviewed its holdings of bank stocks, trust-preferred securities and other securities as of June 30, 2008, and concluded that – with the exception of the bank stocks that have been written down through earnings – none of them were other-than-temporarily impaired. Management will continue to closely monitor the status of impaired securities throughout 2008.

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 (loss) (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 2008 and 2007. 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 related Tables.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

The fully taxable equivalent net interest margin was $21,693,000 in 2008, which is $3,472,000 (19.1%) higher than in 2007. As shown in Table IV, net increases in volume had the effect of increasing net interest income $1,265,000 in 2008 over 2007, and interest rate changes had the effect of increasing net interest income $2,207,000. Increases in the volume of earning assets and interest-bearing liabilities were significantly affected by the acquisition of Citizens Trust Company on May 1, 2007. The most significant components of the volume changes in interest income in 2008 were an increase of $2,626,000 attributable to growth in the available-for-sale securities portfolio and an increase of $921,000 attributable to loan growth. The most significant volume change in interest expense in 2008 was an increase of $1,909,000 resulting from an increase in long-term borrowings. 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 3.17% in the first six months of 2008, as compared to 2.92% for the year ended December 31, 2007 and 2.83% in the first six months of 2007.

INTEREST INCOME AND EARNING ASSETS

Interest income totaled $38,073,000 in 2008, an increase of 9.1% over 2007. Income from available-for-sale securities increased $2,616,000, or 27.0%, and interest and fees from loans increased $638,000, or 2.6%. As indicated in Table III, total average available-for-sale securities in 2008 rose to $445,172,000, an increase of $97,010,000, or 27.9% from 2007. Throughout much of 2007, proceeds from sales and maturities of securities were used, in part, to help fund loans and pay off borrowings. In December 2007, the Corporation purchased approximately $86,152,000 in mortgage-backed securities in connection with two repurchase agreements. The average rate of return on available-for-sale securities was 5.55% for 2008, in line with the 5.65% return for the year ended December 31, 2007 and 5.60% in the first six months of 2007.

The average balance of gross loans increased 3.5% to $737,740,000 in 2008 from $712,858,000 in the first six months of 2007. Over the last several months of 2007 and the first quarter of 2008, the Corporation has experienced modest growth in the average balance of residential mortgage loans, including home equity loans. During the same period, the average commercial loans balances have decreased as a result of payoffs of several individual commercial relationships; however, there has been modest growth during the most recent quarter. The average rate of return on loans was 6.98% in 2008, down from the 7.10% return for the year ended December 31, 2007 and 7.07% in the first six months of 2007.

INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES

Interest expense decreased $299,000, or 1.8%, to $16,380,000 in 2008 from $16,679,000 in 2007. Table III shows that the overall cost of funds on interest-bearing liabilities fell to 3.25% in 2008, from 3.70% for the year ended December 31, 2007 and 3.74% in the first six months of 2007.

From Table III, you can calculate that total average deposits (interest-bearing and noninterest-bearing) increased 5.4%, to $835,466,000 in 2008 from $792,390,000 in the first six months of 2007. The average rates incurred on deposit accounts have decreased significantly in the first six months of 2008 as compared to the first six months of 2007. The decreases in rates reduced interest expense on deposits by $2,478,000.

The combined average total short-term and long-term borrowed funds increased $81,389,000 to $297,688,000 in 2008 from $216,299,000 in the first six months of 2007. In December 2007, the Corporation entered into two repurchase agreements totaling $80,000,000; the proceeds were used to purchase mortgage-backed securities as described above. In addition, the Corporation’s interest expense increased as several borrowings matured in 2007 and were replaced at higher rates. The average rate on long-term borrowings was 4.25% in 2008, up from 4.06% in the first six months of 2007.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

TABLE II — ANALYSIS OF INTEREST INCOME AND EXPENSE

		Six Months Ended
		June 30,								Increase/
(In Thousands)		2008				2007				(Decrease)
INTEREST INCOME
Available-for-sale securities:
Taxable		$	10,196			$	7,606			$	2,590
Tax-exempt			2,095				2,069				26
Total available-for-sale securities			12,291				9,675				2,616
Held-to-maturity securities, Taxable			12				12				—
Trading securities			63				28				35
Interest-bearing due from banks			18				58				(40	)
Federal funds sold			74				150				(76	)
Loans:
Taxable			24,581				23,960				621
Tax-exempt			1,034				1,017				17
Total loans			25,615				24,977				638
Total Interest Income			38,073				34,900				3,173
INTEREST EXPENSE
Interest checking			487				1,025				(538	)
Money market			2,304				3,003				(699	)
Savings			162				167				(5	)
Certificates of deposit			4,871				5,245				(374	)
Individual Retirement Accounts			2,557				2,900				(343	)
Other time deposits			3				3				—
Short-term borrowings			543				965				(422	)
Long-term borrowings			5,453				3,371				2,082
Total Interest Expense			16,380				16,679				(299	)
Net Interest Income		$	21,693			$	18,221			$	3,472

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 34%.

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

Table IIl — Analysis of Average Daily Balances and Rates

		6 Months								Year								6 Months
		Ended				Rate of				Ended				Rate of				Ended				Rate of
		6/30/2008				Return/				12/31/2007				Return/				6/30/2007				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		$	380,963				5.38	%		$	290,743				5.49	%		$	284,469				5.39	%
Tax-exempt			64,209				6.56	%			62,065				6.43	%			63,693				6.55	%
Total available-for-sale securities			445,172				5.55	%			352,808				5.65	%			348,162				5.60	%
Held-to-maturity securities, Taxable			408				5.91	%			412				5.83	%			413				5.86	%
Trading securities			2,041				6.21	%			1,665				5.89	%			943				5.99	%
Interest-bearing due from banks			1,327				2.73	%			1,864				4.67	%			2,481				4.71	%
Federal funds sold			5,247				2.84	%			4,017				5.25	%			6,223				4.86	%
Loans:
Taxable			705,787				7.00	%			696,667				7.13	%			680,346				7.10	%
Tax-exempt			31,953				6.51	%			32,602				6.46	%			32,512				6.31	%
Total loans			737,740				6.98	%			729,269				7.10	%			712,858				7.07	%
Total Earning Assets			1,191,935				6.42	%			1,090,035				6.62	%			1,071,080				6.57	%
Cash			19,159								19,485								18,777
Unrealized gain/loss on securities			(14,947	)							(324	)							2,046
Allowance for loan losses			(9,028	)							(8,697	)							(8,539	)
Bank premises and equipment			27,520								26,767								25,237
Intangible Asset — Core Deposit Intangible			1,248								1,287								1,036
Intangible Asset — Goodwill			12,032								8,864								5,645
Other assets			49,334								41,487								38,771
Total Assets		$	1,277,253							$	1,178,904							$	1,154,053
INTEREST-BEARING LIABILITIES
Interest checking		$	77,484				1.26	%		$	75,488				2.42	%		$	73,868				2.80	%
Money market			188,649				2.46	%			183,178				3.29	%			182,909				3.31	%
Savings			65,639				0.50	%			62,976				0.54	%			61,387				0.55	%
Certificates of deposit			244,464				4.01	%			242,822				4.44	%			237,390				4.46	%
Individual Retirement Accounts			136,833				3.76	%			131,158				4.50	%			127,286				4.59	%
Other time deposits			1,237				0.49	%			1,283				0.55	%			1,172				0.52	%
Short-term borrowings			39,969				2.73	%			48,373				3.98	%			48,724				3.97	%
Long-term borrowings			257,719				4.25	%			170,229				4.17	%			167,575				4.06	%
Total Interest-bearing Liabilities			1,011,994				3.25	%			915,507				3.70	%			900,311				3.74	%
Demand deposits			121,160								115,350								108,378
Other liabilities			7,609								9,378								10,053
Total Liabilities			1,140,763								1,040,235								1,018,742
Stockholders’ equity, excluding other comprehensive income/loss			146,757								140,035								135,126
Other comprehensive income/loss			(10,267	)							(1,366	)							185
Total Stockholders’ Equity			136,490								138,669								135,311
Total Liabilities and Stockholders’ Equity		$	1,277,253							$	1,178,904							$	1,154,053
Interest Rate Spread							3.17	%							2.92	%							2.83	%
Net Interest Income/Earning Assets							3.66	%							3.51	%							3.43	%