10-K 1 tv485825_10k.htm FORM 10-K

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

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

 

For the fiscal year ended December 31, 2017

 

OR

 

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

 

For the transition period from _____________ to _____________.

 

Commission file number: 0-16084

 

CITIZENS & NORTHERN CORPORATION

(Exact name of Registrant as specified in its charter)

 

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

 

90-92 MAIN STREET, WELLSBORO, PA 16901

(Address of principal executive offices) (Zip code)

 

570-724-3411

(Registrant’s telephone number including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class   Name of Exchange Where Registered
Common Stock Par Value $1.00   The NASDAQ Stock Market LLC

 

Securities registered pursuant to section 12(g) of the Act: None

 

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨  No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨  No x

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

(Check one):    Large accelerated filer ¨    Accelerated filer x    Non-accelerated filer ¨    Smaller reporting company ¨    Emerging growth company ¨

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

 

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

 

The aggregate market value of the registrant’s common stock held by non-affiliates at June 30, 2017, the registrant’s most recently completed second fiscal quarter, was $274,571,344.

 

The number of shares of common stock outstanding at February 8, 2018 was 12,246,834.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s proxy statement for the annual meeting of its shareholders to be held April 19, 2018 are incorporated by reference into Parts III and IV of this report.

 

 

 

 

 

 

 

TABLE OF CONTENTS

 

  Page(s)
Part I:  
Item 1. Business 3-4
Item 1A. Risk Factors 4-7
Item 1B. Unresolved Staff Comments 7
Item 2. Properties 7
Item 3. Legal Proceedings 8
Item 4. Mine Safety Disclosure 8
   
Part II.  
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 8-10
Item 6. Selected Financial Data 11-12
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 13-38
Item 7A. Quantitative and Qualitative Disclosures About Market   Risk 38-40
Item 8. Financial Statements and Supplementary Data 41-87
Item 9. Changes in and Disagreements with Accountants on   Accounting and Financial Disclosure 88
Item 9A. Controls and Procedures 88
Item 9B. Other Information 89
   
Part III:  
Item 10. Directors, Executive Officers and Corporate Governance 89
Item 11. Executive Compensation 89
Item 12. Security Ownership of Certain Beneficial Owners and   Management and Related Stockholder Matters 89
Item 13. Certain Relationships and Related Transactions, and   Director Independence 89
Item 14. Principal Accountant Fees and Services 89
   
Part IV:  
Item 15. Exhibits and Financial Statement Schedules 90-93
Signatures 94

 

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PART I

 

ITEM 1. BUSINESS

 

Citizens & Northern Corporation (“Corporation”) is a holding company whose principal activity is community banking. The Corporation’s principal office is located in Wellsboro, Pennsylvania. The largest subsidiary is Citizens & Northern Bank (“C&N Bank” or the “Bank”). The Corporation’s other wholly-owned subsidiaries are Citizens & Northern Investment Corporation and Bucktail Life Insurance Company (“Bucktail”). Citizens & Northern Investment Corporation was formed in 1999 to engage in investment activities. Bucktail reinsures credit and mortgage life and accident and health insurance on behalf of C&N Bank.

 

C&N Bank is a Pennsylvania banking institution that was formed by the consolidation of Northern National Bank of Wellsboro and Citizens National Bank of Towanda on October 1, 1971. Subsequent mergers included: First National Bank of Ralston in May 1972; Sullivan County National Bank in October 1977; Farmers National Bank of Athens in January 1984; and First National Bank of East Smithfield in May 1990. In 2005, the Corporation acquired Canisteo Valley Corporation and its subsidiary, First State Bank, a New York State chartered commercial bank with offices in Canisteo and South Hornell, NY. In 2010, the First State Bank operations were merged into C&N Bank and Canisteo Valley Corporation was merged into the Corporation. On May 1, 2007, the Corporation acquired Citizens Bancorp, Inc. (“Citizens”), with banking offices in Coudersport, Emporium and Port Allegany, Pennsylvania. Citizens Trust Company, the banking subsidiary of Citizens, was merged with and into C&N Bank as part of the transaction. C&N Bank has held its current name since May 6, 1975, at which time C&N Bank changed its charter from a national bank to a Pennsylvania bank.

 

C&N Bank provides an extensive range of banking services, including deposit and loan products for personal and commercial customers. The Bank also maintains a trust division that provides a wide range of financial services, such as 401(k) plans, retirement planning, estate planning, estate settlements and asset management. In January 2000, C&N Bank formed a subsidiary, C&N Financial Services Corporation (“C&NFSC”). C&NFSC is a licensed insurance agency that provides insurance products to individuals and businesses. In 2001, C&NFSC added a broker-dealer division, which offers mutual funds, annuities, educational savings accounts and other investment products through registered agents. C&NFSC’s operations are not significant in relation to the total operations of the Corporation.

 

In December 2017, C&N Bank established a new entity, Northern Tier Holding LLC, for the purpose of acquiring, holding and disposing of real property acquired by the Bank. C&N Bank is the sole member of Northern Tier Holding LLC, which had no transactions in 2017.

 

All phases of the Bank’s business are competitive. The Bank primarily competes in Tioga, Bradford, Sullivan, Lycoming, Potter, Cameron and McKean counties in Pennsylvania, and Steuben and Chemung counties in New York. The Bank competes with local commercial banks headquartered in our market area as well as other commercial banks with branches in our market area. Some of the banks that have branches in our market area are larger in overall size. With respect to lending activities and attracting deposits, the Bank also competes with savings banks, savings and loan associations, insurance companies, regulated small loan companies and credit unions. Also, the Bank competes with mutual funds for deposits. C&N Bank competes with insurance companies, investment counseling firms, mutual funds and other business firms and individuals for trust, investment management, brokerage and insurance services. The Bank is generally competitive with all financial institutions in our service area with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans. The Bank serves a diverse customer base, and is not economically dependent on any small group of customers or on any individual industry.

 

Major initiatives within the last 5 years included the following:

 

·in 2013, worked with consultants on projects which resulted in ongoing increases in revenues from service charges on deposit accounts, starting primarily in the fourth quarter 2013, and ongoing reductions in electronic funds processing expenses;

 

·in 2014, approved a treasury stock repurchase program for repurchase of up to 622,500 shares of the Corporation’s common stock, or approximately 5% of the Corporation’s outstanding shares at July 16, 2014. In total, 622,500 shares were repurchased for a total cost of $12,140,000, at an average price of $19.50 per share;

 

·in 2015, began an organization-wide effort to enhance customer relationships, growth and profitability, including working with consultants on enhanced employee engagement and customer service training, and hiring additional lending personnel to provide more access to commercial and mortgage lending opportunities;

 

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·in 2016, approved a new treasury stock repurchase program authorizing repurchase of up to 600,000 shares of the Corporation’s common stock. Through December 31, 2017, there have been no repurchases of shares under this program; and

 

·in March 2017, opened a loan production office in Elmira, New York.

 

Virtually all of the Corporation’s banking offices are located in the “Marcellus Shale,” an area extending across portions of New York State, Pennsylvania, Ohio, Maryland, West Virginia and Virginia. In recent years, most of the Pennsylvania counties in which the Corporation operates were significantly affected by an upsurge in natural gas exploration, as technological developments made exploration of the Marcellus Shale commercially feasible. After a surge of activity in 2009 through most of 2011, the market price of natural gas declined, causing Marcellus Shale natural gas exploration activity to slow, though some activity has continued to occur throughout the Corporation’s market area. Through December 31, 2017, the Corporation has not experienced significant credit issues as a result of the expansion and subsequent reduction in Marcellus Shale-related activity.

 

At December 31, 2017, C&N Bank had total assets of $1,262,642,000, total deposits of $1,016,035,000, net loans outstanding of $806,857,000 and 296 full-time equivalent employees.

 

Most activities of the Corporation and its subsidiaries are regulated by federal or state agencies. The primary regulatory relationships are described as follows:

 

·The Corporation is a bank holding company formed under the provisions of Section 3 of the Federal Reserve Act. The Corporation is under the direct supervision of the Federal Reserve and must comply with the reporting requirements of the Federal Bank Holding Company Act.

 

·C&N Bank is a state-chartered, nonmember bank, supervised by the Federal Deposit Insurance Corporation and the Pennsylvania Department of Banking and Securities.

 

·C&NFSC is a Pennsylvania corporation. The Pennsylvania Department of Insurance regulates C&NFSC’s insurance activities. Brokerage products are offered through third party networking agreements.

 

·Bucktail is incorporated in the state of Arizona and supervised by the Arizona Department of Insurance.

 

A copy of the Corporation’s annual report on Form 10-K, quarterly reports on Form 10-Q, current events reports on Form 8-K, and amendments to these reports, will be furnished without charge upon written request to the Corporation’s Treasurer at P.O. Box 58, Wellsboro, PA 16901. Copies of these reports will be furnished as soon as reasonably possible, after they are filed electronically with the Securities and Exchange Commission. The information is also available through the Corporation’s web site at www.cnbankpa.com.

 

ITEM 1A. RISK FACTORS

 

The Corporation is subject to the many risks and uncertainties applicable to all banking companies, as well as risks specific to the Corporation’s geographic locations. Although the Corporation seeks to effectively manage risks, and maintains a level of equity that exceeds the banking regulatory agencies’ thresholds for being considered “well capitalized” (see Note 18 to the consolidated financial statements), management cannot predict the future and cannot eliminate the possibility of credit, operational or other losses. Accordingly, actual results may differ materially from management’s expectations. Some of the Corporation’s significant risks and uncertainties are discussed below.

 

Credit Risk from Lending Activities – A significant source of risk is the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loan agreements. Most of the Corporation’s loans are secured, but some loans are unsecured. With respect to secured loans, the collateral securing the repayment of these loans may be insufficient to cover the obligations owed under such loans. Collateral values may be adversely affected by changes in economic, environmental and other conditions, including declines in the value of real estate, changes in interest rates, changes in monetary and fiscal policies of the federal government, wide-spread disease, terrorist activity, environmental contamination and other external events. In addition, collateral appraisals that are out of date or that do not meet industry recognized standards may create the impression that a loan is adequately collateralized when it is not. The Corporation has adopted underwriting and credit monitoring procedures and policies, including regular reviews of appraisals and borrower financial statements, that management believes are appropriate to mitigate the risk of loss. Also, as discussed further in the “Provision and Allowance for Loan Losses” section of Management’s Discussion and Analysis, the Corporation attempts to estimate the amount of losses that may be inherent in the portfolio through a quarterly evaluation process that includes several members of management and that addresses specifically identified problem loans, as well as other quantitative data and qualitative factors. Such risk management and accounting policies and procedures, however, may not prevent unexpected losses that could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.

 

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Interest Rate Risk – Business risk arising from changes in interest rates is an inherent factor in operating a banking organization. The Corporation’s assets are predominantly long-term, fixed-rate loans and debt securities. Funding for these assets comes principally from shorter-term deposits and borrowed funds. Accordingly, there is an inherent risk of lower future earnings or decline in fair value of the Corporation’s financial instruments when interest rates change. Significant fluctuations in interest rates could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity. For additional information regarding interest rate risk, see Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk.”

 

Breach of Information Security and Technology Dependence – The Corporation relies on software, communication, and information exchange on a variety of computing platforms and networks and over the Internet. Despite numerous safeguards, the Corporation cannot be certain that all of its systems are entirely free from vulnerability to attack or other technological difficulties or failures. The Corporation relies on the services of a variety of vendors to meet its data processing and communication needs. If information security is breached or other technology difficulties or failures occur, information may be lost or misappropriated, services and operations may be interrupted and the Corporation could be exposed to claims from customers. Any of these results could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.

 

Limited Geographic Diversification – The Corporation grants commercial, residential and personal loans to customers primarily in the Pennsylvania counties of Tioga, Bradford, Sullivan, Lycoming, Potter, Cameron and McKean, and in Steuben and Chemung Counties in New York State. Although the Corporation has a diversified loan portfolio, a significant portion of its debtors’ ability to honor their contracts is dependent on the local economic conditions within the region. Deterioration in economic conditions could adversely affect the quality of the Corporation’s loan portfolio and the demand for its products and services, and accordingly, could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.

 

Competition – All phases of the Corporation’s business are competitive. Some competitors are much larger in total assets and capitalization than the Corporation, have greater access to capital markets and can offer a broader array of financial services. There can be no assurance that the Corporation will be able to compete effectively in its markets. Furthermore, developments increasing the nature or level of competition could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.

 

Government Regulation and Monetary Policy – The Corporation and the banking industry are subject to extensive regulation and supervision under federal and state laws and regulations. The requirements and limitations imposed by such laws and regulations limit the manner in which the Corporation conducts its business, undertakes new investments and activities and obtains financing. These regulations are designed primarily for the protection of the deposit insurance funds and consumers and not to benefit the Corporation’s shareholders. Financial institution regulation has been the subject of significant legislation in recent years and may be the subject of further significant legislation in the future, none of which is in the control of the Corporation. Significant new laws or changes in, or repeals of, existing laws could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects short-term interest rates and credit conditions, and any unfavorable change in these conditions could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.

 

Mortgage Banking – Since 2009, the Corporation has originated and sold residential mortgage loans to the secondary market through the MPF Xtra program. Since 2014, the Corporation has also originated and sold residential mortgage loans to the secondary market through the MPF Original program. Both of these programs are administered by the Federal Home Loan Banks of Pittsburgh and Chicago. At December 31, 2017, the total outstanding balance of residential mortgages sold and serviced through the two programs amounted to $169,725,000. The Corporation must strictly adhere to the MPF Xtra and MPF Original program guidelines for origination, underwriting and servicing loans, and failure to do so may result in the Corporation being forced to repurchase loans or being dropped from the program. As of December 31, 2017, the total outstanding balance of residential mortgage loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $1,805,000. If the volume of such forced repurchases of loans were to increase significantly, or if the Corporation were to be dropped from the programs, it could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.

 

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Securities Markets – The fair value of the Corporation’s available-for-sale securities, as well as the revenues the Corporation earns from its Trust and Financial Management and brokerage services, are sensitive to price fluctuations and market events.

 

Declines in the values of the Corporation’s securities holdings, combined with adverse changes in the expected cash flows from these investments, could result in other-than-temporary impairment charges.

 

For additional information regarding debt securities, see the “Securities” section of Management’s Discussion and Analysis and Note 7 to the consolidated financial statements.

 

The Corporation’s Trust and Financial Management revenue is determined, in part, from the value of the underlying investment portfolios. Accordingly, if the values of those investment portfolios decrease, whether due to factors influencing U.S. or international securities markets, in general, or otherwise, the Corporation’s revenue could be negatively impacted. In addition, the Corporation’s ability to sell its brokerage services is dependent, in part, upon consumers’ level of confidence in securities markets.

 

The Federal Home Loan Bank of Pittsburgh – Through its subsidiary (C&N Bank), the Corporation is a member of the Federal Home Loan Bank of Pittsburgh (FHLB-Pittsburgh), which is one of 11 regional Federal Home Loan Banks. The Corporation has a line of credit with the FHLB-Pittsburgh that is secured by a blanket lien on its loan portfolio. Access to this line of credit is critical if a funding need arises. However, there can be no assurance that the FHLB-Pittsburgh will be able to provide funding when needed, nor can there be assurance that the FHLB-Pittsburgh will provide funds specifically to the Corporation should its financial condition deteriorate and/or regulators prevent that access. The inability to access this source of funds could have a materially adverse effect on the Corporation’s financial flexibility if alternate financing is not available at acceptable interest rates. The failure of the FHLB-Pittsburgh or the FHLB system in general, may materially impair the Corporation’s ability to meet short- and long-term liquidity needs or to meet growth plans.

 

The Corporation owns common stock of the FHLB-Pittsburgh in order to qualify for membership in the FHLB system and access services from the FHLB-Pittsburgh. The FHLB-Pittsburgh faces a variety of risks in its operations including interest rate risk, counterparty credit risk, and adverse changes in its regulatory framework. In addition, the 11 Federal Home Loan Banks are jointly liable for the consolidated obligations of the FHLB system. To the extent that one FHLB cannot meet its obligations, other FHLBs can be called upon to make required payments. Such risks affecting the FHLB-Pittsburgh could adversely impact the value of the Corporation’s investment in the common stock of the FHLB-Pittsburgh and/or affect its access to credit.

 

Soundness of Other Financial Institutions – In addition to the FHLB-Pittsburgh, the Corporation maintains other credit facilities that provide it with additional liquidity. These facilities include secured and unsecured borrowings from the Federal Reserve Bank and third-party commercial banks. The Corporation believes that it maintains a strong liquidity position and that it is well positioned to withstand foreseeable market conditions. However, legal agreements with counterparties typically include provisions allowing them to restrict or terminate the Corporation’s access to these credit facilities with or without advance notice and at their sole discretion.

 

Financial institutions are interconnected as a result of trading, clearing, counterparty, and other relationships. Financial market conditions have been negatively impacted in the past and such disruptions or adverse changes in the Corporation’s results of operations or financial condition could, in the future, have a negative impact on available sources of liquidity. Such a situation may arise due to circumstances that are outside the Corporation’s control, such as general market disruptions or operational problems affecting the Corporation or third parties. The Corporation’s efforts to monitor and manage liquidity risk may not be successful or sufficient to deal with dramatic or unanticipated reductions in available liquidity. In such events, the Corporation’s cost of funds may increase, thereby reducing net interest income, or the Corporation may need to sell a portion of its securities and/or loan portfolio, which, depending upon market conditions, could necessitate realizing a loss.

 

FDIC Insurance Assessments – In 2008 and 2009, higher levels of bank failures dramatically increased the resolution costs of the Federal Deposit Insurance Corporation, or the FDIC, and depleted the deposit insurance fund. In addition, the FDIC and the U.S. Congress increased federal deposit insurance coverage, placing additional stress on the deposit insurance fund. In order to maintain a strong funding position and restore reserve ratios of the deposit insurance fund, in 2009 the FDIC increased assessment rates. As a result of lowering assessment levels for the Corporation and other US banks, the Corporation’s 2017 FDIC assessment expense decreased to $376,000 from $488,000 in 2016 and from $603,000 in 2015. Although the Corporation’s total expenses from FDIC assessments have steadily decreased from $2,092,000 in 2009, the Corporation is generally unable to control the cost of the premiums. If a significant number of bank or financial institution failures occur, the Corporation may be required to pay higher FDIC premiums. Future increases in FDIC insurance premiums or additional special assessments may materially adversely affect the Corporation’s results of operations.

 

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Bank Secrecy Act and Related Laws and Regulations – These laws and regulations have significant implications for all financial institutions. In recent years, they have increased due diligence requirements and reporting obligations for financial institutions, created new crimes and penalties, and required the federal banking agencies, in reviewing merger and other acquisition transactions, to consider the effectiveness of the parties to such transactions in combating money laundering activities. Even innocent noncompliance and inconsequential failure to follow the regulations could result in significant fines or other penalties, which could have a material adverse impact on the Corporation’s financial condition, results of operations or liquidity.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

Not applicable.

 

ITEM 2. PROPERTIES

 

The Bank owns each of its properties, except for the branch facilities located at 130 Court Street, Williamsport, PA, and at 2 East Mountain Avenue, South Williamsport, PA, which are leased. All of the properties are in good condition. None of the owned properties are subject to encumbrance.

 

A listing of properties is as follows:

 

Main administrative offices:

90-92 Main Street or 10 Nichols Street    
Wellsboro, PA  16901   Wellsboro, PA  16901    

 

Branch offices – Citizens & Northern Bank: 

428 S. Main Street   514 Main Street   2 East Mountain Avenue **
Athens, PA  18810   Laporte, PA  18626   South Williamsport, PA  17702
         
10 North Main Street   4534 Williamson Trail   41 Main Street
Coudersport, PA  16915   Liberty, PA  16930   Tioga, PA  16946
         
111 W. Main Street   1085 S. Main Street   428 Main Street
Dushore, PA  18614   Mansfield, PA  16933   Towanda, PA  18848
         
563 Main Street   612 James Monroe Avenue   64 Elmira Street
East Smithfield, PA  18817   Monroeton, PA  18832   Troy, PA  16947
         
104 W. Main Street   3461 Route 405 Highway   90-92 Main Street
Elkland, PA  16920   Muncy, PA  17756   Wellsboro, PA  16901
         
135 East Fourth Street   100 Maple Street   1510 Dewey Avenue
Emporium, PA  15834   Port Allegany, PA  16743   Williamsport, PA  17701
         
230 Railroad Street   24 Thompson Street   130 Court Street **
Jersey Shore, PA  17740   Ralston, PA  17763   Williamsport, PA  17701
         
102 E. Main Street   1827 Elmira Street   1467 Golden Mile Road
Knoxville, PA  16928   Sayre, PA  18840   Wysox, PA  18854
         
3 Main Street   6250 County Rte 64    
Canisteo, NY  14823   Hornell, NY  14843    

 

Loan production office of Citizens & Northern Bank:

250 East Water Street

Elmira, NY 14901

 

Facilities management office:

13 Water Street

Wellsboro, PA 16901

 

** designates leased branch facility

 

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ITEM 3. LEGAL PROCEEDINGS

 

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

 

ITEM 4. MINE SAFETY DISCLOSURE

 

Not applicable.

 

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

QUARTERLY SHARE DATA

 

Trades of the Corporation’s stock are executed through various brokers who maintain a market in the Corporation’s stock. The Corporation’s stock is listed on the NASDAQ Capital Market with the trading symbol CZNC. As of December 31, 2017, there were 2,206 shareholders of record of the Corporation’s common stock.

 

The following table sets forth the high and low sales prices of the common stock during 2017 and 2016.

 

       2017           2016     
           Dividend           Dividend 
           Declared           Declared 
           per           per 
   High   Low   Quarter   High   Low   Quarter 
First quarter  $26.50   $22.31   $0.26   $20.99   $19.26   $0.26 
Second quarter   24.40    22.00    0.26    21.00    19.40    0.26 
Third quarter   25.42    22.01    0.26    22.67    20.00    0.26 
Fourth quarter   26.75    23.02    0.26    26.57    20.54    0.26 

 

Future dividend payments will depend upon maintenance of a strong financial condition, future earnings and capital and regulatory requirements. Also, the Corporation and C&N Bank are subject to restrictions on the amount of dividends that may be paid without approval of banking regulatory authorities. These restrictions are described in Note 18 to the consolidated financial statements.

 

Effective April 21, 2016, the Corporation’s Board of Directors approved a treasury stock repurchase program. Under this program, the Corporation is authorized to repurchase up to 600,000 shares of the Corporation’s common stock or slightly less than 5% of the Corporation’s issued and outstanding shares at April 19, 2016. The Board of Directors’ April 21, 2016 authorization provides that: (1) the new treasury stock repurchase program shall be effective when publicly announced and shall continue thereafter until suspended or terminated by the Board of Directors, in its sole discretion; and (2) all shares of common stock repurchased pursuant to the new program shall be held as treasury shares and be available for use and reissuance for purposes as and when determined by the Board of Directors including, without limitation, pursuant to the Corporation’s Dividend Reinvestment and Stock Purchase Plan and its equity compensation program. To date, no purchases have been made under this repurchase program.

 

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The following table sets forth a summary of purchases by the Corporation, in the open market, of its equity securities during the fourth quarter 2017:

 

Period  Total Number
of Shares
Purchased
   Average
Price Paid
per Share
   Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs
   Maximum Number of
Shares that May Yet be
Purchased Under the Plans
or Programs
 
October 1 - 31, 2017   0   $-    0    600,000 
November 1 - 30, 2017   0   $-    0    600,000 
December 1 - 31, 2017   0   $-    0    600,000 

 

PERFORMANCE GRAPH

 

Set forth below is a chart comparing the Corporation’s cumulative return to stockholders against the cumulative return of the Russell 2000 and a Peer Group Index of similar banking organizations selected by the Corporation for the five-year period commencing December 31, 2012 and ended December 31, 2017. The index values are market-weighted dividend-reinvestment numbers, which measure the total return for investing $100.00 five years ago. This meets Securities & Exchange Commission requirements for showing dividend reinvestment share performance over a five-year period and measures the return to an investor for placing $100.00 into a group of bank stocks and reinvesting any and all dividends into the purchase of more of the same stock for which dividends were paid.

 

 

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   Period Ending 
Index  12/31/12   12/31/13   12/31/14   12/31/15   12/31/16   12/31/17 
Citizens & Northern Corporation   100.00    114.68    121.20    129.69    170.12    162.63 
Russell 2000 Index   100.00    138.82    145.62    139.19    168.85    193.58 
Peer Group   100.00    125.12    137.72    145.57    199.56    229.49 

 

Peer Group includes all publicly traded SEC filing Commercial Banks & Thrifts within NJ, NY, OH and PA with assets between $750M and $3.5B as of 9/30/2017

 

Source: S&P Global Market Intelligence © 2017

 

EQUITY COMPENSATION PLAN INFORMATION

 

The following table sets forth information concerning the Stock Incentive Plan and Independent Directors Stock Incentive Plan, both of which have been approved by the Corporation’s shareholders. The figures shown in the table below are as of December 31, 2017.

 

           Number of
   Number of   Weighted-   Securities
   Securities to be   average   Remaining
   Issued Upon   Exercise   for Future
   Exercise of   Price of   Issuance Under
   Outstanding   Outstanding   Equity Compen-
   Options   Options   sation Plans
Equity compensation plans approved by shareholders   165,660   $18.49   287,575
              
Equity compensation plans not approved by shareholders   0    N/A   0

 

More details related to the Corporation’s equity compensation plans are provided in Notes 1 and 13 to the consolidated financial statements.

 

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ITEM 6. SELECTED FINANCIAL DATA

 

   As of or for the Year Ended December 31, 
INCOME STATEMENT (In Thousands)  2017   2016   2015   2014   2013 
Interest and fee income  $45,863   $44,098   $44,519   $46,009   $48,914 
Interest expense   3,915    3,693    4,602    5,122    5,765 
Net interest income   41,948    40,405    39,917    40,887    43,149 
Provision for loan losses   801    1,221    845    476    2,047 
Net interest income after provision for loan losses   41,147    39,184    39,072    40,411    41,102 
Noninterest income excluding securities gains   16,153    15,511    15,478    15,420    16,451 
Realized gains on available-for-sale securities, net   257    1,158    2,861    1,104    1,718 
Loss on prepayment of debt   0    0    2,573    0    1,023 
Noninterest expense excluding loss on prepayment of debt   36,967    34,744    33,030    34,157    33,471 
Income before income tax provision   20,590    21,109    21,808    22,778    24,777 
Income tax provision   7,156    5,347    5,337    5,692    6,183 
Net income  $13,434   $15,762   $16,471   $17,086   $18,594 
Net income attributable to common shares  $13,365   $15,677   $16,387   $17,009   $18,490 
                          
PER COMMON SHARE:                         
Basic earnings per share  $1.10   $1.30   $1.35   $1.38   $1.51 
Diluted earnings per share  $1.10   $1.30   $1.35   $1.38   $1.50 
Cash dividends declared per share  $1.04   $1.04   $1.04   $1.04   $1.00 
Book value per common share at period-end  $15.43   $15.36   $15.39   $15.34   $14.49 
Tangible book value per common share at period-end  $14.45   $14.37   $14.41   $14.36   $13.51 
Weighted average common shares outstanding - basic   12,115,840    12,032,820    12,149,252    12,333,933    12,283,426 
Weighted average common shares outstanding - diluted   12,155,136    12,063,055    12,171,084    12,355,916    12,313,833 
END OF PERIOD BALANCES (Dollars In Thousands)                         
Available-for-sale securities  $356,908   $395,077   $420,290   $516,807   $482,658 
Gross loans   815,713    751,835    704,880    630,545    644,303 
Allowance for loan losses   8,856    8,473    7,889    7,336    8,663 
Total assets   1,276,959    1,242,292    1,223,417    1,241,963    1,237,695 
Deposits   1,008,449    983,843    935,615    967,989    954,516 
Borrowings   70,955    64,629    92,263    78,597    96,723 
Stockholders’ equity   188,443    186,008    187,487    188,362    179,472 
Common shares outstanding   12,214,525    12,113,228    12,180,623    12,279,980    12,390,063 
AVERAGE BALANCES (In Thousands)                         
Total assets   1,247,759    1,229,866    1,243,209    1,239,897    1,237,096 
Earning assets   1,169,569    1,147,549    1,159,298    1,155,401    1,145,340 
Gross loans   780,640    723,076    657,727    627,753    656,495 
Deposits   990,917    970,447    968,201    965,418    964,031 
Stockholders’ equity   188,958    188,373    188,905    185,469    181,412 

 

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ITEM 6. SELECTED FINANCIAL DATA (Continued)

 

   As of or for the Year Ended December 31, 
   2017   2016   2015   2014   2013 
KEY RATIOS                         
Return on average assets   1.08%   1.28%   1.32%   1.38%   1.50%
Return on average equity   7.11%   8.37%   8.72%   9.21%   10.25%
Average equity to average assets   15.14%   15.32%   15.19%   14.96%   14.66%
Net interest margin (1)   3.82%   3.76%   3.69%   3.80%   4.05%
Efficiency (2)   60.74%   59.22%   56.66%   57.59%   53.27%
Cash dividends as a % of diluted earnings per share   94.55%   80.00%   77.04%   75.36%   66.67%
Tier 1 leverage   14.23%   14.27%   14.31%   13.89%   13.78%
Tier 1 risk-based capital   21.95%   22.48%   23.29%   26.26%   25.15%
Total risk-based capital   23.07%   23.60%   24.40%   27.60%   26.60%
Tangible common equity/tangible assets   13.95%   14.15%   14.49%   14.34%   13.66%
Nonperforming assets/total assets   1.47%   1.43%   1.31%   1.34%   1.53%
Nonperforming loans/total loans   2.10%   2.07%   2.09%   2.45%   2.80%
Allowance for loan losses/total loans   1.09%   1.13%   1.12%   1.16%   1.34%
Net charge-offs/average loans   0.05%   0.09%   0.04%   0.29%   0.04%

 

(1) Rates of return on tax-exempt securities and loans are calculated on a fully-taxable equivalent basis.

 

(2) The efficiency ratio is calculated by dividing: (a) total noninterest expense excluding losses from prepayment of debt, by (b) the sum of net interest income (including income from tax-exempt securities and loans on a fully-taxable equivalent basis) and noninterest income excluding securities gains or losses.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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

 

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

 

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

 

EARNINGS OVERVIEW

 

In 2017, net income totaled $13,434,000, or $1.10 per common share - basic and diluted, as compared to $1.30 per share – basic and diluted in 2016 and $1.35 per share – basic and diluted in 2015. The results for 2017 represented a return on average assets of 1.08% and a return on average equity of 7.11%. As described below, 2017 earnings were reduced for a tax charge in 2017 attributable to the recent reduction in the marginal corporate income tax rate.

 

2017 vs. 2016

 

In December 2017, the federal corporate income tax rate was lowered to 21% effective January 1, 2018, from the 35% marginal rate in effect throughout 2017 and 2016. As a result of the reduction in the income tax rate, the 2017 results include an additional income tax provision (expense) of $2,159,000 ($0.18 per share) related to a reduction in the carrying value of the net deferred tax asset. Management expects the Corporation’s income tax provision will be significantly lower in 2018 and on an ongoing basis as a result of the lower tax rate.

 

Deferred tax assets and liabilities are recognized based on temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities, and are valued using currently enacted tax rates. The reduction in the deferred tax asset in 2017 reflects the reduced expected future net benefit from these differences, and was recognized upon the new tax bill being signed into law in December 2017.

 

The table below provides a reconciliation of the Corporation’s annual earnings results under U.S. generally accepted accounting principles (U.S. GAAP) to the comparative results excluding the additional tax charge referred to above. Management believes disclosure of 2017 earnings results, adjusted to exclude the additional income tax provision resulting from the change in the tax rate, provides useful information to investors for purposes of comparison with 2016 results.

 

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RECONCILIATION OF NON-U.S. GAAP MEASURE

(Dollars in Thousands, Except Per Share Data)

 

   Year Ended Dec. 31, 2017   Year Ended Dec. 31, 2016 
       Diluted       Diluted 
       Earnings per       Earnings per 
   Earnings   Share   Earnings   Share 
Net Income  $13,434   $1.10   $15,762   $1.30 
Additional Income Tax Provision Resulting from Change in Tax Rate   2,159         0      
                     
Net Income, Excluding Effect of Change in Tax Rate  $15,593   $1.28   $15,762   $1.30 

 

The effective tax rate (income tax provision as a percentage of income before tax) for the year ended December 31, 2017 was 34.75% as compared to 25.33% for 2016. The higher effective tax rate for 2017 resulted mainly from the additional tax provision related to the change in the tax rate. Management estimates the effective tax rate for 2018 to be approximately 15%, reflecting the benefit of a lower corporate rate.

 

In addition to the income tax provision fluctuation discussed above, significant highlights related to earnings in 2017 as compared to 2016 are as follows:

 

·Net interest income was $1,543,000 (3.8%) higher in 2017 as compared to 2016. The net interest margin was 3.82% for 2017, up from 3.76% for 2016. Average total loans outstanding were up $57.6 million (8.0%) in 2017 as compared to 2016, while average total available-for-sale securities were lower by $33.2 million. Average total deposits were $20.5 million (2.1%) higher in 2017 as compared to 2016.

 

·The provision for loan losses was $801,000 in 2017, which was $420,000 lower than the amount in 2016. In 2017, the provision included $1,023,000 related to the change in total specific allowances on impaired loans, as adjusted for net charge-offs during the period and a $101,000 increase in the unallocated portion of the allowance, with a reduction in the provision of $323,000 related to the reduction in the collectively determined allowance for loan losses. The reduction in the collectively determined allowance included the effects of an improvement in the Corporation’s aggregate net charge-off experience and a reduction in the qualitative factors used to estimate the allowance as of December 31, 2017, partially offset by the effects of loan growth. The net increase in specific allowances in 2017 included an increase in the allowance related to one real estate secured commercial loan of $391,000 to $919,000 at December 31, 2017 as compared to $528,000 at December 31, 2016. The increase in the specific allowance for this loan was based on an updated appraisal. In comparison, the provision of $1,221,000 for 2016 included $491,000 related to the change in total specific allowances on impaired loans, as adjusted for net charge-offs during the period, a $29,000 decrease in the unallocated portion of the allowance and an increase in the provision of $759,000 related to an increase in the collectively determined allowance for loan losses. The increase in the collectively determined portion of the allowance at December 31, 2016 as compared to the end of the preceding year resulted from loan growth and slight increases in the net charge-off and qualitative factors used to estimate the allowance.

 

·Noninterest revenue increased $642,000 (4.1%) in 2017 as compared to 2016. Trust and financial management revenue increased $639,000 (13.4%), reflecting growth in assets under management resulting from market appreciation and new business, as well as a recent increase in fee levels and an estimated $215,000 of additional revenue from changing the frequency of billings to monthly for certain services. Interchange revenue from debit card transactions increased $278,000 (14.3%), reflecting improvements in card-related volumes and processing. Loan servicing fees, net, increased $141,000, as the fair value of mortgage servicing rights decreased by $168,000 in 2017 as compared to a reduction of $282,000 in 2016. Net gains from sales of loans decreased $211,000 (20.5%) due to a lower volume of sales. Service charges on deposit accounts decreased $207,000 (4.4%), as revenue from consumer overdrafts declined due to lower volume.

 

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·Net gains on available-for-sale securities totaled $257,000 in 2017, a reduction of $901,000 from $1,158,000 in 2016. In 2016, gains from sales of bank stocks totaled $1,125,000, as the Corporation completed its program of bank stock sales that had begun in 2015. The Corporation had no remaining investments in bank stocks throughout 2017.

 

·Total noninterest expenses increased $2,223,000 (6.4%) in 2017 as compared to 2016. Other operating expense increased $808,000. Within other operating expense, the largest variances included increases of $208,000 in loan collection expenses, $149,000 in accounting and auditing expense stemming from increased internal audit outsourcing and $130,000 in attorney fees (mainly related to a commercial loan workout situation). Employee benefits expense increased $657,000, including an increase of $594,000 from higher health care expenses on the Corporation’s partially self-insured plan. Salaries and wages expense increased $395,000 (2.6%), reflecting the net effects of annual merit-based salary increases, an increase to an average of 292 FTEs in 2017 from 287 in 2016 and a net decrease in officers’ incentive compensation from corporate plans of $166,000.

 

2016 vs. 2015

 

Net income per share – diluted for 2016 was 3.7% lower than in 2015. Some of the more significant highlights related to annual earnings in 2016 as compared to 2015 are as follows:

 

·Net interest income was $488,000 (1.2%) higher than the comparable total for 2015. The net interest margin was 3.76%, which was 0.07% higher than the margin for 2015, reflecting the benefits of a lower cost of borrowed funds and a more favorable mix of earning assets. The average balance of total borrowed funds was $62,516,000 at an average interest rate of 2.57% in 2016, down from average borrowings of $77,642,000 at an average interest rate of 3.45% in 2015. Average total loans outstanding were higher by $65.3 million (9.9%) in 2016 as compared to 2015, while average total available-for-sale securities were lower by $74.2 million. Average total deposits increased $2.2 million (0.2%).

 

·The provision for loan losses was $1,221,000 in 2016, an increase of $376,000 over 2015. In 2016, the provision included the impact of increasing the allowance for loan losses for the effects of loan growth and slight increases in net charge-off experience and qualitative factors used in determining the collectively evaluated portion of the allowance. In comparison, in 2015 the provision also reflected the effects of loan growth, but the qualitative factors used in determining a portion of the collectively determined allowance decreased slightly during the period. Also in 2016, the provision included an increase of $148,000 as compared to 2015 from changes in specific allowances on loans individually identified as impaired, adjusted for the impact of net charge-offs.

 

·Total noninterest revenue for 2016 increased $33,000 (0.2%) over 2015. Net gains from sales of loans increased $294,000 (40.0%), reflecting higher volume of sales, and Trust and Financial Management revenue increased $134,000 (2.9%). Other operating income increased $28,000 (2.2%), including an increase of $148,000 from redemptions of tax credits and increases in lending-related fees of $80,000, while this category included a gain of $212,000 from a split-dollar life insurance policy in 2015. Service charges on deposit accounts decreased $169,000 (3.5%) in 2016, reflecting a reduction in consumer overdraft volume. Loan servicing fees, net, decreased $113,000 in 2016 as compared to 2015, including a decrease in the fair value of mortgage servicing rights of $282,000 in 2016, which was a larger decrease by $120,000 as compared to 2015. Brokerage revenue decreased $83,000 (9.9%), as the volume of sales of annuities declined.

 

·In 2016, realized gains from securities totaled $1,158,000, including gains from sales of bank stocks of $1,125,000. In 2015, the Corporation generated gains from sales of securities totaling $2,861,000, including gains from sales of bank stocks of $2,220,000, and also incurred losses of $2,573,000 from prepayments of a borrowing in the second and fourth quarters totaling $34 million. In the fourth quarter 2016, the Corporation completed its program of bank stock sales that had begun in 2015, and had no remaining investments in bank stocks at December 31, 2016.

 

·Noninterest expenses, excluding losses on prepayment of borrowings, in 2016 exceeded the amount for 2015 by $1,714,000 (5.2%). Salaries and wages expense increased $729,000 (5.0%). Several new positions were established in the latter portion of 2015 and early 2016, including new positions established for lending, lending support, information technology, training, human resources and marketing functions. Professional fees expense increased $488,000, including increases related to employee sales and service training, information technology and marketing. Other operating expense increased $399,000 (7.8%), including increases in other real estate expenses of $123,000, donations and public relations-related expenses of $94,000 and education and training-related expenses of $60,000. Also, other operating expense was reduced in 2015 by $69,000 as a result of a recovery of sales tax previously paid.

 

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·The provision for income tax totaled $5,347,000 in 2016, or an effective tax rate of 25.3% of pre-tax income. In comparison, the provision for income tax of $5,337,000 in 2015 represented a 24.5% effective rate. The higher effective tax rate in 2016 included the impact of a $300,000 reduction in tax-exempt interest income and an increase in the provision for state income tax of $64,000 that resulted mainly from a catch-up adjustment to increase New York State taxes for the effect of changes in the tax methodology that first became effective in 2015.

 

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

 

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. The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and recorded as a reduction of the investment in loans. Management believes the allowance for loan losses is adequate and reasonable. Notes 1 and 8 to the consolidated financial statements provide an overview of the process management uses for evaluating and determining the allowance for loan losses, and additional discussion of the allowance for loan losses is provided in a separate section later in Management’s Discussion and Analysis. Given the very subjective nature of identifying and valuing loan losses, it is likely that well-informed individuals could make materially different assumptions, and could, therefore calculate a materially different allowance value. While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.

 

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

 

As described in Note 7 to the consolidated financial statements, management evaluates securities for other-than-temporary impairment (“OTTI”). In making that evaluation, consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether the Corporation intends to sell the security or more likely than not will be required to sell the security before its anticipated recovery. Management’s assessments of the likelihood and potential for recovery in value of securities are subjective and based on sensitive assumptions.

 

NET INTEREST INCOME

 

The Corporation’s primary source of operating income is net interest income, which is equal to the difference between the amounts of interest income and interest expense. Tables I, II and III include information regarding the Corporation’s net interest income in 2017, 2016, and 2015. In each of these tables, the amounts of interest income earned on tax-exempt securities and loans have been adjusted to a fully taxable-equivalent basis. Accordingly, the net interest income amounts reflected in these tables exceed the amounts presented in the consolidated financial statements. The discussion that follows is based on amounts in the tables.

 

The calculations of fully taxable-equivalent yields on tax-exempt loans and securities in Tables I, II and III reflect inherent tax benefit based on the Corporation’s marginal federal income tax rate of 35% for all periods presented. In 2018, the tax benefit from tax-exempt loans and securities will be reduced as a result of the change to a 21% federal income tax rate. The overall yield on tax-exempt assets, however, in 2018 and future periods will depend on market conditions for new assets originated or purchased and the pace of principal repayments on assets held as of December 31, 2017.

 

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2017 vs. 2016

 

Fully taxable equivalent net interest income was $44,708,000 in 2017, $1,551,000 (3.6%) higher than in 2016. Interest income was $1,773,000 higher in 2017 as compared to 2016; interest expense was also higher by $222,000 in comparing the same periods. As presented in Table II, the Net Interest Margin was 3.82% in 2017 as compared to 3.76% in 2016, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) increased to 3.68% in 2017 from 3.63% in 2016.

 

INTEREST INCOME AND EARNING ASSETS

 

Interest income totaled $48,623,000 in 2017, an increase of 3.8% from 2016. Although the average yield on loans fell, the overall yield on earning assets increased to 4.16% in 2017 from 4.08% in 2016 due to a change in mix of earning assets, as loans increased while available-for-sale securities decreased. Interest and fees on loans receivable increased $2,466,000, or 6.9%, while interest on available-for-sale securities decreased $765,000, or 6.9%. The average balance of gross loans receivable increased 8.0% to $780,640,000 in 2017 from $723,076,000 in 2016. The Corporation experienced significant growth in both residential mortgages and commercial loans. The Corporation’s average rate of return on loans receivable declined to 4.87% in 2017 from 4.92% in 2016 as average interest rates on new loans have been lower than the average rates on loans that have been fully or partially paid off.

 

As indicated in Table II, average available-for-sale securities (at amortized cost) totaled $371,825,000 in 2017, a decrease of $33,154,000 (8.2%) from 2016. Funds generated from the net decrease in the Corporation’s available-for-sale securities portfolio were used, in part, to fund the loan growth described above. The average rate of return on available-for-sale securities was 2.79% in 2017, up from 2.75% in 2016.

 

The average balance of interest-bearing due from banks decreased to $16,634,000 in 2017 from $19,022,000 in 2016, while the average yield increased to 1.14% in 2017 from 0.61% in 2016. This category has consisted primarily of balances held by the Federal Reserve and also includes other overnight deposits and FDIC-insured certificates of deposit issued by other financial institutions.

 

INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES

 

Interest expense rose $222,000, or 6.0%, to $3,915,000 in 2017 from $3,693,000 in 2016. Table II shows that the overall cost of funds on interest-bearing liabilities increased to 0.48% in 2017 from 0.45% in 2016.

 

Total average deposits (interest-bearing and noninterest-bearing) increased 2.1% to $990,917,000 in 2017 from $970,447,000 in 2016. Increases in the average balances of noninterest-bearing demand deposits, savings and interest checking were partially offset by decreases in average balances of money market and Individual Retirement Accounts. The average rate paid on interest-bearing deposits increased to 0.32% in 2017 from 0.28% in 2016. The increase in average rate is mainly due to increases in rates paid on certificates of deposits and interest checking accounts.

 

Total average borrowed funds decreased $3,097,000 to $59,419,000 in 2017 from $62,516,000 in 2016. The average rate on borrowed funds was 2.54% in 2017, down slightly from 2.57% in 2016. Interest expense on short-term borrowings increased $58,000 in 2017 as compared to 2016, reflecting an increase in average rate to 0.90% in 2017 from 0.65% in 2016. Interest expense on long-term borrowings decreased $154,000, as the overall reduction in average balance of $2,952,000 included the impact of repayments of two higher-cost borrowings that had been originated in 2007. These borrowings included a $10 million FHLB advance with an interest rate of 3.81% that matured in September 2017 and repurchase agreements with a broker dealer totaling $27 million with an interest rate of 3.595% that matured in December 2017.

 

2016 vs. 2015

 

Fully taxable equivalent net interest income was $43,157,000 in 2016, $338,000 (0.8%) higher than in 2015. Interest income was $571,000 lower in 2016 as compared to 2015; interest expense was also lower by $909,000 in comparing the same periods. As presented in Table II, the Net Interest Margin was 3.76% in 2016 as compared to 3.69% in 2015, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) increased to 3.63% in 2016 from 3.54% in 2015.

 

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INTEREST INCOME AND EARNING ASSETS

 

Interest income totaled $46,850,000 in 2016, a decrease of 1.2% from 2015. Although yields on securities and loans fell, overall yield on earning assets dropped only 0.01% due to a change in mix of earning assets to increase loans and decrease securities. Interest and fees on loans receivable increased $1,695,000, or 5.0%, while interest on available-for-sale securities decreased $2,300,000, or 17.1%. The average balance of gross loans receivable increased 9.9% to $723,076,000 in 2016 from $657,727,000 in 2015. The Corporation experienced significant growth in both residential and commercial loans. The Corporation’s average rate of return on loans receivable declined to 4.92% in 2016 from 5.15% in 2015.

 

As indicated in Table II, average available-for-sale securities (at amortized cost) totaled $404,979,000 in 2016, a decrease of $74,169,000 (15.5%) from 2015. Funds generated from the net decrease in the Corporation’s available-for-sale securities portfolio were used, in part, to fund the loan growth described above. The Corporation’s yield on securities was lower in 2016 than in 2015, primarily due to higher-yielding securities maturing as the portfolio size was reduced. The average rate of return on available-for-sale securities was 2.75% in 2016 and 2.81% in 2015.

 

INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES

 

Interest expense fell $909,000, or 19.8%, to $3,693,000 in 2016 from $4,602,000 in 2015. Table II shows that the overall cost of funds on interest-bearing liabilities fell to 0.45% in 2016 from 0.55% in 2015.

 

Total average deposits (interest-bearing and noninterest-bearing) increased slightly (0.2%) to $970,447,000 in 2016 from $968,201,000 in 2015. Decreases in the average balances of certificates of deposit and Individual Retirement Accounts were offset by increases in average balances of interest checking, money market accounts, savings accounts and noninterest-bearing demand deposits. The average rate paid on interest-bearing deposits increased slightly to 0.28% in 2016 from 0.26% in 2015.

 

Total average borrowed funds decreased $15,126,000 to $62,516,000 in 2016 from $77,642,000 in 2015. The average rate on borrowed funds was 2.57% in 2016 compared to 3.45% in 2015, reflecting a $27,604,000 reduction in the average balance of higher-rate, long-term borrowings resulting from prepayment in the second and fourth quarters of 2015 of a long-term repurchase agreement borrowing with an interest rate of 4.265%. The average balance of short-term borrowings increased $12,478,000 in 2016 over 2015, as average overnight borrowings were higher in 2016 and the Corporation funded the pay-off of the long-term repurchase agreement with a series of short-term advances from the FHLB-Pittsburgh that matured over the course of 2016.

 

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TABLE I - ANALYSIS OF INTEREST INCOME AND EXPENSE

 

   Years Ended December 31,   Increase/(Decrease) 
(In Thousands)  2017   2016   2015   2017/2016   2016/2015 
                     
INTEREST INCOME                         
Available-for-sale securities:                         
Taxable  $5,499   $5,916   $7,587   $(417)  $(1,671)
Tax-exempt   4,892    5,240    5,869    (348)   (629)
Total available-for-sale securities   10,391    11,156    13,456    (765)   (2,300)
Interest-bearing due from banks   190    116    93    74    23 
Loans held for sale   25    27    16    (2)   11 
Loans receivable:                         
Taxable   34,907    32,827    31,311    2,080    1,516 
Tax-exempt   3,110    2,724    2,545    386    179 
Total loans receivable   38,017    35,551    33,856    2,466    1,695 
Total Interest Income   48,623    46,850    47,421    1,773    (571)
                          
INTEREST EXPENSE                         
Interest-bearing deposits:                         
Interest checking   474    293    214    181    79 
Money market   355    342    299    13    43 
Savings   143    133    128    10    5 
Certificates of deposit   996    882    831    114    51 
Individual Retirement Accounts   434    434    451    0    (17)
Other time deposits   1    1    1    0    0 
Total interest-bearing deposits   2,403    2,085    1,924    318    161 
Borrowed funds:                         
Short-term   213    155    32    58    123 
Long-term   1,299    1,453    2,646    (154)   (1,193)
Total borrowed funds   1,512    1,608    2,678    (96)   (1,070)
Total Interest Expense   3,915    3,693    4,602    222    (909)
                          
Net Interest Income  $44,708   $43,157   $42,819   $1,551   $338 

 

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

 

(2)Fees on loans are included with interest on loans and amounted to $883,000 in 2017, $1,000,000 in 2016, and $1,004,000 in 2015.

 

 19 

 

 

TABLE II - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES

 

(Dollars in Thousands)                        
   Year       Year       Year     
   Ended   Rate of   Ended   Rate of   Ended   Rate of 
   12/31/2017   Return/   12/31/2016   Return/   12/31/2015   Return/ 
   Average   Cost of   Average   Cost of   Average   Cost of 
   Balance   Funds %   Balance   Funds %   Balance   Funds % 
EARNING ASSETS                              
Available-for-sale securities, at amortized cost:                              
Taxable  $259,079    2.12%  $293,636    2.01%  $366,448    2.07%
Tax-exempt   112,746    4.34%   111,343    4.71%   112,700    5.21%
Total available-for-sale securities   371,825    2.79%   404,979    2.75%   479,148    2.81%
Interest-bearing due from banks   16,634    1.14%   19,022    0.61%   22,201    0.42%
Loans held for sale   470    5.32%   472    5.72%   222    7.21%
Loans receivable:                              
Taxable   711,901    4.90%   662,769    4.95%   603,771    5.19%
Tax-exempt   68,739    4.52%   60,307    4.52%   53,956    4.72%
Total loans receivable   780,640    4.87%   723,076    4.92%   657,727    5.15%
Total Earning Assets   1,169,569    4.16%   1,147,549    4.08%   1,159,298    4.09%
Cash   17,322         16,570         16,639      
Unrealized gain/loss on securities   88         7,166         8,871      
Allowance for loan losses   (8,820)        (8,082)        (7,380)     
Bank premises and equipment   15,541         15,413         15,911      
Intangible Assets   11,957         11,966         11,983      
Other assets   42,102         39,284         37,887      
Total Assets  $1,247,759        $1,229,866        $1,243,209      
                               
INTEREST-BEARING LIABILITIES                              
Interest-bearing deposits:                              
Interest checking  $209,893    0.23%  $201,357    0.15%  $195,940    0.11%
Money market   191,356    0.19%   199,405    0.17%   196,585    0.15%
Savings   143,575    0.10%   132,679    0.10%   128,355    0.10%
Certificates of deposit   117,366    0.85%   117,130    0.75%   121,803    0.68%
Individual Retirement Accounts   97,519    0.45%   103,467    0.42%   110,659    0.41%
Other time deposits   1,014    0.10%   1,036    0.10%   1,031    0.10%
Total interest-bearing deposits   760,723    0.32%   755,074    0.28%   754,373    0.26%
Borrowed funds:                              
Short-term   23,761    0.90%   23,906    0.65%   11,428    0.28%
Long-term   35,658    3.64%   38,610    3.76%   66,214    4.00%
Total borrowed funds   59,419    2.54%   62,516    2.57%   77,642    3.45%
Total Interest-bearing Liabilities   820,142    0.48%   817,590    0.45%   832,015    0.55%
Demand deposits   230,194         215,373         213,828      
Other liabilities   8,465         8,530         8,461      
Total Liabilities   1,058,801         1,041,493         1,054,304      
Stockholders’ equity, excluding other comprehensive income/loss   188,756         183,671         183,125      
Other comprehensive income/loss   202         4,702         5,780      
Total Stockholders’ Equity   188,958         188,373         188,905      
Total Liabilities and Stockholders’ Equity  $1,247,759        $1,229,866        $1,243,209      
Interest Rate Spread        3.68%        3.63%        3.54%
Net Interest Income/Earning Assets        3.82%        3.76%        3.69%
                               
Total Deposits (Interest-bearing and Demand)  $990,917        $970,447        $968,201      

 

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

 

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

 

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TABLE III - ANALYSIS OF VOLUME AND RATE CHANGES

 

(In Thousands)  Year Ended 12/31/17 vs. 12/31/16   Year Ended 12/31/16 vs. 12/31/15 
   Change in   Change in   Total   Change in   Change in   Total 
   Volume   Rate   Change   Volume   Rate   Change 
EARNING ASSETS                              
Available-for-sale securities:                              
Taxable  $(721)  $304   $(417)  $(1,472)  $(199) $(1,671)
Tax-exempt   65    (413)   (348)   (70)   (559)   (629)
Total available-for-sale securities   (656)   (109)   (765)   (1,542)   (758)   (2,300)
Interest-bearing due from banks   (17)   91    74    (14)   37    23 
Loans held for sale   0    (2)   (2)   15    (4)   11 
Loans receivable:                              
Taxable   2,412    (332)   2,080    2,965    (1,449)   1,516 
Tax-exempt   381    5    386    290    (111)   179 
Total loans receivable   2,793    (327)   2,466    3,255    (1,560)   1,695 
Total Interest Income   2,120    (347)   1,773    1,714    (2,285)   (571)
                               
INTEREST-BEARING LIABILITIES                              
Interest-bearing deposits:                              
Interest checking   12    169    181    6    73    79 
Money market   (14)   27    13    4    39    43 
Savings   11    (1)   10    4    1    5 
Certificates of deposit   2    112    114    (33)   84    51 
Individual Retirement Accounts   (25)   25    0    (30)   13    (17)
Other time deposits   0    0    0    0    0    0 
Total interest-bearing deposits   (14)   332    318    (49)   210    161 
Borrowed funds:                              
Short-term   (1)   59    58    56    67    123 
Long-term   (109)   (45)   (154)   (1,047)   (146)   (1,193)
Total borrowed funds   (110)   14    (96)   (991)   (79)   (1,070)
Total Interest Expense   (124)   346    222    (1,040)   131    (909)
                               
Net Interest Income  $2,244   $(693)  $1,551   $2,754   $(2,416)  $338 

 

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

 

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

 

 21 

 

 

NONINTEREST INCOME

Years Ended December 31, 2017, 2016 and 2015

 

The table below presents a comparison of noninterest income and excludes realized gains on available-for-sale securities, which are discussed in the “Earnings Overview” section of Management’s Discussion and Analysis.

 

TABLE IV - COMPARISON OF NONINTEREST INCOME

(Dollars In Thousands)

 

   Years Ended         
   December 31,   $   % 
   2017   2016   Change   Change 
Service charges on deposit accounts  $4,488   $4,695   $(207)   (4.4)
Service charges and fees   417    439    (22)   (5.0)
Trust and financial management revenue   5,399    4,760    639    13.4 
Brokerage revenue   797    756    41    5.4 
Insurance commissions, fees and premiums   115    102    13    12.7 
Interchange revenue from debit card transactions   2,221    1,943    278    14.3 
Net gains from sales of loans   818    1,029    (211)   (20.5)
Loan servicing fees, net   244    103    141    136.9 
Increase in cash surrender value of life insurance   379    382    (3)   (0.8)
Other operating income   1,275    1,302    (27)   (2.1)
Total noninterest income before realized gains on available-for-sale securities, net  $16,153   $15,511   $642    4.1 

 

   Years Ended         
   December 31,   $   % 
   2016   2015   Change   Change 
Service charges on deposit accounts  $4,695   $4,864   $(169)   (3.5)
Service charges and fees   439    494    (55)   (11.1)
Trust and financial management revenue   4,760    4,626    134    2.9 
Brokerage revenue   756    839    (83)   (9.9)
Insurance commissions, fees and premiums   102    109    (7)   (6.4)
Interchange revenue from debit card transactions   1,943    1,935    8    0.4 
Net gains from sales of loans   1,029    735    294    40.0 
Loan servicing fees, net   103    216    (113)   (52.3)
Increase in cash surrender value of life insurance   382    386    (4)   (1.0)
Other operating income   1,302    1,274    28    2.2 
Total noninterest income before realized gains on available-for-sale securities, net  $15,511   $15,478   $33    0.2 

 

Total noninterest income, excluding realized gains on available-for-sale securities, increased $642,000 in 2017 compared to 2016. In 2016, total noninterest income increased $33,000 from 2015. Changes of significance are discussed in the narrative that follows.

 

2017 vs. 2016

 

Trust and financial management revenue increased $639,000 (13.4%), reflecting growth in assets under management resulting from market appreciation and new business, as well as an increase in fee levels and an estimated $215,000 of additional revenue from changing the frequency of billings to monthly for certain services.

 

Interchange revenue from debit card transactions increased $278,000 (14.3%), reflecting improvements in card-related volumes and processing.

 

Loan servicing fees, net, increased $141,000. This category includes fees received from servicing residential mortgage loans that have been originated and sold, adjusted for the change in the fair value of servicing rights. The fair value of mortgage servicing rights decreased by $168,000 in 2017 as compared to a reduction of $282,000 in 2016.

 

 22 

 

 

Net gains from sales of loans decreased $211,000 (20.5%) due to a lower volume of residential mortgage sales.

 

Service charges on deposit accounts decreased $207,000 (4.4%). Revenue from consumer overdrafts declined $133,000 due to lower volume. Also, fees on noninterest-bearing, business-related checking accounts decreased $53,000 as the earnings crediting rate used to offset the cost of services increased over the year, consistent with increases in the Fed Funds rate.

 

2016 vs. 2015

 

Net gains from sales of loans increased $294,000 (40.0%), reflecting higher volume of sales. The increase in volume in 2016 included the impact of employing one additional mortgage lender in a dedicated, full-time capacity throughout most of 2016 as compared to 2015.

 

Trust and Financial Management revenue increased $134,000 (2.9%). The increase in Trust revenue in 2016 reflected, in part, the effect of higher value of U.S. equity markets in the latter portion of the year.

 

Service charges on deposit accounts decreased $169,000 (3.5%) in 2016, including a $131,000 reduction in consumer overdraft fees due to a lower volume of overdrafts.

 

Loan servicing fees, net, decreased $113,000 in 2016. The fair value of mortgage servicing rights decreased $282,000 in 2016, as their valuation was negatively impacted by a reduction in demand by banks for purchasing servicing rights resulting from regulatory changes that have generally increased their risk-based capital weighting. In comparison, the fair value of mortgage servicing rights decreased $162,000 in 2015.

 

Brokerage revenue decreased $83,000 (9.9%), as the volume of sales of annuities declined.

 

NONINTEREST EXPENSE

Years Ended December 31, 2017, 2016 and 2015

 

Total noninterest expenses increased $2,223,000 (6.4%) in 2017 as compared to 2016. Total noninterest expense decreased $859,000, or 2.4%, in 2016 as compared to 2015; however, excluding losses from prepayment of borrowings in 2015, noninterest expense was $1,714,000 (5.2%) higher in 2016 as compared to 2015. In 2015, the Corporation incurred losses totaling $2,573,000 from prepayment of borrowings (repurchase agreements). There were no losses from prepayment of borrowings incurred in 2017 or 2016. Changes of significance (other than the previously discussed losses on prepayment of debt) are discussed in the narrative that follows.

 

TABLE V - COMPARISON OF NONINTEREST EXPENSE

(Dollars In Thousands)

 

   Years Ended         
   December 31,   $   % 
   2017   2016   Change   Change 
Salaries and wages  $15,806   $15,411   $395    2.6 
Pensions and other employee benefits   5,374    4,717    657    13.9 
Occupancy expense, net   2,340    2,340    0    0.0 
Furniture and equipment expense   1,834    1,730    104    6.0 
FDIC Assessments   376    488    (112)   (23.0)
Pennsylvania shares tax   1,329    1,274    55    4.3 
Professional fees   1,086    1,126    (40)   (3.6)
Automated teller machine and interchange expense   1,284    1,137    147    12.9 
Software subscriptions   1,190    981    209    21.3 
Other operating expense   6,348    5,540    808    14.6 
Total Other Expense  $36,967   $34,744   $2,223    6.4 

 

 23 

 

 

   Years Ended         
   December 31,   $   % 
   2016   2015   Change   Change 
Salaries and wages  $15,411   $14,682   $729    5.0 
Pensions and other employee benefits   4,717    4,420    297    6.7 
Occupancy expense, net   2,340    2,574    (234)   (9.1)
Furniture and equipment expense   1,730    1,860    (130)   (7.0)
FDIC Assessments   488    603    (115)   (19.1)
Pennsylvania shares tax   1,274    1,248    26    2.1 
Professional fees   1,126    638    488    76.5 
Automated teller machine and interchange expense   1,137    988    149    15.1 
Software subscriptions   981    876    105    12.0 
Loss on prepayment of borrowings   0    2,573    (2,573)   (100.0)
Other operating expense   5,540    5,141    399    7.8 
Total Other Expense  $34,744   $35,603   $(859)   (2.4)

 

2017 vs 2016

 

Other operating expense increased $808,000. Within other operating expense, the largest variances included increases of $208,000 in loan collection expenses, $149,000 in accounting and auditing expense stemming from increased internal audit outsourcing and $130,000 in attorney fees (mainly related to a commercial loan workout situation). The increased loan collection expenses in 2017 included payments of delinquent property taxes associated with mortgage loans on properties located in New York State and $32,000 for the Corporation’s share of collection expenses on a Multi-family residential participation loan that has been classified as impaired at December 31, 2017 and 2016.

 

Employee benefits expense increased $657,000, including an increase of $594,000 from higher health care expenses from the Corporation’s partially self-insured plan. The Corporation is self-insured for health insurance, up to a cap for catastrophic levels of losses, which are insured by a third party.

 

Salaries and wages expense increased $395,000 (2.6%), reflecting the net effects of annual merit-based salary increases, an increase to an average of 292 FTEs in 2017 from 287 in 2016 and a net decrease in officers’ incentive compensation from corporate plans of $166,000.

 

Software subscriptions increased $209,000, including costs associated with new applications as well as annual licensing increases.

 

Automated teller machine and interchange expense increased $147,000, including increases in volume-related costs and fraud monitoring costs.

 

Furniture and equipment expenses in 2017 increased $104,000 primarily as a result of higher depreciation and repair costs.

 

FDIC insurance decreased $112,000 in 2017 reflecting lower assessment levels beginning in the third quarter of 2016.

 

2016 vs 2015

 

Salaries and wages expense increased $729,000 (5.0%), reflecting an increase in number of employees. The average number of full-time equivalent employees was 287 in 2016, up from 281 in 2015, including new positions established for lending, lending support, information technology, training and marketing functions.

 

Pension and other employee benefits expense increased $297,000 (6.7%). The increase resulted mainly from an increase of $214,000 in healthcare expense as a result of increased healthcare claims. Payroll taxes and other expenses within this category increased in 2016, as well, due to the increase in number of employees described above.

 

Professional fees expense increased $488,000, including increases related to employee sales and service training, information technology and marketing.

 

 24 

 

 

Automated teller machine and interchange expense increased $149,000, including the costs of purchasing new debit cards with EMV functionality.

 

Software subscriptions increased $105,000 as a result of enhancements and new applications initiated in 2015 and continuing into 2016 including costs associated with the network operating system, automated document signatures and marketing-related functionality.

 

Other operating expense increased $399,000 (7.8%), including increases in other real estate expenses of $123,000, donations and public relations-related expenses of $94,000 and education and training-related expenses of $60,000. Also, other operating expense was reduced in 2015 by $69,000 as a result of a recovery of sales tax previously paid.

 

Occupancy expenses in 2016 were $234,000 under 2015 primarily as a result of lower depreciation costs as well as lower winter-related expenses such as snow removal and fuel costs.

 

Furniture and equipment expenses in 2016 were $130,000 under 2015 primarily as a result lower depreciation costs.

 

FDIC insurance decreased $115,000 in 2016 reflecting lower assessment levels beginning in the third quarter of 2016.

 

INCOME TAXES

 

The effective income tax rate was 34.8% of pre-tax income in 2017, up from 25.3% in 2016 and 24.5% in 2015. The Corporation’s effective tax rates differed from the statutory rate of 35% in 2016 and 2015 principally because of the effects of tax-exempt interest income. In 2017, the Corporation realized an increase in the income tax provision (expense) due to the write-down of the net deferred tax asset as a result of the recently enacted Tax Cuts and Jobs Act of 2017 that, among other things, lowered the federal corporate income tax rate to 21% effective January 1, 2018, from the 35% marginal tax rate in effect for prior periods. Excluding the effect of the write-down of the deferred tax asset resulting from the change in the federal corporate income tax rate, the effective income tax rate for the year ended December 31, 2017 would have been 24.3%. Further, management estimates that had the recently enacted 21% federal tax rate been in effect throughout 2017 and 2016, the effective federal tax rate would have been 14.5% in 2017 and 15% in 2016. Management estimates the effective tax rate for 2018 will be approximately 15%. In developing these estimates, no adjustments have been made to 2017 and 2016 historical data for reinvestment of additional funds or for any changes to the composition of the Corporation’s assets and liabilities.

 

The Corporation recognizes deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax basis of assets and liabilities. At December 31, 2017, the net deferred tax asset was $3,289,000, a decrease from the balance at December 31, 2016 of $5,117,000. The primary reason for the decrease was the write-down of the deferred tax asset based on the decrease in the federal tax rate as described above. The total amount of the write-down of the net deferred tax asset was $2,159,000, including $325,000 associated with items included in Accumulated Other Comprehensive Loss in the consolidated balance sheet.

 

The Corporation regularly reviews deferred tax assets for recoverability based on history of earnings, expectations for future earnings and expected timing of reversals of temporary differences. Realization of deferred tax assets ultimately depends on the existence of sufficient taxable income, including taxable income in prior carryback years, as well as future taxable income. Further, the value of the benefit from realization of deferred tax assets would be impacted if income tax rates were changed from currently enacted levels.

 

Management believes the recorded net deferred tax asset at December 31, 2017 is fully realizable; however, if management determines the Corporation will be unable to realize all or part of the net deferred tax asset, the Corporation would adjust the deferred tax asset, which would negatively impact earnings.

 

Additional information related to income taxes is presented in Note 14 to the consolidated financial statements.

 

SECURITIES

 

Table VI shows the composition of the investment portfolio at December 31, 2017, 2016 and 2015. Comparison of the amortized cost totals of available-for-sale securities at each year-end presented reflects a decrease of $19,917,000 to $396,538,000 at December 31, 2016 from December 31, 2015. This change was followed by a decrease of $37,221,000 to $359,317,000 at December 31, 2017. The continued decrease in securities in 2017 reflects the use of cash generated from the investment portfolio to help fund the increase in loans outstanding. The Corporation’s holdings of mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies have decreased to $221,187,000 at December 31, 2017 from $237,654,000 at December 31, 2016 and $266,372,000 at December 31, 2015. Within that overall category, in 2017, the Corporation had some commercial mortgage-backed securities for which the underlying collateral consists of multi-family properties. The total amortized cost of commercial mortgage-backed securities held at December 31, 2017 was $33,881,000.

 

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As reflected in Table VI, the fair value of available-for-sale securities as of December 31, 2017 was $2,409,000, or 0.67%, less than the total amortized cost basis. In comparison, the aggregate unrealized loss position at December 31, 2016 was $1,461,000, or 0.37% of the total amortized cost basis. . Modest increases in intermediate-term and long-term interest rates over the course of 2016 and 2017, as well as market expectations of further rate increases, have contributed to the decrease in fair values of debt securities. Also, the fair values of tax-exempt municipal bonds have been negatively impacted by the reduced benefit of their tax-exempt nature as a result of the reduction in the federal corporate income tax rate. At December 31, 2015, the aggregate unrealized gain position was $3,835,000, or 0.92% of total amortized cost, including an unrealized gain of $706,000 on marketable equity securities (bank stocks). The Corporation liquidated its investments in bank stocks in 2015 and 2016, and held no investments in bank stocks in 2017. The Corporation reported net realized gains from sales of available-for-sale securities of $257,000 in 2017. In comparison, net realized gains from sales of available-for-sale securities totaled $1,158,000 in 2016 and $2,861,000 in 2015, including realized gains from sales of bank stocks of $1,125,000 in 2016 and $2,220,000 in 2015.

 

Management has reviewed the Corporation’s holdings as of December 31, 2017 and concluded that unrealized losses on all of the securities in an unrealized loss position are considered temporary. Notes 6 and 7 to the consolidated financial statements provide more detail concerning the Corporation’s processes for evaluating securities for other-than-temporary impairment. Management will continue to closely monitor the status of impaired securities in 2018.

 

TABLE VI - INVESTMENT SECURITIES

 

           As of December 31,         
   2017   2016   2015 
   Amortized   Fair   Amortized   Fair   Amortized   Fair 
(In Thousands)  Cost   Value   Cost   Value   Cost   Value 
                         
AVAILABLE-FOR-SALE SECURITIES:                              
Obligations of U.S. Government agencies  $8,026   $7,873   $9,671   $9,541   $10,663   $10,483 
Obligations of states and political subdivisions:                              
Tax-exempt   103,673    105,111    118,140    119,037    103,414    107,757 
Taxable   25,431    25,573    30,073    30,297    34,317    34,597 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                              
Residential pass-through securities   52,992    52,347    58,922    58,404    73,227    73,343 
Residential collateralized mortgage obligations   134,314    131,814    147,915    146,608    193,145    191,715 
Commercial mortgage-backed securities   33,881    33,219    30,817    30,219    0    0 
Other collateralized debt obligations   0    0    0    0    9    9 
Total debt securities   358,317    355,937    395,538    394,106    414,775    417,904 
Marketable equity securities   1,000    971    1,000    971    1,680    2,386 
Total  $359,317   $356,908   $396,538   $395,077   $416,455   $420,290 

 

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The following table presents the contractual maturities and the weighted-average yields (calculated based on amortized cost) of investment securities as of December 31, 2017. Yields on tax-exempt securities are presented on a nominal basis, that is, the yields are not presented on a fully taxable-equivalent basis. Actual maturities may differ from contractual maturities because counterparties may have the right to call or prepay obligations with or without call or prepayment penalties.

 

(In Thousands, Except for Percentages)  Within       One-       Five-       After             
   One       Five       Ten       Ten             
   Year   Yield   Years   Yield   Years   Yield   Years   Yield   Total   Yield 
                                         
AVAILABLE-FOR-SALE SECURITIES:                                                  
Obligations of U.S. Government agencies  $0    0.00%  $8,026    1.42%  $0    0.00%  $0    0.00%  $8,026    1.42%
Obligations of states and political subdivisions:                                                  
Tax-exempt   6,247    1.55%   45,184    3.00%   32,822    2.21%   19,420    3.60%   103,673    2.78%
Taxable   5,103    1.97%   16,064    2.51%   4,264    3.12%   0    0.00%   25,431    2.51%
Sub-total  $11,350    1.74%  $69,274    2.71%  $37,086    2.32%  $19,420    3.60%   137,130    2.65%
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                                                  
Residential pass-through securities                                           52,992    2.24%
Residential collateralized mortgage obligations                                           134,314    2.12%
Commercial mortgage-backed securities                                           33,881    2.39%
Total                                          $358,317    2.36%

 

The Corporation’s mortgage-backed securities and collateralized mortgage obligations have stated maturities that may differ from actual maturities due to borrowers’ ability to prepay obligations. Cash flows from such investments are dependent upon the performance of the underlying mortgage loans and are generally influenced by the level of interest rates. As rates increase, cash flows generally decrease as prepayments on the underlying mortgage loans decrease. As rates decrease, cash flows generally increase as prepayments increase due to increased refinance activity and other factors. In the table above, the entire balances and weighted-average rates for mortgage-backed securities and collateralized mortgage obligations are shown in one period.

 

FINANCIAL CONDITION

 

Gross loans outstanding (excluding mortgage loans held for sale) were $815,713,000 at December 31, 2017, up 8.5% from $751,835,000 at December 31, 2016. The total outstanding balances of residential mortgage segment loans at December 31, 2017 increased $26,513,000 (6.3%) as compared to December 31, 2016, and the total outstanding balances of commercial segment loans at December 31, 2017 increased $36,148,000 (11.4%) as compared to December 31, 2016. The 2017 loan growth followed growth in loans outstanding in 2016 of 6.7% from December 31, 2015. Total outstanding commercial loans were higher by $9,206,000 (3.0%), and residential mortgage segment loans were up $34,683,000 (9.0%), at December 31, 2016 as compared to December 31, 2015.

 

The increases in loans outstanding in 2016 and 2017 included increases in commercial participation loans. Participation loans represent portions of larger commercial transactions for which other institutions are the “lead banks”. Although not the lead bank, the Corporation conducts detailed underwriting and monitoring of participation loan opportunities. Participation loans are included in the “Commercial and industrial,” “Commercial loans secured by real estate” and “Political subdivisions” classes in the loan tables presented in this Form 10-K. Total participation loans outstanding amounted to $61,245,000 at December 31, 2017, up from $47,508,000 at December 31, 2016. At December 31, 2017, the balance of participation loans outstanding includes a total of $53,756,000 to businesses located outside of the Corporation’s market area, including $10,063,000 from participations in loans originated through the Corporation’s membership in a network that originates loans throughout the U.S. The Corporation’s participation loans originated through the network consist of loans to businesses that are larger than the Corporation’s typical commercial customer base. The loans originated through the network are considered “leveraged loans,” meaning the businesses typically have minimal tangible book equity and the extent of collateral available is limited, though at the time of origination the businesses have demonstrated strong cash flow performance in their recent histories. At December 31, 2017, total leveraged participation loans, including loans originated through the network and four loans to two borrowers originated through another lead institution, totaled $15,328,000, up slightly from $15,207,000 at December 31, 2016. At December 31, 2017, there was a leveraged loan with an outstanding balance of $324,000 classified as impaired with a specific allowance for loan losses of $96,000. With the exception of the loan identified in the preceding sentence, there were no loans classified as impaired at December 31, 2017 and 2016, and all of the leveraged loans (including the loan classified as impaired) were current as to payments of principal and interest as of December 31, 2017 and 2016.

 

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Table VIII presents loan maturity data as of December 31, 2017. The interest rate simulation model used to prepare Table VIII classifies certain loans under different categories from the categories that appear in Table VII. Fixed-rate loans are shown in Table VIII based on their contractually scheduled principal repayments, and variable-rate loans are shown based on the date of the next change in rate. Table VIII shows that fixed-rate loans are approximately 38% of the loan portfolio. Of the 62% of the portfolio made up of variable-rate loans, a significant portion (42%) will re-price after more than one year. Variable-rate loans re-pricing after more than one year include residential and commercial real estate secured loans. The Corporation’s substantial investment in long-term, fixed-rate loans and variable-rate loans with extended periods until re-pricing is one of the concerns management attempts to address through interest rate risk management practices. See Part II, Item 7A for a more detailed discussion of the Corporation’s interest rate risk.

 

Short-term borrowings totaled $61,766,000 at December 31, 2017, up from $26,175,000 at December 31, 2016. Within this category, overnight borrowing from FHLB-Pittsburgh of $29,000,000 was up from $21,000,000 at December 31, 2016. Also at December 31, 2017, the balance of short-term borrowings included a series of advances from FHLB-Pittsburgh totaling $29,000,000, including advances maturing monthly from January through October 2018 with a weighted average interest rate of 1.69% and rates ranging from 1.23% to 1.89%.

 

Long-term borrowings of $9,189,000 at December 31, 2017 were down from the balance at December 31, 2016 of $38,454,000. In 2017, the Corporation paid off two higher-cost borrowings totaling $37,000,000, including an advance from FHLB-Pittsburgh of $10,000,000 with a rate of 3.81% in October and repurchase agreements totaling $27,000,000 with a rate of 3.595% in December. Repayment of these borrowings was funded by advances from FHLB-Pittsburgh, including the short-term advances described above and an additional $8,000,000 of advances included in long-term borrowings at December 31, 2017. The advances included in long-term borrowings at December 31, 2017 had initial maturities of greater than one year, with varying maturities through February 2019 and interest rates ranging from 1.35% to 1.83%.

 

Other significant changes in the average balances of the Corporation’s earning assets and interest-bearing liabilities are described in the “Net Interest Income” section of Management’s Discussion and Analysis. Other significant balance sheet items, including securities, the allowance for loan losses and stockholders’ equity, are discussed in separate sections of Management’s Discussion and Analysis.

 

Total purchases of bank premises and equipment in 2018 are estimated at approximately $3.0 million. Management does not expect the amount of purchases of bank premises and equipment to have a material, detrimental effect on the Corporation’s financial condition in 2018.

 

Since 2009, the Corporation has originated and sold residential mortgage loans to the secondary market through the MPF Xtra program administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Residential mortgages originated and sold through the MPF Xtra program consist primarily of conforming, prime loans sold to the Federal National Mortgage Association (Fannie Mae), a quasi-government entity. In 2014, the Corporation began to originate and sell residential mortgage loans to the secondary market through the MPF Original program, which is also administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Residential mortgages originated and sold through the MPF Original program consist primarily of conforming, prime loans sold to the Federal Home Loan Bank of Pittsburgh.

 

For loan sales originated under the MPF Xtra and Original programs, the Corporation provides customary representations and warranties to investors that specify, among other things, that the loans have been underwritten to the standards established by the investor. The Corporation may be required to repurchase a loan and reimburse a portion of fees received, or reimburse the investor for a credit loss incurred on a loan, if it is determined that the representations and warranties have not been met. Such repurchases or reimbursements generally result from an underwriting or documentation deficiency. At December 31, 2017, the total outstanding balance of loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $1,805,000, and the corresponding total outstanding balance repurchased at December 31, 2016 was $1,852,000.

 

At December 31, 2017, outstanding balances of loans sold and serviced through the two programs totaled $169,725,000, including loans sold through the MPF Xtra program of $107,117,000 and loans sold through the Original program of $62,608,000. At December 31, 2016, outstanding balances of loans sold and serviced through the two programs totaled $163,296,000, including loans sold through the MPF Xtra program of $116,978,000 and loans sold through the Original Program of $46,318,000. Based on the fairly limited volume of required repurchases to date, no allowance has been established for representation and warranty exposures as of December 31, 2017 and December 31, 2016.

 

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For loans sold under the Original program, the Corporation provides a credit enhancement whereby the Corporation would assume credit losses in excess of a defined First Loss Account (“FLA”) balance, up to specified amounts. The FLA is funded by the Federal Home Loan Bank of Pittsburgh based on a percentage of the outstanding balance of loans sold. At December 31, 2017, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $5,742,000, and the Corporation has recorded a related allowance for credit losses in the amount of $260,000 which is included in “Accrued interest and other liabilities” in the accompanying consolidated balance sheets. At December 31, 2016, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $4,664,000, and the related allowance for credit losses was $196,000. The Corporation does not provide a credit enhancement for loans sold through the Xtra program.

 

TABLE VII - Five-year Summary of Loans by Type

(Dollars In Thousands)

 

   2017   %   2016   %   2015   %   2014   %   2013   % 
Residential mortgage:                                                  
Residential mortgage loans - first liens  $359,987    44.1   $334,102    44.4   $304,783    43.2   $291,882    46.3   $299,831    46.5 
Residential mortgage loans - junior liens   25,325    3.1    23,706    3.2    21,146    3.0    21,166    3.4    23,040    3.6 
Home equity lines of credit   35,758    4.4    38,057    5.1    39,040    5.5    36,629    5.8    34,530    5.4 
1-4 Family residential construction   26,216    3.2    24,908    3.3    21,121    3.0    16,739    2.7    13,909    2.2 
Total residential mortgage   447,286    54.8    420,773    56.0    386,090    54.8    366,416    58.1    371,310    57.6 
Commercial:                                                  
Commercial loans secured by real estate   159,266    19.5    150,468    20.0    154,779    22.0    145,878    23.1    147,215    22.8 
Commercial and industrial   88,276    10.8    83,854    11.2    75,196    10.7    50,157    8.0    42,387    6.6 
Political subdivisions   59,287    7.3    38,068    5.1    40,007    5.7    17,534    2.8    16,291    2.5 
Commercial construction   14,527    1.8    14,287    1.9    5,122    0.7    6,938    1.1    17,003    2.6 
Loans secured by farmland   7,255    0.9    7,294    1.0    7,019    1.0    7,916    1.3    10,468    1.6 
Multi-family (5 or more) residential   7,713    0.9    7,896    1.1    9,188    1.3    8,917    1.4    10,985    1.7 
Agricultural loans   6,178    0.8    3,998    0.5    4,671    0.7    3,221    0.5    3,251    0.5 
Other commercial loans   10,986    1.3    11,475    1.5    12,152    1.7    13,334    2.1    14,631    2.3 
Total commercial   353,488    43.3    317,340    42.2    308,134    43.7    253,895    40.3    262,231    40.7 
Consumer   14,939    1.8    13,722    1.8    10,656    1.5    10,234    1.6    10,762    1.7 
Total   815,713    100.0    751,835    100.0    704,880    100.0    630,545    100.0    644,303    100.0 
Less: allowance for loan losses   (8,856)        (8,473)        (7,889)        (7,336)        (8,663)     
Loans, net  $806,857        $743,362        $696,991        $623,209        $635,640      

 

TABLE VIII – LOAN MATURITY DISTRIBUTION

 

(In Thousands)  As of December 31, 2017 
         
   Fixed-Rate Loans   Variable- or Adjustable-Rate Loans 
   1 Year   1-5   >5       1 Year   1-5   >5     
   or Less   Years   Years   Total   or Less   Years   Years   Total 
Real Estate  $6,076   $25,336   $174,902   $206,314   $122,028   $172,436   $123,684   $418,148 
Commercial   12,724    34,971    40,389    88,084    55,832    29,152    3,511    88,495 
Consumer   1,842    9,589    3,188    14,619    45    0    8    53 
Total  $20,642   $69,896   $218,479   $309,017   $177,905   $201,588   $127,203   $506,696 

 

PROVISION AND ALLOWANCE FOR LOAN LOSSES

 

The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and recorded as a reduction of the investment in loans. Notes 1 and 8 to the consolidated financial statements provide an overview of the process management uses for evaluating and determining the allowance for loan losses.

 

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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.

 

The allowance for loan losses was $8,856,000 at December 31, 2017, up from $8,473,000 at December 31, 2016. Table X shows total specific allowances on impaired loans increased $605,000 to $1,279,000 at December 31, 2017 from $674,000 at December 31, 2016. The net increase in specific allowances in 2017 included an increase of $391,000 in the allowance related to one real estate secured commercial loan. The increase in the specific allowance for this loan was based on an updated appraisal received in 2017 as well as principal reductions from scheduled payments. At December 31, 2017, the outstanding balance of this loan was $2,641,000, and the related allowance was $919,000.

 

Table X also shows that the collectively determined portion of the allowance related to commercial loans decreased $295,000, to $3,078,000 at December 31, 2017 from $3,373,000 at December 31, 2016. The decrease in the collectively determined allowance on commercial loans resulted from an aggregate improvement (reduction) in the net charge-off experience and qualitative factors used to value the allowance on commercial loans, partially offset by the impact of an increase in outstanding loans. The aggregate net charge-off experience factor used in the allowance calculation on commercial loans was 0.09% lower at December 31, 2017 as compared to December 31, 2016. The Corporation’s aggregate net charge-off rate on commercial loans has been improving over the past several quarters, as the effects on the overall rate of a large ($1,486,000) charge-off in 2014 on a commercial loan secured by real estate has gradually diminished. The qualitative factors used in the allowance calculation for commercial loans were 0.07% lower at December 31, 2017 as compared to December 31, 2016, reflecting a pattern of overall improvement in loan delinquency levels and a reduction in the unemployment rate throughout most of the Corporation’s market area over the previous 12-18 months.

 

Throughout 2016 and at March 31, 2017, a rolling three-year average net charge-off rate was used for all loan classes. Beginning with the quarter ending June 30, 2017, a five-year average net charge-off rate was used for commercial loans secured by real estate and for multi-family residential loans, while a three-year average net charge-off rate was used for all other loan classes. The change in time period for these two loan classes was based on management’s evaluation of an appropriate time period that captures an historical loss experience relevant to the current portfolio.

 

The provision for loan losses by segment for 2017, 2016 and 2015 is as follows:

 

(In Thousands)            
   2017   2016   2015 
Residential mortgage  $251   $542   $(19)
Commercial   316    687    816 
Consumer   133    21    16 
Unallocated   101    (29)   32 
Total  $801   $1,221   $845 

 

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The provision for loan losses for the two largest lending segments, Residential mortgage and Commercial, is further detailed as follows:

 

Residential mortgage segment            
(In thousands)            
   2017   2016   2015 
Increase (decrease) in total specific allowance on impaired loans, adjusted for the effect of net charge-offs  $300   $69   $(141)
                
Increase (decrease) in collectively determined portion of the allowance attributable to:               
Loan growth   233    325    196 
Changes in historical loss experience factors   (53)   (6)   (111)
Changes in qualitative factors   (229)   154    37 
               
Total provision (credit) for loan losses - Residential mortgage segment  $251   $542   $(19)

 

Commercial segment            
(In thousands)            
   2017   2016   2015 
Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs  $611   $417   $445 
                
Increase (decrease) in collectively determined portion of the allowance attributable to:               
Loan growth   183    114    437 
Changes in historical loss experience factors   (268)   75    (42)
Changes in qualitative factors   (210)   81    (24)
               
Total provision for loan losses - Commercial segment  $316   $687   $816 

 

For each year shown in the table immediately above, the provision related to increases or decreases in specific allowances on impaired loans was affected by changes in the results of management’s assessment of the amount of probable or actual (charged-off) losses associated with a small number of larger, individual loans. This line item also includes net charge-offs or recoveries from smaller loans that had not been individually evaluated for impairment prior to charge-off.

 

In the table immediately above, the portion of the net change in the collectively determined allowance attributable to loan growth was determined by applying the historical loss experience and qualitative factors used in the allowance calculation at the end of the preceding year to the net increase in loans outstanding (excluding loans specifically evaluated for impairment) for the year. The table shows that the provision for both the Residential mortgage and Commercial segments included the effects of loan growth in 2017, 2016 and 2015.

 

The effect on the provision of changes in historical loss experience and qualitative factors, as shown in the table above, was determined by: (1) calculating the net change in each factor used in determining the allowance at the end of the year as compared to the preceding year, and (2) applying the net change in each factor to the outstanding balance of loans at the end of the preceding year (excluding loans specifically evaluated for impairment).

 

As discussed above, the Corporation’s overall net charge-off experience has improved in 2017, consistent with the reductions in the provision for both the Residential mortgage and Commercial segments. Table XII shows the average rate of net charge-offs as a percentage of loans was 0.05% in 2017, with an average over the five-year period ended December 31, 2017 of 0.10%, and annual average rates ranging from lows of 0.04% in 2013 and 2015 to a high of 0.29% in 2014.

 

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The table above also shows the provision for both the Residential mortgage and Commercial segments in 2017 was reduced by the effect of a reduction in qualitative factors. As discussed above, the reduced qualitative factors is consistent with the overall pattern of improving loan delinquency and charge-off levels and an improved local economy as evidenced by a reduction in the unemployment rate throughout most of the Corporation’s market area. In 2016, the provision for both the Residential mortgage and Commercial segments included the effect of slight increases in qualitative factors.

 

Table XI presents information related to past due and impaired loans, and loans that have been modified under terms that are considered troubled debt restructurings (TDRs). Total nonperforming loans as a percentage of outstanding loans was 2.10% at December 31, 2017, up slightly from 2.07% at December 31, 2016. Nonperforming assets as a percentage of total assets was 1.47% at December 31, 2017, also up slightly from 1.43% at December 31, 2016. Table XI presents data at the end of each of the years ended December 31, 2013 through 2017. For the range of dates presented in Table XI, total nonperforming loans as a percentage of loans has ranged from a low of 2.07% at December 31, 2016 to a high of 2.80% at December 31, 2013, and total nonperforming assets as a percentage of assets has ranged from a low of 1.31% at December 31, 2015 to a high of 1.53% at December 31, 2013.

 

Total impaired loans of $9,511,000 at December 31, 2017, are down $1,349,000 from the corresponding amount at December 31, 2016 of $10,860,000. Table XI shows that over the period 2013-2017, the year-end total outstanding balance of impaired loans has ranged from a low of $9,511,000 in 2017 to a high of $16,321,000 in 2013.

 

Total nonperforming assets of $18,726,000 at December 31, 2017 are up $972,000 from the corresponding amount at December 31, 2016. The total amount of nonperforming assets exceeds the amount of total impaired loans because the nonperforming category includes, in addition to impaired loans, foreclosed assets held for sale and loans 90 days or more past due or in nonaccrual status with outstanding balances lower than the minimum amounts that are individually evaluated for impairment. A summary of changes in the components of nonperforming assets at December 31, 2017 as compared to December 31, 2016 is as follows:

 

·Nonaccrual loans totaled $13,404,000 at December 31, 2017, up from $8,736,000 at December 31, 2016. The net increase in nonaccrual loans included the effect of classifying a commercial loan with a recorded investment of $2,811,000 at December 31, 2017 as nonaccrual in 2017. The increase also included the effect of an increase in total residential mortgage loans in nonaccrual status to $5,417,000 at December 31, 2017 from $3,781,000 at December 31, 2016.

 

·Total loans past due 90 days or more and still accruing interest amounted to $3,724,000 at December 31, 2017, a decrease of $3,114,000 from $6,838,000 at December 31, 2016. The decrease in 2017 in the balance of loans past due 90 days or more and still accruing interest included the commercial loan described above moving to nonaccrual status. At December 31, 2017, total residential mortgage loans that were more than 90 days past due but deemed to be well secured and in the process of collection amounted to $2,648,000, down from $3,456,000 at December 31, 2016. The Corporation reviews the status of loans past due 90 days or more each quarter to determine if it is appropriate to continue to accrue interest, and has determined the loans included in this category are well secured and that ultimate collection of all principal and interest is probable.

 

·Foreclosed assets held for sale consisted of real estate, and totaled $1,598,000 at December 31, 2017, a decrease of $582,000 from $2,180,000 at December 31, 2016. At December 31, 2017, the Corporation held 16 such properties for sale, with total carrying values of $721,000 related to residential real estate, $632,000 of land and $245,000 related to commercial real estate. At December 31, 2016, the Corporation held 19 such properties for sale, with total carrying values of $1,102,000 related to residential real estate, $650,000 of land and $428,000 related to commercial real estate. The Corporation evaluates the carrying values of foreclosed assets each quarter based on the most recent market activity or appraisals for each property.

 

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As shown in Table XI, loans classified as TDRs decreased to $3,663,000 at December 31, 2017 from $8,677,000 at December 31, 2016. The decrease resulted primarily from removing one commercial relationship from TDR status in 2017. At December 31, 2017, the outstanding contractual balances of loans to this borrower totaled $6,425,000, and the recorded investments totaled $4,593,000. In 2014, the Corporation entered into a forbearance agreement with this commercial borrower which was extended for two additional twelve-month periods, most recently in July 2016. The Corporation recorded a charge-off of $1,486,000 in 2014 as a result of these modifications, as the payment amounts based on the forbearance agreement were not sufficient to fully amortize the contractual amount of principal outstanding on the loans. In December 2016, the Corporation and the borrower entered into a modification agreement, terminating the forbearance agreement and establishing loan terms with essentially the same interest rate and monthly payment amounts as had been in effect under the forbearance agreement. The interest rates provided for in the modification agreement were equal to or greater than rates the Corporation would be willing to accept for loans with comparable terms to borrowers with a comparable risk profile at the time of modification. The borrower has made all required payments on the loans in accordance with the terms of the forbearance agreement, as extended, and the modification agreement. Accordingly, the loans were restored to full accrual status at December 31, 2016 and are no longer included in the amounts reported as TDRs at December 31, 2017. Table XI shows that over the period 2013-2017, the year-end total outstanding balance of TDRs has ranged from a low of $3,663,000 in 2017 to a high of $8,677,000 in 2016.

 

Over the period 2013-2017, each period includes a few large commercial relationships that have required significant monitoring and workout efforts. As a result, a limited number of relationships may significantly impact the total amount of allowance required on impaired loans, and may significantly impact the amount of total charge-offs reported in any one period.

 

Management believes it has been conservative in its decisions concerning identification of impaired loans, estimates of loss, and nonaccrual status; however, the actual losses realized from these relationships could vary materially from the allowances calculated as of December 31, 2017. Management continues to closely monitor its commercial loan relationships for possible credit losses, and will adjust its estimates of loss and decisions concerning nonaccrual status, if appropriate.

 

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

 

TABLE IX - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES

 

(Dollars In Thousands)      Years Ended December 31,     
   2017   2016   2015   2014   2013 
Balance, beginning of year  $8,473   $7,889   $7,336   $8,663   $6,857 
Charge-offs:                         
Residential mortgage   (197)   (73)   (217)   (327)   (95)
Commercial   (132)   (597)   (251)   (1,715)   (459)
Consumer   (150)   (87)   (94)   (97)   (117)
Total charge-offs   (479)   (757)   (562)   (2,139)   (671)
Recoveries:                         
Residential mortgage   19    3    1    25    24 
Commercial   4    35    214    264    348 
Consumer   38    82    55    47    58 
Total recoveries   61    120    270    336    430 
Net charge-offs   (418)   (637)   (292)   (1,803)   (241)
Provision for loan losses   801    1,221    845    476    2,047 
Balance, end of period  $8,856   $8,473   $7,889   $7,336   $8,663 
                          
Net charge-offs as a % of average loans   0.05%   0.09%   0.04%   0.29%   0.04%

 

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TABLE X - COMPONENTS OF THE ALLOWANCE FOR LOAN LOSSES

 

(In Thousands)                    
   As of December 31, 
   2017   2016   2015   2014   2013 
ASC 310 - Impaired loans  $1,279   $674   $820   $769   $2,333 
ASC 450 - Collective segments:                         
Commercial   3,078    3,373    3,103    2,732    2,583 
Residential mortgage   3,841    3,890    3,417    3,295    3,156 
Consumer   159    138    122    145    193 
Unallocated   499    398    427    395    398 
Total Allowance  $8,856   $8,473   $7,889   $7,336   $8,663 

 

TABLE XI  - PAST DUE AND IMPAIRED LOANS, NONPERFORMING ASSETS        
AND TROUBLED DEBT RESTRUCTURINGS (TDRs)                    
(Dollars In Thousands)                    
   As of December 31, 
   2017   2016   2015   2014   2013 
Impaired loans with a valuation allowance  $4,100   $3,372   $1,933   $3,241   $9,889 
Impaired loans without a valuation allowance   5,411    7,488    8,041    9,075    6,432 
Total impaired loans  $9,511   $10,860   $9,974   $12,316   $16,321 
Total loans past due 30-89 days and still accruing  $9,449   $7,735   $7,057   $7,121   $8,305 
                          
Nonperforming assets:                         
Total nonaccrual loans  $13,404   $8,736   $11,517   $12,610   $14,934 
Total loans past due 90 days or more and still accruing   3,724    6,838    3,229    2,843    3,131 
Total nonperforming loans   17,128    15,574    14,746    15,453    18,065 
Foreclosed assets held for sale (real estate)   1,598    2,180    1,260    1,189    892 
Total nonperforming assets  $18,726   $17,754   $16,006   $16,642   $18,957 
                          
Loans subject to troubled debt restructurings (TDRs):                         
Performing  $636   $5,803   $1,186   $1,807   $3,267 
Nonperforming   3,027    2,874    5,178    5,388    908 
Total TDRs  $3,663   $8,677   $6,364   $7,195   $4,175 
                          
Total nonperforming loans as a % of loans   2.10%   2.07%   2.09%   2.45%   2.80%
Total nonperforming assets as a % of assets   1.47%   1.43%   1.31%   1.34%   1.53%
Allowance for loan losses as a % of total loans   1.09%   1.13%   1.12%   1.16%   1.34%
Allowance for loan losses as a % of nonperforming loans   51.70%   54.40%   53.50%   47.47%   47.95%

 

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TABLE XII - FIVE-YEAR HISTORY OF LOAN LOSSES                
(Dollars In Thousands)                        
   2017   2016   2015   2014   2013   Average 
Average gross loans  $780,640   $723,076   $657,727   $627,753   $656,495   $689,138 
Year-end gross loans   815,713    751,835    704,880    630,545    644,303   $709,455 
Year-end allowance for loan losses   8,856    8,473    7,889    7,336    8,663   $8,243 
Year-end nonaccrual loans   13,404    8,736    11,517    12,610    14,934   $12,240 
Year-end loans 90 days or more past due and still accruing   3,724    6,838    3,229    2,843    3,131    3,953 
Net charge-offs   418    637    292    1,803    241    678 
Provision for loan losses   801    1,221    845    476    2,047    1,078 
Earnings coverage of charge-offs   56x   37x   85x   14x   116x   37x
Allowance coverage of charge-offs   21x   13x   27x   4x   36x   12x
Net charge-offs as a % of provision for loan losses   52.18%   52.17%   34.56%   378.78%   11.77%   62.89%
Net charge-offs as a % of average gross loans   0.05%   0.09%   0.04%   0.29%   0.04%   0.10%
Income before income taxes on a fully taxable equivalent basis   23,350    23,861    24,710    25,784    28,012    25,143 

 

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

 

Table XIII presents the Corporation’s significant fixed and determinable contractual obligations as of December 31, 2017 by payment date. The payment amounts represent the principal amounts of time deposits and borrowings and do not include interest.

 

TABLE XIII – CONTRACTUAL OBLIGATIONS

(In Thousands)

 

   1 Year   1-3   3-5   Over 5     
   or Less   Years   Years   Years   Total 
Time deposits  $112,563   $79,933   $18,459   $2,716   $213,671 
Short-term borrowings:                         
Federal Home Loan Bank of Pittsburgh   58,000    0    0    0    58,000 
Customer repurchase agreements   3,766    0    0    0    3,766 
Long-term borrowings:                         
Federal Home Loan Bank of Pittsburgh   6,000    2,463    0    726    9,189 
Total  $180,329   $82,396   $18,459   $3,442   $284,626 

 

In addition to the amounts described in Table XIII, the Corporation has obligations related to deposits without a stated maturity with outstanding principal balances totaling $794,778,000 at December 31, 2017.

 

The Corporation’s operating lease and other commitments at December 31, 2017 are immaterial. The Corporation’s significant off-balance sheet arrangements include commitments to extend credit and standby letters of credit. Off-balance sheet arrangements are described in Note 16 to the consolidated financial statements.

 

As described in more detail in the “Financial Condition” section of Management’s Discussion and Analysis, the Corporation sells residential mortgage loans for which the Corporation provides customary representations and warranties to investors that specify, among other things, that the loans have been underwritten to the standards established by the investor. The Corporation may be required to repurchase a loan and reimburse a portion of fees received, or reimburse the investor for a credit loss incurred on a loan, if it is determined that the representations and warranties have not been met. At December 31, 2017, outstanding balances of such loans sold totaled $169,725,000.

 

Also, for loans sold under the MPF Original program, the Corporation provides a credit enhancement. At December 31, 2017, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $5,742,000, and the Corporation has recorded a related allowance for credit losses in the amount of $260,000 which is included in “Accrued interest and other liabilities” in the accompanying consolidated balance sheets.

 

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LIQUIDITY

 

Liquidity is the ability to quickly raise cash at a reasonable cost. An adequate liquidity position permits the Corporation to pay creditors, compensate for unforeseen deposit fluctuations and fund unexpected loan demand. At December 31, 2017, the Corporation maintained overnight interest-bearing deposits with the Federal Reserve Bank of Philadelphia and other correspondent banks totaling $11,340,000.

 

The Corporation maintains overnight borrowing facilities with several correspondent banks that provide a source of day-to-day liquidity. Also, the Corporation maintains borrowing facilities with the Federal Home Loan Bank of Pittsburgh, secured by various mortgage loans.

 

The Corporation has a line of credit with the Federal Reserve Bank of Philadelphia’s Discount Window. Management intends to use this line of credit as a contingency funding source. As collateral for the line, the Corporation has pledged available-for-sale securities with a carrying value of $16,301,000 at December 31, 2017.

 

The Corporation’s outstanding, available, and total credit facilities at December 31, 2017 and 2016 are as follows:

 

   Outstanding   Available   Total Credit 
(In Thousands)  Dec. 31,   Dec. 31,   Dec. 31,   Dec. 31,   Dec. 31,   Dec. 31, 
   2017   2016   2017   2016   2017   2016 
Federal Home Loan Bank of Pittsburgh  $67,189   $32,454   $295,441   $306,767   $362,630   $339,221 
Federal Reserve Bank Discount Window   0    0    15,877    15,636    15,877    15,636 
Other correspondent banks   0    0    45,000    45,000    45,000    45,000 
Total credit facilities  $67,189   $32,454   $356,318   $367,403   $423,507   $399,857 

 

At December 31, 2017, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowings of $29,000,000, short-term borrowings of $29,000,000 and long-term borrowings with a total amount of $9,189,000. At December 31, 2016, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowings of $21,000,000 and long-term borrowings with a total amount of $11,454,000. Additional information regarding borrowed funds is included in Note 12 to the consolidated financial statements.

 

Additionally, the Corporation uses repurchase agreements placed with brokers to borrow funds secured by investment assets and “RepoSweep” arrangements to borrow funds from commercial banking customers on an overnight basis. If required to raise cash in an emergency situation, the Corporation could sell available-for-sale securities to meet its obligations. At December 31, 2017, the carrying value of available-for-sale securities in excess of amounts required to meet pledging or repurchase agreement obligations was $196,810,000.

 

Management believes the Corporation is well-positioned to meet its short-term and long-term obligations.

 

STOCKHOLDERS’ EQUITY AND CAPITAL ADEQUACY

 

The Corporation and C&N Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Details concerning regulatory capital amounts and ratios are presented in Note 18 to the consolidated financial statements. As reflected in Note 18, at December 31, 2017 and 2016, the Corporation and C&N Bank meet all capital adequacy requirements to which they are subject and maintain capital conservation buffers that allow the Corporation and C&N Bank to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to certain executive officers.

 

In July 2013, the federal regulatory authorities issued a new capital rule based, in part, on revisions developed by the Basel Committee on Banking Supervision to the Basel capital framework (Basel III). The Corporation and C&N Bank were subject to the new rule on January 1, 2015. Generally, the new rule implements higher minimum capital requirements, revises the definition of regulatory capital components and related calculations, adds a new common equity tier 1 capital ratio, implements a new capital conservation buffer, increases the risk weighting for past due loans and provides a transition period for several aspects of the new rule.

 

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The current (new) capital rule provides that, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of common equity tier 1 capital above its minimum risk-based capital requirements. The buffer is measured relative to risk-weighted assets and is added to the minimum required risk-based capital ratios (as defined) for common equity tier 1 capital, tier 1 capital and total capital. The minimum capital conservation buffer needed in 2017 in order to fully avoid limitations on capital distributions, along with the remaining transition schedule, is as follows:

 

   As of January 1: 
   2017   2018   2019 
Common equity tier 1 capital conservation buffer   1.25%   1.875%   2.5%

 

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

 

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

 

At December 31, 2017, the Corporation’s Capital Conservation Buffer, determined based on the minimum total capital ratio, was 15.07%. C&N Bank’s Capital Conservation Buffer (also determined based on the minimum total capital ratio) was 12.47%.

 

Future dividend payments will depend upon maintenance of a strong financial condition, future earnings and capital and regulatory requirements. In addition, the Corporation and C&N Bank are subject to restrictions on the amount of dividends that may be paid without approval of banking regulatory authorities. These restrictions are described in Note 18 to the consolidated financial statements.

 

Management expects the Corporation and C&N Bank to maintain capital levels that exceed the regulatory standards for well-capitalized institutions for the next 12 months and for the foreseeable future. Planned capital expenditures are not expected to have a significantly detrimental effect on capital ratios.

 

The Corporation’s total stockholders’ equity is affected by fluctuations in the fair values of available-for-sale securities. The difference between amortized cost and fair value of available-for-sale securities, net of deferred income tax, is included in Accumulated Other Comprehensive Income (Loss) within stockholders’ equity. The balance in Accumulated Other Comprehensive Income (Loss) related to unrealized gains (losses) on available-for-sale securities, net of deferred income tax, amounted to ($1,566,000) at December 31, 2017, ($949,000) at December 31, 2016 and $2,493,000 at December 31, 2015. Changes in accumulated other comprehensive income (loss) are excluded from earnings and directly increase or decrease stockholders’ equity. If available-for-sale securities are deemed to be other-than-temporarily impaired, unrealized losses are recorded as a charge against earnings, and amortized cost for the affected securities is reduced. Note 7 to the consolidated financial statements provides additional information concerning management’s evaluation of available-for-sale securities for other-than-temporary impairment at December 31, 2017.

 

Stockholders’ equity is also affected by the underfunded or overfunded status of defined benefit pension and postretirement plans. The balance in Accumulated Other Comprehensive Income (Loss) related to defined benefit plans, net of deferred income tax, was $59,000 at December 31, 2017, $51,000 at December 31, 2016 and $35,000 at December 31, 2015.

 

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COMPREHENSIVE INCOME

 

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

 

Comprehensive Income totaled $12,825,000 in 2017 as compared to $12,336,000 in 2016 and $13,639,000 in 2015. In 2017, Comprehensive Income included: (1) Net Income of $13,434,000, which was $2,328,000 lower than in 2016 and $3,037,000 lower than in 2015; (2) Other Comprehensive Loss from unrealized losses on available-for-sale securities, net of deferred income tax, of ($617,000) as compared to Other Comprehensive Loss of ($3,442,000) in 2016 and Other Comprehensive Loss of ($2,788,000) in 2015; and (3) Other Comprehensive Income from defined benefit plans of $8,000 in 2017 as compared to Other Comprehensive Income of $16,000 in 2016 and Other Comprehensive Loss of ($44,000) in 2015. Fluctuations in interest rates significantly affected fair values of available-for-sale securities in 2015 through 2017, and accordingly had an effect on Other Comprehensive Income (Loss) in each year.

 

INFLATION

 

The Corporation is significantly affected by the Federal Reserve Board’s efforts to control inflation through changes in short-term interest rates. Since September 2007, the Federal Reserve has maintained the fed funds target rate at extremely low levels by historical standards. Further, throughout the period of low interest rates, the Federal Reserve has injected massive amounts of liquidity into the nation’s monetary system through a variety of programs. Since late 2015, the Federal Reserve has begun to move its fed funds target rate higher, in an effort to re-establish a more normalized level by historical standards, with 0.25% increases in December 2015 and 2016, March 2017, June 2017 and December 2017, resulting in the current range of 1.25% to 1.50%. Inflation has remained subdued, measured for most of 2016 and through 2017 at levels below the Federal Open Market Committee’s 2% longer run objective, though there have been some reports of wage pressure as the U.S. employment picture has gradually improved over the past several years.

 

Although management cannot predict future changes in the rates of inflation, management monitors the impact of economic trends, including any indicators of inflationary pressures, in managing interest rate and other financial risks.

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

See Note 2 to the consolidated financial statements for a description of recent accounting pronouncements and their recent or potential future effects on the Corporation’s financial statements.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

MARKET RISK

 

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

 

The Corporation’s major category of market risk, interest rate risk, is discussed in the following section.

 

INTEREST RATE RISK

 

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

 

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The Corporation uses a simulation model to calculate the potential effects of interest rate fluctuations on net interest income and the market value of portfolio equity. For purposes of these calculations, the market value of portfolio equity includes the fair values of financial instruments, such as securities, loans, deposits and borrowed funds, and the book values of nonfinancial assets and liabilities, such as premises and equipment and accrued expenses. The model measures and projects potential changes in net interest income, and calculates the discounted present value of anticipated cash flows of financial instruments, assuming an immediate increase or decrease in interest rates. Management ordinarily runs a variety of scenarios within a range of plus or minus 100-400 basis points of current rates.

 

The model makes estimates, at each level of interest rate change, regarding cash flows from principal repayments on loans and mortgage-backed securities and call activity on other investment securities. Actual results could vary significantly from these estimates, which could result in significant differences in the calculations of projected changes in net interest income and market value of portfolio equity. Also, the model does not make estimates related to changes in the composition of the deposit portfolio that could occur due to rate competition, and the table does not necessarily reflect changes that management would make to realign the portfolio as a result of changes in interest rates.

 

The Corporation’s Board of Directors has established policy guidelines for acceptable levels of interest rate risk, based on an immediate increase or decrease in interest rates. The policy limits acceptable fluctuations in net interest income from the baseline (flat rates) one-year scenario and variances in the market value of portfolio equity from the baseline values based on current rates.

 

Table XIV, which follows this discussion, is based on the results of calculations performed using the simulation model as of December 31, 2017 and 2016. Table XIV reflects two significant changes to the analysis using December 31, 2017 data as compared to the analysis based on December 31, 2016 data, as follows:

 

·Management lowered assumptions of sensitivity of market interest rate changes on some types of the Corporation’s deposits. This change resulted in a reduction in the amount of increase in interest expense in the rising rate scenarios presented in Table XIV. The reduction in estimated sensitivity was based on data showing the Corporation’s prior sensitivity assumptions were higher than may be expected based on industry norms.

 

·The policy limits for present value of equity volatility were lowered based on a determination that the prior levels were so high they would be unlikely to be approached, thereby limiting their effectiveness as a tool for timely identification of long-term interest rate risk.

 

Table XIV shows that as of the respective dates, the changes in net interest income and changes in market value were within the policy limits in all scenarios.

 

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TABLE XIV - THE EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES

 

December 31, 2017 Data        
(Dollars In Thousands) Period Ending December 31, 2018  

 

Basis Point  Interest   Interest   Net Interest   NII   NII 
Change in Rates  Income   Expense   Income (NII)   % Change   Risk Limit 
+400  $57,619   $19,730   $37,889    -10.8%   25.0%
+300   54,978    15,852    39,126    -7.9%   20.0%
+200   52,334    11,974    40,360    -5.0%   15.0%
+100   49,620    8,095    41,525    -2.2%   10.0%
0   46,717    4,243    42,474    0.0%   0.0%
-100   43,581    2,781    40,800    -3.9%   10.0%
-200   41,290    2,216    39,074    -8.0%   15.0%
-300   40,463    2,191    38,272    -9.9%   20.0%
-400   40,194    2,191    38,003    -10.5%   25.0%

 

Market Value of Portfolio Equity at December 31, 2017

 

   Present   Present   Present 
Basis Point  Value   Value   Value 
Change in Rates  Equity   % Change   Risk Limit 
+400  $195,385    -16.8%   40.0%
+300   203,648    -13.3%   30.0%
+200   213,689    -9.0%   25.0%
+100   224,389    -4.4%   15.0%
0   234,759    0.0%   0.0%
-100   236,030    0.5%   15.0%
-200   234,863    0.0%   25.0%
-300   252,464    7.5%   30.0%
-400   292,124    24.4%   40.0%

 

December 31, 2016 Data          
(Dollars In Thousands)   Period Ending December 31, 2017  

 

Basis Point  Interest   Interest   Net Interest   NII   NII 
Change in Rates  Income   Expense   Income (NII)   % Change   Risk Limit 
+400  $53,712   $22,315   $31,397    -20.5%   25.0%
+300   51,128    17,545    33,583    -15.0%   20.0%
+200   48,500    12,809    35,691    -9.6%   15.0%
+100   45,845    8,102    37,743    -4.4%   10.0%
0   43,132    3,643    39,489    0.0%   0.0%
-100   40,581    2,978    37,603    -4.8%   10.0%
-200   38,881    2,949    35,932    -9.0%   15.0%
-300   38,269    2,936    35,333    -10.5%   20.0%
-400   38,104    2,936    35,168    -10.9%   25.0%

 

Market Value of Portfolio Equity at December 31, 2016

 

   Present   Present   Present 
Basis Point  Value   Value   Value 
Change in Rates  Equity   % Change   Risk Limit 
+400  $168,600    -24.6%   50.0%
+300   180,500    -19.3%   45.0%
+200   194,471    -13.1%   35.0%
+100   208,830    -6.7%   25.0%
0   223,744    0.0%   0.0%
-100   227,806    1.8%   25.0%
-200   229,602    2.6%   35.0%
-300   252,118    12.7%   45.0%
-400   290,792    30.0%   50.0%

 

 40 

 

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA        
CONSOLIDATED BALANCE SHEETS        
         
(In Thousands, Except Share and Per Share Data)  December 31,   December 31, 
   2017   2016 
ASSETS          
Cash and due from banks:          
Noninterest-bearing  $25,664   $17,551 
Interest-bearing   14,580    14,558 
Total cash and due from banks   40,244    32,109 
Available-for-sale securities, at fair value   356,908    395,077 
Loans held for sale   765    142 
           
Loans receivable   815,713    751,835 
Allowance for loan losses   (8,856)   (8,473)
Loans, net   806,857    743,362 
           
Bank-owned life insurance   20,083    19,704 
Accrued interest receivable   4,048    3,963 
Bank premises and equipment, net   15,432    15,397 
Foreclosed assets held for sale   1,598    2,180 
Deferred tax asset, net   3,289    5,117 
Intangible assets - Goodwill and core deposit intangibles   11,954    11,959 
Other assets   15,781    13,282 
TOTAL ASSETS  $1,276,959   $1,242,292 
           
LIABILITIES          
Deposits:          
Noninterest-bearing  $241,214   $224,175 
Interest-bearing   767,235    759,668 
Total deposits   1,008,449    983,843 
Short-term borrowings   61,766    26,175 
Long-term borrowings   9,189    38,454 
Accrued interest and other liabilities   9,112    7,812 
TOTAL LIABILITIES   1,088,516    1,056,284 
           
STOCKHOLDERS’ EQUITY          
Preferred stock, $1,000 par value; authorized 30,000 shares; $1,000 liquidation
preference per share; no shares issued
   0    0 
Common stock, par value $1.00 per share; authorized 20,000,000 shares;
issued 12,655,171; outstanding 12,214,525 at December 31, 2017 and
12,113,228 December 31, 2016
   12,655    12,655 
Paid-in capital   72,035    71,730 
Retained earnings   113,608    112,790 
Treasury stock, at cost; 440,646 shares at December 31, 2017 and 541,943 shares at December 31, 2016   (8,348)   (10,269)
Accumulated other comprehensive loss   (1,507)   (898)
TOTAL STOCKHOLDERS’ EQUITY   188,443    186,008 
TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY  $1,276,959   $1,242,292 

 

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

 

 41 

 

 

Consolidated Statements of Income        
         
(In Thousands Except Per Share Data)  Years Ended December 31, 
  2017   2016   2015 
INTEREST INCOME            
Interest and fees on loans:               
Taxable  $34,907   $32,827   $31,311 
Tax-exempt   2,037    1,783    1,668 
Interest on mortgages held for sale   25    27    16 
Interest on balances with depository institutions   190    116    93 
Income from available-for-sale securities:               
Taxable   5,478    5,846    7,303 
Tax-exempt   3,205    3,429    3,844 
Dividends   21    70    284 
Total interest and dividend income   45,863    44,098    44,519 
INTEREST EXPENSE               
Interest on deposits   2,403    2,085    1,924 
Interest on short-term borrowings   213    155    32 
Interest on long-term borrowings   1,299    1,453    2,646 
Total interest expense   3,915    3,693    4,602 
Net interest income   41,948    40,405    39,917 
Provision for loan losses   801    1,221    845 
Net interest income after provision for loan losses   41,147    39,184    39,072 
OTHER INCOME               
Service charges on deposit accounts   4,488    4,695    4,864 
Service charges and fees   417    439    494 
Trust and financial management revenue   5,399    4,760    4,626 
Brokerage revenue   797    756    839 
Insurance commissions, fees and premiums   115    102    109 
Interchange revenue from debit card transactions   2,221    1,943    1,935 
Net gains from sale of loans   818    1,029    735 
Loan servicing fees, net   244    103    216 
Increase in cash surrender value of life insurance   379    382    386 
Other operating income   1,275    1,302    1,274 
Sub-total   16,153    15,511    15,478 
Realized gains on available-for-sale securities, net   257    1,158    2,861 
Total other income   16,410    16,669    18,339 
OTHER EXPENSES               
Salaries and wages   15,806    15,411    14,682 
Pensions and other employee benefits   5,374    4,717    4,420 
Occupancy expense, net   2,340    2,340    2,574 
Furniture and equipment expense   1,834    1,730    1,860 
FDIC Assessments   376    488    603 
Pennsylvania shares tax   1,329    1,274    1,248 
Professional fees   1,086    1,126    638 
Automated teller machine and interchange expense   1,284    1,137    988 
Software subscriptions   1,190    981    876 
Loss on prepayment of debt   0    0    2,573 
Other operating expense   6,348    5,540    5,141 
Total other expenses   36,967    34,744    35,603 
Income before income tax provision   20,590    21,109    21,808 
Income tax provision   7,156    5,347    5,337 
NET INCOME  $13,434   $15,762   $16,471 
EARNINGS PER COMMON SHARE - BASIC  $1.10   $1.30   $1.35 
EARNINGS PER COMMON SHARE - DILUTED  $1.10   $1.30   $1.35 

 

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

 

 42 

 

 

Consolidated Statements of Comprehensive Income        
         
(In Thousands) Years Ended December 31,
   2017   2016   2015 
Net income  $13,434   $15,762   $16,471 
                
Unrealized losses on available-for-sale securities:               
Unrealized holding losses on available-for-sale securities   (691)   (4,138)   (1,429)
Reclassification adjustment for gains realized in income   (257)   (1,158)   (2,861)
Other comprehensive loss on available-for-sale securities   (948)   (5,296)   (4,290)
                
Unfunded pension and postretirement obligations:               
Changes from plan amendments and actuarial gains and losses
included in accumulated other comprehensive gain (loss)
   36    46    (135)
Amortization of net transition obligation, prior service cost, net
actuarial (gain) loss and loss on settlement included in
net periodic benefit cost
   (24)   (22)   67 
Other comprehensive gain (loss) on unfunded retirement obligations   12    24    (68)
                
Other comprehensive loss before income tax   (936)   (5,272)   (4,358)
Income tax related to other comprehensive loss   327    1,846    1,526 
                
Net other comprehensive loss   (609)   (3,426)   (2,832)
                
Comprehensive income  $12,825   $12,336   $13,639 
                

 

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

 

 43 

 

 

Consolidated Statements of Changes in Stockholders’ Equity

(In Thousands Except Share and Per Share Data)                  Accumulated         
                       Other         
                       Comprehensive         
   Common   Treasury   Common   Paid-in   Retained   Income   Treasury     
   Shares   Shares   Stock   Capital   Earnings   (Loss)   Stock   Total 
                                 
Balance, January 1, 2015   12,655,171    375,191   $12,655   $71,541   $105,550   $5,360   ($6,744)  $188,362 
Net income                       16,471              16,471 
Other comprehensive loss, net                            (2,832)        (2,832)
Cash dividends declared on common stock, $1.04 per share                       (12,710)             (12,710)
Shares issued for dividend reinvestment plan        (73,810)        86              1,379    1,465 
Treasury stock purchased        226,900                        (4,415)   (4,415)
Shares issued from treasury related to exercise of stock options        (22,435)        (27)             408    381 
Restricted stock granted        (34,800)        (627)             627    0 
Forfeiture of restricted stock        3,502         59              (59)   0 
Stock-based compensation expense                  606                   606 
Tax benefit from compensation plans                  16    143              159 
Balance, December 31, 2015   12,655,171    474,548    12,655    71,654    109,454    2,528    (8,804)   187,487 
Net income                       15,762              15,762 
Other comprehensive loss, net                            (3,426)        (3,426)
Cash dividends declared on common stock, $1.04 per share                       (12,578)             (12,578)
Shares issued for dividend reinvestment plan        (68,571)        170              1,296    1,466 
Treasury stock purchased        187,300                        (3,723)   (3,723)
Shares issued from treasury related to exercise of stock options        (19,113)        (98)             361    263 
Restricted stock granted        (35,427)        (658)             658    0 
Forfeiture of restricted stock        3,431         61              (61)   0 
Stock-based compensation expense                  578                   578 
Other stock-based expense        (225)                       4    4 
Tax benefit from compensation plans                  23    152              175 
Balance, December 31, 2016   12,655,171    541,943    12,655    71,730    112,790    (898)   (10,269)   186,008 
Net income                       13,434              13,434 
Other comprehensive loss, net                            (609)        (609)
Cash dividends declared on common stock, $1.04 per share                       (12,616)             (12,616)
Shares issued for dividend reinvestment plan        (63,066)        276              1,195    1,471 
Shares issued from treasury related to exercise of stock options        (11,780)        (100)             227    127 
Restricted stock granted        (30,782)        (583)             583    0 
Forfeiture of restricted stock        4,406         85              (85)   0 
Stock-based compensation expense                  627                   627 
Other stock-based expense        (75)                       1    1 
Balance, December 31, 2017   12,655,171    440,646   $12,655   $72,035   $113,608   $(1,507)  $(8,348)  $188,443 

 

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

 

 44 

 

 

CONSOLIDATED STATEMENTS OF CASH FLOWS            
             
(In Thousands)  Years Ended December 31, 
   2017   2016   2015 
CASH FLOWS FROM OPERATING ACTIVITIES:               
Net income  $13,434   $15,762   $16,471 
Adjustments to reconcile net income to net cash provided by operating activities:               
Provision for loan losses   801    1,221    845 
Realized gains on available-for-sale securities, net   (257)   (1,158)   (2,861)
Loss on prepayment of debt   0    0    2,573 
Depreciation expense   1,639    1,589    1,888 
Accretion and amortization on securities, net   1,157    1,462    1,562 
Increase in cash surrender value of life insurance   (379)   (382)   (386)
Gain on life insurance benefits   0    0    (212)
Stock-based compensation and other expense   628    582    606 
Deferred income taxes   2,155    (156)   79 
Decrease in fair value of servicing rights   168    282    162 
Gains on sales of loans, net   (818)   (1,029)   (735)
Origination of loans for sale   (25,129)   (29,296)   (21,823)
Proceeds from sales of loans   25,119    30,215    22,101 
Increase in accrued interest receivable and other assets   (595)   (410)   (1,697)
Increase (decrease) in accrued interest payable and other liabilities   1,312    (216)   1,195 
Other   139    44    (82)
Net Cash Provided by Operating Activities   19,374    18,510    19,686 
CASH FLOWS FROM INVESTING ACTIVITIES:               
Proceeds from maturities of certificates of deposit   348    1,540    1,780 
Purchase of certificates of deposit   (100)   (2,280)   (100)
Proceeds from sales of available-for-sale securities   24,118    37,032    44,504 
Proceeds from calls and maturities of available-for-sale securities   63,679    74,477    89,159 
Purchase of available-for-sale securities   (51,476)   (91,896)   (40,363)
Redemption of Federal Home Loan Bank of Pittsburgh stock   7,288    5,277    5,029 
Purchase of Federal Home Loan Bank of Pittsburgh stock   (9,418)   (5,046)   (8,102)
Net increase in loans   (65,225)   (49,085)   (77,129)
Proceeds from bank owned life insurance   0    1,442    1,953 
Purchase of premises and equipment   (1,697)   (1,580)   (1,039)
Proceeds from sale of foreclosed assets   1,387    539    2,536 
Other   191    181    181 
Net Cash (Used in) Provided by Investing Activities   (30,905)   (29,399)   18,409 
CASH FLOWS FROM FINANCING ACTIVITIES:               
Net increase (decrease) in deposits   24,606    48,228    (32,374)
Net increase (decrease) in short-term borrowings   35,591    (27,321)   47,959 
Proceeds from long-term borrowings   8,000    0    0 
Repayments of long-term borrowings   (37,265)   (313)   (36,866)
Purchase of treasury stock   0    (3,723)   (4,415)
Sale of treasury stock   127    263    381 
Tax benefit from compensation plans   0    175    159 
Common dividends paid   (11,145)   (11,112)   (11,245)
Net Cash Provided by (Used in) Financing Activities   19,914    6,197    (36,401)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS   8,383    (4,692)   1,694 
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR   28,621    33,313    31,619 
CASH AND CASH EQUIVALENTS, END OF PERIOD  $37,004   $28,621   $33,313 

 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:            
Assets acquired through foreclosure of real estate loans  $940   $1,508   $2,523 
Interest paid  $3,934   $3,698   $4,636 
Income taxes paid  $4,913   $5,129   $4,827 

 

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

 

 45 

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

BASIS OF CONSOLIDATION – The consolidated financial statements include the accounts of Citizens & Northern Corporation and its subsidiaries, Citizens & Northern Bank (“C&N Bank”), Bucktail Life Insurance Company and Citizens & Northern Investment Corporation (collectively, “Corporation”), as well as C&N Bank’s wholly-owned subsidiary, C&N Financial Services Corporation. In December 2017, C&N Bank established a new entity, Northern Tier Holding LLC, for the purpose of acquiring, holding and disposing of real property acquired by the Bank. C&N Bank is the sole member of Northern Tier Holding LLC, which had no transactions in 2017. All material intercompany balances and transactions have been eliminated in consolidation.

 

NATURE OF OPERATIONS – The Corporation is primarily engaged in providing a full range of banking and mortgage services to individual and corporate customers in North Central Pennsylvania and Southern New York State. Lending products include mortgage loans, commercial loans and consumer loans, as well as specialized instruments such as commercial letters-of-credit. Deposit products include various types of checking accounts, passbook and statement savings, money market accounts, interest checking accounts, Individual Retirement Accounts and certificates of deposit. The Corporation also offers non-insured “RepoSweep” accounts.

 

The Corporation provides Trust and Financial Management services, including administration of trusts and estates, retirement plans, and other employee benefit plans, and investment management services. The Corporation offers a variety of personal and commercial insurance products through C&N Financial Services Corporation. C&N Financial Services Corporation also offers mutual funds, annuities, educational savings accounts and other investment products through registered agents.

 

Management has determined that the Corporation has one reportable segment, “Community Banking.” All of the Corporation’s activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Corporation supports the others.

 

The Corporation is subject to competition from other financial institutions. It is also subject to regulation by certain federal and state agencies and undergoes periodic examination by those regulatory authorities. As a consequence, the Corporation’s business is particularly susceptible to being affected by future federal and state legislation and regulations.

 

USE OF ESTIMATES – The financial information is presented in accordance with generally accepted accounting principles and general practice for financial institutions in the United States of America (“U.S. GAAP”). In preparing financial statements, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements. In addition, these estimates and assumptions affect revenues and expenses in the financial statements and as such, actual results could differ from those estimates.

 

Material estimates that are particularly susceptible to change include: (1) the allowance for loan losses, (2) fair values of debt securities based on estimates from independent valuation services or from brokers, (3) assessment of impaired securities to determine whether or not the securities are other-than-temporarily impaired, (4) valuation of deferred tax assets and (5) valuation of obligations from defined benefit plans.

 

INVESTMENT SECURITIES – Investment securities are accounted for as follows:

 

Available-for-sale securities – includes debt securities not classified as held-to-maturity or trading, and unrestricted equity securities. Such securities are reported at fair value, with unrealized gains and losses excluded from earnings and reported separately through accumulated other comprehensive income (loss), net of tax. Amortization of premiums and accretion of discounts on available-for-sale securities are recorded using the level yield method over the remaining contractual life of the securities, adjusted for actual prepayments. Realized gains and losses on sales of available-for-sale securities are computed on the basis of specific identification of the adjusted cost of each security. Securities within the available-for-sale portfolio may be used as part of the Corporation’s asset and liability management strategy and may be sold in response to changes in interest rate risk, prepayment risk or other factors.

 

Other-than-temporary impairment – Credit-related declines in the fair value of available-for-sale securities that are deemed to be other-than-temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment (OTTI) losses, management considers (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, (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, and (4) whether the Corporation intends to sell the security or if it is more likely than not that the Corporation will be required to sell the security before the recovery of its amortized cost basis. The credit-related impairment is recognized in earnings and is the difference between a security’s amortized cost basis and the present value of expected future cash flows discounted at the security’s effective interest rate. For debt securities classified as held-to-maturity, if any, the amount of noncredit-related impairment is recognized in other comprehensive income and accreted over the remaining life of the debt security as an increase in the carrying value of the security.

 

 46 

 

 

Restricted equity securities – Restricted equity securities consist primarily of Federal Home Loan Bank of Pittsburgh stock, and are carried at cost and evaluated for impairment. Holdings of restricted equity securities are included in Other Assets in the consolidated balance sheets, and dividends received on restricted securities are included in Other Income in the consolidated statements of income.

 

LOANS HELD FOR SALE – Mortgage loans held for sale are reported at the lower of cost or market, determined in the aggregate.

 

LOANS RECEIVABLE – Loans receivable which management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at unpaid principal balances, less the allowance for loan losses and net deferred loan fees. Interest income is accrued on the unpaid principal balance. Loan origination and commitment fees, as well as certain direct origination costs, are deferred and amortized as a yield adjustment over the lives of the related loans using the interest method.

 

The loans receivable portfolio is segmented into residential mortgage, commercial and consumer loans. The residential mortgage segment includes the following classes: first and junior lien residential mortgages, home equity lines of credit and residential construction loans. The most significant classes of commercial loans are commercial loans secured by real estate, non-real estate secured commercial and industrial loans, loans to political subdivisions, commercial construction, and loans secured by farmland.

 

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

 

ALLOWANCE FOR LOAN LOSSES – The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the collection of all, or part, of the principal balance is highly unlikely. Non-residential consumer loans are generally charged off no later than when they are 120 days past due on a contractual basis, or earlier in the event of bankruptcy or if there is an amount deemed uncollectible.

 

The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Corporation’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available. In 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. In the process of evaluating the loan portfolio, management also considers the Corporation’s exposure to losses from unfunded loan commitments. As of December 31, 2017 and 2016, management determined that no allowance for credit losses related to unfunded loan commitments was required.

 

The allowance consists primarily of two major components – (1) a specific component based on a detailed assessment of certain larger loan relationships, mainly commercial purpose, determined on a loan-by-loan basis; and (2) a general component for the remainder of the portfolio based on a collective evaluation of pools of loans with similar risk characteristics. The general component is assigned to each pool of loans based on both historical net charge-off experience, and an evaluation of certain qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the above methodologies for estimating specific and general losses in the portfolio.

 

The specific component relates to loans that are classified as impaired based on a detailed assessment of certain larger loan relationships evaluated by a management committee referred to as the Watch List Committee. Specific loan relationships are identified for evaluation based on the related credit risk rating. For individual loans classified as impaired, an allowance is established when the collateral value less estimated selling costs, present value of discounted cash flows or observable market price of the impaired loan is lower than the carrying value of that loan.

 

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The general component covers pools of loans by loan class including commercial loans not considered individually impaired, as well as smaller balance homogeneous classes of loans, such as residential real estate, home equity lines of credit and other consumer loans. Accordingly, the Corporation generally does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are subject to a restructuring agreement. The pools of loans for each loan segment are evaluated for loss exposure based upon average historical net charge-off rates, adjusted for qualitative factors. The time period used in determining the average historical net charge-off rate for each loan class is based on management’s evaluation of an appropriate time period that captures an historical loss experience relevant to the current portfolio. Qualitative risk factors (described in the following paragraph) are evaluated for the impact on each of the three distinct segments (residential mortgage, commercial and consumer) within the loan portfolio. Each qualitative factor is assigned a value to reflect improving, stable or declining conditions based on management’s judgment using relevant information available at the time of the evaluation. Any adjustments to the factors are supported by a narrative documentation of changes in conditions accompanying the allowance for loan losses calculation.

 

The qualitative factors used in the general component calculations are designed to address credit risk characteristics associated with each segment. The Corporation’s credit risk associated with all of the segments is significantly impacted by these factors, which include economic conditions within its market area, the Corporation’s lending policies, changes or trends in the portfolio, risk profile, competition, regulatory requirements and other factors. Further, the residential mortgage segment is significantly affected by the values of residential real estate that provide collateral for the loans. The majority of the Corporation’s commercial segment loans (approximately 53% at December 31, 2017) are secured by real estate, and accordingly, the Corporation’s risk for the commercial segment is significantly affected by commercial real estate values. The consumer segment includes a wide mix of loans for different purposes, primarily secured loans, including loans secured by motor vehicles, manufactured housing and other types of collateral.

 

Loans are classified as impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial loans by the fair value of the collateral (if the loan is collateral dependent), by future cash flows discounted at the loan’s effective rate or by the loan’s observable market price.

 

For commercial loans secured by real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.

 

For commercial and industrial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging data or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.

 

Loans whose terms are modified are classified as troubled debt restructurings if the Corporation grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a troubled debt restructuring generally involve reductions in required payments, an extension of a loan’s stated maturity date or a temporary reduction in interest rate. Loans classified as troubled debt restructurings are designated as impaired. Non-accrual troubled debt restructurings may be restored to accrual status if the ultimately collectability of principal and interest payments under the modified terms is not in doubt, and there has been a period (generally, for at least six consecutive months) of satisfactory payment performance by the borrower either immediately before or after the restructuring.

 

BANK PREMISES AND EQUIPMENT – Bank premises and equipment are stated at cost less accumulated depreciation. Repair and maintenance expenditures which extend the useful lives of assets are capitalized, and other repair and maintenance expenditures are expensed as incurred. Depreciation expense is computed using the straight-line method.

 

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IMPAIRMENT OF LONG-LIVED ASSETS – The Corporation reviews long-lived assets, such as premises and equipment and intangibles, for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. These changes in circumstances may include a significant decrease in the market value of an asset or the manner in which an asset is used. If there is an indication the carrying value of an asset may not be recoverable, future undiscounted cash flows expected to result from use of the asset are estimated. If the sum of the expected cash flows is less than the carrying value of the asset, a loss is recognized for the difference between the carrying value and fair market value of the asset.

 

FORECLOSED ASSETS HELD FOR SALE – Foreclosed assets held for sale consist of real estate acquired by foreclosure and are initially recorded at fair value, less estimated selling costs.

 

GOODWILL AND CORE DEPOSIT INTANGIBLE ASSETSGoodwill represents the excess of the cost of acquisitions over the fair value of the net assets acquired. Goodwill is tested at least annually for impairment, or more often if events or circumstances indicate there may be impairment. Core deposit intangibles are being amortized over periods of time that represent the expected lives using a method of amortization that reflects the pattern of economic benefit. Core deposit intangibles are subject to impairment testing whenever events or changes in circumstances indicate their carrying amounts may not be recoverable.

 

SERVICING RIGHTS – The estimated fair value of servicing rights related to mortgage loans sold and serviced by the Corporation is recorded as an asset upon the sale of such loans. The valuation of servicing rights is adjusted quarterly, with changes in fair value included in Loan Servicing Fees, Net, in the consolidated statements of income. Significant inputs to the valuation include expected net servicing income to be received, the expected life of the underlying loans and the discount rate. The servicing rights asset is included in Other Assets in the consolidated balance sheets.

 

INCOME TAXES – Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases given the provisions of the enacted tax laws. Deferred tax assets are reduced, if necessary, by the amount of such benefits that are not expected to be realized based upon available evidence. Tax benefits from investments in limited partnerships that have qualified for federal low-income tax credits are recognized as a reduction in the provision for income tax over the term of the investment using the effective yield method. The Corporation includes income tax penalties in the provision for income tax. The Corporation has no accrued interest related to unrecognized tax benefits.

 

STOCK COMPENSATION PLANS – The Corporation’s stock-based compensation policy applies to all forms of stock-based compensation including stock options and restricted stock units. All stock-based compensation is accounted for under the fair value method as required by U.S. GAAP. The expense associated with stock-based compensation is recognized over the vesting period of each individual arrangement.

 

The fair value of each stock option is estimated on the date of grant using the Black-Scholes-Merton option valuation model. The fair value of restricted stock is based on the current market price on the date of grant.

 

OFF-BALANCE SHEET FINANCIAL INSTRUMENTS – In the ordinary course of business, the Corporation has entered into off-balance sheet financial instruments consisting of commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they become payable.

 

CASH FLOWS – The Corporation utilizes the net reporting of cash receipts and cash payments for certain deposit and lending activities. Cash equivalents include federal funds sold and all cash and amounts due from depository institutions and interest-bearing deposits in other banks with original maturities of three months or less.

 

TRUST ASSETS AND INCOME – Assets held by the Corporation in a fiduciary or agency capacity for its customers are not included in the financial statements since such items are not assets of the Corporation. Trust income is recorded on a cash basis, which is not materially different from the accrual basis.

 

2. RECENT ACCOUNTING PRONOUNCEMENTS

 

The Financial Accounting Standards Board (“FASB”) issues Accounting Standards Updates (ASUs) to the FASB Accounting Standards Codification (ASC). This section provides a summary description of recent ASUs that have significant implications (elected or required) within the consolidated financial statements, or that management expects may have a significant impact on financial statements issued in the near future.

 

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In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which provides a principles-based framework for revenue recognition under U.S. GAAP. The core principle of the five-step revenue recognition framework is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Several additional ASUs have been issued subsequent to ASU 2014-09 to provide clarifying guidance related to various revenue recognition areas and to defer the effective date of the standard by a year, making it applicable for the Corporation in the first quarter 2018 and for the annual period ending December 31, 2018. More than 70% of the Corporation’s revenue comes from net interest income and is explicitly out of the scope of ASU 2014-09. The Corporation’s largest sources of noninterest revenue which are subject to the guidance include Trust and financial management revenue, service charges on deposit accounts and interchange revenue from debit card transactions. Management has evaluated the Corporation’s noninterest revenue streams and adoption of ASU 2014-09 using the modified retrospective method had no effect on the Corporation’s revenue recognition practices. Additionally, the ASU requires expanded disclosures to help users of financial statements better understand the nature, amount, timing, and uncertainty of revenue that is recognized. Management is in the process of reviewing the Corporation’s business processes, systems and controls to support the expanded disclosure requirements that will be effective in the first quarter 2018.

 

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities. This makes significant changes in U.S. GAAP related to certain aspects of recognition, measurement, presentation and disclosure of financial instruments. The changes provided for in this Update that are applicable to the Corporation are as follows: (1) require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; however, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer; (2) for equity investments without readily determinable fair values, require a qualitative assessment to identify impairment, and if a qualitative assessment indicates that impairment exists, requiring an entity to measure the investment at fair value; (3) eliminate the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (4) require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (5) require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments (at December 31, 2017 and 2016, the Corporation has no liabilities for which the fair value measurement option has been elected); (6) require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (7) clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The amendments in this Update will become effective for the Corporation for annual and interim periods beginning in the first quarter 2018. With limited exceptions, early adoption of the amendments in this Update is not permitted. Amendments are to be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values should be applied prospectively. The Corporation’s current exposure related to investments in marketable equity securities and other issues considered in ASU 2016-01 is limited, and accordingly, initial adoption of this ASU had no effect on the Corporation’s financial position. Management is in the process of reviewing the changes in disclosure requirements that will become effective in the first quarter 2018.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases. Specifically, a lessee should recognize on the balance sheet a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee would be permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and liabilities. Topic 842 would not significantly change the recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee from current U.S. GAAP; however, the principal change from current GAAP is that lease assets and liabilities arising from operating leases would be recognized on the balance sheet. Topic 842 provides several other changes or clarifications to existing GAAP, and will require qualitative disclosures, along with quantitative disclosures, so that financial statement users can understand more about the nature of an entity’s leasing activities. In transition, Topic 842 provides that lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach, including optional practical expedients. An entity that elects to apply the practical expedients will, in effect, continue to account for leases that commence before the effective date in accordance with previous GAAP unless the lease is modified, except that lessees will be required to recognize a right-of-use asset and a lease liability for all operating leases at each reporting date based on the present value of the remaining minimum rental payments that were tracked and disclosed under previous GAAP. Topic 842 will become effective for the Corporation for annual and interim periods beginning in the first quarter 2019. The Corporation is in the early stages of evaluating the potential impact of adopting this amendment.

 

In March 2016, the FASB issued ASU No. 2016-07, Investments – Equity Method and Joint Ventures. This ASU eliminates the requirement that when an investment qualifies for the equity method as a result of an increase in the level of ownership interest or influence, an investor must adjust the investment, results of operations and retained earnings retroactively as if the equity method had been in effect during all previous periods the investment had been held. The ASU requires the equity method investor to add the cost of acquiring an additional interest in the investee to the basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for the equity method. The ASU further requires that an entity that has an available-for-sale equity security that becomes qualified for the equity method recognize through earnings the unrealized gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method. The amendments in this Update were effective for the Corporation for annual and interim periods beginning in the first quarter 2017. Initial adoption of this ASU in 2017 did not have a significant impact on the Corporation.

 

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In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation. This ASU changes several aspects of accounting for share-based payment transactions, and includes some changes that apply only to nonpublic companies. This Update includes amendments that currently apply, or may apply in the future, to the Corporation related to the following: (1) accounting for the difference between the deduction for tax purposes and the amount of compensation cost recognized for financial reporting purposes; (2) classification of excess tax benefits on the statement of cash flows; (3) accounting for forfeitures; (4) accounting for awards partially settled in cash in excess of the employer’s minimum statutory tax withholding requirements; and (5) classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax-withholding purposes. The amendments in this Update were effective for the Corporation for annual and interim periods beginning in the first quarter 2017. The ASU provides separate transition provisions for each of the amendments. Initial adoption of this ASU in 2017 did not have a significant impact on the Corporation.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326). This ASU will result in significant changes in the Corporation’s accounting for credit losses related to loans receivable and investment securities. A summary of significant provisions of this ASU is as follows:

 

·The ASU requires that a financial asset (or a group of financial assets) measured at amortized cost basis be presented, net of a valuation allowance for credit losses, at an amount expected to be collected on the financial asset(s), and that the income statement include the measurement of credit losses for newly recognized financial assets as well as changes in expected losses on previously recognized financial assets. The provisions of this ASU require measurement of expected credit losses based on relevant information including past events, historical experience, current conditions, and reasonable and supportive forecasts that affect the collectability of the asset. The provisions of this ASU differ from current U.S. GAAP in that current U.S. GAAP generally delays recognition of the full amount of credit losses until the loss is probable of occurring.

 

·The amendments in the Update retain many of the disclosure requirements related to credit quality in current U.S. GAAP, updated to reflect the change from an incurred loss methodology to an expected credit loss methodology.

 

·In addition, the Update requires that disclosure of credit quality indicators in relation to the amortized cost of financing receivables, a current requirement, be further disaggregated by year of origination.

 

·This ASU requires that credit losses on available-for-sale debt securities be presented as an allowance rather than as a write-down, and limits the amount of the allowance for credit losses to the amount by which the fair value is below amortized cost. For purchased available-for-sale securities with a more-than-insignificant amount of credit deterioration since origination, the ASU requires an allowance be determined in a manner similar to other available-for-sale debt securities; however, the initial allowance would be added to the purchase price, with only subsequent changes in the allowance recorded in credit loss expense, and interest income recognized at the effective rate excluding the discount embedded in the purchase price related to estimated credit losses at acquisition.

 

·This ASU will be effective for the Corporation for interim and annual periods beginning in the first quarter of 2020. Earlier adoption is permitted beginning in the first quarter of 2019. The Corporation will record the effect of implementing this ASU through a cumulative-effect adjustment through retained earnings as of the beginning of the reporting period in which Topic 326 is effective.

 

The Corporation is in the early stages of evaluating the potential impact of adopting this amendment.

 

In June 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) – Classification of Certain Cash Receipts and Cash Payments. This Update provides clarification regarding eight specific cash flow issues with the objective of reducing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. For the Corporation, the amendments in this Update are effective beginning in the first quarter 2018. The amendments in this Update should be applied using a retroactive transition method to each period presented. The Corporation anticipates there will be no adjustments to the Consolidated Statements of Cash Flows, as previously reported, as a result of the clarifications provided in the Update.

 

In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350) to simplify the accounting for goodwill impairment. This guidance, among other things, removes step 2 of the goodwill impairment test thus eliminating the need to determine the fair value of individual assets and liabilities of the reporting unit. Upon adoption of this ASU, goodwill impairment will be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. This may result in more or less impairment being recognized than under current guidance. This Update will become effective for the Corporation’s annual and interim goodwill impairment tests beginning in the first quarter of 2020.

 

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In March 2017, the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20). This Update will shorten the amortization period for certain callable debt securities held at a premium. Under current U.S. GAAP, entities generally amortize the premium over the contractual life of the instrument. This Update requires the premium be amortized to the earliest call date. Discounts will continue to be amortized to maturity. The Corporation expects to adopt the amendments in this Update through a cumulative-effect adjustment directly to retained earnings in 2018, and does not expect the amount of the adjustment to be significant.

 

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 (loss) income. The components of other comprehensive (loss) income, and the related tax effects, are as follows:

 

(In Thousands)  Before-Tax   Income Tax   Net-of-Tax 
   Amount   Effect   Amount 
2017               
Unrealized losses on available-for-sale securities:               
Unrealized holding losses on available-for-sale securities  $(691)  $242   $449)
Reclassification adjustment for (gains) realized in income   (257)   89    (168)
Other comprehensive loss on available-for-sale securities   (948)   331    (617)
                
Unfunded pension and postretirement obligations:               
Changes from plan amendments and actuarial gains and losses included in other comprehensive income   36    (12)   24 
Amortization of net transition obligation, prior service cost and net actuarial gain included in net periodic benefit cost   (24)   8    (16)
Other comprehensive income on unfunded retirement obligations   12    (4)   8 
Total other comprehensive loss  $(936)  $327   $609)

 

(In Thousands)  Before-Tax   Income Tax   Net-of-Tax 
   Amount   Effect   Amount 
2016               
Unrealized losses on available-for-sale securities:               
Unrealized holding losses on available-for-sale securities  $(4,138)  $1,448   $2,690)
Reclassification adjustment for (gains) realized in income   (1,158)   406    (752)
Other comprehensive loss on available-for-sale securities   (5,296)   1,854    (3,442)
                
Unfunded pension and postretirement obligations:               
Changes from plan amendments and actuarial gains and losses included in other comprehensive income   46    (16)   30 
Amortization of net transition obligation, prior service cost and net actuarial gain included in net periodic benefit cost   (22)   8    (14)
Other comprehensive income on unfunded retirement obligations   24    (8)   16 
                
Total other comprehensive loss  $(5,272)  $1,846   $(3,426)

 

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(In Thousands)  Before-Tax   Income Tax   Net-of-Tax 
   Amount   Effect   Amount 
2015               
Unrealized losses on available-for-sale securities:               
Unrealized holding losses on available-for-sale securities  $(1,429)  $500   $(929)
Reclassification adjustment for (gains) realized in income   (2,861)   1,002    (1,859)
Other comprehensive loss on available-for-sale securities   (4,290)   1,502    (2,788)
                
Unfunded pension and postretirement obligations:               
Changes from plan amendments and actuarial gains and losses included in other comprehensive loss   (135)   47    (88)
Amortization of net transition obligation, prior service cost, net actuarial loss and loss on settlement included in net period benefit cost   67    (23)   44 
Other comprehensive loss on unfunded retirement obligations   (68)   24    (44)
                
Total other comprehensive loss  $(4,358)  $1,526   $(2,832)

 

Changes in the components of accumulated other comprehensive (loss) income, included in stockholders’ equity, are as follows:

 

(In Thousands)  Unrealized       Accumulated 
   Holding (Losses)   Unfunded   Other 
   Gains on   Retirement   Comprehensive 
   Securities   Obligations   (Loss) Income 
2017               
Balance, beginning of period  $(949)  $51   $(898)
Change during year ended December 31, 2017   (617)   8    (609)
Balance, end of period  $(1,566)  $59   $(1,507)
                
2016               
Balance, beginning of period  $2,493   $35   $2,528 
Change during year ended December 31, 2016   (3,442)   16    (3,426)
Balance, end of period  $(949)  $51   $(898)
                
2015               
Balance, beginning of period  $5,281   $79   $5,360 
Change during year ended December 31, 2015   (2,788)   (44)   (2,832)
Balance, end of period  $2,493   $35   $2,528 

 

Items reclassified out of each component of accumulated other comprehensive (loss) income are as follows:

 

For the Year Ended December 31, 2017       
(In Thousands)       
   Reclassified from    
Details about Accumulated Other  Accumulated Other   Affected Line Item in the Consolidated
Comprehensive Loss Components  Comprehensive Loss   Statements of Income
Unrealized gains and losses on available-for-sale securities  $(257)  Realized gains on available-for-sale securities, net
    89   Income tax provision
    (168)  Net of tax
Amortization of defined benefit pension and postretirement items:        
Prior service cost   (31)  Pensions and other employee benefits
Actuarial loss   7   Pensions and other employee benefits
    (24)  Total before tax
    8   Income tax provision
    (16)  Net of tax
Total reclassifications for the period  $(184)   

 

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For the Year Ended December 31, 2016       
(In Thousands)       
   Reclassified from    
Details about Accumulated Other  Accumulated Other   Affected Line Item in the Consolidated
Comprehensive Income Components  Comprehensive Income   Statements of Income
Unrealized gains and losses on available-for-sale  securities  $(1,158)  Realized gains on available-for-sale securities, net
    406   Income tax provision
    (752)  Net of tax
Amortization of defined benefit pension and postretirement items:        
Prior service cost   (31)  Pensions and other employee benefits
Actuarial loss   9   Pensions and other employee benefits
    (22)  Total before tax
    8   Income tax provision
    (14)  Net of tax
Total reclassifications for the period  $(766)   

 

For the Year Ended December 31, 2015       
(In Thousands)       
   Reclassified from    
Details about Accumulated Other  Accumulated Other   Affected Line Item in the Consolidated
Comprehensive Income Components  Comprehensive Income   Statements of Income
Unrealized gains and losses on available-for-sale  securities  $(2,861)  Realized gains on available-for-sale securities, net
    1,002   Income tax provision
    (1,859)  Net of tax
Amortization of defined benefit pension and postretirement items:        
Prior service cost   (31)  Pensions and other employee benefits
Actuarial loss   11   Pensions and other employee benefits
Loss on settlement   87   Pensions and other employee benefits
    67   Total before tax
    (23)  Income tax provision
    44   Net of tax
Total reclassifications for the period  $(1,815)   

 

4. PER SHARE DATA

 

Basic earnings per common share are calculated using the two-class method to determine income attributable to common shareholders. Unvested restricted stock awards that contain nonforfeitable rights to dividends are considered participating securities under the two-class method. Distributed dividends and an allocation of undistributed net income to participating securities reduce the amount of income attributable to common shareholders. Income attributable to common shareholders is then divided by weighted-average common shares outstanding for the period to determine basic earnings per common share.

 

Diluted earnings per common share are calculated under the more dilutive of either the treasury method or the two-class method. Diluted earnings per common 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.

 

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   Years Ended 
   Dec. 31,   Dec. 31,   Dec. 31, 
   2017   2016   2015 
Basic               
Net income  $13,434,000   $15,762,000   $16,471,000 
Less: Dividends and undistributed earnings allocated to participating securities   (69,000)   (85,000)   (84,000)
Net income attributable to common shares  $13,365,000   $15,677,000   $16,387,000 
Basic weighted-average common shares outstanding   12,115,840    12,032,820    12,149,252 
Basic earnings per common share (a)  $1.10   $1.30   $1.35 
                
Diluted               
Net income attributable to common shares  $13,365,000   $15,677,000   $16,387,000 
Basic weighted-average common shares outstanding   12,115,840    12,032,820    12,149,252 
Dilutive effect of potential common stock arising from stock options   39,296    30,235    21,832 
Diluted weighted-average common shares outstanding   12,155,136    12,063,055    12,171,084 
Diluted earnings per common share (a)  $1.10   $1.30   $1.35 

 

(a)Basic and diluted earnings per share under the two-class method are determined on net income reported on the income statement less earnings allocated to nonvested restricted shares with nonforfeitable dividends (participating securities).

 

The weighted-average number of nonvested restricted shares outstanding was 62,329 shares in 2017, 65,309 shares in 2016 and 62,689 shares in 2015.

 

Stock options that were anti-dilutive were excluded from net income per share calculations. There were no anti-dilutive instruments in 2017. Weighted-average common shares available from anti-dilutive instruments totaled 31,153 shares in 2016 and 61,590 shares in 2015.

 

5. CASH AND DUE FROM BANKS

 

Cash and due from banks at December 31, 2017 and 2016 include the following:

 

(In thousands)  Dec. 31,   Dec. 31, 
   2017   2016 
Cash and cash equivalents  $37,004   $28,621 
Certificates of deposit   3,240    3,488 
Total cash and due from banks  $40,244   $32,109 

 

Certificates of deposit are issues by U.S. banks with original maturities greater than three months. Each certificate of deposit is fully FDIC-insured. The Corporation maintains cash and cash equivalents with certain financial institutions in excess of the FDIC insurance limit.

 

The Corporation is required to maintain reserves against deposit liabilities in the form of cash and balances with the Federal Reserve Bank. The reserves are based on deposit levels, account activity, and other services provided by the Federal Reserve Bank. Required reserves were $17,178,000 at December 31, 2017 and $16,654,000 at December 31, 2016.

 

6. FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS

 

The Corporation measures certain assets at fair value. Fair value is defined as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date. FASB ASC topic 820, “Fair Value Measurements and Disclosures” establishes a framework for measuring fair value that includes a hierarchy used to classify the inputs used in measuring fair value. The hierarchy prioritizes the inputs used in determining valuations into three levels. The level in the fair value hierarchy within which the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement. The levels of the fair value hierarchy are as follows:

 

Level 1 – Fair value is based on unadjusted quoted prices in active markets that are accessible to the Corporation for identical assets. These generally provide the most reliable evidence and are used to measure fair value whenever available.

 

 55 

 

 

Level 2 – Fair value is based on significant inputs, other than Level 1 inputs, that are observable either directly or indirectly for substantially the full term of the asset through corroboration with observable market data. Level 2 inputs include quoted market prices in active markets for similar assets, quoted market prices in markets that are not active for identical or similar assets and other observable inputs.

 

Level 3 – Fair value is based on significant unobservable inputs. Examples of valuation methodologies that would result in Level 3 classification include option pricing models, discounted cash flows and other similar techniques.

 

The Corporation monitors and evaluates available data relating to fair value measurements on an ongoing basis and recognizes transfers among the levels of the fair value hierarchy as of the date of an event or change in circumstances that affects the valuation method chosen. Examples of such changes may include the market for a particular asset becoming active or inactive, changes in the availability of quoted prices, or changes in the availability of other market data.

 

At December 31, 2017 and 2016, assets measured at fair value and the valuation methods used are as follows:

 

       December 31, 2017     
  

Quoted

Prices

   Other         
   in Active   Observable   Unobservable   Total 
   Markets   Inputs   Inputs   Fair 
(In Thousands)  (Level 1)   (Level 2)   (Level 3)   Value 
                 
Recurring fair value measurements                    
AVAILABLE-FOR-SALE SECURITIES:                    
Obligations of U.S. Government agencies  $0   $7,873   $0   $7,873 
Obligations of states and political subdivisions:                    
Tax-exempt   0    105,111    0    105,111 
Taxable   0    25,573    0    25,573 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                    
Residential pass-through securities   0    52,347    0    52,347 
Residential collateralized mortgage obligations   0    131,814    0    131,814 
Commercial mortgage-backed securities   0    33,219    0    33,219 
Total debt securities   0    355,937    0    355,937 
Marketable equity securities   971    0    0    971 
Total available-for-sale securities   971    355,937    0    356,908 
Servicing rights   0    0    1,299    1,299 
Total recurring fair value measurements  $971   $355,937   $1,299   $358,207 
                     
Nonrecurring fair value measurements                    
Impaired loans with a valuation allowance  $0   $0   $3,776   $3,776 
Valuation allowance   0    0    (1,183)   (1,183)
Impaired loans, net   0    0    2,593    2,593 
Foreclosed assets held for sale   0    0    1,598    1,598 
Total nonrecurring fair value measurements  $0   $0   $4,191   $4,191 

 

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       December 31, 2016     
   Quoted Prices   Other         
   in Active   Observable   Unobservable   Total 
   Markets   Inputs   Inputs   Fair 
(In Thousands)  (Level 1)   (Level 2)   (Level 3)   Value 
                 
Recurring fair value measurements                    
AVAILABLE-FOR-SALE SECURITIES:                    
Obligations of U.S. Government agencies  $0   $9,541   $0   $9,541 
Obligations of states and political subdivisions:                    
Tax-exempt   0    119,037    0    119,037 
Taxable   0    30,297    0    30,297 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                    
Residential pass-through securities   0    58,404    0    58,404 
Residential collateralized mortgage obligations   0    146,608    0    146,608 
Commercial mortgage-backed securities   0    30,219    0    30,219 
Total debt securities   0    394,106    0    394,106 
Marketable equity securities   971    0    0    971 
Total available-for-sale securities   971    394,106    0    395,077 
Servicing rights   0    0    1,262    1,262 
Total recurring fair value measurements  $971   $394,106   $1,262   $396,339 
                     
Nonrecurring fair value measurements                    
Impaired loans with a valuation allowance  $0   $0   $3,372   $3,372 
Valuation allowance   0    0    (674)   (674)
Impaired loans, net   0    0    2,698    2,698 
Foreclosed assets held for sale   0    0    2,180    2,180 
Total nonrecurring fair value measurements  $0   $0   $4,878   $4,878 

 

Management’s evaluation and selection of valuation techniques and the unobservable inputs used in determining the fair values of assets valued using Level 3 methodologies include sensitive assumptions. Other market participants might use substantially different assumptions, which could result in calculations of fair values that would be substantially different than the amount calculated by management. The following table shows quantitative information regarding significant techniques and inputs used at December 31, 2017 and 2016 for servicing rights assets measured using unobservable inputs (Level 3 methodologies) on a recurring basis:

 

   Fair Value at              
   12/31/17   Valuation  Unobservable      Method or Value As of
Asset  (In Thousands)   Technique  Input(s)      12/31/17
Servicing rights  $1,299   Discounted cash flow  Discount rate   13.00%  Rate used through modeling period
           Loan prepayment speeds   140.00%  Weighted-average PSA
           Servicing fees   0.25%  of loan balances
               4.00%  of payments are late
               5.00%  late fees assessed
              $1.94   Miscellaneous fees per account per month
           Servicing costs  $6.00   Monthly servicing cost per account
              $24.00   Additional monthly servicing cost per loan on loans more than 30 days delinquent
               1.50%  of loans more than 30 days delinquent
               3.00%  annual increase in servicing costs

 

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   Fair Value at              
   12/31/16   Valuation  Unobservable      Method or Value As of
Asset  (In Thousands)   Technique  Input(s)      12/31/16
Servicing rights  $1,262   Discounted cash flow  Discount rate   13.00%  Rate used through modeling period
           Loan prepayment speeds   138.00%  Weighted-average PSA
           Servicing fees   0.25%  of loan balances
               4.00%  of payments are late
               5.00%  late fees assessed
              $1.94   Miscellaneous fees per account per month
           Servicing costs  $6.00   Monthly servicing cost per account
              $24.00   Additional monthly servicing cost per loan on loans more than 30 days delinquent
               1.50%  of loans more than 30 days delinquent
               3.00%  annual increase in servicing costs

 

The fair value of servicing rights is affected by expected future interest rates. Increases (decreases) in future expected interest rates tend to increase (decrease) the fair value of the Corporation’s servicing rights because of changes in expected prepayment behavior by the borrowers on the underlying loans.

 

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

 

(In Thousands)  Years Ended December 31, 
   2017   2016   2015 
Balance, beginning of period  $1,262   $1,296   $1,281 
Issuances of servicing rights   205    248    177 
Unrealized losses included in earnings   (168)   (282)   (162)
Balance, end of period  $1,299   $1,262   $1,296 

 

Loans are classified as impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Foreclosed assets held for sale consist of real estate acquired by foreclosure. For impaired commercial loans secured by real estate and foreclosed assets held for sale, estimated fair values are determined primarily using values from third-party appraisals. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.

 

At December 31, 2017 and 2016, quantitative information regarding significant techniques and inputs used for nonrecurring fair value measurements using unobservable inputs (Level 3 methodologies) are as follows:

 

(In Thousands, Except                    Weighted- 
Percentages)      Valuation             Average 
   Balance at   Allowance at   Fair Value at   Valuation  Unobservable  Discount at 
Asset  12/31/17   12/31/17   12/31/17   Technique  Inputs  12/31/17 
                       
Impaired loans:                          
Residential mortgage loans - first liens  $515   $122   $393   Sales comparison  Discount to appraised value   26%
Commercial:                          
Commercial loans secured by real estate   2,641    919    1,722   Sales comparison  Discount to appraised value   16%
Commercial and industrial   126    92    34   Sales comparison  Discount to appraised value   72%
Loans secured by farmland   494    50    444   Sales comparison  Discount to appraised value   53%
Total impaired loans  $3,776   $1,183   $2,593            
Foreclosed assets held for sale - real estate:                          
Residential (1-4 family)  $721   $0   $721   Sales comparison  Discount to appraised value   37%
Land   632    0    632   Sales comparison  Discount to appraised value   35%
Commercial real estate   245    0    245   Sales comparison  Discount to appraised value   71%
Total foreclosed assets held for sale  $1,598   $0   $1,598            

 

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(In Thousands, Except                    Weighted- 
Percentages)      Valuation             Average 
   Balance at   Allowance at   Fair Value at   Valuation  Unobservable  Discount at 
Asset  12/31/16   12/31/16   12/31/16   Technique  Inputs  12/31/16 
                       
Impaired loans:                          
Commercial:                          
Commercial loans secured by real estate  $2,773   $528   $2,245   Sales comparison  Discount to appraised value   7%
Commercial and industrial   95    95    0   Sales comparison  Discount to appraised value   100%
Loans secured by farmland   504    51    453   Sales comparison  Discount to appraised value   55%
Total impaired loans  $3,372   $674   $2,698            
Foreclosed assets held for sale - real estate:                          
Residential (1-4 family)  $1,102   $0   $1,102   Sales comparison  Discount to appraised value   35%
Land   650    0    650   Sales comparison  Discount to appraised value   33%
Commercial real estate   428    0    428   Sales comparison  Discount to appraised value   50%
Total foreclosed assets held for sale  $2,180   $0   $2,180            

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

DEPOSITS – The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, money market and interest checking accounts, is (by definition) equal to the amount payable at December 31, 2017 and 2016. The fair value of time deposits, such as certificates of deposit and Individual Retirement Accounts, is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value estimates of deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market, commonly referred to as the core deposit intangible.

 

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

 

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

 

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

 

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

 

(In Thousands)  Valuation  December 31, 2017   December 31, 2016 
   Method(s)  Carrying   Fair   Carrying   Fair 
   Used  Amount   Value   Amount   Value 
Financial assets:                       
Cash and cash equivalents  Level 1  $37,004   $37,004   $28,621   $28,621 
Certificates of deposit  Level 2   3,240    3,234    3,488    3,481 
Available-for-sale securities  See Above   356,908    356,908    395,077    395,077 
Restricted equity securities (included in Other Assets)  Level 2   6,556    6,556    4,426    4,426 
Loans held for sale  Level 2   765    765    142    142 
Loans, net  Level 3   806,857    789,891    743,362    725,787 
Accrued interest receivable  Level 2   4,048    4,048    3,963    3,963 
Servicing rights  Level 3   1,299    1,299    1,262    1,262 
                        
Financial liabilities:                       
Deposits with no stated maturity  Level 2   794,778    794,778    771,625    771,625 
Time deposits  Level 2   213,671    213,734    212,218    212,274 
Short-term borrowings  Level 2   61,766    61,643    26,175    26,024 
Long-term borrowings  Level 2   9,189    9,256    38,454    39,062 
Accrued interest payable  Level 2   46    46    65    65 

 

7. SECURITIES

 

Amortized cost and fair value of available-for-sale securities at December 31, 2017 and 2016 are summarized as follows:

 

       December 31, 2017     
       Gross   Gross     
       Unrealized   Unrealized     
   Amortized   Holding   Holding   Fair 
(In Thousands)  Cost   Gains   Losses   Value 
                 
Obligations of U.S. Government agencies  $8,026   $0   $(153)  $7,873 
Obligations of states and political subdivisions:                    
Tax-exempt   103,673    2,291    (853)   105,111 
Taxable   25,431    226    (84)   25,573 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                    
Residential pass-through securities   52,992    79    (724)   52,347 
Residential collateralized mortgage obligations   134,314    110    (2,610)   131,814 
Commercial mortgage-backed securities   33,881    4    (666)   33,219 
Total debt securities   358,317    2,710    (5,090)   355,937 
Marketable equity securities   1,000    0    (29)   971 
Total  $359,317   $2,710   $(5,119)  $356,908 

 

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       December 31, 2016     
       Gross   Gross     
       Unrealized   Unrealized     
   Amortized   Holding   Holding   Fair 
(In Thousands)  Cost   Gains   Losses   Value 
                 
Obligations of U.S. Government agencies  $9,671   $5   $(135)  $9,541 
Obligations of states and political subdivisions:                    
Tax-exempt   118,140    2,592    (1,695)   119,037 
Taxable   30,073    303    (79)   30,297 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                    
Residential pass-through securities   58,922    306    (824)   58,404 
Residential collateralized mortgage obligations   147,915    408    (1,715)   146,608 
Commercial mortgage-backed securities   30,817    0    (598)   30,219 
Total debt securities   395,538    3,614    (5,046)   394,106 
Marketable equity securities   1,000    0    (29)   971 
Total  $396,538   $3,614   $(5,075)  $395,077 

 

The following table presents gross unrealized losses and fair value of available-for-sale securities with unrealized loss positions that are not deemed to be other-than-temporarily impaired, aggregated by length of time that individual securities have been in a continuous unrealized loss position at December 31, 2017 and 2016:

 

December 31, 2017  Less Than 12 Months   12 Months or More   Total 
(In Thousands)  Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Losses   Value   Losses   Value   Losses 
                         
Obligations of U.S. Government agencies  $0   $0   $7,873   $(153)  $7,873   $(153)
Obligations of states and political subdivisions:                              
Tax-exempt   19,050    (135)   24,391    (718)   43,441    (853)
Taxable   9,279    (45)   2,116    (39)   11,395    (84)
Mortgage-backed securities issued or guaranteed  by U.S. Government agencies or sponsored  agencies:                              
Residential pass-through securities   25,255    (242)   22,549    (482)   47,804    (724)
Residential collateralized mortgage obligations   50,812    (589)   68,558    (2,021)   119,370    (2,610)
Commercial mortgage-backed securities   14,713    (173)   14,569    (493)   29,282    (666)
Total debt securities   119,109    (1,184)   140,056    (3,906)   259,165    (5,090)
Marketable equity securities   0    0    971    (29)   971    (29)
Total temporarily impaired available-for-sale securities  $119,109   $(1,184)  $141,027   $(3,935)  $260,136   $(5,119)

 

December 31, 2016  Less Than 12 Months   12 Months or More   Total 
(In Thousands)  Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Losses   Value   Losses   Value   Losses 
                         
Obligations of U.S. Government agencies  $7,899   $(135)  $0   $0   $7,899   $(135)
Obligations of states and political subdivisions:                              
Tax-exempt   54,479    (1,676)   1,278    (19)   55,757    (1,695)
Taxable   9,594    (79)   0    0    9,594    (79)
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:                              
Residential pass-through securities   48,674    (824)   0    0    48,674    (824)
Residential collateralized mortgage obligations   85,198    (1,124)   16,073    (591)   101,271    (1,715)
Commercial mortgage-backed securities   30,219    (598)   0    0    30,219    (598)
Total debt securities   236,063    (4,436)   17,351    (610)   253,414    (5,046)
Marketable equity securities   1,000    (29)   0    0    1,000    (29)
Total temporarily impaired available-for-sale securities  $237,063   $(4,465)  $17,351   $(610)  $254,414   $(5,075)

 

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Gross realized gains and losses from available-for-sale securities and the related income tax provision were as follows:

 

(In Thousands)            
   2017   2016   2015 
Gross realized gains from sales  $315   $1,392   $2,972 
Gross realized losses from sales   (58)   (234)   (111)
Net realized gains  $257   $1,158   $2,861 
Income tax provision related to net realized gains  $89   $406   $1,002 

 

The amortized cost and fair value of available-for-sale debt securities by contractual maturity are shown in the following table as of December 31, 2017. Actual maturities may differ from contractual maturities because counterparties may have the right to call or prepay obligations with or without call or prepayment penalties.

 

   December 31, 2017 
   Amortized   Fair 
(In Thousands)  Cost   Value 
         
Due in one year or less  $11,350   $11,347 
Due from one year through five years   69,274    70,016 
Due from five years through ten years   37,086    37,089 
Due after ten years   19,420    20,105 
Sub-total   137,130    138,557 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:          
Residential pass-through securities   52,992    52,347 
Residential collateralized mortgage obligations   134,314    131,814 
Commercial mortgage-backed securities   33,881    33,219 
Total  $358,317   $355,937 

 

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

 

Investment securities carried at $217,925,000 at December 31, 2017 and $230,803,000 at December 31, 2016 were pledged as collateral for public deposits, trusts and certain other deposits as provided by law. See Note 12 for information concerning securities pledged to secure borrowing arrangements.

 

Management evaluates securities for OTTI at least on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether the Corporation intends to sell the security or more likely than not will be required to sell the security before its anticipated recovery.

 

The Corporation recognized no net impairment losses in earnings for the years ended December 31, 2017, 2016 and 2015.

 

A summary of information management considered in evaluating debt and equity securities for OTTI at December 31, 2017 and 2016 is provided below.

 

Debt Securities

 

At December 31, 2017 and 2016, management performed an assessment for possible OTTI of the Corporation’s debt securities on an issue-by-issue basis, relying on information obtained from various sources, including publicly available financial data, ratings by external agencies, brokers and other sources. The extent of individual analysis applied to each security depended on the size of the Corporation’s investment, as well as management’s perception of the credit risk associated with each security. Based on the results of the assessment, management believes impairment of these debt securities at December 31, 2017 and 2016 to be temporary.

 

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Equity Securities

 

The Corporation’s marketable equity securities at December 31, 2017 and 2016 consisted exclusively of one mutual fund. The Corporation recognized no other-than-temporary impairment losses related to equities in 2017, 2016 or 2015. At December 31, 2017, the mutual fund held by the Corporation had an unrealized loss of $29,000 for which management determined an OTTI charge was not required.

 

There were no realized gains or losses on equity securities in 2017. Realized gains from sales of equity securities (bank stocks) totaled $1,125,000 in 2016 and $2,220,000 in 2015.

 

C&N Bank is a member of the Federal Home Loan Bank of Pittsburgh (FHLB-Pittsburgh), which is one of 11 regional Federal Home Loan Banks. As a member, C&N Bank is required to purchase and maintain stock in FHLB-Pittsburgh. There is no active market for FHLB-Pittsburgh stock, and it must ordinarily be redeemed by FHLB-Pittsburgh in order to be liquidated. C&N Bank’s investment in FHLB-Pittsburgh stock, included in Other Assets in the consolidated balance sheets, was $6,426,000 at December 31, 2017 and $4,296,000 at December 31, 2016. The Corporation evaluated its holding of FHLB-Pittsburgh stock for impairment and deemed the stock to not be impaired at December 31, 2017 and December 31, 2016. In making this determination, management concluded that recovery of total outstanding par value, which equals the carrying value, is expected. The decision was based on review of financial information that FHLB-Pittsburgh has made publicly available.

 

8. LOANS

 

Loans outstanding at December 31, 2017 and 2016 are summarized as follows:

 

Summary of Loans by Type        
(In Thousands)  Dec. 31,   Dec. 31, 
   2017   2016 
Residential mortgage:          
Residential mortgage loans - first liens  $359,987   $334,102 
Residential mortgage loans - junior liens   25,325    23,706 
Home equity lines of credit   35,758    38,057 
1-4 Family residential construction   26,216    24,908 
Total residential mortgage   447,286    420,773 
Commercial:          
Commercial loans secured by real estate   159,266    150,468 
Commercial and industrial   88,276    83,854 
Political subdivisions   59,287    38,068 
Commercial construction and land   14,527    14,287 
Loans secured by farmland   7,255    7,294 
Multi-family (5 or more) residential   7,713    7,896 
Agricultural loans   6,178    3,998 
Other commercial loans   10,986    11,475 
Total commercial   353,488    317,340 
Consumer   14,939    13,722 
Total   815,713    751,835 
Less: allowance for loan losses   (8,856)   (8,473)
Loans, net  $806,857   $743,362 

 

The Corporation grants loans to individuals as well as commercial and tax-exempt entities. Commercial, residential and personal loans are made to customers geographically concentrated in the Pennsylvania and New York counties that make up the market serviced by Citizens & Northern Bank. Although the Corporation has a diversified loan portfolio, a significant portion of its debtors’ ability to honor their contracts is dependent on the local economic conditions within the region. There is no concentration of loans to borrowers engaged in similar businesses or activities that exceed 10% of total loans at December 31, 2017.

 

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Transactions within the allowance for loan losses, summarized by segment and class, were as follows:

 

Year Ended December 31, 2017  Dec. 31,               Dec. 31, 
   2016           Provision   2017 
(In Thousands)  Balance   Charge-offs   Recoveries   (Credit)   Balance 
Allowance for Loan Losses:                         
Residential mortgage:                         
Residential mortgage loans - first liens  $3,033   $(167)  $15   $319   $3,200 
Residential mortgage loans - junior liens   258    (16)   4    (22)   224 
Home equity lines of credit   350    (14)   0    (40)   296 
1-4 Family residential construction   249    0    0    (6)   243 
Total residential mortgage   3,890    (197)   19    251    3,963 
Commercial:                         
Commercial loans secured by real estate   2,380    (96)   0    300    2,584 
Commercial and industrial   999    (36)   4    98    1,065 
Commercial construction and land   162    0    0    (12)   150 
Loans secured by farmland   110    0    0    (5)   105 
Multi-family (5 or more) residential   241    0    0    (69)   172 
Agricultural loans   40    0    0    17    57 
Other commercial loans   115    0    0    (13)   102 
Total commercial   4,047    (132)   4    316    4,235 
Consumer   138    (150)   38    133    159 
Unallocated   398    0    0    101    499 
Total Allowance for Loan Losses  $8,473   $(479)  $61   $801   $8,856 

 

Year Ended December 31, 2016  Dec. 31               Dec. 31 
   2015           Provision   2016 
(In Thousands)  Balance   Charge-offs   Recoveries   (Credit)   Balance 
Allowance for Loan Losses:                         
Residential mortgage:                         
Residential mortgage loans - first liens  $2,645   $(73)  $3   $458   $3,033 
Residential mortgage loans - junior liens   219    0    0    39    258 
Home equity lines of credit   347    0    0    3    350 
1-4 Family residential construction   207    0    0    42    249 
Total residential mortgage   3,418    (73)   3    542    3,890 
Commercial:                         
Commercial loans secured by real estate   1,939    0    2    439    2,380 
Commercial and industrial   981    (2)   3    17    999 
Political subdivisions   0    0    0    0    0 
Commercial construction and land   58    0    30    74    162 
Loans secured by farmland   106    0    0    4    110 
Multi-family (5 or more) residential   675    (595)   0    161    241 
Agricultural loans   45    0    0    (5)   40 
Other commercial loans   118    0    0    (3)   115 
Total commercial   3,922    (597)   35    687    4,047 
Consumer   122    (87)   82    21    138 
Unallocated   427    0    0    (29)   398 
Total Allowance for Loan Losses  $7,889   $(757)  $120   $1,221   $8,473 

 

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Year Ended December 31, 2015  Dec. 31,               Dec. 31, 
   2014           Provision   2015 
(In Thousands)  Balance   Charge-offs   Recoveries   (Credit)   Balance 
Allowance for Loan Losses:                         
Residential mortgage:                         
Residential mortgage loans - first liens  $2,941   $(175)  $1   $(122)  $2,645 
Residential mortgage loans - junior liens   176    (42)   0    85    219 
Home equity lines of credit   322    0    0    25    347 
1-4 Family residential construction   214    0    0    (7)   207 
Total residential mortgage   3,653    (217)   1    (19)   3,418 
Commercial:                         
Commercial loans secured by real estate   1,758    (115)   208    88    1,939 
Commercial and industrial   688    (21)   6    308    981 
Political subdivisions   0    0    0    0    0 
Commercial construction and land   283    (115)   0    (110)   58 
Loans secured by farmland   165    0    0    (59)   106 
Multi-family (5 or more) residential   87    0    0    588    675 
Agricultural loans   31    0    0    14    45 
Other commercial loans   131    0    0    (13)   118 
Total commercial   3,143    (251)   214    816    3,922 
Consumer   145    (94)   55    16    122 
Unallocated   395    0    0    32    427 
Total Allowance for Loan Losses  $7,336   $(562)  $270   $845   $7,889 

 

In the evaluation of the loan portfolio, management determines two major components for the allowance for loan losses – (1) a specific component based on an assessment of certain larger relationships, mainly commercial purpose loans, on a loan-by-loan basis; and (2) a general component for the remainder of the portfolio based on a collective evaluation of pools of loans with similar risk characteristics.

 

In determining the larger loan relationships for detailed assessment under the specific allowance component, the Corporation uses an internal risk rating system. Under the risk rating system, the Corporation classifies problem or potential problem loans as “Special Mention,” “Substandard,” or “Doubtful” on the basis of currently existing facts, conditions and values. Substandard loans include those characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected. Loans classified as Doubtful have all the weaknesses inherent in those classified as Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans that do not currently expose the Corporation to sufficient risk to warrant classification as Substandard or Doubtful, but possess weaknesses that deserve management’s close attention, are deemed to be Special Mention. Risk ratings are updated any time that conditions or the situation warrants. Loans not classified are included in the “Pass” column in the table below.

 

The following tables summarize the aggregate credit quality classification of outstanding loans by risk rating as of December 31, 2017 and 2016:

 

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December 31, 2017                    
(In Thousands)      Special             
   Pass   Mention   Substandard   Doubtful   Total 
Residential Mortgage:                         
Residential mortgage loans - first liens  $350,609   $307   $9,019   $52   $359,987 
Residential mortgage loans - junior liens   24,795    104    426    0    25,325 
Home equity lines of credit   35,233    61    464    0    35,758 
1-4 Family residential construction   26,216    0    0    0    26,216 
Total residential mortgage   436,853    472    9,909    52    447,286 
Commercial:                         
Commercial loans secured by real estate   150,806    936    7,524    0    159,266 
Commercial and Industrial   82,724    3,896    1,645    11    88,276 
Political subdivisions   59,287    0    0    0    59,287 
Commercial construction and land   14,449    0    78    0    14,527 
Loans secured by farmland   5,283    581    1,379    12    7,255 
Multi-family (5 or more) residential   7,130    0    583    0    7,713 
Agricultural loans   5,203    270    705    0    6,178 
Other commercial loans   10,913    0    73    0    10,986 
Total commercial   335,795    5,683    11,987    23    353,488 
Consumer   14,853    0    86    0    14,939 
Totals  $787,501   $6,155   $21,982   $75   $815,713 

 

December 31, 2016                    
(In Thousands)      Special             
   Pass   Mention   Substandard   Doubtful   Total 
Residential Mortgage:                         
Residential mortgage loans - first liens  $324,377   $408   $9,258   $59   $334,102 
Residential mortgage loans - junior liens   23,274    132    300    0    23,706 
Home equity lines of credit   37,360    123    574    0    38,057 
1-4 Family residential construction   24,820    0    88    0    24,908 
Total residential mortgage   409,831    663    10,220    59    420,773 
Commercial:                         
Commercial loans secured by real estate   139,358    3,092    8,018    0    150,468 
Commercial and Industrial   79,202    4,180    461    11    83,854 
Political subdivisions   38,068    0    0    0    38,068 
Commercial construction and land   14,136    70    81    0    14,287 
Loans secured by farmland   5,745    129    1,404    16    7,294 
Multi-family (5 or more) residential   7,277    0    619    0    7,896 
Agricultural loans   3,208    0    790    0    3,998 
Other commercial loans   11,401    0    74    0    11,475 
Total commercial   298,395    7,471    11,447    27    317,340 
Consumer   13,546    0    176    0    13,722 
Totals  $721,772   $8,134   $21,843   $86   $751,835 

 

The scope of loans reviewed individually each quarter to determine if they are impaired include all commercial loan relationships greater than $200,000 for which there is at least one extension of credit graded Special Mention, Substandard or Doubtful. In the fourth quarter 2017, the scope was expanded to include any residential mortgage or consumer loans of $400,000 or more with a credit grade of Special Mention, Substandard or Doubtful. Loans that are individually reviewed, but which are determined to not be impaired, are combined with all remaining loans that are not reviewed on a specific basis, and such loans are included within larger pools of loans based on similar risk and loss characteristics for purposes of determining the general component of the allowance. The loans that have been individually reviewed, but which have been determined to not be impaired, are included in the “Collectively Evaluated” column in the table summarizing the allowance and associated loan balances as of December 31, 2017 and 2016. All loans classified as troubled debt restructurings (discussed in more detail below) and all commercial loan relationships less than $200,000 or other loan relationships less than $400,000 in the aggregate, but with an estimated loss of $100,000 or more, are individually evaluated for impairment.

 

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The following tables present a summary of loan balances and the related allowance for loan losses summarized by portfolio segment and class for each impairment method used as of December 31, 2017 and 2016:

 

December 31, 2017  Loans:   Allowance for Loan Losses: 
(In Thousands)                        
   Individually   Collectively       Individually   Collectively     
   Evaluated   Evaluated   Totals   Evaluated   Evaluated   Totals 
Residential mortgage:                              
Residential mortgage loans - first liens  $984   $359,003   $359,987   $0   $3,200   $3,200 
Residential mortgage loans - junior liens   302    25,023    25,325    122    102    224 
Home equity lines of credit   0    35,758    35,758    0    296    296 
1-4 Family residential construction   0    26,216    26,216    0    243    243 
Total residential mortgage   1,286    446,000    447,286    122    3,841    3,963 
Commercial:                              
Commercial loans secured by real estate   5,873    153,393    159,266    919    1,665    2,584 
Commercial and industrial   568    87,708    88,276    188    877    1,065 
Political subdivisions   0    59,287    59,287    0    0    0 
Commercial construction and land   0    14,527    14,527    0    150    150 
Loans secured by farmland   1,365    5,890    7,255    50    55    105 
Multi-family (5 or more) residential   392    7,321    7,713    0    172    172 
Agricultural loans   7    6,171    6,178    0    57    57 
Other commercial loans   0    10,986    10,986    0    102    102 
Total commercial   8,205    345,283    353,488    1,157    3,078    4,235 
Consumer   20    14,919    14,939    0    159    159 
Unallocated                            499 
                               
Total  $9,511   $806,202   $815,713   $1,279   $7,078   $8,856 

 

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December 31, 2016  Loans:   Allowance for Loan Losses: 
(In Thousands)                        
   Individually   Collectively       Individually   Collectively     
   Evaluated   Evaluated   Totals   Evaluated   Evaluated   Totals 
Residential mortgage:                              
Residential mortgage loans - first liens  $753   $333,349   $334,102   $0   $3,033   $3,033 
Residential mortgage loans - junior liens   68    23,638    23,706    0    258    258 
Home equity lines of credit   0    38,057    38,057    0    350    350 
1-4 Family residential construction   0    24,908    24,908    0    249    249 
Total residential mortgage   821    419,952    420,773    0    3,890    3,890 
Commercial:                              
Commercial loans secured by real estate   8,005    142,463    150,468    528    1,852    2,380 
Commercial and industrial   212    83,642    83,854    95    904    999 
Political subdivisions   0    38,068    38,068    0    0    0 
Commercial construction and land   0    14,287    14,287    0    162    162 
Loans secured by farmland   1,394    5,900    7,294    51    59    110 
Multi-family (5 or more) residential   392    7,504    7,896    0    241    241 
Agricultural loans   13    3,985    3,998    0    40    40 
Other commercial loans   0    11,475    11,475    0    115    115 
Total commercial   10,016    307,324    317,340    674    3,373    4,047 
Consumer   23    13,699    13,722    0    138    138 
Unallocated                            398 
                               
Total  $10,860   $740,975   $751,835   $674   $7,401   $8,473 

 

Summary information related to impaired loans as of December 31, 2017 and 2016 is as follows:

 

(In Thousands)  December 31, 2017   December 31, 2016 
   Unpaid           Unpaid         
   Principal   Recorded   Related   Principal   Recorded   Related 
   Balance   Investment   Allowance   Balance   Investment   Allowance 
With no related allowance recorded:                              
Residential mortgage loans - first liens  $740   $711   $0   $783   $753   $0 
Residential mortgage loans - junior liens   60    60    0    68    68    0 
Commercial loans secured by real estate   3,230    3,230    0    6,975    5,232    0 
Commercial and industrial   119    119    0    117    117    0 
Loans secured by farmland   871    871    0    890    890    0 
Multi-family (5 or more) residential   987    392    0    987    392    0 
Agricultural loans   8    8    0    13    13    0 
Consumer   20    20    0    23    23    0 
Total with no related allowance recorded   6,035    5,411    0    9,856    7,488    0 
                               
With a related allowance recorded:                              
Residential mortgage loans - first liens   273    273    0    0    0    0 
Residential mortgage loans - junior liens   242    242    122    0    0    0 
Commercial loans secured by real estate   2,641    2,641    919    2,773    2,773    528 
Commercial and industrial   449    449    188    95    95    95 
Loans secured by farmland   495    495    50    504    504    51 
Total with a related allowance recorded   4,100    4,100    1,279    3,372    3,372    674 
Total  $10,135   $9,511   $1,279   $13,228   $10,860   $674 

 

In the table immediately above, two loans to one borrower are presented under the Residential mortgage loans – first liens and Residential mortgage loans – junior liens classes. These loans are collateralized by one property, and the allowance associated with these loans was determined based on an analysis of the total amounts of the Corporation’s exposure in comparison to the estimated net proceeds if the Corporation were to sell the property.

 

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

 

               Interest Income Recognized on 
   Average Investment in Impaired Loans   Impaired Loans on a Cash Basis 
(In Thousands)  Year Ended December 31,   Year Ended December 31, 
   2017   2016   2015   2017   2016   2015 
Residential mortgage:                              
Residential mortgage loans - first lien  $857   $806   $2,206   $52   $43   $86 
Residential mortgage loans - junior lien   112    71    64    15    3    4 
Total residential mortgage   969    877    2,270    67    46    90 
Commercial:                              
Commercial loans secured by real estate   6,272    6,806    6,357    173    495    380 
Commercial and industrial   301    547    438    24    20    20 
Commercial construction and land   0    0    40    0    0    0 
Loans secured by farmland   1,379    1,409    1,459    45    94    103 
Multi-family (5 or more) residential   392    511    790    0    0    0 
Agricultural loans   10    14    21    1    1    3 
Total commercial   8,354    9,287    9,105    243    610    506 
Consumer   26    21    0    1    1    0 
Total  $9,349   $10,185   $11,375   $311   $657   $596 

 

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

 

(In Thousands)  December 31, 2017   December 31, 2016 
   Past Due       Past Due     
   90+ Days and       90+ Days and     
   Accruing   Nonaccrual   Accruing   Nonaccrual 
Residential mortgage:                    
Residential mortgage loans - first liens  $2,340   $5,131   $3,022   $3,770 
Residential mortgage loans - junior liens   105    242    114    0 
Home equity lines of credit   203    44    320    11 
Total residential mortgage   2,648    5,417    3,456    3,781 
Commercial:                    
Commercial loans secured by real estate   175    5,645    2,774    3,080 
Commercial and industrial   603    517    286    119 
Commercial construction and land   26    52    0    0 
Loans secured by farmland   271    1,308    219    1,331 
Multi-family (5 or more) residential   0    392    0    392 
Agricultural loans   0    7    0    13 
Total commercial   1,075    7,921    3,279    4,935 
Consumer   1    66    103    20 
                     
Totals  $3,724   $13,404   $6,838   $8,736 

 

The amounts shown in the table immediately above include loans classified as troubled debt restructurings (described in more detail below), if such loans are considered past due ninety days or more, or nonaccrual.

 

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The tables below present a summary of the contractual aging of loans as of December 31, 2017 and 2016:

 

   As of December 31, 2017   As of December 31, 2016 
   Current &               Current &             
(In Thousands)  Past Due   Past Due   Past Due       Past Due   Past Due   Past Due     
   Less than   30-89   90+       Less than   30-89   90+     
   30 Days   Days   Days   Total   30 Days   Days   Days   Total 
Residential mortgage:                                        
Residential mortgage loans - first liens  $347,032   $7,967   $4,988   $359,987   $321,670   $6,695   $5,737   $334,102 
Residential mortgage loans - junior liens   25,133    87    105    25,325    23,268    324    114    23,706 
Home equity lines of credit   34,789    732    237    35,758    37,603    134    320    38,057 
1-4 Family residential construction   25,667    549    0    26,216    24,567    341    0    24,908 
Total residential mortgage   432,621    9,335    5,330    447,286    407,108    7,494    6,171    420,773 
                                         
Commercial:                                        
Commercial loans secured by real estate   155,917    311    3,038    159,266    147,464    82    2,922    150,468 
Commercial and industrial   87,306    303    667    88,276    83,364    185    305    83,854 
Political subdivisions   59,287    0    0    59,287    38,068    0    0    38,068 
Commercial construction and land   14,400    49    78    14,527    14,199    88    0    14,287 
Loans secured by farmland   6,226    12    1,017    7,255    6,181    83    1,030    7,294 
Multi-family (5 or more) residential   7,321    0    392    7,713    7,439    65    392    7,896 
Agricultural loans   6,114    57    7    6,178    3,981    4    13    3,998 
Other commercial loans   10,986    0    0    10,986    11,475    0    0    11,475 
Total commercial   347,557    732    5,199    353,488    312,171    507    4,662    317,340 
Consumer   14,760    123    56    14,939    13,446    153    123    13,722 
                                         
Totals  $794,938   $10,190   $10,585   $815,713   $732,725   $8,154   $10,956   $751,835 

 

Nonaccrual loans are included in the contractual aging immediately above. A summary of the contractual aging of nonaccrual loans at December 31, 2017 and 2016 is as follows:

 

   Current &             
(In Thousands)  Past Due   Past Due   Past Due     
   Less than   30-89   90+     
   30 Days   Days   Days   Total 
December 31, 2017 Nonaccrual Totals  $5,802   $741   $6,861   $13,404 
December 31, 2016 Nonaccrual Totals  $4,199   $419   $4,118   $8,736 

 

Loans whose terms are modified are classified as Troubled Debt Restructurings (TDRs) if the Corporation grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty. Loans classified as TDRs are designated as impaired and reviewed each quarter to determine if a specific allowance for loan losses is required. The outstanding balance of loans subject to TDRs, as well as the contractual aging information at December 31, 2017 and 2016 is as follows:

 

Troubled Debt Restructurings (TDRs):                    
   Current &                 
(In Thousands)  Past Due   Past Due   Past Due         
   Less than   30-89   90+         
   30 Days   Days   Days   Nonaccrual   Total 
December 31, 2017 Totals  $636   $0   $0   $3,027   $3,663 
December 31, 2016 Totals  $5,453   $350   $0   $2,874   $8,677 

 

At December 31, 2017 and 2016, there were no commitments to loan additional funds to borrowers whose loans have been classified as TDRs.

 

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There were no TDRs that occurred during 2017. A summary of TDRs that occurred during 2016 and 2015 is as follows:

 

(Balances in Thousands)        
   2016   2015 
       Post-       Post- 
   Number   Modification   Number   Modification 
   of   Recorded   of   Recorded 
   Loans   Investment   Loans   Investment 
Residential mortgage - first liens:                    
Extended maturity with interest rate reduction   1   $71    1   $56 
Extended maturity with reduced monthly payments   1    26    0    0 
Reduced monthly payments for a six-month period   0    0    1    242 
Residential mortgage - junior liens,                    
Interest rate and monthly payment reduction   0    0    1    32 
Commercial loans secured by real estate,                    
Interest only payments for a period of one year   1    2,773    0    0 
Commercial and industrial,                    
Extended maturity   1    5    0    0 
Consumer:                    
Interest rate and monthly payment reduction   0    0    1    30 
New unsecured loan after short-fall from sale                    
of property   1    24    0    0 
Total   5   $2,899    4   $360 

 

There were no differences between the outstanding contractual amounts and the recorded investments in receivables resulting from TDRs that occurred in 2016 and 2015.

 

For 2017, there were no defaults on loans for which modifications considered to be TDRs were entered into within the previous 12 months. For 2016 and 2015, defaults on loans for which modifications considered to be TDRs were entered into within the previous 12 months are summarized as follows:

 

(Balances in Thousands)        
   2016   2015 
   Number       Number     
   of   Recorded   of   Recorded 
   Loans   Investment   Loans   Investment 
Residential mortgage - first liens   2   $294    1   $32 
Residential mortgage - junior liens   1    29    0    0 
Commercial and industrial   1    5    0    0 
Consumer   1    27    0    0 
Total   5   $355    1   $32 

 

The carrying amount of foreclosed residential real estate properties held as a result of obtaining physical possession (included in Foreclosed assets held for sale in the consolidated balance sheets) is as follows:

 

(In Thousands)  Dec. 31,   Dec. 31, 
   2017   2016 
Foreclosed residential real estate  $721   $1,102 

 

The recorded investment of consumer mortgage loans secured by residential real properties for which formal foreclosure proceedings were in process is as follows:

 

(In Thousands)  Dec. 31,   Dec. 31, 
   2017   2016 
Residential real estate in process of foreclosure  $1,789   $2,738 

 

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9. BANK PREMISES AND EQUIPMENT

 

(In Thousands)      December 31, 
       2017   2016 
Land       $2,818   $2,818 
Buildings and improvements        28,285    27,619 
Furniture and equipment        15,578    18,741 
Construction in progress        268    392 
Total        46,949    49,570 
Less: accumulated depreciation        (31,517)   (34,173)
Net       $15,432   $15,397 

 

Depreciation expense included in occupancy expense and furniture and equipment expense was as follows:

 

(In Thousands)  2017   2016   2015 
Occupancy expense  $801   $804   $954 
Furniture and equipment expense   838    785    934 
Total  $1,639   $1,589   $1,888 

 

10. INTANGIBLE ASSETS

 

There were no changes in the carrying amount of goodwill in 2017 and 2016. The balance in goodwill was $11,942,000 at December 31, 2017 and 2016. The Corporation did not complete any acquisitions in 2017 or 2016.

 

In testing goodwill for impairment as of December 31, 2017, the Corporation assessed qualitative factors to determine whether it is more likely than not that the fair value of its only reporting unit, its community banking operation, is less than its carrying amount. The qualitative factors assessed included the Corporation’s recent financial performance, economic conditions in the Corporation’s market area, macroeconomic conditions and other factors. Based on the assessment of qualitative factors, the Corporation determined that it is not more likely than not that the fair value of the community banking operation has fallen below its carrying value, and therefore, the Corporation did not perform the more detailed, two-step goodwill impairment test described in Topic 350. Accordingly, there was no goodwill impairment as of December 31, 2017.

 

Information related to the core deposit intangibles is as follows:

   December 31, 
(In Thousands)  2017   2016 
Gross amount  $2,034   $2,034 
Less: accumulated amortization   (2,022)   (2,017)
Net  $12   $17 

 

Amortization expense was $5,000 in 2017, $13,000 in 2016 and $22,000 in 2015. The amount of amortization expense to be recognized each of the ensuing five years is not significant.

 

11. DEPOSITS

 

At December 31, 2017, the scheduled maturities of time deposits are as follows:

 

(In Thousands)    
2018  $112,563 
2019   57,097 
2020   22,836 
2021   7,975 
2022   10,484 
Thereafter   2,716 
Total  $213,671 

 

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Time deposits of more than $250,000 totaled $12,653,000 at December 31, 2017 and $7,929,000 at December 31, 2016. As of December 31, 2017, the remaining maturities or time to next re-pricing of time deposits more than $250,000 was as follows:

 

(In Thousands)    
Three months or less  $4,833 
Over 3 months through 12 months   5,375 
Over 1 year through 3 years   1,148 
Over 3 years   1,297 
Total  $12,653 

 

12. BORROWED FUNDS

 

Short-term borrowings (initial maturity within one year) include the following:

 

(In Thousands)  Dec. 31,   Dec. 31, 
   2017   2016 
FHLB-Pittsburgh borrowings  $58,000   $21,000 
Customer repurchase agreements   3,766    5,175 
Total short-term borrowings  $61,766   $26,175 

 

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

 

(In Thousands)  Dec. 31,   Dec. 31 
   2017   2016 
Overnight borrowing  $29,000   $21,000 
Other short-term advances   29,000    0 
Total short-term FHLB-Pittsburgh borrowings  $58,000   $21,000 

 

The weighted average interest rate on total short-term borrowings outstanding was 1.52% at December 31, 2017 and 0.61% at December 31, 2016. The maximum amount of total short-term borrowings outstanding at any month-end was $61,766,000 in 2017, $47,005,000 in 2016 and $53,496,000 in 2015.

 

The Corporation had available credit with other correspondent banks totaling $45,000,000 at December 31, 2017 and 2016. These lines of credit are primarily unsecured. No amounts were outstanding at December 31, 2017 or 2016.

 

The Corporation has a line of credit with the Federal Reserve Bank of Philadelphia’s Discount Window. At December 31, 2017, the Corporation had available credit in the amount of $15,877,000 on this line with no outstanding advances. At December 31, 2016, the Corporation had available credit in the amount of $15,636,000 on this line with no outstanding advances. As collateral for this line, the Corporation has pledged available-for-sale securities with a carrying value of $16,301,000 at December 31, 2017 and $17,690,000 at December 31, 2016.

 

The FHLB-Pittsburgh loan facility is collateralized by qualifying loans secured by real estate with a book value totaling $488,889,000 at December 31, 2017 and $471,454,000 at December 31, 2016. Also, the FHLB-Pittsburgh loan facility requires the Corporation to invest in established amounts of FHLB-Pittsburgh stock. The carrying values of the Corporation’s holdings of FHLB-Pittsburgh stock (included in Other Assets) were $6,426,000 at December 31, 2017 and $4,296,000 at December 31, 2016. The Corporation’s total credit facility with FHLB-Pittsburgh was $362,630,000 at December 31, 2017, including an unused (available) amount of $295,441,000. At December 31, 2016, the Corporation’s total credit facility with FHLB-Pittsburgh was $339,221,000, including an unused (available) amount of $306,767,000.

 

Overnight borrowings from FHLB-Pittsburgh had an interest rate of 1.54% at December 31, 2017 and 0.74% at December 31, 2016. At December 31, 2017, the other short-term advances included 9 advances of $3,000,000 and 1 advance of $2,000,000, each maturing monthly from January through October 2018, with a weighted average interest rate of 1.69% and rates ranging from 1.23% to 1.89%.

 

The Corporation engages in repurchase agreements with certain commercial customers. These agreements provide that the Corporation sells specified investment securities to the customers on an overnight basis and repurchases them on the following business day. The weighted average rate paid by the Corporation on customer repurchase agreements was 0.10% at December 31, 2017 and December 31, 2016. The carrying value of the underlying securities was $12,158,000 at December 31, 2017 and $15,019,000 at December 31, 2016.

 

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LONG-TERM BORROWINGS

 

Long-term borrowings (initial maturity of greater than one year) are as follows:

 

(In Thousands)  Dec. 31,   Dec. 31, 
   2017   2016 
FHLB-Pittsburgh borrowings  $9,189   $11,454 
Repurchase agreements   0    27,000 
Total long-term borrowings  $9,189   $38,454 

 

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

 

(In Thousands)  Dec. 31,   Dec. 31, 
   2017   2016 
Loan matured in 2017 with a rate of 6.83%  $0   $4 
Loan matured in 2017 with a rate of 3.81%   0    10,000 
Loan maturing in 2018 with a rate of 1.63%   3,000    0 
Loan maturing in 2018 with a rate of 1.35%   3,000    0 
Loan maturing in 2019 with a rate of 1.83%   2,000    0 
Loan maturing in 2020 with a rate of 4.79%   463    646 
Loan maturing in 2025 with a rate of 4.91%   726    804 
Total long-term FHLB-Pittsburgh borrowings  $9,189   $11,454 

 

The repurchase agreement included in long-term borrowings had an interest rate of 3.595% and matured in December 2017.

 

Securities sold under repurchase agreements were delivered to the broker-dealer who was the counter-party to the transactions. The broker-dealer may have sold, loaned or otherwise disposed of such securities to other parties in the normal course of their operations, and resold to the Corporation substantially identical securities at the maturities of the agreements. The carrying value of the underlying securities sold under the repurchase agreements with the broker dealer was $0 at December 31, 2017 and $31,494,000 at December 31, 2016, as detailed in the following table:

 

(In Thousands)  Dec. 31,   Dec. 31, 
   2017   2016 
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:          
Residential pass-through securities  $0   $18,181 
Residential collateralized mortgage obligations   0    13,313 
Total  $0   $31,494 

 

Average daily repurchase agreement borrowings amounted to $26,112,000 in 2017, $27,000,000 in 2016 and $54,304,000 in 2015. The maximum amounts of outstanding borrowings under repurchase agreements with broker-dealers were $27,000,000 in 2017 and 2016, and $61,000,000 in 2015. The weighted average interest rate on repurchase agreements was 3.60% in 2017 and 2016, and 3.99% in 2015.

 

13. EMPLOYEE AND POSTRETIREMENT BENEFIT PLANS

 

DEFINED BENEFIT PLANS

 

The Corporation sponsors a defined benefit health care plan that provides postretirement medical benefits and life insurance to employees who meet certain age and length of service requirements. Full-time employees no longer accrue service time toward the Corporation-subsidized portion of the medical benefits. The plan contains a cost-sharing feature which causes participants to pay for all future increases in costs related to benefit coverage. Accordingly, actuarial assumptions related to health care cost trend rates do not significantly affect the liability balance at December 31, 2017 and December 31, 2016, and are not expected to significantly affect the Corporation’s future expenses. The Corporation uses a December 31 measurement date for the postretirement plan.

 

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In an acquisition in 2007, the Corporation assumed the Citizens Trust Company Retirement Plan, a defined benefit pension plan. This plan covers certain employees who were employed by Citizens Trust Company on December 31, 2002, when the plan was amended to discontinue admittance of any future participant and to freeze benefit accruals. Information related to the Citizens Trust Company Retirement Plan has been included in the tables that follow. The Corporation uses a December 31 measurement date for this plan.

 

The following table shows the funded status of the defined benefit plans:

 

(In Thousands)                
   Pension   Postretirement 
   2017   2016   2017   2016 
CHANGE IN BENEFIT OBLIGATION:                    
Benefit obligation at beginning of year  $713   $722   $1,555   $1,539 
Service cost   0    0    36    37 
Interest cost   24    26    57    62 
Plan participants’ contributions   0    0    211    215 
Actuarial loss (gain)   127    3    (103)   (30)
Benefits paid   (14)   (38)   (259)   (268)
Benefit obligation at end of year  $850   $713   $1,497   $1,555 
                     
CHANGE IN PLAN ASSETS:                    
Fair value of plan assets at beginning of year  $846   $839   $0   $0 
Actual return on plan assets   91    45    0    0 
Employer contribution   0    0    48    53 
Plan participants’ contributions   0    0    211    215 
Benefits paid   (14)   (38)   (259)   (268)
Fair value of plan assets at end of year  $923   $846   $0   $0 
                     
Funded status at end of year  $73   $133   $(1,497)  $(1,555)

 

At December 31, 2017 and 2016, the following pension plan and postretirement plan asset and liability amounts were recognized in the consolidated balance sheets:

 

Assets and liabilities:                
(In Thousands)  Pension   Postretirement 
   2017   2016   2017   2016 
Other assets  $73   $133         
Accrued interest and other liabilities            $1,497   $1,555 

 

At December 31, 2017 and 2016, the following items included in accumulated other comprehensive income had not been recognized as components of expense:

 

Items not yet recognized as a component                
of net periodic benefit cost:                
(In Thousands)  Pension   Postretirement 
   2017   2016   2017   2016 
Prior service cost  $0   $0   $(309)  $(340)
Net actuarial loss (gain)   221    161    (2)   101 
Total  $221   $161   $(311)  $(239)

 

For the defined benefit pension plan, amortization of the net actuarial loss is expected to be $13,000 in 2018. For the postretirement plan, the estimated amount of prior service cost that will be amortized from accumulated other comprehensive loss into net periodic benefit cost in 2018 is a reduction in expense of $31,000, and no net actuarial gain is expected to be amortized in 2018.

 

The accumulated benefit obligation for the defined benefit pension plan was $850,000 at December 31, 2017 and $713,000 at December 31, 2016.

 

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

 

(In Thousands)  Pension   Postretirement 
   2017   2016   2015   2017   2016   2015 
Service  cost  $0   $0   $0   $36   $37   $38 
Interest cost   24    26    36    57    62    57 
Expected return on plan assets   (31)   (26)   (45)   0    0    0 
Amortization of prior service cost   0    0    0    (31)   (31)   (31)
Recognized net actuarial loss   7    9    11    0    0    0 
Loss on settlement   0    0    87    0    0    0 
Total net periodic benefit cost  $0   $9   $89   $62   $68   $64 

 

In 2015, there was a distribution from the pension plan of $337,000, or 32% of the plan’s total accumulated benefit obligation prior to the distribution. The Corporation recognized a loss of $87,000 (included in net periodic benefit cost) in 2015 as a result of this settlement.

 

The weighted-average assumptions used to determine net periodic benefit cost are as follows:

 

   Pension   Postretirement 
   2017   2016   2015   2017   2016   2015 
  Discount rate   4.05%   4.30%   3.75%   3.75%   4.25%   4.00%
  Expected return on plan assets   6.00%   5.00%   5.31%   N/A    N/A    N/A 
  Rate of compensation increase   N/A    N/A    N/A    N/A    N/A    N/A 

 

The weighted-average assumptions used to determine benefit obligations as of December 31, 2017 and 2016 are as follows:

 

   Pension   Postretirement 
   2017   2016   2017   2016 
  Discount rate   3.55%   4.05%   3.75%   4.25%
  Rate of compensation increase   N/A    N/A    N/A    N/A 

 

Estimated future benefit payments, including only estimated employer contributions for the postretirement plan, which reflect expected future service, are as follows:

 

(In Thousands)  Pension   Postretirement 
2018  $312   $96 
2019   41    96 
2020   13    104 
2021   12    101 
2022   14    105 
2023-2027   226    516 

 

No estimated minimum contribution to the defined benefit pension plan is required in 2018, though the Corporation may make discretionary contributions.

 

The expected return on pension plan assets is a significant assumption used in the calculation of net periodic benefit cost. This assumption reflects the average long-term rate of earnings expected on the funds invested or to be invested to provide for the benefits included in the projected benefit obligation.

 

The fair values of pension plan assets at December 31, 2017 and 2016 are as follows:

 

   2017   2016 
Mutual funds invested principally in:          
  Cash and cash equivalents   2%   2%
  Debt securities   37%   38%
  Equity securities   45%   44%
  Alternative funds   16%   16%
Total   100%   100%

 

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C&N Bank’s Trust and Financial Management Department manages the investment of the pension plan assets. The Plan’s securities include mutual funds invested principally in debt securities, a diversified mix of large, mid- and small-capitalization U.S. stocks, foreign stocks and alternative asset classes such as real estate, commodities, and inflation-protected securities. The fair values of plan assets are determined based on Level 1 inputs (as described in Note 6). At December 31, 2017, the targeted asset allocation of mutual funds for the pension plan was 45% equity securities, 37% debt securities, 16% alternative assets, and 2% cash. At December 31, 2016, the targeted asset allocation of mutual funds for the pension plan was 44% equity securities, 38% debt securities, 16% alternative assets and 2% cash. The pension plan’s assets do not include any shares of the Corporation’s common stock.

 

PROFIT SHARING AND DEFERRED COMPENSATION PLANS

 

The Corporation has a profit sharing plan that incorporates the deferred salary savings provisions of Section 401(k) of the Internal Revenue Code. The Corporation’s matching contributions to the Plan depend upon the tax deferred contributions of employees. The Corporation’s total basic and matching contributions were $681,000 in 2017, $646,000 in 2016 and $609,000 in 2015.

 

The Corporation has an Employee Stock Ownership Plan (ESOP). Contributions to the ESOP are discretionary, and the ESOP uses funds contributed to purchase Corporation stock for the accounts of ESOP participants. These purchases are made on the market (not directly from the Corporation), and employees are not permitted to purchase Corporation stock under the ESOP. The ESOP includes a diversification feature, which allows participants, upon reaching age 55 and 10 years of service (as defined), to sell up to 50% of their Corporation shares over a period of 6 years. As of December 31, 2017 and 2016, there were no shares allocated for repurchase by the ESOP.

 

Dividends paid on shares held by the ESOP are charged to retained earnings. All Corporation shares owned through the ESOP are included in the calculation of weighted-average shares outstanding for purposes of calculating earnings per share - basic and diluted. The ESOP held 419,067 shares of Corporation stock at December 31, 2017 and 417,753 shares at December 31, 2016, all of which had been allocated to Plan participants. The Corporation’s contributions to the ESOP totaled $588,000 in 2017, $549,000 in 2016 and $522,000 in 2015.

 

The Corporation has a nonqualified supplemental deferred compensation arrangement with its key officers. Charges to operating expense for officers’ supplemental deferred compensation were $200,000 in 2017, $184,000 in 2016 and $167,000 in 2015.

 

In December 2015, the Corporation established a nonqualified deferred compensation plan that allows selected officers, beginning in 2016, the option to defer receipt of cash compensation, including base salary and any cash bonuses or other cash incentives. This nonqualified deferred compensation plan does not provide for Corporation contributions.

 

STOCK-BASED COMPENSATION PLANS

 

The Corporation has a Stock Incentive Plan for a selected group of senior officers. A total of 850,000 shares of common stock may be issued under the Stock Incentive Plan. Awards may be made under the Stock Incentive Plan in the form of qualified options (“Incentive Stock Options,” as defined in the Internal Revenue Code), nonqualified options, stock appreciation rights or restricted stock. Historically through December 31, 2017, all awards made under this Plan have consisted of Incentive Stock Options or restricted stock. Incentive Stock Options have an exercise price equal to the market value of the stock at the date of grant, vest after 6 months and expire after 10 years. There are 270,179 shares available for issuance under the Stock Incentive Plan as of December 31, 2017.

 

Also, the Corporation has an Independent Directors Stock Incentive Plan. This plan permits awards of nonqualified stock options and/or restricted stock to non-employee directors. A total of 135,000 shares of common stock may be issued under the Independent Directors Stock Incentive Plan. The recipients’ rights to exercise stock options under this plan expire 10 years from the date of grant. The exercise prices of all stock options awarded under the Independent Directors Stock Incentive Plan are equal to market value as of the dates of grant. There are 17,396 shares available for issuance under the Independent Directors Stock Incentive Plan as of December 31, 2017.

 

Total stock-based compensation expense is as follows:

 

(In Thousands)  2017   2016   2015 
 Restricted stock  $627   $578   $606 
 Stock options   0    0    0 
 Total  $627   $578   $606 

 

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The following summarizes non-vested restricted stock activity for the year ended December 31, 2017:

 

       Weighted 
       Average 
   Number   Grant
Date
 
   of
Shares
   Fair
Value
 
Outstanding, December 31, 2016   63,362   $20.35 
Granted   30,782   $25.97 
Vested   (28,981)  $20.21 
Forfeited       (4,406)  $21.74 
Outstanding, December 31, 2017   60,757   $23.17 

 

Compensation cost related to restricted stock is recognized based on the market price of the stock at the grant date over the vesting period, adjusted for estimated and actual forfeitures. As of December 31, 2017, there was $671,000 total unrecognized compensation cost related to restricted stock, which is expected to be recognized over a weighted average period of 1.3 years.

 

In 2017 and 2016, the Corporation awarded shares of restricted stock under the Stock Incentive Plan, as follows:

 

   2017   2016 
Executive Officers   14,897    17,289 
Other employees     7,415    10,304 
Total       22,312    27,593 

 

Restricted stock awards in 2017 and 2016 to employees other than executive officers vest over a three-year term, subject to continued employment and satisfactory job performance, with no additional performance conditions (time vesting). Restricted stock awards in 2017 and 2016 to Executive Officers vest over a three-year term, with vesting for half of the shares based on time vesting and vesting for half of the shares based on time vesting and upon the Corporation meeting an annual return on average equity (“ROAE”) performance ratio, as defined. The minimum level for satisfying the performance condition defined in the 2017 and 2016 awards was an ROAE at the 50th percentile of the defined Peer Group’s results. The Corporation did not meet the performance condition defined in the 2017 and 2016 awards, as the Corporation’s return on average equity ROAE was in the 37th percentile of the Peer Group’s results for the 12-month period ended September 30, 2017 and in the 47th percentile of the Peer Group’s results for the 12-month period ended September 30, 2016. For purposes of the 2017 and 2016 awards, the Peer Group included all publicly traded commercial banks and bank holding companies with headquarters in Pennsylvania, New York, New Jersey and Ohio, and total assets ranging between $750 million and $3.5 billion as of the beginning of the applicable period.

 

Most of the restricted stock awards issued under this Plan prior to 2016, for which a portion of the awards vested in 2017 and 2016, include a condition that the Corporation must meet an annual targeted ROAE performance ratio, as defined, in order for participants to vest. In 2017, 2016 and 2015, the Corporation met the ROAE target applicable to these awards, which is based on the Corporation’s ROAE for 12-month periods ended September 30 of each year as compared to the applicable peer group of bank holding companies based in Pennsylvania and one local competitor based in New York with total assets of $750 million to $2 billion as of the beginning of each applicable period.

 

In 2017, a total of 8,470 restricted shares were granted under the Independent Directors Stock Incentive Plan, subject to time vesting over a term of one year. In 2016, a total of 7,834 restricted shares were granted under the Independent Directors Stock Incentive Plan, also with time vesting over a term of one year.

 

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There were no stock options granted in 2017, 2016 or 2015. A summary of stock option activity is presented below:

 

   2017   2016   2015 
       Weighted       Weighted       Weighted 
       Average       Average       Average 
       Exercise       Exercise       Exercise 
   Shares   Price   Shares   Price   Shares   Price 
Outstanding, beginning of year   202,037   $18.58    248,486   $18.59    316,157   $19.05 
Granted   0         0         0      
Exercised   (24,976)  $17.50    (35,880)  $18.86    (29,557)  $17.56 
Forfeited   (635)  $19.88    (10,569)  $18.03    (20,211)  $19.76 
Expired   (10,766)  $22.33    0         (17,903)  $27.00 
Outstanding, end of year   165,660   $18.49    202,037   $18.58    248,486   $18.59 
Options exercisable at year-end   165,660   $18.49    202,037   $18.58    248,486   $18.59 
Weighted-average fair value of options forfeited       $4.21        $4.04        $4.86 

 

The weighted-average remaining contractual term of outstanding stock options at December 31, 2017 was 3.5 years. The aggregate intrinsic value of stock options outstanding was $913,000 at December 31, 2017. The total intrinsic value of options exercised was $164,000 in 2017, $183,000 in 2016 and $77,000 in 2015.

 

The Corporation has issued shares from treasury stock for almost all stock option exercises through December 31, 2017. Management does not anticipate that stock repurchases will be necessary to accommodate stock option exercises in 2018.

 

In January 2018, the Corporation awarded 25,416 shares of restricted stock under the Stock Incentive Plan and 9,086 shares of restricted stock under the Independent Directors Stock Incentive Plans. The 2018 restricted stock awards under the Stock Incentive Plan vest ratably over three years, and vesting for one-half of the 16,578 restricted shares awarded to Executive Officers depends on the Corporation meeting a ROAE target each year. The 2018 restricted stock issued under the Independent Directors Stock Incentive Plan vests over one year. Total estimated stock-based compensation for 2018 is $716,000. The restricted stock awards made in January 2018 are not included in the tables above.

 

14. INCOME TAXES

 

The net deferred tax asset at December 31, 2017 and 2016 represents the following temporary difference components:

 

   December 31,   December 31, 
(In Thousands)  2017   2016 
Deferred tax assets:          
Unrealized holding losses on securities:          
Included in accumulated other comprehensive loss  $843   $512 
Included in retained earnings   (337)   0 
Allowance for loan losses   1,894    2,998 
Other deferred tax assets   1,726    2,658 
Total deferred tax assets   4,126    6,168 
           
Deferred tax liabilities:          
Defined benefit plans - ASC 835:          
Included in accumulated other comprehensive loss   31    27 
Included in retained earnings   (12)   0 
Bank premises and equipment   751    913 
Core deposit intangibles   3    6 
Other deferred tax liabilities   64    105 
Total deferred tax liabilities   837    1,051 
Deferred tax asset, net  $3,289   $5,117 

 

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The provision for income taxes includes the following:

 

(In thousands)  2017   2016   2015 
Currently payable  $4,938   $5,328   $5,097 
Tax expense resulting from allocations of certain tax benefits to equity or as a reduction in other assets   63    175    161 
Deferred   2,155    (156)   79 
Total provision  $7,156   $5,347   $5,337 

 

A reconciliation of income tax at the statutory rate to the Corporation’s effective rate is as follows (amounts in thousands):

 

(Amounts in thousands)  2017       2016       2015     
   Amount   %   Amount   %   Amount   % 
Expected provision  $7,207    35.00   $7,388    35.00   $7,633    35.00 
Tax-exempt interest income   (1,817)   (8.82)   (1,801)   (8.53)   (1,914)   (8.78)
Nondeductible interest expense   42    0.20    40    0.19    51    0.23 
Dividends received deduction   (7)   (0.03)   (22)   (0.10)   (75)   (0.34)
Increase in cash surrender value of life insurance   (133)   (0.65)   (134)   (0.63)   (135)   (0.62)
Employee stock option compensation   8    0.04    0    0.00    0    0.00 
ESOP Dividends   (154)   (0.75)   0    0.00    0    0.00 
Tax benefit from limited partnership investment   (73)   (0.35)   (76)   (0.36)   (80)   (0.37)
Effect of tax rate change   2,159    10.49    0    0.00    0    0.00 
Other, net   (76)   (0.37)   (48)   (0.23)   (143)   (0.66)
Effective income tax provision  $7,156    34.75   $5,347    25.33   $5,337    24.47 

 

In 2017, the Corporation recognized a reduction in the carrying value of the net deferred tax asset of $2,159,000 as a result of the December 2017 enactment of a reduction in the federal corporate income tax rate to 21% effective January 1, 2018, from the 35% marginal tax rate in effect throughout 2017, 2016 and 2015. Included in the total related provision was $325,000 associated with items included in Accumulated Other Comprehensive Loss in the consolidated balance sheets. Management believes the Corporation’s accounting for the effects of the reduction in the federal income tax rate is materially complete at December 31, 2017.

 

The Corporation has investments in three limited partnerships that manage affordable housing projects that have qualified for the federal low-income housing tax credit. The Corporation’s expected return from these investments is based on the receipt of tax credits and tax benefits from deductions of operating losses. The Corporation uses the effective yield method to account for these investments, with the benefits recognized as a reduction of the provision for income taxes. For two of the three limited partnership investments, the tax credits have been received in full in prior years, and the Corporation has fully realized the benefits of the credits and amortized its initial investments in the partnerships. The most recent affordable housing project was completed in 2013, and the Corporation received tax credits in 2013 through 2017 and expects to continue to receive tax credits annually through 2022. The carrying amount of the Corporation’s investment is $608,000 at December 31, 2017 and $713,000 at December 31, 2016 (included in Other Assets in the consolidated balance sheets). For 2017, the estimated amount of tax credits and other tax benefits to be received is $157,000 and the amount recognized as a reduction of the provision for income taxes is $73,000. In 2016, the Corporation received tax credits and other tax benefits totaling $158,000, and recognized a reduction of the provision for income tax of $76,000. In 2015, the Corporation received tax credits and other tax benefits totaling $160,000, and recognized a reduction of the provision for income tax of $80,000.

 

The Corporation has no unrecognized tax benefits, nor pending examination issues related to tax positions taken in preparation of its income tax returns. With limited exceptions, the Corporation is no longer subject to examination by the Internal Revenue Service for years prior to 2014.

 

15. RELATED PARTY TRANSACTIONS

 

Loans to executive officers, directors of the Corporation and its subsidiaries and any associates of the foregoing persons are as follows:

 

(In Thousands)  Beginning   New       Other   Ending 
   Balance   Loans   Repayments   Changes   Balance 
12 directors, 7 executive officers 2017  $11,414   $2,128   $(2,061)  $2,931   $14,412 
12 directors, 7 executive officers 2016   10,246    307    (1,160)   2,021    11,414 
11 directors, 7 executive officers 2015   12,023    52    (808)   (1,021)   10,246 

 

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In the table above, other changes represent net changes in the balance of existing lines of credit and transfers in and out of the related party category.

 

Deposits from related parties held by the Corporation amounted to $7,171,000 at December 31, 2017 and $6,261,000 at December 31, 2016.

 

16. OFF-BALANCE SHEET RISK

 

The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit, interest rate or liquidity risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of these instruments express the extent of involvement the Corporation has in particular classes of financial instruments.

 

The Corporation’s exposure to credit loss from nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

 

Financial instruments whose contract amounts represent credit risk at December 31, 2017 and 2016 are as follows:

 

(In Thousands)  2017   2016 
Commitments to extend credit  $187,919   $180,768 
Standby letters of credit   7,445    9,025 

 

Commitments to extend credit are legally binding agreements to lend to customers. Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future liquidity requirements. The Corporation evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation, for extensions of credit is based on management’s credit assessment of the counterparty.

 

Standby letters of credit are conditional commitments issued by the Corporation guaranteeing performance by a customer to a third party. Those guarantees are issued primarily to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Some of the standby letters of credit are collateralized by real estate or other assets, and others are unsecured. The extent to which proceeds from liquidation of collateral would be expected to cover the maximum potential amount of future payments related to standby letters of credit is not estimable. The Corporation has recorded no liability associated with standby letters of credit as of December 31, 2017 and 2016.

 

Standby letters of credit as of December 31, 2017 expire as follows:

 

Year of Expiration  (In Thousands) 
2018  $7,042 
2019   355 
2020   48 
Total  $7,445 

 

17. CONTINGENCIES

 

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

 

18. REGULATORY MATTERS

 

The Corporation (on a consolidated basis) and C&N Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Corporation’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and C&N Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

 

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Quantitative measures established by regulation to ensure capital adequacy require the Corporation and C&N Bank to maintain minimum amounts and ratios (set forth in the following table) of total capital, Tier I capital (as defined in the regulations) and Common equity Tier 1 capital (as defined) to risk-weighted assets (as defined) and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2017 and 2016, that the Corporation and C&N Bank meet all capital adequacy requirements (described in more detail below) to which they are subject and maintain capital conservation buffers that allow the Corporation and C&N Bank to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to certain executive officers.

 

To be categorized as well capitalized, an institution must maintain minimum total risk based, Tier I risk based, Common equity risk based and Tier I leverage ratios as set forth in the following table. The Corporation’s and C&N Bank’s actual capital amounts and ratios are also presented in the following table:

 

(Dollars in Thousands)                          Minimum To Be Well         
   Actual       Minimum To Maintain   Capitalized Under   Minimum To Meet 
           Minimum   Capital Conservation   Prompt Corrective   the Corporation’s 
   Actual       Capital
Requirement
   Buffer at
Reporting Date
   Action
Provisions
   Policy
Thresholds
 
   Amount   Ratio   Amount   Ratio   Amount   Ratio   Amount   Ratio   Amount   Ratio 
December 31, 2017:                                        
Total capital to risk-weighted assets:                                                  
Consolidated  $187,097    23.07%  $64,872    ³8%   $75,008    ³9.25%   $81,090    ³10%   $85,144    ³10.5% 
C&N Bank   165,142    20.47%   64,528    ³8%    74,611    ³9.25%    80,661    ³10%    84,694    ³10.5% 
Tier 1 capital to risk-weighted assets:                                                  
Consolidated   177,981    21.95%   48,654    ³6%    58,790    ³7.25%    64,872    ³8%    68,926    ³8.5% 
C&N Bank   156,026    19.34%   48,396    ³6%    58,479    ³7.25%    64,528    ³8%    68,561    ³8.5% 
Common equity tier 1 capital to risk-weighted assets:                                                  
Consolidated   177,981    21.95%   36,490    ³4.5%    46,626    ³5.75%    52,708    ³6.5%    56,763    ³7% 
C&N Bank   156,026    19.34%   36,297    ³4.5%    46,380    ³5.75%    52,429    ³6.5%    56,462    ³7% 
Tier 1 capital to average assets:                                                  
Consolidated   177,981    14.23%   50,023    ³4%    N/A    N/A    62,529    ³5%    62,529    ³5% 
C&N Bank   156,026    12.63%   49,418    ³4%    N/A    N/A    61,772    ³5%    61,772    ³5% 
                                                   
December 31, 2016:                                                  
Total capital to risk-weighted assets:                                                  
Consolidated  $183,597    23.60%  $62,245    ³8%   $67,108    ³8.625%   $77,806    ³10%   $81,697    ³10.5% 
C&N Bank   162,705    21.03%   61,894    ³8%    66,730    ³8.625%    77,368    ³10%    81,236    ³10.5% 
Tier 1 capital to risk-weighted assets:                                                  
Consolidated   174,928    22.48%   46,684    ³6%    51,547    ³6.625%    62,245    ³8%    66,135    ³8.5% 
C&N Bank   154,036    19.91%   46,421    ³6%    51,256    ³6.625%    61,894    ³8%    65,762    ³8.5% 
Common equity tier 1 capital to risk-weighted assets:                                                  
Consolidated   174,928    22.48%   35,013    ³4.5%    39,876    ³5.125%    50,574    ³6.5%    54,464    ³7% 
C&N Bank   154,036    19.91%   34,815    ³4.5%    39,651    ³5.125%    50,289    ³6.5%    54,157    ³7% 
Tier 1 capital to average assets:                                                  
Consolidated   174,928    14.27%   49,026    ³4%    N/A    N/A    61,282    ³5%    61,282    ³5% 
C&N Bank   154,036    12.73%   48,404    ³4%    N/A    N/A    60,506    ³5%    60,506    ³5% 

 

In July 2013, the federal regulatory authorities issued a new capital rule based, in part, on revisions developed by the Basel Committee on Banking Supervision to the Basel capital framework (Basel III). The Corporation and C&N Bank became subject to the new rule effective January 1, 2015. Generally, the new rule implemented higher minimum capital requirements, revised the definition of regulatory capital components and related calculations, added a new common equity tier 1 capital ratio, implemented a new capital conservation buffer, increased the risk weighting for past due loans and provided a transition period for several aspects of the new rule.

 

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The current (new) capital rule provides that, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of common equity tier 1 capital above its minimum risk-based capital requirements. The buffer is measured relative to risk-weighted assets. The 2017 minimum required capital ratios and capital conservation buffer needed in order to fully avoid limitations on capital distributions, along with the remaining transition schedule for new ratios and the capital conservation buffer, is as follows:

 

   As of January 1: 
   2017   2018   2019 
Minimum common equity tier 1 capital ratio   4.5%   4.5%   4.5%
Common equity tier 1 capital conservation buffer   1.25%   1.875%   2.5%
Minimum common equity tier 1 capital ratio plus capital conservation buffer   5.75%   6.375%   7.0%
Phase-in of most deductions from common equity tier 1 capital   80%   100%   100%
Minimum tier 1 capital ratio   6.0%   6.0%   6.0%
Minimum tier 1 capital ratio plus capital conservation buffer   7.25%   7.875%   8.5%
Minimum total capital ratio   8.0%   8.0%   8.0%
Minimum total capital ratio plus capital               
conservation buffer   9.25%   9.875%   10.5%

 

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

 

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

 

At December 31, 2017, the Corporation’s Capital Conservation Buffer, determined based on the minimum total capital ratio, was 15.07%. C&N Bank’s Capital Conservation Buffer (also determined based on the minimum total capital ratio) was 12.47%.

 

Banking regulators limit the amount of dividends that may be paid by C&N Bank to the Corporation. Retained earnings against which dividends may be paid without prior approval of the banking regulators amounted to approximately $88,980,000 at December 31, 2017, subject to the minimum capital ratio requirements noted above.

 

Restrictions imposed by federal law prohibit the Corporation from borrowing from C&N Bank unless the loans are secured in specific amounts. Such secured loans to the Corporation are generally limited to 10% of C&N Bank’s tangible stockholder’s equity (excluding accumulated other comprehensive loss) or $15,604,000 at December 31, 2017.

 

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19. PARENT COMPANY ONLY

 

The following is condensed financial information for Citizens & Northern Corporation:

 

CONDENSED BALANCE SHEET  December 31, 
(In Thousands)  2017   2016 
ASSETS          
Cash  $6,790   $6,033 
Investment in subsidiaries:          
Citizens & Northern Bank   166,576    165,397 
Citizens & Northern Investment Corporation   11,588    11,168 
Bucktail Life Insurance Company   3,488    3,419 
Other assets   15    4 
TOTAL ASSETS  $188,457   $186,021 
LIABILITIES AND STOCKHOLDERS’ EQUITY          
Other liabilities  $14   $13 
Stockholders’ equity   188,443    186,008 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY  $188,457   $186,021 

 

CONDENSED INCOME STATEMENT            
(In Thousands)  2017   2016   2015 
Dividends from Citizens & Northern Bank  $12,022   $14,960   $11,569 
Expenses   (233)   (367)   (234)
Income before equity in undistributed income of subsidiaries   11,789    14,593    11,335 
Equity in undistributed income of subsidiaries   1,645    1,169    5,136 
NET INCOME  $13,434   $15,762   $16,471 

 

CONDENSED STATEMENT OF CASH FLOWS            
(In Thousands)            
   2017   2016   2015 
CASH FLOWS FROM OPERATING ACTIVITIES:               
Net income  $13,434   $15,762   $16,471 
Adjustments to reconcile net income to net               
cash provided by operating activities:               
Equity in undistributed net income of subsidiaries   (1,645)   (1,169)   (5,136)
(Increase) decrease in other assets   (11)   20    12 
Increase (decrease) in other liabilities   1    (6)   12 
Net Cash Provided by Operating Activities   11,779    14,607    11,359 
CASH FLOWS FROM FINANCING ACTIVITIES:               
Proceeds from sale of treasury stock   128    263    381 
Tax (cost) benefit from compensation plans, net   (5)   151    143 
Purchase of treasury stock   0    (3,723)   (4,415)
Dividends paid   (11,145)   (11,112)   (11,245)
Net Cash Used in Financing Activities   (11,022)   (14,421)   (15,136)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS   757    186    (3,777)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR   6,033    5,847    9,624 
CASH AND CASH EQUIVALENTS, END OF YEAR  $6,790   $6,033   $5,847 

 

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20. SUMMARY OF QUARTERLY CONSOLIDATED FINANCIAL DATA (Unaudited)

 

The following table presents summarized quarterly financial data for 2017 and 2016:

 

SUMMARY OF QUARTERLY CONSOLIDATED FINANCIAL DATA        
(In Thousands Except Per Share Data) (Unaudited)            
   2017 Quarter Ended 
   Mar. 31,   June 30,   Sept. 30,   Dec. 31, 
   2017   2017   2017   2017 
Interest income  $11,112   $11,340   $11,626   $11,785 
Interest expense   953    978    985    999 
Net interest income   10,159    10,362    10,641    10,786 
Provision for loan losses   452    4    322    23 
Net interest income after provision for loan losses   9,707    10,358    10,319    10,763 
Other income   3,864    4,106    4,066    4,117 
Net gains on available-for-sale securities   145    107    5    0 
Other expenses   9,298    9,076    9,192    9,401 
Income before income tax provision   4,418    5,495    5,198    5,479 
Income tax provision   984    1,374    1,262    3,536 
Net income  $3,434   $4,121   $3,936   $1,943 
Net income attributable to common shares  $3,416   $4,100   $3,916   $1,933 
Net income per share – basic  $0.28   $0.34   $0.32   $0.16 
Net income per share – diluted  $0.28   $0.34   $0.32   $0.16 

 

   2016 Quarter Ended 
   Mar. 31,   June 30,   Sept. 30,   Dec. 31, 
   2016   2016   2016   2016 
Interest income  $10,937   $10,924   $11,131   $11,106 
Interest expense   904    925    944    920 
Net interest income   10,033    9,999    10,187    10,186 
Provision (credit) for loan losses   368    318    538    (3)
Net interest income after provision (credit) for loan losses   9,665    9,681    9,649    10,189 
Other income   3,690    3,906    3,884    4,031 
Net gains on available-for-sale securities   383    122    584    69 
Other expenses   9,072    8,535    8,579    8,558 
Income before income tax provision   4,666    5,174    5,538    5,731 
Income tax provision   1,093    1,303    1,451    1,500 
Net income  $3,573   $3,871   $4,087   $4,231 
Net income attributable to common shares  $3,553   $3,850   $4,065   $4,209 
Net income per share – basic  $0.29   $0.32   $0.34   $0.35 
Net income per share – diluted  $0.29   $0.32   $0.34   $0.35 

 

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Report of Independent Registered Public Accounting Firm

 

Stockholders and Board of Directors of

Citizens & Northern Corporation

 

Opinions on the Financial Statements and Internal Control over Financial Reporting

 

We have audited the accompanying consolidated balance sheets of Citizens & Northern Corporation and subsidiaries (collectively, the “Corporation”) as of December 31, 2017 and 2016 and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows, for each of the three years in the period ended December 31, 2017, and the related notes (collectively referred to as the “consolidated financial statements”). We have also audited the Corporation’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).

 

In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Corporation as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework (2013) issued by COSO.

 

Basis for Opinion

 

The Corporation’s management is responsible for these consolidated financial statements, for maintaining effective control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Corporation’s consolidated financial statements and an opinion on the Corporation’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud and whether effective internal control over financial reporting was maintained. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.

 

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Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. We believe that our audits provide a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

/s/  Baker Tilly Virchow Krause, LLP  
   
Williamsport, Pennsylvania  
   
We have served as the Corporation’s auditor since 1979.  
   
February 15, 2018  

 

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None

 

ITEM 9A. CONTROLS AND PROCEDURES

 

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

 

The Corporation’s management, under the supervision of and with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, has carried out an evaluation of the design and effectiveness of the Corporation’s disclosure controls and procedures as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Securities Exchange Act of 1934 as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Corporation’s disclosure controls and procedures are effective to ensure that all material information required to be disclosed in reports the Corporation files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.

 

There were no significant changes in the Corporation’s internal control over financial reporting that occurred during the period covered by this report that has materially affected, or that is reasonably likely to affect, our internal control over financial reporting.

 

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

 

The Corporation’s management is responsible for establishing and maintaining effective internal control over financial reporting, as that term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). The Corporation’s system of internal control over financial reporting has been designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation and fair presentation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. The Corporation’s internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Corporation’s assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Corporation are being made only in accordance with authorizations of the Corporation’s management and directors; and (3) provide reasonable assurance regarding prevention, or timely detection and correction of unauthorized acquisition, use or disposition of the Corporation’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect and correct misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.

 

The Corporation’s management assessed the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2017, based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control – Integrated Framework (2013). Based on that assessment, we concluded that, as of December 31, 2017, the Corporation’s internal control over financial reporting is effective based on the criteria established in Internal Control – Integrated Framework (2013).

 

Baker Tilly Virchow Krause, LLP, the independent registered public accounting firm that audited the Corporation’s consolidated financial statements, has issued an audit report on the Corporation’s internal control over financial reporting as of December 31, 2017. That report appears immediately prior to this report.

 

February 15, 2018 By: /s/ J. Bradley Scovill
Date   President and Chief Executive Officer
     
February 15, 2018 By: /s/ Mark A. Hughes
Date   Treasurer and Chief Financial Officer

 

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ITEM 9B. OTHER INFORMATION

 

There was no information the Corporation was required to disclose in a report on Form 8-K during the fourth quarter 2017 that was not disclosed.

 

PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

Information concerning Directors and Executive Officers is incorporated herein by reference to disclosure under the captions “Proposal 1 - Election of Directors,” “Executive Officers,” “Information Concerning Security Ownership” and “Meetings and Committees of the Board of Directors” of the Corporation’s proxy statement dated March 9, 2018 for the annual meeting of stockholders to be held on April 19, 2018.

 

The Corporation’s Board of Directors has adopted a Code of Ethics, available on the Corporation’s web site at www.cnbankpa.com for the Corporation’s employees, officers and directors. (The provisions of the Code of Ethics are also included in the Corporation’s employee handbook.)

 

ITEM 11. EXECUTIVE COMPENSATION

 

Information concerning executive compensation is incorporated herein by reference to disclosure under the captions “Compensation Discussion and Analysis” and “Executive Compensation Tables” of the Corporation’s proxy statement dated March 9, 2018 for the annual meeting of stockholders to be held on April 19, 2018.

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference to disclosure under the caption “Beneficial Ownership of Executive Officers and Directors” of the Corporation’s proxy statement dated March 9, 2018 for the annual meeting of stockholders to be held on April 19, 2018.

 

“Equity Compensation Plan Information” as required by Item 201(d) of Regulation S-K is incorporated by reference herein from Item 5 (Market for Registrant’s Common Equity and Related Stockholder Matters) of this Form 10-K.

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

Information concerning loans and deposit balances with Directors and Executive Officers is provided in Note 15 to the Consolidated Financial Statements, which is included in Part II, Item 8 of this Annual Report on Form 10-K. Additional information, including information concerning director independence, is incorporated herein by reference to disclosure appearing under the captions “Director Independence” and “Related Person Transaction and Policies” of the Corporation’s proxy statement dated March 9, 2018 for the annual meeting of stockholders to be held on April 19, 2018.

 

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

Information concerning services provided by the Corporation’s independent auditor Baker Tilly Virchow Krause, LLP, the audit committee’s pre-approval policies and procedures for such services, and fees paid by the Corporation to that firm, is incorporated herein by reference to disclosure under the caption “Fees of Independent Public Accountants” of the Corporation’s proxy statement dated March 9, 2018 for the annual meeting of stockholders to be held on April 19, 2018.

 

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PART IV

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

(a) (1). The following consolidated financial statements are set forth in Part II, Item 8:

 

  Page
Report of Independent Registered Public Accounting Firm 86-87
   
Financial Statements:  
Consolidated Balance Sheets - December 31, 2017 and 2016 41
Consolidated Statements of Income - Years Ended December 31, 2017, 2016 and 2015 42
Consolidated Statements of Comprehensive Income - Years Ended December 31, 2017, 2016 and 2015 43
Consolidated Statements of Changes in Stockholders’ Equity - Years Ended December 31, 2017, 2016 and 2015 44
Consolidated Statements of Cash Flows - Years Ended December 31, 2017, 2016 and 2015 45
Notes to Consolidated Financial Statements 46-85

 

(a)(2) Financial statement schedules are not applicable or included in the financial statements or related notes.

 

2. Plan of acquisition, reorganization, arrangement, liquidation or succession   Not applicable
     
3. (i) Articles of Incorporation   Incorporated by reference to Exhibit 3.1 of the Corporation’s Form 8-K filed September 21, 2009
     
3. (ii) By-laws   Incorporated by reference to Exhibit 3.1 of the Corporation’s Form 8-K filed April 19, 2013
     
4. Instruments defining the rights of Security holders, including Indentures   Not applicable
     
9. Voting trust agreement   Not applicable
     
10. Material contracts:    
10.1 Form of Restricted Stock agreement dated January 3, 2018 between the Corporation and Executive Officers pursuant to the Citizens & Northern Corporation Stock Incentive Plan   Filed herewith
     
10.2 Form of Restricted Stock agreement dated January 3, 2018 between the Corporation and certain non-executive officers pursuant to the Citizens & Northern Corporation Stock Incentive Plan   Filed herewith
     
10.3 Form of Restricted Stock agreement dated January 3, 2018 between the Corporation and its independent directors pursuant to the Citizens & Northern Corporation Independent Directors Stock Incentive Plan   Filed herewith
     
10.4 2018 Annual Performance Incentive Award Plan   Filed herewith
     
10.5 2018 Annual Performance Incentive Award Plan - Mortgage Lenders   Filed herewith

 

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10.6 Form of Indemnification Agreement dated January 9, 2018 between the Corporation and Tracy E. Watkins   Filed herewith
     
10.7 Change in Control Agreement dated January 9, 2018 between the Corporation and Tracy E. Watkins   Filed herewith
     
10.8 Deferred Compensation Agreement dated December 17, 2015   Filed herewith
     
10.9 Employment agreement dated March 2, 2015 between the Corporation and J. Bradley Scovill   Incorporated by reference to Exhibit 10.1 filed with Corporation’s Form 8-K on February 9, 2015
     
10.10 Employment agreement dated September 19, 2013 between the Corporation and Mark A. Hughes   Incorporated by reference to Exhibit 10.2 filed with Corporation’s Form 8-K on September 19, 2013
     
10.11 Employment agreement dated September 19, 2013 between the Corporation and Harold F. Hoose, III   Incorporated by reference to Exhibit 10.3 filed with Corporation’s Form 8-K on September 19, 2013
     
10.12 Employment agreement dated September 19, 2013 between the Corporation and Deborah E. Scott   Incorporated by reference to Exhibit 10.4 filed with Corporation’s Form 8-K on September 19, 2013
     
10.13 Form of Indemnification Agreement dated February 11, 2015 between the Corporation and Stan R. Dunsmore   Incorporated by reference to Exhibit 10.9 filed with Corporation’s Form 10-K on February 26, 2015
     
10.14 Form of Indemnification Agreement dated January 2, 2013 between the Corporation and Shelley L. D’Haene   Incorporated by reference to Exhibit 10.5 filed with Corporation’s Form 10-K on February 21, 2013
     
10.15 Form of Indemnification Agreement dated January 19, 2011 between the Corporation and John M. Reber   Incorporated by reference to Exhibit 10.6 filed  with Corporation’s Form 10-K on Feb. 28, 2011
     
10.16 Form of Indemnification Agreements dated May 2004 between the Corporation and the Directors and certain officers   Incorporated by reference to Exhibit 10.1 filed with Corporation’s 10-K on March 14, 2005
     
10.17 Change in Control Agreement dated March 17, 2015 between the Corporation and Stan R. Dunsmore   Incorporated by reference to Exhibit 10.1 filed with Corporation’s Form 10-Q on May 8, 2015
     
10.18 Change in Control Agreement dated January 2, 2013 between the Corporation and Shelley L. D’Haene   Incorporated by reference to Exhibit 10.7 filed with Corporation’s Form 10-K on February 21, 2013
     
10.19  Change in Control Agreement dated January 20, 2005 between the Corporation and John M. Reber   Incorporated by reference to Exhibit 10.18 filed with Corporation’s Form 10-K on February 18, 2016
     
10.20 Change in Control Agreement dated December 31, 2003 between the Corporation and Thomas L. Rudy, Jr.   Incorporated by reference to Exhibit 10.2 filed with the Corporation’s Form 10-K on March 14, 2005
     
10.21 Executive Compensation Recoupment Policy dated September 19, 2013   Incorporated by reference to Exhibit 10.5 filed with Corporation’s Form 8-K on September 19, 2013
     
10.22 Fourth Amendment to Citizens & Northern Corporation Stock Incentive Plan and Annual Incentive Plan   Incorporated by reference to Exhibit 10.6 filed with Corporation’s Form 8-K on September 19, 2013
     
10.23 Third Amendment to Citizens & Northern Corporation Stock Incentive Plan   Incorporated by reference to Exhibit A to the Corporation’s proxy statement dated March 18, 2008 for the annual meeting of stockholders held on April 15, 2008
     
10.24 Second Amendment to Citizens & Northern Corporation Stock Incentive Plan   Incorporated by reference to Exhibit 10.5 filed with the Corporation’s Form 10-K on March 10, 2004

 

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10.25 First Amendment to Citizens & Northern Corporation Stock Incentive Plan   Incorporated by reference to Exhibit 10.6 filed with the Corporation’s Form 10-K on March 10, 2004
     
10.26 Citizens & Northern Corporation Stock Incentive Plan   Incorporated by reference to Exhibit 10.7 filed with the Corporation’s Form 10-K on March 10, 2004
     
10.27 First Amendment to Citizens & Northern Corporation Independent Directors Stock Incentive Plan   Incorporated by reference to Exhibit B to the Corporation’s proxy statement dated March 18, 2008 for the annual meeting of stockholders held on April 15, 2008
     
10.28 Citizens & Northern Corporation Independent Directors Stock Incentive Plan   Incorporated by reference to Exhibit A to the Corporation’s proxy statement dated March 19, 2001 for the annual meeting of stockholders held on April 17, 2001.
     
10.29 Citizens & Northern Corporation Supplemental Executive Retirement Plan (as amended and restated)   Incorporated by reference to Exhibit 10.21 filed with the Corporation’s Form 10-K on March 6, 2009
     
11. Statement re: computation of per share earnings   Information concerning the computation of earnings per share is provided in Note 4 to the Consolidated Financial Statements, which is included in Part II, Item 8 of Form 10-K
     
12. Statements re: computation of ratios   Not applicable
     
13. Annual report to security holders, Form 10-Q or quarterly report to security holders   Not applicable
     
14. Code of ethics   The Code of Ethics is available through the Corporation’s website at www.cnbankpa.com. To access the Code of Ethics, click on “Investor Relations,” followed by “Pages within Investor Relations,” “Corporate Governance Policies,” and “Code of Ethics.”
     
16. Letter re: change in certifying accountant   Not applicable
     
18. Letter re: change in accounting principles   Not applicable
     
21. Subsidiaries of the registrant   Filed herewith
     
22. Published report regarding matters submitted to vote of security holders   Not applicable
     
23. Consent of Independent Registered Public Accounting Firm   Filed herewith
     
24. Power of attorney   Not applicable
     
31. Rule 13a-14(a)/15d-14(a) certifications:    
31.1 Certification of Chief Executive Officer   Filed herewith
31.2 Certification of Chief Financial Officer   Filed herewith
     
32. Section 1350 certifications   Filed herewith

 

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33. Report on assessment of compliance with servicing criteria for asset-backed securities   Not applicable
     
34. Attestation report on assessment of compliance with servicing criteria for asset-backed securities   Not applicable
     
35. Service compliance statement   Not applicable
     
99. Additional exhibits:    
99.1 Additional information mailed or made available online to shareholders with proxy statement and Form 10-K on March 9, 2018   Filed herewith
     
100. XBRL-related documents   Not applicable
     
101. Interactive data file   Filed herewith

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated.

 

 

By: /s/ J. Bradley Scovill  
President and Chief Executive Officer  
   
Date: February 15, 2018  
   
By: /s/ Mark A. Hughes  
Treasurer and Principal Accounting Officer  

 

Date: February 15, 2018

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

BOARD OF DIRECTORS

 

/s/ Dennis F. Beardslee   /s/ Edward H. Owlett, III
  Dennis F. Beardslee     Edward H. Owlett, III
  Date: February 15, 2018     Date: February 15, 2018
         
/s/ Jan E. Fisher   /s/ J. Bradley Scovill
  Jan E. Fisher     J. Bradley Scovill
  Date: February 15, 2018     Date: February 15, 2018
         
/s/ R. Bruce Haner   /s/ Leonard Simpson
  R. Bruce Haner     Leonard Simpson
  Date: February 15, 2018     Date: February 15, 2018
         
/s/ Susan E. Hartley   /s/ James E. Towner
  Susan E. Hartley     James E. Towner
  Date: February 15, 2018     Date: February 15, 2018
         
/s/ Leo F. Lambert   /s/ Aaron K. Singer
  Leo F. Lambert     Aaron K. Singer
  Date: February 15, 2018     Date:  February 15, 2018
         
/s/ Terry L. Lehman   /s/ Frank G. Pellegrino
  Terry L. Lehman     Frank G. Pellegrino
  Date: February 15, 2018     Date: February 15, 2018

 

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