LOAN CREDIT QUALITY AND RELATED ALLOWANCE FOR LOAN LOSSES

Management segments the Banks' loan portfolio to a level that enables risk and performance monitoring according to similar risk characteristics. Loans are segmented based on the underlying collateral characteristics. Categories include commercial, financial,

and agricultural, real estate, and installment loans to individuals. Real estate loans are further segmented into three categories: residential, commercial, and construction.

The following table presents the related aging categories of loans, by segment, as of December 31, 2015 and 2014:



	2015
(In Thousands)	Current			Past Due 30 To 89 Days		Past Due 90 Days Or More & Still Accruing		Non-Accrual		Total
Commercial, financial, and agricultural	$	162,312		$	164	$	—	$	1,596	$	164,072
Real estate mortgage:
Residential	517,753			6,827		714		889		526,183
Commercial	295,784			720		265		5,770		302,539
Construction	26,545			67		—		212		26,824
Installment loans to individuals	26,572			429		—		—		27,001
	1,028,966			$	8,207	$	979	$	8,467	1,046,619
Net deferred loan fees and discounts	(1,412		)							(1,412		)
Allowance for loan losses	(12,044		)							(12,044		)
Loans, net	$	1,015,510								$	1,033,163



	2014
(In Thousands)	Current			Past Due 30 To 89 Days		Past Due 90 Days Or More & Still Accruing		Non-Accrual		Total
Commercial, financial, and agricultural	$	122,624		$	773	$	—	$	759	$	124,156
Real estate mortgage:
Residential	450,503			6,078		332		847		457,760
Commercial	279,731			1,819		54		9,744		291,348
Construction	21,485			—		—		511		21,996
Installment loans to individuals	21,125			383		1		—		21,509
	895,468			$	9,053	$	387	$	11,861	916,769
Net deferred loan fees and discounts	(1,190		)							(1,190		)
Allowance for loan losses	(10,579		)							(10,579		)
Loans, net	$	883,699								$	905,000

Purchased loans acquired are recorded at fair value on their purchase date without a carryover of the related allowance for loan losses.

Upon acquisition, the Company evaluated whether each acquired loan (regardless of size) was within the scope of ASC 310-30. Purchased credit-impaired loans are loans that have evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. The fair value of purchased credit-impaired loans, on the acquisition date, was determined, primarily based on the fair value of loan collateral. The carrying value of purchased loans acquired with deteriorated credit quality was $341,000 at December 31, 2015.

On the acquisition date, the preliminary estimate of the unpaid principal balance for all loans evidencing credit impairment acquired in the Luzerne acquisition was $1,211,000 and the estimated fair value of the loans was $878,000. Total contractually required payments on these loans, including interest, at the acquisition date was $1,783,000. However, the Company’s preliminary estimate of expected cash flows was $941,000. At such date, the Company established a credit risk related non-accretable discount (a discount representing amounts which are not expected to be collected from the customer nor liquidation of collateral) of $842,000 relating to these impaired loans, reflected in the recorded net fair value. Such amount is reflected as a non-accretable fair value adjustment to loans. The Company further estimated the timing and amount of expected cash flows in excess of the estimated fair value and established an accretable discount of $63,000 on the acquisition date relating to these impaired loans.

The carrying value of the loans acquired and accounted for in accordance with ASC 310-30, was determined by projecting discounted contractual cash flows. The table below presents the components of the purchase accounting adjustments related to the purchased impaired loans acquired in the Luzerne acquisition as of June 1, 2013:



(In Thousands)	June 1, 2013
Unpaid principal balance	$	1,211
Interest	572
Contractual cash flows	1,783
Non-accretable discount	(842		)
Expected cash flows	941
Accretable discount	(63		)
Estimated fair value	$	878

The amortizable yield for purchased credit-impaired loans was fully amortized during 2014. Changes in the amortizable yield for purchased credit-impaired loans were as follows for the twelve months ended December 31, 2014



(In Thousands)	December 31, 2014
Balance at beginning of period	$	35
Accretion	(35		)
Balance at end of period	$	—

The following table presents additional information regarding loans acquired with specific evidence of deterioration in credit quality under ASC 310-30:



(In Thousands)	December 31, 2015		December 31, 2014
Outstanding balance	$	441	$	449
Carrying amount	341		349

The following table presents the interest income if interest had been recorded based on the original loan agreement terms and rate of interest for non-accrual loans and interest income recognized on a cash basis for non-accrual loans as of December 31, 2015, 2014, and 2013:



	Year Ended December 31,
	2015				2014				2013
(In Thousands)	Interest Income That Would Have Been Recorded Based on Original Term and Rate		Interest Income Recorded on a Cash Basis		Interest Income That Would Have Been Recorded Based on Original Term and Rate		Interest Income Recorded on a Cash Basis		Interest Income That Would Have Been Recorded Based on Original Term and Rate		Interest Income Recorded on a Cash Basis
Commercial, financial, and agricultural	$	48	$	53	$	42	$	33	$	7	$	3
Real estate mortgage:
Residential	53		38		63		34		41		20
Commercial	281		54		600		264		447		251
Construction	16		—		63		2		88		56
	$	398	$	145	$	768	$	333	$	583	$	330

Impaired Loans

Impaired loans are loans for which it is probable the Banks will not be able to collect all amounts due according to the contractual terms of the loan agreement. The Banks individually evaluate such loans for impairment and do not aggregate loans by major risk classifications. The definition of “impaired loans” is not the same as the definition of “non-accrual loans,” although the two categories overlap. The Banks may choose to place a loan on non-accrual status due to payment delinquency or uncertain collectability, while not classifying the loan as impaired. Factors considered by management in determining impairment include payment status and collateral value. The amount of impairment for these types of loans is determined by the difference between the present value of the expected cash flows related to the loan, using the original interest rate, and its recorded value, or as a practical expedient in the case of collateralized loans, the difference between the fair value of the collateral and the recorded amount of the loan. When foreclosure is probable, impairment is measured based on the fair value of the collateral.

Management evaluates individual loans in all of the commercial segments for possible impairment if the loan is greater than $100,000 and if the loan is either on non-accrual status or has a risk rating of substandard or worse. Management may also elect to measure an individual loan for impairment if less than $100,000 on a case by case basis.

Mortgage loans on one-to-four family properties and all consumer loans are large groups of smaller-balance homogeneous loans and are measured for impairment collectively with the exception of loans identified as troubled debt restructurings. Loans that experience insignificant payment delays, which are defined as 90 days or less, generally are not classified as impaired. Management determines the significance of payment delays on a case-by-case basis taking into consideration all circumstances surrounding the loan and the borrower including the length of the delay, the borrower’s prior payment record, and the amount of shortfall in relation to the principal and interest owed. Interest income for impaired loans is recorded consistent to the Banks' policy on non-accrual loans.

The following table presents the recorded investment, unpaid principal balance, and related allowance of impaired loans by segment as of December 31, 2015 and 2014:



	2015
(In Thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded:
Commercial, financial, and agricultural	$	319	$	319	$	—
Real estate mortgage:
Residential	1,142		1,142		—
Commercial	1,735		1,785		—
Construction	212		212		—
	3,408		3,458		—
With an allowance recorded:
Commercial, financial, and agricultural	150		150		75
Real estate mortgage:
Residential	1,573		1,703		376
Commercial	10,752		10,752		1,653
Construction	—		—		—
	12,475		12,605		2,104
Total:
Commercial, financial, and agricultural	469		469		75
Real estate mortgage:
Residential	2,715		2,845		376
Commercial	12,487		12,537		1,653
Construction	212		212		—
	$	15,883	$	16,063	$	2,104



	2014
(In Thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded:
Commercial, financial, and agricultural	$	439	$	439	$	—
Real estate mortgage:
Residential	139		139		—
Commercial	3,228		3,228		—
Construction	716		716		—
	4,522		4,522		—
With an allowance recorded:
Commercial, financial, and agricultural	673		673		298
Real estate mortgage:
Residential	1,327		1,449		147
Commercial	10,745		10,889		1,581
Construction	309		309		67
	13,054		13,320		2,093
Total:
Commercial, financial, and agricultural	1,112		1,112		298
Real estate mortgage:
Residential	1,466		1,588		147
Commercial	13,973		14,117		1,581
Construction	1,025		1,025		67
	$	17,576	$	17,842	$	2,093

The following table presents the average recorded investment in impaired loans and related interest income recognized for December 31, 2015, 2014, and 2013:



	2015
(In Thousands)	Average Investment in Impaired Loans		Interest Income Recognized on an Accrual Basis on Impaired Loans		Interest Income Recognized on a Cash Basis on Impaired Loans
Commercial, financial, and agricultural	$	1,031	$	21	$	10
Real estate mortgage:
Residential	2,570		72		47
Commercial	17,529		342		80
Construction	865		1		53
	$	21,995	$	436	$	190



	2014
(In Thousands)	Average Investment in Impaired Loans		Interest Income Recognized on an Accrual Basis on Impaired Loans		Interest Income Recognized on a Cash Basis on Impaired Loans
Commercial, financial, and agricultural	$	763	$	26	$	25
Real estate mortgage:
Residential	1,245		46		20
Commercial	10,987		130		101
Construction	1,086		17		89
	$	14,081	$	219	$	235



	2013
(In Thousands)	Average Investment in Impaired Loans		Interest Income Recognized on an Accrual Basis on Impaired Loans		Interest Income Recognized on a Cash Basis on Impaired Loans
Commercial, financial, and agricultural	$	538	$	26	$	—
Real estate mortgage:
Residential	1,581		62		25
Commercial	8,605		183		95
Construction	2,651		1		569
	$	13,375	$	272	$	689

Additional funds totaling $20,000 are committed to be advanced in connection with impaired loans.

Modifications

The loan portfolio also includes certain loans that have been modified in a Troubled Debt Restructuring (TDR), where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.

Loan modifications that are considered TDRs completed during the twelve months ended December 31, 2015 and 2014 were as follows:



	Year Ended December 31,
	2015					2014
(In Thousands, Except Number of Contracts)	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial, financial, and agricultural	4	$	213	$	213	3	$	620	$	620
Real estate mortgage:
Residential	11	962		962		3	392		392
Commercial	6	1,013		1,013		3	636		636
Construction	1	398		398		—	—		—
Total	22	$	2,586	$	2,586	9	$	1,648	$	1,648

Of the twenty-two new troubled debt restructurings granted for the year ended December 31, 2015, seven loans totaling $1,008,000 were granted payment concessions, four loans totaling $183,000 were granted term concessions, two loans totaling $287,000 were granted rate concessions, and nine loans totaling 1,108,000 were granted concessions due to other default.

Of the nine new troubled debt restructurings granted for the year ended December 31, 2014, five loans totaling $1,142,000 were granted term concessions, three loans totaling $288,000 were granted payment concessions, and one loan totaling 218,000 was granted a rate concession.

Loan modifications considered troubled debt restructurings made during the twelve months previous to December 31, 2015, that have defaulted during the twelve month period ending December 31, 2015 were as follows:



	Year Ended December 31, 2015
(In Thousands, Except Number of Contracts)	Number of Contracts	Recorded Investment
Commercial, financial, and agricultural	1	$	106
Real estate mortgage:
Residential	6	374
Commercial	1	242
Total	8	$	722

There was one commercial real estate loan modifications considered a troubled debt restructurings made during the twelve months previous to December 31, 2014 that defaulted during the twelve month period ending December 31, 2014. However, that loan was paid off in the fourth quarter of 2014.

Internal Risk Ratings

Management uses a ten point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first six categories are considered not criticized, and are aggregated as “Pass” rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are evaluated for Substandard classification. Loans in the Doubtful category exhibit the same weaknesses found in the Substandard loans, however, the weaknesses are more pronounced. Such loans are static and collection in full is improbable. However, these loans are not yet rated as loss because certain events may occur which would salvage the debt. Loans classified Loss are considered uncollectible and charge-off is imminent.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Banks have a structured loan rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the pass category unless a specific action, such as bankruptcy, repossession, or death occurs to raise awareness of a possible credit event. An external annual loan review of large commercial relationships is performed, as well as a sample of smaller transactions. During 2015, the threshold for the annual loan review was commercial relationships $1,100,000 or greater for JSSB and $1,450,000 or greater for Luzerne. Confirmation of the appropriate risk category is included in the review. Detailed reviews, including plans for resolution, are performed on loans classified as Substandard, Doubtful, or Loss on a quarterly basis.

The following table presents the credit quality categories identified above as of December 31, 2015 and 2014:



	2015
	Commercial and		Real Estate Mortgages						Installment Loans
(In Thousands)	Agricultural		Residential		Commercial		Construction		to Individuals		Totals
Pass	$	160,734	$	522,853	$	277,248	$	26,612	$	27,001	$	1,014,448
Special Mention	1,669		823		8,625		—		—		11,117
Substandard	1,669		2,507		16,666		212		—		21,054
Total	$	164,072	$	526,183	$	302,539	$	26,824	$	27,001	$	1,046,619



	2014
	Commercial and		Real Estate Mortgages						Installment Loans
(In Thousands)	Agricultural		Residential		Commercial		Construction		to Individuals		Totals
Pass	$	118,210	$	454,885	$	256,444	$	20,927	$	21,509	$	871,975
Special Mention	3,186		2,384		16,262		445		—		22,277
Substandard	2,760		491		18,642		624		—		22,517
Total	$	124,156	$	457,760	$	291,348	$	21,996	$	21,509	$	916,769

Allowance for Loan Losses

An allowance for loan losses (“ALL”) is maintained to absorb losses from the loan portfolio. The ALL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated future loss experience, and the amount of non-performing loans.

The Banks' methodology for determining the ALL is based on the requirements of ASC Section 310-10-35 for loans individually evaluated for impairment (previously discussed) and ASC Subtopic 450-20 for loans collectively evaluated for impairment, as well as the Interagency Policy Statements on the Allowance for Loan and Lease Losses and other bank regulatory guidance. The total of the two components represents the Banks' ALL.

Loans that are collectively evaluated for impairment are analyzed with general allowances being made as appropriate. Allowances are segmented based on collateral characteristics previously disclosed, and consistent with credit quality monitoring. Loans that are collectively evaluated for impairment are grouped into two classes for evaluation. A general allowance is determined for “Pass” rated credits, while a separate pool allowance is provided for “Criticized” rated credits that are not individually evaluated for impairment.

For the general allowances historical loss trends are used in the estimation of losses in the current portfolio. These historical loss amounts are modified by other qualitative factors. A historical charge-off factor is calculated utilizing a twelve quarter moving average. However, management may adjust the moving average time frame by up to four quarters to adjust for variances in the economic cycle. Management has identified a number of additional qualitative factors which it uses to supplement the historical charge-off factor because these factors are likely to cause estimated credit losses associated with the existing loan pools to differ from historical loss experience. The additional factors that are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources are: national and local economic trends and conditions; levels of and trends in delinquency rates and non-accrual loans; trends in volumes and terms of loans; effects of changes in lending policies; experience, ability, and depth of lending staff; value of underlying collateral; and concentrations of credit from a loan type, industry, and/or geographic standpoint.

Loans in the criticized pools, which possess certain qualities or characteristics that may lead to collection and loss issues, are closely monitored by management and subject to additional qualitative factors. Management also monitors industry loss factors by loan segment for applicable adjustments to actual loss experience.

Management reviews the loan portfolio on a quarterly basis in order to make appropriate and timely adjustments to the ALL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL.

Activity in the allowance is presented for the twelve months ended December 31, 2015 and 2014:



	2015
	Commercial and Agricultural			Real Estate Mortgages									Installment Loans to Individual
(In Thousands)	Commercial and Agricultural			Residential			Commercial			Construction			Installment Loans to Individual			Unallocated		Totals
Beginning Balance	$	1,124		$	3,755		$	4,205		$	786		$	245		$	464	$	10,579
Charge-offs	(283		)	(49		)	(743		)	(46		)	(240		)	—		(1,361		)
Recoveries	176			81			182			23			64			—		526
Provision	515			1,329			573			(603		)	174			312		2,300
Ending Balance	$	1,532		$	5,116		$	4,217		$	160		$	243		$	776	$	12,044



	2014
	Commercial and Agricultural			Real Estate Mortgages								Installment Loans to Individuals
(In Thousands)	Commercial and Agricultural			Residential			Commercial			Construction		Installment Loans to Individuals			Unallocated			Totals
Beginning Balance	$	474		$	3,917		$	4,079		$	741	$	139		$	794		$	10,144
Charge-offs	(289		)	(65		)	(2,038		)	—		(142		)	—			(2,534		)
Recoveries	18			15			—			22		64			—			119
Provision	921			(112		)	2,164			23		184			(330		)	2,850
Ending Balance	$	1,124		$	3,755		$	4,205		$	786	$	245		$	464		$	10,579

The Company grants commercial, industrial, residential, and installment loans to customers throughout north-central and north-eastern Pennsylvania. Although the Company has a diversified loan portfolio at December 31, 2015 and 2014, a substantial portion of its debtors’ ability to honor their contracts is dependent on the economic conditions within this region.

The Company has a concentration of loans at December 31, 2015 and 2014 as follows:



	2015		2014
Owners of residential rental properties	16.21	%	16.01	%
Owners of commercial rental properties	14.22	%	14.67	%

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of December 31, 2015 and 2014:



	2015
	Commercial and Agricultural		Real Estate Mortgages						Installment Loans to Individuals		Unallocated		Totals
(In Thousands)	Commercial and Agricultural		Residential		Commercial		Construction		Installment Loans to Individuals		Unallocated		Totals
Allowance for Loan Losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	75	$	376	$	1,653	$	—	$	—	$	—	$	2,104
Collectively evaluated for impairment	1,457		4,740		2,564		160		243		776		9,940
Total ending allowance balance	$	1,532	$	5,116	$	4,217	$	160	$	243	$	776	$	12,044
Loans:
Individually evaluated for impairment	$	469	$	2,374	$	12,487	$	212	$	—			$	15,542
Loans acquired with deteriorated credit quality	—		341		—		—		—				341
Collectively evaluated for impairment	163,603		523,468		290,052		26,612		27,001				1,030,736
Total ending loans balance	$	164,072	$	526,183	$	302,539	$	26,824	$	27,001			$	1,046,619



	2014
	Commercial and Agricultural		Real Estate Mortgages						Installment Loans to Individuals
(In Thousands)	Commercial and Agricultural		Residential		Commercial		Construction		Installment Loans to Individuals		Unallocated		Totals
Allowance for Loan Losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	298	$	147	$	1,581	$	67	$	—	$	—	$	2,093
Collectively evaluated for impairment	826		3,608		2,624		719		245		464		8,486
Total ending allowance balance	$	1,124	3,755		$	4,205	$	786	$	245	$	464	$	10,579
Loans:
Individually evaluated for impairment	$	1,112	$	1,117	$	13,973	$	1,025	$	—			$	17,227
Loans acquired with deteriorated credit quality	—		349		—		—		—				349
Collectively evaluated for impairment	123,044		456,294		277,375		20,971		21,509				899,193
Total ending loans balance	$	124,156	457,760		$	291,348	$	21,996	$	21,509			$	916,769