Note 5 – Loans

The Company grants loans primarily to customers throughout North Central Pennsylvania and Southern New York. Although the Company had a diversified loan portfolio at March 31, 2015 and December 31, 2014, a substantial portion of its debtors’ ability to honor their contracts is dependent on the economic conditions within these regions. The following table summarizes the primary segments of the loan portfolio and how those segments are analyzed within the allowance for loan losses as of March 31, 2015 and December 31, 2014 (in thousands):

March 31, 2015	Total Loans	Individually evaluated for impairment	Collectively evaluated for impairment
Real estate loans:
Residential	$ 183,838	$ 310	$ 183,528
Commercial and agricultural	218,392	6,010	212,382
Construction	6,036	-	6,036
Consumer	8,171	-	8,171
Other commercial and agricultural loans	63,386	2,890	60,496
State and political subdivision loans	85,356	-	85,356
Total	565,179	$ 9,210	$ 555,969
Allowance for loan losses	6,922
Net loans	$ 558,257

December 31, 2014	Total Loans	Individually evaluated for impairment	Collectively evaluated for impairment
Real estate loans:
Residential	$ 185,438	$ 316	$ 185,122
Commercial and agricultural	215,584	6,112	209,472
Construction	6,353	-	6,353
Consumer	8,497	-	8,497
Other commercial and agricultural loans	58,516	2,394	56,122
State and political subdivision loans	79,717	-	79,717
Total	554,105	$ 8,822	$ 545,283
Allowance for loan losses	6,815
Net loans	$ 547,290

The segments of the Company’s loan portfolio are disaggregated into classes to a level that allows management to monitor risk and performance. Residential real estate mortgages consists primarily of 15 to 30 year first mortgages on residential real estate, while residential real estate home equity loans are consumer purpose installment loans or lines of credit secured by a mortgage which is often a second lien on residential real estate with terms of 15 years or less. Commercial real estate loans are business purpose loans secured by a mortgage on commercial real estate. Agricultural real estate loans are loans secured by a mortgage on real estate used in agriculture production. Construction real estate loans are loans secured by residential or commercial real estate used during the construction phase of residential and commercial projects. Consumer loans are typically unsecured or primarily secured by assets other than real estate and overdraft lines of credit are typically secured by customer deposit accounts. Other commercial loans are loans for commercial purposes primarily secured by non-real estate collateral. Other agricultural loans are loans for agricultural purposes primarily secured by non-real estate collateral. State and political subdivision loans are loans to state and local municipalities for capital and operating expenses or tax free loans used to finance commercial development.

Management considers commercial loans, other agricultural loans, state and political subdivision loans, commercial real estate loans and agricultural real estate loans which are 90 days or more past due to be impaired. Management will also consider a loan impaired based on other factors it becomes aware of, including the customer’s results of operations and cash flows or if the loan is modified in a troubled debt restructuring. In addition, certain residential mortgages, home equity and consumer loans that are cross collateralized with commercial relationships that are determined to be impaired may also be classified as impaired. Impaired loans are analyzed to determine if it is probable that all amounts will not be collected according to the contractual terms of the loan agreement. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allocation of the allowance for loan losses or a charge-off to the allowance for loan losses.

The following table includes the recorded investment and unpaid principal balances for impaired financing receivables by class, with the associated allowance amount, if applicable (in thousands):

		Recorded	Recorded
	Unpaid	Investment	Investment	Total
	Principal	With No	With	Recorded	Related
March 31, 2015	Balance	Allowance	Allowance	Investment	Allowance
Real estate loans:
Mortgages	$ 218	$ 121	$ 66	$ 187	$ 13
Home Equity	129	59	64	123	12
Commercial	8,398	5,851	159	6,010	72
Other commercial loans	2,988	2,431	459	2,890	91
Total	$ 11,733	$ 8,462	$ 748	$ 9,210	$ 188

December 31, 2014
Real estate loans:
Mortgages	$ 222	$ 125	$ 66	$ 191	$ 13
Home Equity	130	60	65	125	12
Commercial	8,433	5,708	404	6,112	72
Other commercial loans	2,480	2,346	48	2,394	1
Total	$ 11,265	$ 8,239	$ 583	$ 8,822	$ 98

The following tables includes the average balance of impaired financing receivables by class and the income recognized on impaired loans for the three month periods ended March 31, 2015 and 2014(in thousands):

	March 31, 2015			March 31, 2014
			Interest			Interest
	Average	Interest	Income	Average	Interest	Income
	Recorded	Income	Recognized	Recorded	Income	Recognized
	Investment	Recognized	Cash Basis	Investment	Recognized	Cash Basis
Real estate loans:
Mortgages	$ 188	$ 2	$ -	$ 205	$ 2	$ -
Home Equity	124	1	-	133	1	-
Commercial	6,023	13	-	8,533	26	-
Consumer	-	-	-	15	-	-
Other commercial loans	2,729	25	1	1,893	33	-
Total	$ 9,064	$ 41	$ 1	$ 10,779	$ 62	$ -

Credit Quality Information

For commercial real estate, agricultural real estate, construction, other commercial, other agricultural and state and political subdivision loans, management uses a nine point internal risk rating system to monitor credit quality. The first five categories are considered not criticized and are aggregated as “Pass” rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The definitions of each rating are defined below:

·	Pass (Grades 1-5) – These loans are to customers with credit quality ranging from an acceptable to very high quality and are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral.

·	Special Mention (Grade 6) – This loan grade is in accordance with regulatory guidance and includes loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected.

·	Substandard (Grade 7) – This loan grade is in accordance with regulatory guidance and includes loans that have a well-defined weakness based on objective evidence and be characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

·	Doubtful (Grade 8) – This loan grade is in accordance with regulatory guidance and includes loans that have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, based on existing circumstances.

·	Loss (Grade 9) – This loan grade is in accordance with regulatory guidance and includes loans that are considered uncollectible, or of such value that continuance as an asset is not warranted.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay the loan as agreed, the Company’s loan rating process includes several layers of internal and external oversight. The Company’s loan officers are responsible for the timely and accurate risk rating of the loans in each of their portfolios at origination and on an ongoing basis under the supervision of management. All commercial and agricultural loans are reviewed annually to ensure the appropriateness of the loan grade. In addition, the Company engages an external consultant on at least an annual basis. The external consultant is engaged to 1) review a minimum of 55% of the dollar volume of the commercial loan portfolio on an annual basis, 2) review new loans originated for over $1.0 million in the last years, 3) review a majority of borrowers with commitments greater than or equal to $1.0 million, 4) review selected loan relationships over $750,000 which are over 30 days past due, classified Special Mention, Substandard, Doubtful, or Loss, and 5) such other loans which management or the consultant deems appropriate.

The following tables represent credit exposures by internally assigned grades as of March 31, 2015 and December 31, 2014 (in thousands):

March 31, 2015	Pass	Special Mention	Substandard	Doubtful	Ending Balance
Real estate loans:
Commercial	$ 175,890	$ 4,912	$ 11,855	$ 44	$ 192,701
Agricultural	20,695	3,361	1,635	-	25,691
Construction	6,036	-	-	-	6,036
Other commercial loans	46,267	4,109	2,082	148	52,606
Other agricultural loans	9,000	675	1,105	-	10,780
State and political
subdivision loans	85,356	-	-	-	85,356
Total	$ 343,244	$ 13,057	$ 16,677	$ 192	$ 373,170

December 31, 2014	Pass	Special Mention	Substandard	Doubtful	Ending Balance
Real estate loans:
Commercial	$ 169,383	$ 8,948	$ 12,614	$ -	$ 190,945
Agricultural	19,575	3,394	1,670	-	24,639
Construction	6,353	-	-	-	6,353
Other commercial loans	40,683	4,413	2,355	-	47,451
Other agricultural loans	9,221	727	1,117	-	11,065
State and political
subdivision loans	79,717	-	-	-	79,717
Total	$ 324,932	$ 17,482	$ 17,756	$ -	$ 360,170

For residential real estate mortgages, home equity and consumer loans, credit quality is monitored based on whether the loan is performing or non-performing, which is typically based on the aging status of the loan and payment activity, unless a specific action, such as bankruptcy, repossession, death or significant delay in payment occurs to raise awareness of a possible credit event. Non-performing loans include those loans that are considered nonaccrual, described in more detail below, and all loans past due 90 or more days and still accruing. The following table presents the recorded investment in those loan classes based on payment activity as of March 31, 2015 and December 31, 2014 (in thousands):

March 31, 2015	Performing	Non- performing	Total
Real estate loans:
Mortgages	$ 122,090	$ 1,021	$ 123,111
Home Equity	60,458	269	60,727
Consumer	8,113	58	8,171
Total	$ 190,661	$ 1,348	$ 192,009

December 31, 2014	Performing	Non-performing	Total
Real estate loans:
Mortgages	$ 121,968	$ 890	$ 122,858
Home Equity	62,296	284	62,580
Consumer	8,444	53	8,497
Total	$ 192,708	$ 1,227	$ 193,935

Aging Analysis of Past Due Financing Receivables

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following table includes an aging analysis of the recorded investment of past due financing receivables as of March 31, 2015 and December 31, 2014 (in thousands):

		30-59 Days	60-89 Days	90 Days	Total Past		Total Financing	90 Days and
March 31,2015		Past Due	Past Due	Or Greater	Due	Current	Receivables	Accruing
Real estate loans:
Mortgages		$ 438	$ 432	$ 708	$ 1,578	$ 121,533	$ 123,111	$ 212
Home Equity		333	76	254	663	60,064	60,727	128
Commercial		1,111	-	1,257	2,368	190,333	192,701	44
Agricultural		210	-	-	210	25,481	25,691	-
Construction		-	-	-	-	6,036	6,036	-
Consumer		34	32	12	78	8,093	8,171	1
Other commercial loans		333	158	335	826	51,780	52,606	18
Other agricultural loans		53	-	-	53	10,727	10,780	-
State and political
subdivision loans		-	-	-	-	85,356	85,356	-

	Total	$ 2,512	$ 698	$ 2,566	$ 5,776	$ 559,403	$ 565,179	$ 403

Loans considered non-accrual		$ 579	$ 171	$ 2,163	$ 2,913	$ 4,236	$ 7,149
Loans still accruing		1,933	527	403	2,863	555,167	558,030
	Total	$ 2,512	$ 698	$ 2,566	$ 5,776	$ 559,403	$ 565,179

December 31, 2014
Real estate loans:
Mortgages		$ 318	$ 230	$ 675	$ 1,223	$ 121,635	$ 122,858	$ 214
Home Equity		442	99	260	801	61,779	62,580	132
Commercial		97	231	1,432	1,760	189,185	190,945	310
Agricultural		-	-	-	-	24,639	24,639	-
Construction		-	-	-	-	6,353	6,353	-
Consumer		119	4	7	130	8,367	8,497	6
Other commercial loans		503	258	476	1,237	46,214	47,451	174
Other agricultural loans		-	-	-	-	11,065	11,065	-
State and political
subdivision loans		-	-	-	-	79,717	79,717	-

	Total	$ 1,479	$ 822	$ 2,850	$ 5,151	$ 548,954	$ 554,105	$ 836

Loans considered non-accrual		$ 48	$ 181	$ 2,014	$ 2,243	$ 4,356	$ 6,599
Loans still accruing		1,431	641	836	2,908	544,598	547,506
	Total	$ 1,479	$ 822	$ 2,850	$ 5,151	$ 548,954	$ 554,105

Nonaccrual Loans

Loans are considered for non-accrual status upon reaching 90 days delinquency, although the Company may be receiving partial payments of interest and partial repayments of principal on such loans or if full payment of principal and interest is not expected. Additionally, if management is made aware of other information, including bankruptcy, repossession, death, or legal proceedings, the loan may be placed on non-accrual status. If a loan is 90 days or more past due and is well secured and in the process of collection, it may still be considered accruing.

The following table reflects the financing receivables on non-accrual status as of March 31, 2015 and December 31, 2014, respectively. The balances are presented by class of financing receivable (in thousands):

	March 31, 2015	December 31, 2014
Real estate loans:
Mortgages	$ 809	$ 676
Home Equity	141	152
Commercial	5,030	5,010
Consumer	57	47
Other commercial loans	1,112	714
	$ 7,149	$ 6,599

Troubled Debt Restructurings

In situations where, for economic or legal reasons related to a borrower's financial difficulties, management may grant a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the related loan is classified as a Troubled Debt Restructuring (TDR). Management strives to identify borrowers in financial difficulty early and work with them to modify more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where borrowers are granted new terms that provide for a reduction of interest or principal, or both, management measures any impairment on the restructuring by calculating the present value of the revised loan terms and comparing this balance to the Company’s investment in the loan prior to the restructuring. As these loans are individually evaluated, they are excluded from pooled portfolios when calculating the allowance for loan and lease losses and a separate allocation within the allowance for loan and lease losses is provided. Management continually evaluates loans that are considered TDRs, including payment history under the modified loan terms, the borrower’s ability to continue to repay the loan based on continued evaluation of their operating results and cash flows from operations. Based on this evaluation management would no longer consider a loan to be a TDR when the relevant facts support such a conclusion. As of March 31, 2015 and December 31, 2014, included within the allowance for loan losses are reserves of $25,000 and $26,000 respectively, that are associated with loans modified as TDRs.

Loan modifications that are considered TDRs completed during the three months ended March 31, 2015 and 2014 were as follows (dollars in thousands):

	For the Three Months Ended March 31, 2015
	Number of contracts		Pre-modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
	Interest Modification	Term Modification	Interest Modification	Term Modification	Interest Modification	Term Modification
Real estate loans:
Mortgages	1	-	$ 71	-	$ 71	-
Total	1	-	$ 71	$ -	$ 71	$ -

	For the Three Months Ended March 31, 2014
	Number of contracts		Pre-modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
	Interest Modification	Term Modification	Interest Modification	Term Modification	Interest Modification	Term Modification
Real estate loans:
Commercial	-	1	$ -	$ 125	$ -	$ 125
Total	-	1	$ -	$ 125	$ -	$ 125

Recidivism, or the borrower defaulting on its obligation pursuant to a modified loan, results in the loan once again becoming a non-accrual loan. Recidivism occurs at a notably higher rate than do defaults on new origination loans, so modified loans present a higher risk of loss than do new origination loans. The following table presents the recorded investment in loans that were modified as TDRs during each 12-month period prior to the current reporting periods, which begin January 1, 2015 and 2014, respectively, and that subsequently defaulted during these reporting periods (dollars in thousands):

	For the Three Months Ended
	March 31, 2015		March 31, 2014
	Number of contracts	Recorded investment	Number of contracts	Recorded investment
Real estate loans:
Commercial	1	$ 124	1	$ 483
Total recidivism	1	$ 124	1	$ 483

Allowance for Loan Losses

The following table segregates the allowance for loan losses (ALLL) into the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of March 31, 2015 and December 31, 2014, respectively (in thousands):

	March 31, 2015			December 31, 2014
	Individually evaluated for impairment	Collectively evaluated for impairment	Total	Individually evaluated for impairment	Collectively evaluated for impairment	Total
Real estate loans:
Residential	$ 25	$ 898	$ 923	$ 25	$ 853	$ 878
Commercial and agricultural	72	3,627	3,699	72	3,798	3,870
Construction	-	11	11	-	26	26
Consumer	-	82	82	-	84	84
Other commercial and agricultural loans	91	1,195	1,286	1	1,223	1,224
State and political
subdivision loans	-	572	572	-	545	545
Unallocated	-	349	349	-	188	188
Total	$ 188	$ 6,734	$ 6,922	$ 98	$ 6,717	$ 6,815

The following tables roll forward the balance of the ALLL by portfolio segment for the three month periods ended March 31, 2015 and 2014, respectively (in thousands):

	Balance at December 31, 2014	Charge-offs	Recoveries	Provision	Balance at March 31, 2015
Real estate loans:
Residential	$ 878	$ (17)	$ -	$ 62	$ 923
Commercial and agricultural	3,870	-	4	(175)	3,699
Construction	26	-	-	(15)	11
Consumer	84	(7)	8	(3)	82
Other commercial and agricultural loans	1,224	(1)	-	63	1,286
State and political				-
subdivision loans	545	-	-	27	572
Unallocated	188	-	-	161	349
Total	$ 6,815	$ (25)	$ 12	$ 120	$ 6,922

	Balance at December 31, 2013	Charge-offs	Recoveries	Provision	Balance at March 31, 2014
Real estate loans:
Residential	$ 946	$ (38)	$ -	$ (22)	$ 886
Commercial and agricultural	4,558	(10)	2	(20)	4,530
Construction	50	-	-	(42)	8
Consumer	105	(8)	9	(23)	83
Other commercial and agricultural loans	942	-	-	231	1,173
State and political				-
subdivision loans	330	-	-	66	396
Unallocated	167	-	-	(10)	157
Total	$ 7,098	$ (56)	$ 11	$ 180	$ 7,233

The Company allocates the ALLL based on the factors described below, which conform to the Company’s loan classification policy and credit quality measurements. In reviewing risk within the Company’s loan portfolio, management has determined there to be several different risk categories within the loan portfolio. The ALLL consists of amounts applicable to: (i) residential real estate loans; (ii) residential real estate home equity loans; (iii) commercial real estate loans; (iv) agricultural real estate loans; (v) real estate construction loans; (vi) other commercial and agricultural loans; (vii) consumer loans; (viii) other agricultural loans and (ix) state and political subdivision loans. Factors considered in this process include general loan terms, collateral, and availability of historical data to support the analysis. Historical loss percentages are calculated and used as the basis for calculating allowance allocations. Certain qualitative factors are evaluated to determine additional inherent risks in the loan portfolio, which are not necessarily reflected in the historical loss percentages. These factors are then added to the historical allocation percentage to get the adjusted factor to be applied to non-classified loans. The following qualitative factors are analyzed:

·	Level of and trends in delinquencies, impaired/classified loans

Change in volume and severity of past due loans

Volume of non-accrual loans

Volume and severity of classified, adversely or graded loans;

·	Level of and trends in charge-offs and recoveries;

·	Trends in volume, terms and nature of the loan portfolio;

·	Effects of any changes in risk selection and underwriting standards and any other changes in lending and recovery policies, procedures and practices;

·	Changes in the quality of the Company’s loan review system;

·	Experience, ability and depth of lending management and other relevant staff;

·	National, state, regional and local economic trends and business conditions

General economic conditions

Unemployment rates

Inflation / Consumer Price Index

Changes in values of underlying collateral for collateral-dependent loans;

·	Industry conditions including the effects of external factors such as competition, legal, and regulatory requirements on the level of estimated credit losses; and

·	Existence and effect of any credit concentrations, and changes in the level of such concentrations; and

·	Any change in the level of board oversight.

The Company also maintains an unallocated allowance to account for any factors or conditions that may cause a potential loss but are not specifically addressed in the process described above. The Company analyzes its loan portfolio each quarter to determine the appropriateness of its allowance for loan losses.

Loans determined to be TDRs are impaired and for purposes of estimating the ALLL must be individually evaluated for impairment. In calculating the impairment, the Company calculates the present value utilizing an analysis of discounted cash flows. If the present value calculated is below the recorded investment of the loan, impairment is recognized by a charge to the provision for loan and lease losses and a credit to the ALLL.

We continually review the model utilized in calculating the required allowance. The following qualitative factors experienced changes during the three months ended March 31, 2015:

·	The qualitative factor for national, state, regional and local economic trends and business conditions was increased for all loan categories due to an increase in the unemployment rates in the local economy during the first quarter of 2015.

The qualitative factor for industry conditions, including the effects of external factors such as competition, legal, and regulatory requirements on the level of estimated credit losses was increased for agricultural related loans due to the decrease in the price received for product sold and the increase in feed costs, which negatively affected customer earnings that occurred in the first quarter of 2015.

·	The qualitative factor for levels of and trends in charge-offs and recoveries was increased for residential real estate loans due to the increase in charge-offs compared to historical norms for the Company.

·	The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans was decreased for other commercial loans due to the decrease in the amount of classified loans as of March 31, 2015.

·	The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans was increased for residential mortgages due to increases in the amount of delinquent loans as of March 31, 2015.

·	The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans was increased for agricultural related loans due to increases in the amount of loans past due as of March 31, 2015.

The primary factor that resulted in negative provision for commercial and agricultural loans was the reduction in the amount of special mention and substandard loans for the period ended March 31, 2015.

The following qualitative factors experienced changes during the first three months of 2014:

·	The qualitative factor for national, state, regional and local economic trends and business conditions was decreased for all loan categories due to a decrease in the unemployment rates in the local economy.

·	The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans were decreased for commercial real estate due to the decrease in the Company’s classified loans to its lowest level in three years.

·	The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans were increased for other commercial loans due to an increase in classified loans during the quarter.

The primary factor that resulted in a negative provisions for the first quarter of 2014 for residential real estate, commercial and agricultural real estate loans, construction and consumer loans was the decrease in loan balances from December 31, 2013 and the decrease in the qualitative factor associated with the improvement in unemployment rates noted above.

Foreclosed Assets Held For Sale

Foreclosed assets acquired in settlement of loans are carried at fair value, less estimated costs to sell, and are included in other assets on the Consolidated Balance Sheet. As of March 31, 2015 and December 31, 2014 included with other assets are $1,773,000 and 1,792,000, respectively, of foreclosed assets. As of March 31, 2015, included within the foreclosed assets is $321,000 of consumer residential mortgages that were foreclosed on or received via a deed in lieu transaction prior to the period end. As of March 31, 2015, the Company has initiated formal foreclosure proceeds on $1,411,000 of consumer residential mortgages, which have not yet been transferred into foreclosed assets.