XNAS:CZNC Citizens and Northern Corp Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2012

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: 000-16084

 

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)

 

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

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

 

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.

Common Stock ($1.00 par value) 12,216,950 Shares Outstanding on May 4, 2012

 

 
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

CITIZENS & NORTHERN CORPORATION

Index

 

Part I. Financial Information    
     
Item 1. Financial Statements    
     
Consolidated Balance Sheets (Unaudited) – March 31, 2012 and December 31, 2011   Page 3
     
Consolidated Statements of Operations (Unaudited) – Three Months Ended March 31, 2012 and 2011   Page 4
     
Consolidated Statements of Comprehensive Income  (Unaudited) – Three Months Ended March 31, 2012 and 2011   Page 5
     
Consolidated Statements of Cash Flows (Unaudited) – Three Months Ended March 31, 2012 and 2011   Page 6
     
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) - Three Months Ended March 31, 2012 and 2011   Page 7
     
Notes to Unaudited Consolidated Financial Statements   Pages 8 – 35
     
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations   Pages 36 – 52
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk   Pages 52 – 55
     
Item 4. Controls and Procedures   Page 55
     
Part II. Other Information   Pages 56 – 57
     
Signatures   Page 58
     
Exhibit 31.1. Rule 13a-14(a)/15d-14(a) Certification - Chief Executive Officer    
     
Exhibit 31.2. Rule 13a-14(a)/15d-14(a) Certification - Chief Financial Officer    
     
Exhibit 32. Section 1350 Certifications    

 

2
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

PART 1. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS (Unaudited)

(In Thousands Except Share Data)  March 31,   December 31, 
   2012   2011 
ASSETS          
Cash and due from banks:          
Noninterest-bearing  $19,022   $17,618 
Interest-bearing   37,476    42,957 
Total cash and due from banks   56,498    60,575 
Available-for-sale securities, at fair value   486,664    481,685 
Loans held for sale   2,223    939 
           
Loans receivable   697,588    708,315 
Allowance for loan losses   (7,370)   (7,705)
Loans, net   690,218    700,610 
Bank-owned life insurance   21,008    20,889 
Accrued interest receivable   4,943    4,797 
Bank premises and equipment, net   18,761    19,028 
Foreclosed assets held for sale   977    1,235 
Deferred tax asset, net   5,003    6,173 
Intangible asset - Core deposit intangibles   193    212 
Intangible asset - Goodwill   11,942    11,942 
Other assets   18,334    15,650 
TOTAL ASSETS  $1,316,764   $1,323,735 
           
LIABILITIES          
Deposits:          
Noninterest-bearing  $202,439   $193,595 
Interest-bearing   814,362    824,611 
Total deposits   1,016,801    1,018,206 
Short-term borrowings   4,030    4,950 
Long-term borrowings   115,202    125,363 
Accrued interest and other liabilities   9,117    7,831 
TOTAL LIABILITIES   1,145,150    1,156,350 
           
STOCKHOLDERS' EQUITY          
Preferred stock, $1,000 par value; authorized 30,000 shares; $1,000 liquidation preference per share; no shares issued at March 31, 2012 and December 31, 2011   0    0 
Common stock, par value $1.00 per share; authorized 20,000,000 shares in 2012 and 2011; issued 12,473,495 at March 31, 2012 and 12,460,920 at December 31, 2011   12,474    12,461 
Paid-in capital   67,360    67,568 
Retained earnings   85,715    82,302 
Treasury stock, at cost; 257,745 shares at March 31, 2012 and 305,391 shares at December 31, 2011   (4,309)   (5,106)
Sub-total   161,240    157,225 
Accumulated other comprehensive income:          
Unrealized gains on available-for-sale securities   10,852    10,791 
Defined benefit plans   (478)   (631)
Total accumulated other comprehensive income   10,374    10,160 
TOTAL STOCKHOLDERS' EQUITY   171,614    167,385 
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY  $1,316,764   $1,323,735 

 

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

 

3
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

CONSOLIDATED STATEMENTS OF OPERATIONS  3 Months Ended 
(In Thousands, Except Per Share Data) (Unaudited)  March 31,
2012
   March 31,
2011
 
INTEREST INCOME           
Interest and fees on loans  $10,375   $10,868 
Interest on balances with depository institutions   28    16 
Interest on loans to political subdivisions   377    375 
Income from available-for-sale and held-to-maturity securities:          
Taxable   2,658    2,693 
Tax-exempt   1,263    1,284 
Dividends   75    62 
Total interest and dividend income   14,776    15,298 
INTEREST EXPENSE          
Interest on deposits   1,350    2,568 
Interest on short-term borrowings   3    6 
Interest on long-term borrowings   1,149    1,442 
Total interest expense   2,502    4,016 
Net interest income   12,274    11,282 
(Credit) provision for loan losses   (182)   (192)
Net interest income after (credit) provision for loan losses   12,456    11,474 
OTHER INCOME          
Service charges on deposit accounts   1,161    1,131 
Service charges and fees   220    218 
Trust and financial management revenue   929    877 
Interchange revenue from debit card transactions   495    452 
Net gains from sale of loans   265    259 
Increase in cash surrender value of life insurance   119    122 
Insurance commissions, fees and premiums   34    68 
Impairment loss on limited partnership investment   0    (948)
Other operating income   536    376 
Sub-total   3,759    2,555 
Total other-than-temporary impairment losses on available-for-sale securities   (67)   0 
Portion of (gain) recognized in other comprehensive income (before taxes)   0    0 
Net impairment losses recognized in earnings   (67)   0 
Realized gains on available-for-sale securities, net   65    1,839 
Net realized (losses) gains on available-for-sale securities   (2)   1,839 
Total other income   3,757    4,394 
OTHER EXPENSES          
Salaries and wages   3,575    3,401 
Pensions and other employee benefits   1,366    1,306 
Occupancy expense, net   636    732 
Furniture and equipment expense   482    484 
FDIC Assessments   146    325 
Pennsylvania shares tax   332    319 
Other operating expense   1,980    1,696 
Total other expenses   8,517    8,263 
Income before income tax provision   7,696    7,605 
Income tax provision   2,109    2,064 
NET INCOME  $5,587   $5,541 
NET INCOME PER SHARE - BASIC  $0.46   $0.46 
NET INCOME PER SHARE - DILUTED  $0.46   $0.45 

 

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

 

4
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In Thousands) (Unaudited)

 

   Three Months Ended 
   March 31, 
   2012   2011 
Net income  $5,587   $5,541 
           
Unrealized gains on available-for-sale securities:          
Unrealized holding gains on available-for-sale securities   344    6,125 
Reclassification adjustment for losses (gains) realized in income   2    (1,839)
Other comprehensive gain on available-for-sale securities   346    4,286 
           
Unfunded pension and postretirement obligations:          
Change in items from defined benefit plans included in accumulated other comprehensive income   200    (119)
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost   20    13 
Other comprehensive gain (loss) on unfunded retirement obligations   220    (106)
           
Other comprehensive income before income tax   566    4,180 
Income tax related to other comprehensive income   (352)   (1,421)
           
Net other comprehensive income   214    2,759 
           
Total comprehensive income  $5,801   $8,300 

 

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

 

5
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

CONSOLIDATED STATEMENTS OF CASH FLOWS  3 Months Ended March 31, 
(In Thousands) (Unaudited)  2012   2011 
CASH FLOWS FROM OPERATING ACTIVITIES:        
Net income  $5,587   $5,541 
Adjustments to reconcile net income to net cash provided by operating activities:          
Credit for loan losses   (182)   (192)
Realized losses (gains) on available-for-sale securities, net   2    (1,839)
(Gain) loss on sale of foreclosed assets, net   (104)   19 
Depreciation expense   493    536 
Accretion and amortization on securities, net   182    446 
Accretion and amortization on loans, deposits and borrowings, net   (12)   (8)
Amortization of mortgage servicing rights   21    13 
Impairment loss on limited partnership interest   0    948 
Increase in cash surrender value of life insurance   (119)   (122)
Stock-based compensation   241    192 
Amortization of core deposit intangibles   19    29 
Deferred income taxes   818    1,826 
Gains on sales of mortgage loans, net   (265)   (259)
Origination of mortgage loans for sale   (9,174)   (4,529)
Proceeds from sales of mortgage loans   8,100    9,798 
(Increase) decrease in accrued interest receivable and other assets   (2,941)   1,396 
Increase (decrease) in accrued interest payable and other liabilities   741    (844)
Net Cash Provided by Operating Activities   3,407    12,951 
CASH FLOWS FROM INVESTING ACTIVITIES:          
Purchase of certificates of deposit   (480)   0 
Proceeds from sales of available-for-sale securities   27    15,950 
Proceeds from calls and maturities of available-for-sale securities   27,279    26,781 
Purchase of available-for-sale securities   (31,358)   (46,069)
Redemption of Federal Home Loan Bank of Pittsburgh stock   332    408 
Net decrease in loans   10,094    11,207 
Purchase of premises and equipment   (226)   (86)
Purchase of investment in limited liability entity   (214)   0 
Return of principal on limited liability entity investments   27    70 
Proceeds from sale of foreclosed assets   858    0 
Net Cash Provided by Investing Activities   6,339    8,261 
CASH FLOWS FROM FINANCING ACTIVITIES:          
Net (decrease) increase in deposits   (1,409)   5,648 
Net decrease in short-term borrowings   (920)   (2,345)
Repayments of long-term borrowings   (10,161)   (10,155)
Sale of treasury stock   101    3 
Tax benefit from compensation plans   22    15 
Common dividends paid   (1,936)   (1,401)
Net Cash Used in Financing Activities   (14,303)   (8,235)
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS   (4,557)   12,977 
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR   56,815    46,301 
CASH AND CASH EQUIVALENTS, END OF PERIOD  $52,258   $59,278 
           
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:          
Assets acquired through foreclosure of real estate loans  $496   $189 
Accrued purchase of available-for-sale securities  $765   $0 
Interest paid  $2,573   $4,049 
Income taxes paid  $300   $4 

 

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

 

6
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Consolidated Statements of Changes in Stockholders' Equity

Three Months Ended March 31, 2012 and 2011

(In Thousands Except Share and Per Share Data)

(Unaudited)

 

                       Accum. Other         
   Common   Treasury   Common   Paid-in   Retained   Comprehensive   Treasury     
   Shares   Shares   Stock   Capital   Earnings   Income (Loss)   Stock   Total 
Three Months Ended March 31, 2012:                                        
Balance, December 31, 2011   12,460,920    305,391   $12,461   $67,568   $82,302   $10,160   $(5,106)  $167,385 
Net income                       5,587              5,587 
Other comprehensive income, net                            214         214 
Cash dividends declared on common stock, $.18 per share                       (2,196)             (2,196)
Shares issued for dividend reinvestment plan   12,575         13    247                   260 
Shares issued from treasury related to exercise of stock options        (6,835)        (15)             116    101 
Restricted stock granted        (42,552)        (711)             711    0 
Forfeiture of restricted stock        1,741         30              (30)   0 
Stock-based compensation expense                  241                   241 
Tax benefit from employee benefit plan                       22              22 
Balance, March 31, 2012   12,473,495    257,745   $12,474   $67,360   $85,715   $10,374   $(4,309)  $171,614 
                                         
Three Months Ended March 31, 2011:                                        
Balance, December 31, 2010   12,408,212    254,614   $12,408   $66,648   $65,920   ($1,601)  $(4,431)  $138,944 
Net income                       5,541              5,541 
Other comprehensive income, net                            2,759         2,759 
Cash dividends declared on common stock, $.13 per share                       (1,582)             (1,582)
Shares issued for dividend reinvestment plan   12,153         12    169                   181 
Shares issued from treasury related to exercise of stock options        (228)        (1)             4    3 
Restricted stock granted        (15,622)        (272)             272    0 
Forfeiture of restricted stock        189         3              (3)   0 
Stock-based compensation expense                  192                   192 
Tax benefit from employee benefit plan                       15              15 
Balance, March 31, 2011   12,420,365    238,953   $12,420   $66,739   $69,894   $1,158   $(4,158)  $146,053 

 

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

 

7
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Notes to Unaudited Consolidated Financial Statements

 

1. BASIS OF INTERIM PRESENTATION

 

The consolidated financial information included herein, with the exception of the consolidated balance sheet dated December 31, 2011, is unaudited. Such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations, comprehensive income, cash flows and changes in stockholders’ equity for the interim periods; however, the information does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for a complete set of financial statements. Certain 2011 information has been reclassified for consistency with the 2012 presentation.

 

Operating results reported for the three-month period ended March 31, 2012 might not be indicative of the results for the year ending December 31, 2012. The Corporation evaluates subsequent events through the date of filing with the Securities and Exchange Commission.

 

2. PER COMMON SHARE DATA

 

Net income per share is based on the weighted-average number of shares of common stock outstanding. The following data show the amounts used in computing basic and diluted net income per share. As shown in the table that follows, diluted earnings per share is computed using weighted average common shares outstanding, plus weighted-average common shares available from the exercise of all dilutive stock options, less the number of shares that could be repurchased with the proceeds of stock option exercises based on the average share price of the Corporation's common stock during the period.

   Net Income   Weighted-     
   Available   Average   Earnings 
   to Common   Common   Per 
   Shareholders   Shares   Share 
Quarter Ended March 31, 2012               
Earnings per common share – basic  $5,587,000    12,206,870   $0.46 
Dilutive effect of potential common stock arising from stock options:               
Exercise of outstanding stock options        271,980      
Hypothetical share repurchase at $15.57        (233,098)     
Earnings per common share – diluted  $5,587,000    12,245,752   $0.46 
Quarter Ended March 31, 2011               
Earnings per common share – basic  $5,541,000    12,174,935   $0.46 
Dilutive effect of potential common stock arising from stock options:               
Exercise of outstanding stock options        255,727      
Hypothetical share repurchase at $15.58        (252,563)     
Earnings per common share – diluted  $5,541,000    12,178,099   $0.45 

 

Stock options that were anti-dilutive were excluded from net income per share calculations. Weighted-average common shares available from anti-dilutive instruments totaled 84,144 shares in the three-month period ended March 31, 2012 and 226,426 shares in the three months ended March 31, 2011.

 

8
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

3. COMPREHENSIVE INCOME

 

Comprehensive income is the total of (1) net income, and (2) all other changes in equity from non-stockholder sources, which are referred to as other comprehensive income. The components of other comprehensive income, and the related tax effects, are as follows:

 

   Before-Tax   Income Tax   Net-of-Tax 
   Amount   Effect   Amount 
Three Months Ended March 31, 2012               
Unrealized gains (losses) on available-for-sale securities:               
Unrealized holding gains on available-for-sale securities  $344   $(284)  $60 
Reclassification adjustment for losses (gains) realized in income   2    (1)   1 
Other comprehensive gain on available-for-sale securities   346    (285)   61 
                
Unfunded pension and postretirement obligations:               
Change in items from defined benefit plans included in accumulated other comprehensive income   200    (61)   139 
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost   20    (6)   14 
Other comprehensive gain on unfunded retirement obligations   220    (67)   153 
                
Total other comprehensive income  $566   $(352)  $214 
                
Three Months Ended March 31, 2011               
Unrealized gains (losses) on available-for-sale securities:               
Unrealized holding gains (losses) on available-for-sale securities  $6,125   $(2,082)  $4,043 
Reclassification adjustment for (gains) losses realized in income   (1,839)   625    (1,214)
Other comprehensive gain on available-for-sale securities   4,286    (1,457)   2,829 
                
Unfunded pension and postretirement obligations:               
Change in items from defined benefit plans included in accumulated other comprehensive income   (119)   40    (79)
Amortization of net transition obligation, prior service cost and net actuarial loss included in net periodic benefit cost   13    (4)   9 
Other comprehensive (loss) on unfunded retirement obligations   (106)   36    (70)
                
Total other comprehensive income  $4,180   $(1,421)  $2,759 

 

Changes in the components of other comprehensive income and in accumulated other comprehensive income are as follows:

 

   Unrealized   Unfunded   Accumulated 
   Holding Gains   Retirement   Other Comprehensive 
   on Securities   Obligations   Income (Loss) 
Three Months Ended March 31, 2012               
Balance, beginning of period  $10,791   $(631)  $10,160 
Change during three months ended March 31, 2012   61    153    214 
Balance, end of period  $10,852   $(478)  $10,374 
                
Three Months Ended March 31, 2011               
Balance, beginning of period  $(1,351)  $(250)  $(1,601)
Change during three months ended March 31, 2011   2,829    (70)   2,759 
Balance, end of period  $1,478   $(320)  $1,158 

 

9
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

4. CASH AND DUE FROM BANKS

 

Cash and due from banks at March 31, 2012 and December 31, 2011 include the following:

 

(In thousands)  Mar. 31,   Dec. 31, 
   2012   2011 
Cash and cash equivalents  $52,258   $56,815 
Certificates of deposit   4,240    3,760 
Total cash and due from banks  $56,498   $60,575 

 

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 $14,059,000 at March 31, 2012 and $14,035,000 at December 31, 2011.

 

5. 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.

 

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.

 

10
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

At March 31, 2012 and December 31, 2011, assets measured at fair value and the valuation methods used are as follows:

 

       March 31, 2012     
   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   $25,488   $0   $25,488 
Obligations of states and political subdivisions:                    
Tax-exempt   0    133,337    0    133,337 
Taxable   0    17,206    0    17,206 
Mortgage-backed securities   0    121,943    0    121,943 
Collateralized mortgage obligations, Issued by U.S. Government agencies   0    165,764    0    165,764 
Trust preferred securities issued by individual institutions   0    8,147    0    8,147 
Collateralized debt obligations:                    
Pooled trust preferred securities - senior tranches   0    0    4,638    4,638 
Pooled trust preferred securities - mezzanine tranches   0    0    782    782 
Other collateralized debt obligations   0    660    0    660 
Total debt securities   0    472,545    5,420    477,965 
Marketable equity securities   8,699    0    0    8,699 
Total available-for-sale securities   8,699    472,545    5,420    486,664 
Servicing rights   0    0    409    409 
Total recurring fair value measurements  $8,699   $472,545   $5,829   $487,073 
                     
Nonrecurring fair value measurements                    
Impaired loans with a valuation allowance  $0   $0   $3,299   $3,299 
Valuation allowance   0    0    (1,126)   (1,126)
Impaired loans, net   0    0    2,173    2,173 
Foreclosed assets held for sale   0    0    977    977 
Total nonrecurring fair value measurements  $0   $0   $3,150   $3,150 

 

11
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

       December 31, 2011     
   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   $25,587   $0   $25,587 
Obligations of states and political subdivisions:                    
Tax-exempt   0    132,962    0    132,962 
Taxable   0    14,334    0    14,334 
Mortgage-backed securities   0    121,769    0    121,769 
Collateralized mortgage obligations, Issued by U.S. Government agencies   0    165,131    0    165,131 
Trust preferred securities issued by individual institutions   0    8,146    0    8,146 
Collateralized debt obligations:                    
Pooled trust preferred securities - senior tranches   0    0    4,638    4,638 
Pooled trust preferred securities - mezzanine tranches   0    0    730    730 
Other collateralized debt obligations   0    660    0    660 
Total debt securities   0    468,589    5,368    473,957 
Marketable equity securities   7,728    0    0    7,728 
Total available-for-sale securities   7,728    468,589    5,368    481,685 
Servicing rights   0    0    375    375 
Total recurring fair value measurements  $7,728   $468,589   $5,743   $482,060 
                     
Nonrecurring fair value measurements                    
Impaired loans with a valuation allowance  $0   $0   $3,433   $3,433 
Valuation allowance   0    0    (1,126)   (1,126)
Impaired loans, net   0    0    2,307    2,307 
Foreclosed assets held for sale   0    0    1,235    1,235 
Total nonrecurring fair value measurements  $0   $0   $3,542   $3,542 

 

Management determined there have been few trades of pooled trust-preferred securities since 2008, except for a limited number of transactions that have taken place as a result of bankruptcies, forced liquidations or similar circumstances. Also, in management’s judgment, there were no available quoted market prices in active markets for assets sufficiently similar to the Corporation’s pooled trust-preferred securities to be reliable as observable inputs. Accordingly, the Corporation follows a method of valuing pooled trust-preferred securities using a Level 3 methodology, based on discounted cash flows.

 

Management has calculated the fair value of the Corporation’s pooled trust-preferred securities by applying a discount rate to the estimated cash flows. Management used the cash flow estimates determined using the process described in Note 6 for evaluating pooled trust-preferred securities for other-than-temporary impairment (OTTI). Management used discount rates considered reflective of a market participant’s expectations regarding the extent of credit and liquidity risk inherent in the securities. In establishing the discount rate, management considered: (1) the implied discount rates as of the end of 2007, prior to the market for trust-preferred securities becoming inactive; (2) adjustment to the year-end 2007 discount rates for the change in the spread between indicative market rates over corresponding risk-free rates; and (3) an additional adjustment – an increase of 2% in the discount rate – for liquidity risk. Management considered the additional 2% increase in the discount rate necessary in order to give some consideration to price estimates based on trades made under distressed conditions, as reported by brokers and pricing services.

 

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 less estimated selling costs.

 

12
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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 March 31, 2012 for assets measured using unobservable inputs (Level 3 methodologies) on a recurring basis:

 

    Fair Value at                      
    3/31/12     Valuation   Unobservable           Method or Value As of
Asset   (In Thousands)     Technique   Input(s)           3/31/12
Pooled trust preferred    $ 4,638       Discounted cash flow   Issuer defaults     37.69   Actual Deferrals and Defaults as % of Outstanding Collateral
securities - senior tranches                       13.21   Expected Additional Net Deferrals and Defaults as % of Performing Collateral
                  Issuer prepayments     45.27   Expected Issuer Prepayments as % of Performing Collateral
                  Discount rate     11.70   Implied 7.57% discount rate at 12/31/07 plus 4.13% spread for credit and liquidity risk
                               
Pooled trust preferred     782       Discounted cash flow   Issuer defaults     20.44   Actual Deferrals and Defaults as % of Outstanding Collateral
securities - mezzanine tranches                       42.19   Expected Additional Net Deferrals and Defaults as % of Performing Collateral
                  Future interest rates           Three-month LIBOR forward curve
                  Issuer prepayments     0.00   Expected Issuer Prepayments as % of Performing Collateral
                  Discount rate     3.95   Credit and liquidity risk spread added to three-month LIBOR forward curve
                               
Servicing rights     409       Discounted cash flow   Discount rate     9.00   Rate used through modeling period
                  Loan prepayment speeds     324.00   Weighted-average PSA
                  Servicing fees     0.25   of loan balances
                        5.00   of payments are late
                        5.00   late fees assessed
                      $ 1.94     Miscellaneous fees per account per month
                  Servicing costs   5.50     Monthly servicing cost per account
                      22.00     Additional monthly servicing cost per loan on loans more than 30 days delinquent
                        1.00   of loans more than 30 days delinquent
                        3.50   annual increase in servicing costs

 

Increases (decreases) in actual or expected issuer defaults tend to decrease (increase) the fair value of the Corporation’s senior and mezzanine tranches of pooled trust preferred securities. The values of the Corporation’s mezzanine tranches of pooled trust preferred securities are also affected by expected future interest rates. However, due to the structure of each security, timing of cash flows, and secondary effects on the financial performance of the underlying issuers, the effects of changes in future interest rates on the fair value of the Corporation’s holdings are not quantifiably estimable. 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.

 

13
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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

 

   Three Months Ended March 31, 2012 
   Pooled
Trust
   Pooled
Trust
         
   Preferred   Preferred         
   Securities -   Securities -         
   Senior   Mezzanine   Servicing     
   Tranches   Tranches   Rights   Total 
Balance, beginning of period  $4,638   $730   $375   $5,743 
Issuances of servicing rights   0    0    55    55 
Accretion and amortization, net   (3)   0    0    (3)
Proceeds from sales and calls   0    (27)   0    (27)
Realized gains, net   0    27    0    27 
Unrealized losses included in earnings   0    0    (21)   (21)
Unrealized gains included in other comprehensive income   3    52    0    55 
Balance, end of period  $4,638   $782   $409   $5,829 

 

   Three Months Ended March 31, 2011 
   Pooled
Trust
   Pooled
Trust
         
   Preferred   Preferred         
   Securities -   Securities -         
   Senior   Mezzanine   Servicing     
   Tranches   Tranches   Rights   Total 
Balance, beginning of period  $7,400   $0   $204   $7,604 
Issuances of servicing rights   0    0    102    102 
Accretion and amortization, net   (20)   0    0    (20)
Proceeds from sales and calls   0    (25)   0    (25)
Realized gains, net   0    25    0    25 
Unrealized losses included in earnings   0    0    (13)   (13)
Unrealized gains included in other comprehensive income   1,658    0    0    1,658 
Balance, end of period  $9,038   $0   $293   $9,331 

 

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 sheet, 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 Xtra program.

 

14
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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 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 on demand at March 31, 2012 and December 31, 2011. 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.

 

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   March 31, 2012   December 31, 2011 
   Method(s)   Carrying   Fair   Carrying   Fair 
   Used   Amount   Value   Amount   Value 
Financial assets:                     
Cash and cash equivalents   Level 1   $52,258   $52,258   $56,815   $56,815 
Certificates of deposit   Level 2    4,240    4,254    3,760    3,683 
Available-for-sale securities   See Above    486,664    486,664    481,685    481,685 
Restricted equity securities   Level 2    6,441    6,441    6,773    6,773 
Loans held for sale   Level 1    2,223    2,223    939    939 
Loans, net   Level 3    690,218    709,596    700,610    718,274 
Accrued interest receivable   Level 1    4,943    4,943    4,797    4,797 
Servicing rights   Level 3    409    409    375    375 
                          
Financial liabilities:                         
Deposits with no stated maturity   Level 1    680,746    680,746    677,461    677,461 
Time deposits   Level 3    336,055    339,447    340,745    344,936 
Short-term borrowings   Level 3    4,030    3,989    4,950    4,897 
Long-term borrowings   Level 3    115,202    130,500    125,363    145,641 
Accrued interest payable   Level 1    245    245    358    358 

 

15
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

6. SECURITIES

 

Amortized cost and fair value of available-for-sale securities at March 31, 2012 and December 31, 2011 are summarized as follows:

 

       March 31, 2012     
       Gross   Gross     
       Unrealized   Unrealized     
   Amortized   Holding   Holding   Fair 
(In Thousands)  Cost   Gains   Losses   Value 
                 
Obligations of U.S. Government agencies  $24,810   $678   $0   $25,488 
Obligations of states and political subdivisions:                    
Tax-exempt   128,628    5,356    (647)   133,337 
Taxable   16,846    402    (42)   17,206 
Mortgage-backed securities   117,251    4,704    (12)   121,943 
Collateralized mortgage obligations, Issued by U.S. Government agencies   162,846    2,928    (10)   165,764 
Trust preferred securities issued by individual institutions   7,783    411    (47)   8,147 
Collateralized debt obligations:                    
Pooled trust preferred securities - senior tranches   4,993    0    (355)   4,638 
Pooled trust preferred securities - mezzanine tranches   0    782    0    782 
Other collateralized debt obligations   660    0    0    660 
Total debt securities   463,817    15,261    (1,113)   477,965 
Marketable equity securities   6,151    2,569    (21)   8,699 
Total  $469,968   $17,830   $(1,134)  $486,664 

 

       December 31, 2011     
       Gross   Gross     
       Unrealized   Unrealized     
   Amortized   Holding   Holding   Fair 
(In Thousands)  Cost   Gains   Losses   Value 
                 
Obligations of U.S. Government agencies  $24,877   $710   $0   $25,587 
Obligations of states and political subdivisions:                    
Tax-exempt   129,401    4,891    (1,330)   132,962 
Taxable   14,004    334    (4)   14,334 
Mortgage-backed securities   116,602    5,167    0    121,769 
Collateralized mortgage obligations, Issued by U.S. Government agencies   161,818    3,350    (37)   165,131 
Trust preferred securities issued by individual institutions   7,334    865    (53)   8,146 
Collateralized debt obligations:                    
Pooled trust preferred securities - senior tranches   4,996    0    (358)   4,638 
Pooled trust preferred securities - mezzanine tranches   0    730    0    730 
Other collateralized debt obligations   660    0    0    660 
Total debt securities   459,692    16,047    (1,782)   473,957 
Marketable equity securities   5,643    2,186    (101)   7,728 
Total  $465,335   $18,233   $(1,883)  $481,685 

 

16
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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 March 31, 2012 and December 31, 2011:

 

March 31, 2012  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 states and political subdivisions:                              
Tax-exempt  $11,604   $(98)  $9,488   $(549)  $21,092   $(647)
Taxable   1,701    (41)   243    (1)   1,944    (42)
Mortgage-backed securities   10,406    (12)   0    0    10,406    (12)
Collateralized mortgage obligations, Issued by U.S. Government agencies   4,485    (10)   0    0    4,485    (10)
Trust preferred securities issued by individual institutions   0    0    953    (47)   953    (47)
Collateralized debt obligations, Pooled trust preferred securities - senior tranches   0    0    4,638    (355)   4,638    (355)
Total debt securities   28,196    (161)   15,322    (952)   43,518    (1,113)
Marketable equity securities   241    (17)   86    (4)   327    (21)
Total temporarily impaired available-for-sale securities  $28,437   $(178)  $15,408   $(956)  $43,845   $(1,134)

 

December 31, 2011  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 states and political subdivisions:                              
Tax-exempt  $4,301   $(34)  $20,692   $(1,296)  $24,993   $(1,330)
Taxable   927    (2)   244    (2)   1,171    (4)
Collateralized mortgage obligations, Issued by U.S. Government agencies   6,886    (36)   5,075    (1)   11,961    (37)
Trust preferred securities issued by individual institutions   0    0    947    (53)   947    (53)
Collateralized debt obligations, Pooled trust preferred securities - senior tranches   0    0    4,638    (358)   4,638    (358)
Total debt securities   12,114    (72)   31,596    (1,710)   43,710    (1,782)
Marketable equity securities   776    (44)   98    (57)   874    (101)
Total temporarily impaired available-for-sale securities  $12,890   $(116)  $31,694   $(1,767)  $44,584   $(1,883)

 

Gross realized gains and losses from available-for-sale securities (including OTTI losses in gross realized losses) and the related income tax provision were as follows:

 

(In Thousands)  3 Months Ended 
   Mar. 31,   Mar. 31, 
   2012   2011 
Gross realized gains  $65   $1,840 
Gross realized losses   (67)   (1)
Net realized gains  $(2)  $1,839 
Income tax provision related to net realized gains  $(1)  $625 

 

During the first quarter 2011, management sold the Corporation’s holding of the mezzanine tranche of MMCAPS Funding I, Ltd. The security was sold for aggregate pretax proceeds of $1,485,000, which was recorded as a gain on the sale of securities.

 

17
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

The amortized cost and fair value of available-for-sale debt securities by contractual maturity are shown in the following table as of March 31, 2012. 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.

 

   Amortized   Fair 
(In Thousands)  Cost   Value 
         
Due in one year or less  $9,072   $9,525 
Due from one year through five years   46,346    47,542 
Due from five years through ten years   27,782    28,421 
Due after ten years   100,520    104,770 
Subtotal   183,720    190,258 
Mortgage-backed securities   117,251    121,943 
Collateralized mortgage obligations, Issued by U.S. Government agencies   162,846    165,764 
Total   463,817    477,965 

 

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.

 

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 an impairment loss in earnings of $67,000 in the first quarter 2012, which was related to a bank stock. No impairment losses were recognized in the first quarter 2011.

 

A summary of information management considered in evaluating debt and equity securities for OTTI at March 31, 2012 is provided below.

 

Debt Securities

 

At March 31, 2012, 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, including municipal bonds with no external ratings, at March 31, 2012 to be temporary.

 

The credit rating agencies have withdrawn their ratings on numerous municipal bonds held by the Corporation. At March 31, 2012, the total amortized cost basis of municipal bonds with no external credit ratings was $23,082,000, with an aggregate unrealized loss of $65,000. At the time of purchase, each of these bonds was considered investment grade and had been rated by at least one credit rating agency. The bonds for which the ratings were removed were almost all insured by an entity that has reported significant financial problems and declines in its regulatory capital ratios, and most of the ratings were removed in the fourth quarter 2009. However, the insurance remains in effect on the bonds, and none of the affected municipal bonds has failed to make a scheduled interest payment.

 

18
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

The following table provides information related to trust preferred securities issued by individual institutions as of March 31, 2012:

 

(In Thousands)                          Moody's/ 
                       Cumulative   S&P/ 
                   Unrealized   Realized   Fitch 
       Par Amount   Amortized   Fair   Gain   Credit   Credit 
Name of Issuer  Issuer's Parent Company   Outstanding   Cost   Value   (Loss)   Losses   Ratings 
Astoria Capital Trust I   Astoria Financial Corporation   $5,000   $5,184   $5,194   $10   $0    Baa3/BB/B+ (1) 
Carolina First Mortgage Loan Trust   The Toronto-Dominion Bank   $2,000   $1,599   $2,000    401    (1,769)   NR 
Patriot Capital Trust I   Susquehanna Bancshares, Inc.   $1,000   $1,000   $953    (47)   0    NR 
Total      $8,000   $7,783   $8,147   $364   $(1,769)    

 

(1) Astoria Capital Trust I is on negative outlook with Moody's.

 

NR = not rated.

 

Management assesses each of the trust preferred securities issued by individual institutions for the possibility of OTTI by reviewing financial information that is publicly available. Neither Astoria Financial Corporation nor Susquehanna Bancshares, Inc. has deferred or defaulted on payments associated with the Corporation’s securities.

 

The Corporation recognized OTTI charges in 2009 and 2010 related to the Carolina First Mortgage Loan Trust security. In the fourth quarter 2010, The Toronto-Dominion Bank acquired The South Financial Group, Inc., the parent company of Carolina First. After the acquisition, The Toronto-Dominion Bank made a payment for the full amount of previously deferred interest and resumed quarterly payments on the security. The Corporation recognized a material change in the expected cash flows in the fourth quarter 2010. The Corporation recorded accretion income totaling $457,000 in the first quarter 2012 and $111,000 in the first quarter 2011. For the year ended December 31, 2011, the Corporation recorded accretion income totaling $825,000. Management expects to record accretion income to offset the previous OTTI charges over the security’s remaining life, through May 2012.

 

Pooled trust-preferred securities are very long-term (usually 30-year maturity) instruments, mainly issued by banks. The Corporation’s investments in pooled trust-preferred securities are each made up of companies with geographic and size diversification. Almost all of the Corporation’s pooled trust-preferred securities are composed of debt issued by banking companies, with a lesser amount issued by insurance companies. Trust-preferred securities typically permit deferral of quarterly interest payments for up to five years, and some of the issuers of trust-preferred securities that are included in the Corporation’s pooled investments have elected to defer payment of interest on these obligations. Some issuers have defaulted.

 

Management evaluated pooled trust-preferred securities for OTTI by estimating the cash flows expected to be received from each security, taking into account estimated levels of deferrals and defaults by the underlying issuers. In determining cash flows, management assumed all issuers currently deferring or in default would make no future payments, and assigned estimated future default levels for the remaining issuers in each security based on financial strength ratings assigned by a national ratings service. Management calculated the present value of each security based on the current book yield, adjusted for future changes in three-month LIBOR (which is the index rate on the Corporation’s adjustable-rate pooled trust-preferred securities) based on the applicable forward curve. Management’s estimates of cash flows used to evaluate other-than-temporary impairment of pooled trust-preferred securities were based on sensitive assumptions regarding the timing and amounts of defaults that may occur, and changes in the assumptions used could produce different conclusions for each security. Additional information regarding these assumptions is included in Note 5.

 

The following table provides detailed information related to pooled trust preferred securities – mezzanine tranches held as of March 31, 2012:

 

(In Thousands)                        
       Par Amount   Amortized   Fair   Unrealized   Cumulative 
Security  Tranche   Outstanding   Cost   Value   Gain   OTTI 
ALESCO Preferred Funding IX, Ltd.   C-1   $3,000   $0   $0   $0   $(2,988)
U.S. Capital Funding II, Ltd.   B-1    2,000    0    313    313    (1,992)
U.S. Capital Funding II, Ltd.   B-2    3,000    0    469    469    (2,973)
Total       $8,000   $0   $782   $782   $(7,953)

 

19
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

As of March 31, 2012, the Corporation’s investment in the senior tranche of MMCAPS Funding I, Ltd. had an investment grade rating. The security, with an amortized cost of $4,993,000, has been subjected to impairment analysis based on estimated cash flows (using the process described above), and management has determined that impairment was temporary as of March 31, 2012.

 

The table that follows provides additional information related to pooled trust preferred securities as of March 31, 2012:

 

Security  MMCAPS   U.S. Capital   U.S. Capital 
   Funding I, Ltd.   Funding II, Ltd.   Funding II, Ltd. 
Tranche  Senior   B-1   B-2 
Number of Banks Currently Performing   12    36    36 
Moody's/Fitch Credit Ratings   A3/BBB (1)    Caa3/C    Caa3/C 
Actual Deferrals and Defaults as % of Outstanding Collateral   37.7%   20.4%   20.4%
Expected Additional Net Deferrals and Defaults as % of Performing Collateral   13.2%   42.2%   42.2%
Excess Subordination as % of Performing Collateral   40.7%   -12.7%   -12.7%
Expected Issuer Prepayments as % of Performing Collateral   45.3%   0.0%   0.0%

 

   (1) Fitch has the senior tranche of MMCAPS Funding I, Ltd. on negative outlook.

 

In the table above, “Excess Subordination as % of Performing Collateral” (Excess Subordination Ratio) was calculated as follows: (Total face value of performing collateral – Face value of all outstanding note balances not subordinate to the Corporation’s investment)/Total face value of performing collateral.

 

The Excess Subordination Ratio measures the extent to which there may be tranches within the pooled trust preferred structure available to absorb credit losses before the Corporation’s security would be impacted. A positive Excess Subordination Ratio signifies there is available support from subordinate tranches to absorb losses before the Corporation’s investment would be impacted. A negative Excess Subordination Ratio signifies there is no available support from subordinate tranches to absorb losses before the Corporation’s securities would be impacted. The Excess Subordination Ratio is not definitive, in isolation, for determining OTTI or whether the Corporation will receive future payments on a pooled trust preferred security. Other factors affect the timing and amount of cash flows available for payments to the note holders (investors), including the excess interest paid by the issuers, who typically pay higher rates of interest than are paid out to the note holders.

 

The Corporation separates OTTI related to the trust-preferred securities into (a) the amount of the total impairment related to credit loss, which is recognized in the statement of earnings, and (b) the amount of the total impairment related to all other factors, which is recognized in other comprehensive income. The Corporation measures the credit loss component of OTTI based on the difference between: (1) the present value of estimated cash flows, at the book yield in effect prior to recognition of any OTTI, as of the most recent balance sheet date, and (2) the present value of estimated cash flows as of the previous quarter-end balance sheet date based on management’s cash flow assumptions at that time.

 

The Corporation recorded no OTTI losses related to pooled trust-preferred securities in the three-month periods ended March 31, 2012 and 2011.

 

Equity Securities

 

The Corporation’s marketable equity securities at March 31, 2012 and December 31, 2011 consisted exclusively of stocks of banking companies. The Corporation recognized an impairment loss in earnings related to a bank stock of $67,000 in the first quarter 2012. Management’s decision to recognize an impairment loss on this security followed an evaluation of the issuer’s published financial results in which management determined that the recovery of the Corporation’s cost basis within the foreseeable future was uncertain. As a result of this determination, the Corporation recognized an impairment loss to write the stock down to the most recent trade price at March 31, 2012. The Corporation recognized no OTTI losses related to bank stocks in the first quarter 2011. At March 31, 2012, management did not intend to sell impaired bank stocks, and based on the intent to hold the securities for the foreseeable future and other factors specific to the securities, has determined that none of the Corporation’s other bank stock holdings at March 31, 2012 were other than temporarily impaired.

 

The Corporation did not sell any bank stocks or realize any gains or losses from sales of bank stocks during the first quarter 2012. Realized gains from sales of bank stocks totaled $2,000 in the first quarter 2011 and included no transactions involving stocks for which OTTI had been previously recognized.

 

20
 

 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

C&N Bank is a member of the Federal Home Loan Bank of Pittsburgh (FHLB-Pittsburgh), which is one of 12 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 sheet, was $6,311,000 at March 31, 2012 and $6,643,000 at December 31, 2011. The Corporation evaluated its holding of FHLB-Pittsburgh stock for impairment and deemed the stock to not be impaired at March 31, 2012 and December 31, 2011. 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.

 

7. LOANS

 

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 land loans, and loans secured by farmland.

 

Loans outstanding at March 31, 2012 and December 31, 2011 are summarized as follows:

 

Summary of Loans by Type            
(In Thousands)  Mar. 31,   % of   Dec. 31,   % of 
   2012   Total   2011   Total 
Residential mortgage:                    
Residential mortgage loans - first liens  $326,343    46.78%  $331,015    46.73%
Residential mortgage loans - junior liens   27,590    3.96%   28,851    4.07%
Home equity lines of credit   30,534    4.38%   30,037    4.24%
1-4 Family residential construction   8,409    1.20%   9,959    1.41%
Total residential mortgage   392,876    56.32%   399,862    56.45%
Commercial:                    
Commercial loans secured by real estate   158,323    22.70%   156,388    22.08%
Commercial and industrial   54,370    7.79%   57,191    8.07%
Political subdivisions   36,517    5.23%   37,620    5.31%
Commercial construction and land   23,577    3.38%   23,518    3.32%
Loans secured by farmland   10,334    1.48%   10,949    1.55%
Multi-family (5 or more) residential   6,326    0.91%   6,583    0.93%
Agricultural loans   2,982    0.43%   2,987    0.42%
Other commercial loans   323    0.05%   552    0.08%
Total commercial   292,752    41.97%   295,788    41.76%
Consumer   11,960    1.71%   12,665    1.79%
Total   697,588    100.00%   708,315    100.00%
Less: allowance for loan losses   (7,370)        (7,705)     
Loans, net  $690,218        $700,610      

 

21
 

 

CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

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 comprise 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 either March 31, 2012 or December 31, 2011.

 

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. 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 the process of evaluating the loan portfolio, management also considers the Corporation’s exposure to losses from unfunded loan commitments. As of March 31, 2012 and December 31, 2011, management determined that no allowance for credit losses related to unfunded loan commitments was required.

 

Transactions within the allowance for loan losses, summarized by segment and class, for the three months ended March 31, 2012 and 2011 were as follows:

 

   December 31,               March 31, 
(In Thousands)  2011   Charge-       Provision   2012 
   Balance   offs   Recoveries   (Credit)   Balance 
Allowance for Loan Losses:                         
Residential mortgage:                         
Residential mortgage loans - first liens  $3,026   $(138)  $0   $65   $2,953 
Residential mortgage loans - junior liens   266    0    0    (6)   260 
Home equity lines of credit   231    0    0    1    232 
1-4 Family residential construction   79    0    0    (17)   62 
Total residential mortgage   3,602    (138)   0    43    3,507 
Commercial:                         
Commercial loans secured by real estate   2,004    0    0    (84)   1,920 
Commercial and industrial   946    0    1    (185)   762 
Political subdivisions   0    0    0    0    0 
Commercial construction and land   267    0    0    58    325 
Loans secured by farmland   126    0    0    (5)   121 
Multi-family (5 or more) residential   66    0    0    (3)   63 
Agricultural loans   27    0    0    0    27 
Other commercial loans   5    0    0    (2)   3 
Total commercial   3,441    0    1    (221)   3,221 
Consumer   228    (38)   22    (6)   206 
Unallocated   434              2    436 
                          
Total Allowance for Loan Losses  $7,705   $(176)  $23   $(182)  $7,370 

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

   December 31,               March 31, 
(In Thousands)  2010           (Credit)   2011 
   Balance   Charge-offs   Recoveries   Provision   Balance 
Allowance for Loan Losses:                         
Residential mortgage:                         
Residential mortgage loans - first liens  $2,745   $(1)       $406   $3,150 
Residential mortgage loans - junior liens   334    (51)        22    305 
Home equity lines of credit   218              (6)   212 
1-4 Family residential construction   208              (146)   62 
Total residential mortgage   3,505    (52)   0    276    3,729 
Commercial:                         
Commercial loans secured by real estate   3,314              (196)   3,118 
Commercial and industrial   862         1    (21)   842 
Political subdivisions   0              0    0 
Commercial construction   590              (319)   271 
Loans secured by farmland   139              3    142 
Multi-family (5 or more) residential   63              14    77 
Agricultural loans   32              (3)   29 
Other commercial loans   0              8    8 
Total commercial   5,000    0    1    (514)   4,487 
Consumer   289    (45)   27    4    275 
Unallocated   313              42    355 
                          
Total Allowance for Loan Losses  $9,107   $(97)  $28   $(192)  $8,846 

 

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. 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.

 

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.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

The following tables summarize the aggregate credit quality classification of outstanding loans by risk rating as of March 31, 2012 and December 31, 2011:

 

March 31, 2012:                    
(In Thousands)  Pass   Special
Mention
   Substandard   Doubtful   Total 
Residential mortgage:                         
Residential mortgage loans - first liens  $311,183   $2,517   $12,442   $201   $326,343 
Residential mortgage loans - junior liens   26,033    636    921    0    27,590 
Home equity lines of credit   29,971    294    269    0    30,534 
1-4 Family residential construction   8,409    0    0    0    8,409 
Total residential mortgage   375,596    3,447    13,632    201    392,876 
Commercial:                         
Commercial loans secured by real estate   144,964    7,743    5,616    0    158,323 
Commercial and industrial   45,006    4,816    4,167    381    54,370 
Political subdivisions   36,399    118    0    0    36,517 
Commercial construction and land   21,788    208    1,581    0    23,577 
Loans secured by farmland   8,001    772    1,525    36    10,334 
Multi-family (5 or more) residential   5,950    363    13    0    6,326 
Agricultural loans   2,895    29    58    0    2,982 
Other commercial loans   323    0    0    0    323 
Total commercial   265,326    14,049    12,960    417    292,752 
Consumer   11,758    20    182    0    11,960 
                          
Totals  $652,680   $17,516   $26,774   $618   $697,588 

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

December 31, 2011:                    
(In Thousands)  Pass   Special
Mention
   Substandard   Doubtful   Total 
Residential mortgage:                         
Residential mortgage loans - first liens  $314,900   $2,955   $12,956   $204   $331,015 
Residential mortgage loans - junior liens   27,260    660    924    7    28,851 
Home equity lines of credit   29,408    264    365    0    30,037 
1-4 Family residential construction   9,959    0    0    0    9,959 
Total residential mortgage   381,527    3,879    14,245    211    399,862 
Commercial:                         
Commercial loans secured by real estate   143,247    7,385    5,046    710    156,388 
Commercial and industrial   46,110    6,254    4,413    414    57,191 
Political subdivisions   37,499    121    0    0    37,620 
Commercial construction and land   21,668    211    1,639    0    23,518 
Loans secured by farmland   8,040    1,341    1,531    37    10,949 
Multi-family (5 or more) residential   6,200    369    14    0    6,583 
Agricultural loans   2,765    164    58    0    2,987 
Other commercial loans   552    0    0    0    552 
Total commercial   266,081    15,845    12,701    1,161    295,788 
Consumer   12,437    20    207    1    12,665 
                          
Totals  $660,045   $19,744   $27,153   $1,373   $708,315 

 

The general component of the allowance for loan losses 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 three-year average historical net charge-off rates, adjusted for qualitative factors. 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 loss 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 68% at March 31, 2012) is 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.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

The scope of loans evaluated individually for impairment include all loan relationships greater than $200,000 for which there is at least one extension of credit graded Special Mention, Substandard or Doubtful. Also, all loans classified as troubled debt restructurings (discussed in more detail below) and all loan relationships less than $200,000 in the aggregate, but with an estimated loss of $100,000 or more, are individually evaluated for impairment. Loans that are individually evaluated for impairment, but which are not determined to 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 evaluated, but which have not been determined to be impaired, are included in the “Collectively Evaluated” column in the tables summarizing the allowance and associated loan balances as of March 31, 2012 and December 31, 2011.

 

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 March 31, 2012 and December 31, 2011:

 

March 31, 2012  Individually   Collectively     
(In Thousands)  Evaluated   Evaluated   Totals 
Loans:               
Residential mortgage:               
Residential mortgage loans - first liens  $1,682   $324,661   $326,343 
Residential mortgage loans - junior liens   136    27,454    27,590 
Home equity lines of credit   0    30,534    30,534 
1-4 Family residential construction   0    8,409    8,409 
Total residential mortgage   1,818    391,058    392,876 
Commercial:               
Commercial loans secured by real estate   2,042    156,281    158,323 
Commercial and industrial   854    53,516    54,370 
Political subdivisions   0    36,517    36,517 
Commercial construction and land   1,236    22,341    23,577 
Loans secured by farmland   926    9,408    10,334 
Multi-family (5 or more) residential   12    6,314    6,326 
Agricultural loans   40    2,942    2,982 
Other commercial loans   0    323    323 
Total commercial   5,110    287,642    292,752 
Consumer   49    11,911    11,960 
                
Total Loans  $6,977   $690,611   $697,588 

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

March 31, 2012  Individually   Collectively     
(In Thousands)  Evaluated   Evaluated   Totals 
Allowance for Loan Losses:               
Residential mortgage:               
Residential mortgage loans - first liens  $454   $2,499   $2,953 
Residential mortgage loans - junior liens   8    252    260 
Home equity lines of credit   0    232    232 
1-4 Family residential construction   0    62    62 
Total residential mortgage   462    3,045    3,507 
Commercial:               
Commercial loans secured by real estate   154    1,766    1,920 
Commercial and industrial   329    433    762 
Political subdivisions   0    0    0 
Commercial construction and land   122    203    325 
Loans secured by farmland   35    86    121 
Multi-family (5 or more) residential   0    63    63 
Agricultural loans   0    27    27 
Other commercial loans   0    3    3 
Total commercial   640    2,581    3,221 
Consumer   24    182    206 
Unallocated             436 
                
Total Allowance for Loan Losses  $1,126   $5,808   $7,370 

 

December 31, 2011  Individually   Collectively     
(In Thousands)  Evaluated   Evaluated   Totals 
Loans:               
Residential mortgage:               
Residential mortgage loans - first liens  $2,227   $328,788   $331,015 
Residential mortgage loans - junior liens   137    28,714    28,851 
Home equity lines of credit   93    29,944    30,037 
1-4 Family residential construction   0    9,959    9,959 
Total residential mortgage   2,457    397,405    399,862 
Commercial:               
Commercial loans secured by real estate   2,169    154,219    156,388 
Commercial and industrial   942    56,249    57,191 
Political subdivisions   0    37,620    37,620 
Commercial construction and land   1,266    22,252    23,518 
Loans secured by farmland   927    10,022    10,949 
Multi-family (5 or more) residential   14    6,569    6,583 
Agricultural loans   39    2,948    2,987 
Other commercial loans   0    552    552 
Total commercial   5,357    290,431    295,788 
Consumer   50    12,615    12,665 
                
Total Loans  $7,864   $700,451   $708,315 

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

December 31, 2011  Individually   Collectively     
(In Thousands)  Evaluated   Evaluated   Totals 
Allowance for Loan Losses:               
Residential mortgage:               
Residential mortgage loans - first liens  $461   $2,565   $3,026 
Residential mortgage loans - junior liens   11    255    266 
Home equity lines of credit   0    231    231 
1-4 Family residential construction   0    79    79 
Total residential mortgage   472    3,130    3,602 
Commercial:               
Commercial loans secured by real estate   169    1,835    2,004 
Commercial and industrial   361    585    946 
Political subdivisions   0    0    0 
Commercial construction and land   65    202    267 
Loans secured by farmland   35    91    126 
Multi-family (5 or more) residential   0    66    66 
Agricultural loans   0    27    27 
Other commercial loans   0    5    5 
Total commercial   630    2,811    3,441 
Consumer   24    204    228 
Unallocated             434 
                
Total Allowance for Loan Losses  $1,126   $6,145   $7,705 

 

Summary information related to impaired loans as of March 31, 2012 and December 31, 2011 is as follows:

 

   As of   As of 
(In Thousands)  Mar. 31,   Dec. 31, 
   2012   2011 
         
Impaired loans with a valuation allowance  $3,299   $3,433 
Impaired loans without a valuation allowance   3,678    4,431 
Total impaired loans  $6,977   $7,864 
Valuation allowance related to impaired loans  $1,126   $1,126 

 

The average investment in impaired loans was $7,120,000 for the three months ended March 31, 2012 compared to $8,774,000 for the three months ended March 31, 2011. Interest income recognized on impaired loans was $83,000 for the three months ended March 31, 2012 compared to $50,000 for the three months ended March 31, 2011 with all interest recognized on a cash basis.

 

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.

 

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

 

   March 31, 2012   December 31, 2011 
   Past Due       Past Due     
(In Thousands)  90+ Days and       90+ Days and     
   Accruing   Nonaccrual   Accruing   Nonaccrual 
Residential mortgage:                    
Residential mortgage loans - first liens  $849   $2,841   $949   $3,058 
Residential mortgage loans - junior liens   30    66    11    67 
Total residential mortgage   879    2,907    960    3,125 
Commercial:                    
Commercial loans secured by real estate   218    1,573    75    1,595 
Commercial and industrial   35    508    21    541 
Commercial construction and land   111    978    139    978 
Loans secured by farmland   0    926    53    927 
Agricultural loans   5    39    0    0 
Total commercial   369    4,024    288    4,041 
Consumer   4    30    19    31 
                     
Totals  $1,252   $6,961   $1,267   $7,197 

  

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

 

The table below presents a summary of the contractual aging of loans as of March 31, 2012 and December 31, 2011:

 

   As of March 31, 2012 
   Current &             
(In Thousands)  Past Due   Past Due   Past Due     
   Less than   30-89   90+     
   30 Days   Days   Days   Total 
Residential mortgage:                    
Residential mortgage loans - first liens  $319,866   $4,563   $1,914   $326,343 
Residential mortgage loans - junior liens   27,309    241    40    27,590 
Home equity lines of credit   30,358    176    0    30,534 
1-4 Family residential construction   8,409    0    0    8,409 
Total residential mortgage   385,942    4,980    1,954    392,876 
                     
Commercial:                    
Commercial loans secured by real estate   156,656    518    1,149    158,323 
Commercial and industrial   54,124    94    152    54,370 
Political subdivisions   36,517    0    0    36,517 
Commercial construction and land   22,259    257    1,061    23,577 
Loans secured by farmland   9,352    92    890    10,334 
Multi-family (5 or more) residential   6,236    90    0    6,326 
Agricultural loans   2,938    0    44    2,982 
Other commercial loans   323    0    0    323 
Total commercial   288,405    1,051    3,296    292,752 
                     
Consumer   11,829    127    4    11,960 
                     
Totals  $686,176   $6,158   $5,254   $697,588 

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

   As of December 31, 2011 
   Current &             
(In Thousands)  Past Due   Past Due   Past Due     
   Less than   30-89   90+     
   30 Days   Days   Days   Total 
Residential mortgage:                    
Residential mortgage loans - first liens  $321,907   $6,723   $2,385   $331,015 
Residential mortgage loans - junior liens   28,437    393    21    28,851 
Home equity lines of credit   29,986    51    0    30,037 
1-4 Family residential construction   9,959    0    0    9,959 
Total residential mortgage   390,289    7,167    2,406    399,862 
                     
Commercial:                    
Commercial loans secured by real estate   155,025    343    1,020    156,388 
Commercial and industrial   56,835    169    187    57,191 
Political subdivisions   37,620    0    0    37,620 
Commercial construction and land   22,323    1,056    139    23,518 
Loans secured by farmland   9,973    33    943    10,949 
Multi-family (5 or more) residential   6,583    0    0    6,583 
Agricultural loans   2,945    3    39    2,987 
Other commercial loans   552    0    0    552 
Total commercial   291,856    1,604    2,328    295,788 
                     
Consumer   12,340    306    19    12,665 
                     
Totals  $694,485   $9,077   $4,753   $708,315 

 

Nonaccrual loans are included in the contractual aging immediately above and on the previous page. A summary of the contractual aging of nonaccrual loans at March 31, 2012 and December 31, 2011 is as follows:

 

   Current &             
(In Thousands)  Past Due   Past Due   Past Due     
   Less than   30-89   90+     
   30 Days   Days   Days   Total 
                 
March 31, 2012 Nonaccrual Totals  $2,628   $331   $4,002   $6,961 
December 31, 2011 Nonaccrual Totals  $2,532   $1,179   $3,486   $7,197 

 

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. In April 2011, the FASB issued ASU 2011-02, Receivables (Topic 310) - A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The Update provides guidance in evaluating whether a restructuring constitutes a TDR. The Update was effective for the Corporation in 2011, with retrospective application to January 1, 2011.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

The outstanding balance of loans subject to TDRs, as well as contractual aging information at March 31, 2012 and December 31, 2011 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 
                     
March 31, 2012 Totals  $960   $0   $111   $1,862   $2,933 
December 31, 2011 Totals  $1,064   $0   $146   $2,267   $3,477 

 

TDRs that occurred during the three-month period ended March 31, 2012 are as follows:

 

Three Months Ended March 31, 2012      Pre-   Post- 
(Balances in Thousands)      Modification   Modification 
   Number   Outstanding   Outstanding 
   of   Recorded   Recorded 
   Contracts   Investment   Investment 
Commercial,               
Commercial and industrial   1   $65   $65 

 

The TDR in the three-month period ended March 31, 2012 was an extension of the final maturity and lowering of monthly payments required on a commercial loan. There was no allowance for loan losses on this loan at March 31, 2012, and no change in the allowance for loan losses resulting from this TDR.

 

The outstanding balance of TDRs at December 31, 2011 included a balance of $466,000 related to six commercial loans secured by real estate stemming from a forbearance agreement entered into with one commercial customer. Under the terms of the forbearance agreement, the Corporation had agreed to accept payment of less than the total principal amount of the loans, assuming payment was received by dates specified within the forbearance agreement. In the first quarter 2012, the loans were not repaid and the forbearance agreement expired. Accordingly, the Corporation’s concession terminated, and the loans were not classified as TDRs at March 31, 2012. The outstanding balance of the loans was $466,000 at March 31, 2012. The loans were in nonaccrual status at March 31, 2012 and December 31, 2011. At March 31, 2012, the risk rating of the loans was Substandard, while the risk rating of the loans was Doubtful at December 31, 2011. Based on management’s estimate of the value of the underlying collateral, net of selling costs, the Corporation had no allowance for loan losses associated with these loans at March 31, 2012 and December 31, 2011.

 

Defaults on loans for which modifications considered to be TDRs were entered into within the previous 12 months are as follows:

 

   Number     
(Balances in Thousands)  of   Recorded 
   Contracts   Investment 
Commercial,          
Commercial construction and land   1   $950 

 

The event of default in the table above resulted from the borrowers’ failure to make payments due at maturity, based on a loan maturity date that had been extended from the original due date. The allowance for loan losses on this loan was $122,000 at March 31, 2012, an increase of $57,000 over the allowance on the loan at December 31, 2011.

 

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8. 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. This plan contains a cost-sharing feature, which causes participants to pay for all future increases in costs related to benefit coverage. Accordingly, actuarial assumptions related to health care cost trend rates do not significantly affect the liability balance at March 31, 2012 and December 31, 2011, and are not expected to significantly affect the Corporation's future expenses. The Corporation uses a December 31 measurement date for the postretirement plan.

 

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

 

Defined Benefit Plans                
(In Thousands)  Pension   Postretirement 
   Three Months Ended   Three Months Ended 
   March 31,   March 31, 
   2012   2011   2012   2011 
Service cost  $0   $0   $23   $21 
Interest cost   18    18    20    23 
Expected return on plan assets   (18)   (18)   0    0 
Amortization of transition (asset) obligation   0    0    9    9 
Amortization of prior service cost   0    0    4    3 
Recognized net actuarial loss   7    1    0    0 
Net periodic benefit cost  $7   $1   $56   $56 

 

In the first three months of 2012, the Corporation funded postretirement contributions totaling $15,000, with estimated annual postretirement contributions of $60,000 expected in 2012 for the full year. The Corporation made a contribution to the defined benefit pension plan of $21,000 in the first quarter of 2012 for the 2011 plan year. Based upon the related actuarial reports, the Corporation made a $23,000 contribution in the second quarter 2012 for the 2012 plan year. No further contributions are expected in 2012.

 

9. STOCK-BASED COMPENSATION PLANS

 

In January 2012, the Corporation granted options to purchase a total of 64,757 shares of common stock through its Stock Incentive and Independent Directors Stock Incentive Plans. In January 2011, the Corporation granted options to purchase a total of 93,674 shares of common stock. The exercise price for the 2012 awards is $18.54 per share, and the exercise price for the 2011 awards is $15.06 per share, based on the market price as of the date of grant. Stock option expense is recognized over the vesting period of each option. The Corporation expects total stock option expense for the year ending December 31, 2012 to be $247,000, and total stock option expense for the year ended December 31, 2011 was $279,000.

 

The Corporation records stock option expense based on estimated fair value calculated using an option valuation model. In calculating the 2012 and 2011 fair values, the Corporation utilized the Black-Scholes-Merton option-pricing model. The calculated fair value of each option granted, and significant assumptions used in the calculations, are as follows:

 

   2012   2011 
Fair value of each option granted  $5.15   $4.26 
Volatility   41%   37%
Expected option lives   7 Years    8 Years 
Risk-free interest rate   1.53%   3.10%
Dividend yield   3.97%   3.86%

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

In calculating the estimated fair value of 2012 and 2011 stock option awards, management based its estimates of volatility and dividend yield on the Corporation’s experience over the immediately prior period of time consistent with the estimated lives of the options. The risk-free interest rate was based on the published yield of zero-coupon U.S. Treasury strips with an applicable maturity as of the grant dates. The expected option lives were based on management’s estimates of the average term for all options issued under both plans. In 2012 and 2011, management assumed a 33% forfeiture rate for options granted under the Stock Incentive Plan, and a 0% forfeiture rate for the Directors Stock Incentive Plan. These estimated forfeiture rates were determined based on the Corporation’s historical experience.

 

In January 2012, the Corporation awarded a total of 42,552 shares of restricted stock under the Stock Incentive and Independent Directors Stock Incentive Plans. In January 2011, a total of 15,622 shares of restricted stock were awarded under the Plans. Compensation cost related to restricted stock is recognized based on the market price of the stock at the grant date over the vesting period. For restricted stock awards granted under the Stock Incentive Plan, the Corporation must meet an annual targeted return on average equity (“ROAE”) performance ratio, as defined, in order for participants to vest. Management has estimated restricted stock expense in the first three months of 2012 based on an assumption that the ROAE target for 2012 will be met. In the first quarter 2010, the Corporation awarded 9,125 shares of restricted stock to the Chief Executive Officer under the Stock Incentive Plan. This award provides that vesting will occur upon the earliest of (i) the third anniversary of the date of grant, (ii) death or disability or (iii) the occurrence of a change in control of the Corporation.

 

Total stock-based compensation expense is as follows:

 

(In Thousands)  3 Months Ended 
   March 31,   March 31, 
   2012   2011 
Stock options  $159   $156 
Restricted stock   82    36 
           
Total  $241   $192 

 

10. INCOME TAXES

 

The net deferred tax asset at March 31, 2012 and December 31, 2011 represents the following temporary difference components:

 

   March 31,   December 31, 
(In Thousands)  2012   2011 
Deferred tax assets:          
Defined benefit plans - ASC 835  $257   $324 
Net realized losses on securities   3,048    3,175 
Allowance for loan losses   2,579    2,697 
Credit for alternative minimum tax paid   4,576    4,569 
Capital loss carryforwards   44    44 
General business credit carryforwards   233    831 
Other deferred tax assets   1,628    1,671 
Total deferred tax assets   12,365    13,311 
           
Deferred tax liabilities:          
Unrealized holding gains on securities   5,844    5,559 
Bank premises and equipment   1,314    1,357 
Core deposit intangibles   68    74 
Other deferred tax liabilities   136    148 
Total deferred tax liabilities   7,362    7,138 
Deferred tax asset, net  $5,003   $6,173 

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

The deferred tax asset from realized losses on securities resulted primarily from OTTI charges for financial statement purposes that are not deductible for income tax reporting purposes through March 31, 2012. Of the total deferred tax asset from realized losses on securities, $332,000 is from securities that, if the Corporation were to sell them, would be classified as capital losses for income tax reporting purposes.

 

The Corporation has available an estimated $130,000 capital loss carryforward at March 31, 2012, expiring in 2015. The Corporation has available, unused tax credits of $233,000 at March 31, 2012 arising from investments in low income and elderly housing projects. These tax credits may provide future benefits and, if unused, would expire in varying annual amounts from 2029 through 2031.

 

The provision for income tax for the three-month periods ended March 31, 2012 and 2011 is based on the Corporation’s estimate of the effective tax rate expected to be applicable for the full year. The effective tax rates for the Corporation are as follows:

 

   Three Months Ended 
(In thousands)  March 31, 
   2012   2011 
   (Current)   (Prior Year) 
Income before income tax provision  $7,696   $7,605 
Income tax provision   2,109    2,064 
           
Effective tax rate   27.40%   27.14%

 

The effective tax rate for each period presented differs from the statutory rate of 35% principally because of the effects of tax-exempt interest income.

 

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 2008.

 

11. IMPAIRMENT OF LIMITED PARTNERSHIP INVESTMENT

 

In the first quarter 2011, the Corporation reported an impairment loss of $948,000 related to an investment in a real estate limited partnership. In addition to the limited partnership investment, the Corporation has a loan receivable from the limited partnership with an outstanding balance of $1,032,000 at March 31, 2012. Based on updated financial information, management prepared an estimated valuation based on cash flow analysis. That analysis showed the estimated return to the Corporation would be sufficient to repay the loan in full, but would not provide sufficient additional cash flow for return on the limited partnership investment. Accordingly, management made the decision to completely write-off the limited partnership investment in the first quarter 2011.

 

12. CONTINGENCIES

 

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

 

13. RECENT ACCOUNTING PRONOUNCEMENTS

 

The 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.

 

In April 2011, the FASB issued ASU 2011-02, Receivables (Topic 310) - A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The Update amends ASC Topic 310 to provide guidance in evaluating whether a restructuring constitutes a Troubled Debt Restructuring. The main provisions conclude that a creditor must separately conclude that both of the following exist – (1) the restructuring constitutes a concession, and (2) the debtor is experiencing financial difficulties. The amendments then provide guidance on a creditor’s evaluation of each of the requirements for a Troubled Debt Restructuring. For public entities, the Update was effective for the first interim or annual period beginning on or after June 15, 2011, including retrospective application to the beginning of the annual period of adoption. Note 7 provides disclosures required by this standard.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820) – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this Update will result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. The Update includes various amendments, including amendments that: (1) clarify FASB’s intent about the application of existing fair value measurement and disclosure requirements, and (2) change some particular principles or requirements for measuring fair value or disclosing information about fair value measurements. There were no changes in the Corporation’s procedures for determining fair value measurements as a result of this Update, however additional quantitative disclosures about unobservable inputs used in fair value measurements categorized within Level 3 of the fair value hierarchy are provided. The amendments in this ASU are applied prospectively, and Note 5 includes disclosures required by this ASU.

 

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220) – Presentation of Comprehensive Income. The intent of this standard is to increase the prominence of comprehensive income in the financial statements. This standard requires the components of comprehensive income be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The single format includes the traditional income statement and the components of other comprehensive income, total other comprehensive income and total comprehensive income. In the two statement approach, the first statement is the traditional income statement, which would be immediately followed by a separate statement which would include the components of other comprehensive income, total other comprehensive income and total comprehensive income. The amendments in this ASU are applied retrospectively, and the Corporation has adopted the two statement approach as reflected in the accompanying financial statements.

 

In September 2011, the FASB issued ASU No. 2011-08, Intangibles – Goodwill and Other (Topic 350) – Testing Goodwill for Impairment. The amendments in this ASU permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. The amendments in this ASU are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, and management adopted this ASU in assessing goodwill for impairment as of December 31, 2011.

 

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

AND RESULTS OF OPERATIONS

 

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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

 

·changes in monetary and fiscal policies of the Federal Reserve Board and the U. S. Government, particularly related to changes in interest rates
·changes in general economic conditions
·legislative or regulatory changes
·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

 

Net income available to common shareholders for the first quarter 2012 was $5,587,000, or $0.46 per basic and diluted share. The first quarter 2012 return on average assets was 1.72%, and the return on average equity was 13.15%. First quarter 2012 earnings were down from fourth quarter 2011 earnings of $6,141,000, or $0.51 per basic and diluted share. First quarter 2012 earnings were up slightly as compared to first quarter 2011 earnings of $5,541,000, or $0.46 per basic share and $0.45 per diluted share.

 

Some of the more significant fluctuations in the components of earnings are as follows:

 

·First quarter 2012 net interest income was $120,000 (1.0%) lower than in the fourth quarter 2011, and $992,000 (8.8%) higher than in the first quarter 2011. Although the interest margin improved to 4.41% in the first quarter 2012 as compared to 4.33% in the fourth quarter 2011, the most recent quarterly net interest income was impacted by a 1.2% lower average volume of earning assets. The higher level of net interest income in the first quarter 2012 as compared to first quarter 2011 reflected significant improvement in the margin, which was up from 4.05% in the first quarter 2011, primarily because of a lower cost of funds. Net interest income includes the benefit of accretion from the offset of a previous write-down on a security, with a benefit of $457,000 recorded in the most recent quarter, up from $325,000 in the fourth quarter 2011 and $111,000 in the first quarter 2011. This security matures in May 2012, and assuming the Corporation holds it until maturity, accretion of $398,000 would be recorded in the second quarter 2012, with no accretion on the security thereafter.

 

·The provision for loan losses was a credit (reduction in expense) of $182,000 in the first quarter 2012, as compared to a credit of $87,000 in the fourth quarter 2011 and a credit of $192,000 in the first quarter 2011. The credits for loan losses in 2012 and 2011 have resulted, in part, from a reduction in loans outstanding, as the general component of the allowance for loan losses was reduced. In the first quarter 2012, the credit included a reduction in a component of the allowance for loan losses that is determined based on the 3 previous years’ net charge-off experience. In recent years, the Corporation has experienced a limited amount of loan-related credit problems, as compared to averages for comparable-sized peer banks.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

·Total noninterest revenue, excluding losses or gains from available-for-sale securities, was $3,759,000 in the first quarter 2012, up slightly over the fourth quarter 2011 total of $3,711,000 and up from $2,555,000 in the first quarter 2011. In 2011, noninterest revenue was negatively impacted by an impairment loss in the first quarter of $948,000 related to an investment in a real estate limited partnership.

 

·In the first quarter 2012, net losses from available-for-sale securities were $2,000, down from gains of $188,000 in the fourth quarter 2011 and considerably lower than gains of $1,839,000 in the first quarter 2011. In the most recent quarter, the Corporation had realized gains from securities totaling $65,000, but recorded an other-than-temporary-impairment loss of $67,000 on an investment in a bank stock. In the first quarter 2011, the Corporation realized gains of $1,510,000 from two pooled trust-preferred securities that had been written off in prior periods.

 

·Total noninterest expense was $8,517,000 in the first quarter 2012, up $569,000 over the fourth quarter 2011, and up $254,000 (3.1%) over the first quarter 2011. A portion of the reason for the higher expenses in the first quarter 2012 as compared to the fourth quarter 2011 is timing-related, as payroll taxes and some other employee benefit costs are typically higher in the first quarter than in the remainder of the year. This is reflected in pensions and other benefit expenses, which totaled $1,366,000 in the most recent quarter, up $303,000 over the fourth quarter 2011 and up $60,000 over the first quarter 2011. Other operating expense, a category that includes many different types of expenses, totaled $1,980,000 in the most recent quarter, up $203,000 over the fourth quarter 2011 and $284,000 over the first quarter 2011. Within other operating expense, first quarter 2012 expenses for director stock options, business development and postage were higher than in the fourth quarter 2011. The largest increases in other operating expense in the most recent quarter as compared to the first quarter 2011 were from software subscriptions and updates, postage and expenses related to other real estate properties. FDIC assessments totaled $146,000 in the most recent quarter, in line with the fourth quarter 2011 and considerably lower than the first quarter 2011 expense of $325,000. Effective in the second quarter 2011, the FDIC changed its method for determining assessments, which helped to reduce the amounts charged to the Corporation, and improvements in the Corporation’s financial data also had a favorable impact on the amounts assessed.

 

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

 

TABLE I - QUARTERLY FINANCIAL DATA                    
(In Thousands)                    
   Mar. 31,   Dec 31,   Sept. 30,   June 30,   Mar. 31, 
   2012   2011   2011   2011   2011 
Interest income  $14,776   $15,198   $15,317   $15,443   $15,298 
Interest expense   2,502    2,804    3,108    3,628    4,016 
Net interest income   12,274    12,394    12,209    11,815    11,282 
(Credit) provision for loan losses   (182)   (87)   (37)   31    (192)
Net Interest income after (credit) provision for loan losses   12,456    12,481    12,246    11,784    11,474 
Other income   3,759    3,711    3,999    3,673    2,555 
Net (losses) gains on available-for-sale securities   (2)   188    26    163    1,839 
Other expenses   8,517    7,948    8,052    7,794    8,263 
Income before income tax provision   7,696    8,432    8,219    7,826    7,605 
Income tax provision   2,109    2,291    2,230    2,129    2,064 
Net income available to common shareholders  $5,587   $6,141   $5,989   $5,697   $5,541 
Net income per common share – basic  $0.46   $0.51   $0.49   $0.47   $0.46 
Net income per common share – diluted  $0.46   $0.51   $0.49   $0.47   $0.45 

 

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.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

A material estimate that is particularly susceptible to significant change is the determination of the allowance for loan losses. Management believes that the allowance for loan losses is adequate and reasonable. Analytical information related to the Corporation’s aggregate loans and the related allowance for loan losses is summarized by loan segment and classes of loans in Note 7 to the consolidated financial statements. Additional discussion of the Corporation’s methodology for determining the allowance for loan losses is described in a separate section later in Management’s Discussion and Analysis. Given the very subjective nature of identifying and valuing loan losses, it is likely that well-informed individuals could make materially different assumptions, and could, therefore calculate a materially different allowance value. While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.

 

Another material estimate is the calculation of fair values of the Corporation’s debt securities. 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 5 to the consolidated financial statements, management calculates the fair values of pooled trust-preferred securities by applying discount rates to estimated cash flows for each security. Management estimated the cash flows expected to be received from each security, taking into account estimated levels of deferrals and defaults by the underlying issuers, and used discount rates considered reflective of a market participant’s expectations regarding the extent of credit and liquidity risk inherent in the securities. Management’s estimates of cash flows and discount rates used to calculate fair values of pooled trust-preferred securities were based on sensitive assumptions, and use of different assumptions could result in calculations of fair values that would be substantially different than the amounts calculated by management.

 

As described in Note 6 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. Also, management’s estimates of cash flows used to evaluate OTTI of pooled trust-preferred securities are based on sensitive assumptions, and use of different assumptions could produce different conclusions for each security.

 

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 II, III and IV include information regarding the Corporation’s net interest income for the three-month periods ended March 31, 2012 and March 31, 2011. 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 related Tables.

 

For the three-month periods, fully taxable equivalent net interest income was $13,123,000 in 2012, $1,038,000 (8.6%) higher than in 2011. As shown in Table IV, net changes in volume had the effect of increasing net interest income $271,000 in 2012 compared to 2011, and interest rate changes had the effect of increasing net interest income $767,000. The most significant components of the volume change in net interest income in 2012 were a decrease in interest expense of $292,000 attributable to a reduction in the balance of borrowed funds, a decrease in interest expense of $186,000 attributable to a reduction in the balance of interest-bearing deposits (primarily certificates of deposit and Individual Retirement Accounts), and a decrease in interest income of $260,000 attributable to a decline in the balance of loans receivable. The most significant components of the rate change in net interest income in 2012 were a decrease in interest expense of $1,032,000 due to lower rates paid on interest-bearing deposits and a decrease in interest income of $205,000 attributable to lower rates earned on loans receivable. As presented in Table III, the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) was 4.17% in 2012, as compared to 3.77% in 2011.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

INTEREST INCOME AND EARNING ASSETS

 

Interest income totaled $15,625,000 in 2012, a decrease of 3.0% from 2011. Interest and fees on loans receivable decreased $465,000, or 4.1%. As indicated in Table III, average available-for-sale securities (at amortized cost) totaled $458,736,000 in 2012, an increase of $4,659,000 (1.0%) from 2011. Net growth in the Corporation’s taxable available-for-sale securities portfolio was primarily made up of U.S. Government agency collateralized mortgage obligations and mortgage-backed securities and also included a significant increase in the balance of taxable municipal securities. This growth was partially offset by a reduction in the balance of U.S. Government agency bonds and pooled trust preferred securities. The Corporation’s yield on taxable securities fell in 2011 and 2012 primarily because of low market interest rates, including the effects of management’s decision to limit purchases of taxable securities to investments that mature or are expected to repay a substantial portion of principal within approximately four years or less. The average rate of return on available-for-sale securities was 4.08% for 2012 and 4.16% in 2011.

 

The average balance of gross loans receivable decreased 2.8% to $702,154,000 in 2012 from $722,326,000 in 2011. The Corporation experienced contraction in the balance of loans receivable due to borrowers prepaying or refinancing existing loans combined with modest demand for new loans. The decline in the balance of the residential mortgage portfolio was also affected by management’s decision to sell a portion of newly originated residential mortgages on the secondary market. The Corporation’s average rate of return on loans receivable declined to 6.27% in 2012 from 6.40% in 2011 as rates on new loans as well as existing, variable-rate loans have decreased.

 

The average balance of interest-bearing due from banks increased to $34,334,000 in 2012 from $31,750,000 in 2011. This has consisted primarily of balances held by the Federal Reserve. Although the rates of return on balances with the Federal Reserve are low, the Corporation has maintained relatively high levels of liquid assets in 2011 and 2012 (as opposed to increasing long-term, available-for-sale securities at higher yields) in order to maximize flexibility for dealing with possible fluctuations in cash requirements, and due to management’s concern about the possibility of substantial increases in interest rates within the next few years. During the fourth quarter 2011, the Corporation began investing in FDIC-insured certificates of deposit issued by other financial institutions and maturing within five years; these investments averaged $4,090,000 for 2012 and totaled $4,240,000 at March 31, 2012. The Corporation held no such investments in the first quarter 2011 or in prior periods.

 

INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES

 

Interest expense fell $1,514,000, or 37.7%, to $2,502,000 in 2012 from $4,016,000 in 2011. Table III shows that the overall cost of funds on interest-bearing liabilities fell to 1.08% in 2012 from 1.63% in 2011.

 

Total average deposits (interest-bearing and noninterest-bearing) decreased 0.2%, to $1,000,304,000 in 2012 from $1,002,017,000 in 2011. Decreases in the average balance of certificates of deposit and Individual Retirement Accounts were partially offset by increases in demand deposits and savings accounts. Consistent with continuing low short-term market interest rates, the average rates incurred on deposit accounts have decreased significantly in 2012 as compared to 2011.

 

Variable-rate accounts comprised $135,106,000 of the average balance in Individual Retirement Accounts in 2012 and $150,570,000 in 2011. Prior to May 2011, substantially all of these accounts were paid interest at a rate that could change quarterly at management’s discretion with a contractual floor of 3.00%. Effective in May 2011, the rate floor was removed; following this change, the rate paid on these accounts was lowered several times and was 0.75% at March 31, 2012. As shown in Table III, the average rate on Individual Retirement Accounts decreased to 0.96% in 2012 from 2.99% in 2011.

 

Total average borrowed funds decreased $39,638,000 to $123,029,000 in 2012 from $162,667,000 in 2011. During 2011 and 2012, the Corporation has paid off long-term borrowings as they matured using the cash flow received from loans and investment securities. The average balance of “RepoSweep” arrangements, which are used by the Corporation to borrow funds from commercial banking customers on an overnight basis and included within short-term borrowings, declined to $4,015,000 in 2012 from $16,865,000 in 2011 primarily as a result of changes to service charges assessed on related business checking accounts. In the first quarter 2012, the Corporation took two short-term advances from the Federal Home Loan Bank of Pittsburgh (FHLB) to offset seasonal declines in deposit balances. Short-term advances averaged $3,407,000 in 2012 with no such advances outstanding during 2011. The short-term advances matured during the first quarter 2012, and none were outstanding at March 31, 2012. The average rate on borrowed funds was 3.77% in 2012, compared to 3.61% in 2011.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

TABLE II - ANALYSIS OF INTEREST INCOME AND EXPENSE

 

   Three Months 
Ended
     
   March 31,   Increase/ 
(In Thousands)  2012   2011   (Decrease) 
             
INTEREST INCOME               
Available-for-sale securities:               
Taxable  $2,733   $2,755   $(22)
Tax-exempt   1,916    1,905    11 
Total available-for-sale securities   4,649    4,660    (11)
Interest-bearing due from banks   28    16    12 
Loans held for sale   9    21    (12)
Loans receivable:               
Taxable   10,366    10,847    (481)
Tax-exempt   573    557    16 
Total loans receivable   10,939    11,404    (465)
Total Interest Income   15,625    16,101    (476)
                
INTEREST EXPENSE               
Interest-bearing deposits:               
Interest checking   51    130    (79)
Money market   97    151    (54)
Savings   26    56    (30)
Certificates of deposit   826    1,041    (215)
Individual Retirement Accounts   350    1,189    (839)
Other time deposits   0    1    (1)
Total interest-bearing deposits   1,350    2,568    (1,218)
Borrowed funds:               
Short-term   3    6    (3)
Long-term   1,149    1,442    (293)
Total borrowed funds   1,152    1,448    (296)
Total Interest Expense   2,502    4,016    (1,514)
                
Net Interest Income  $13,123   $12,085   $1,038 

 

Note: Interest income from tax-exempt securities and loans has been adjusted to a fully tax-equivalent basis, using the Corporation’s marginal federal income tax rate of 35% in 2012 and 34% in 2011.

 

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CITIZENS & NORTHERN CORPORATION – FORM 10-Q

 

Table IIl - Analysis of Average Daily Balances and Rates

(Dollars in Thousands)

   3 Months       3 Months     
   Ended   Rate of   Ended   Rate of 
   3/31/2012   Return/   3/31/2011   Return/ 
   Average   Cost of   Average   Cost of 
   Balance   Funds %   Balance   Funds % 
EARNING ASSETS                
Available-for-sale securities, at amortized cost:                    
Taxable  $331,007    3.32%  $327,104    3.42%
Tax-exempt   127,729    6.03%   126,973    6.08%
Total available-for-sale securities   458,736    4.08%   454,077    4.16%
Interest-bearing due from banks   34,334    0.33%   31,750    0.20%
Loans held for sale   1,057    3.42%   1,722    4.95%
Loans receivable:                    
Taxable   665,936    6.26%   687,253    6.40%
Tax-exempt   36,218    6.36%   35,073    6.44%
Total loans receivable   702,154    6.27%   722,326    6.40%
Total Earning Assets   1,196,281    5.25%   1,209,875    5.40%
Cash   16,891         16,985      
Unrealized gain/loss on securities   17,923         (588)     
Allowance for loan losses   (7,739)        (9,201)     
Bank premises and equipment   18,898         22,474      
Intangible Asset - Core Deposit Intangible   204         315      
Intangible Asset - Goodwill   11,942         11,942      
Other assets   48,282         60,758      
Total Assets  $1,302,682        $1,312,560      
                     
INTEREST-BEARING LIABILITIES                    
Interest-bearing deposits:                    
Interest checking  $161,524    0.13%  $163,479    0.32%
Money market   205,866    0.19%   203,439    0.30%
Savings   104,532    0.10%   92,625    0.25%
Certificates of deposit   191,924    1.73%   212,133    1.99%
Individual Retirement Accounts   146,241    0.96%   161,174    2.99%
Other time deposits   942    0.00%   956    0.42%
Total interest-bearing deposits   811,029    0.67%   833,806    1.25%
Borrowed funds:                    
Short-term   7,422    0.16%   16,865    0.14%
Long-term   115,607    4.00%   145,802    4.01%
Total borrowed funds   123,029    3.77%   162,667    3.61%
Total Interest-bearing Liabilities   934,058    1.08%   996,473    1.63%
Demand deposits   189,275         168,211      
Other liabilities   9,452         6,461      
Total Liabilities   1,132,785         1,171,145      
Stockholders' equity, excluding other comprehensive income/loss   158,801         142,054      
Other comprehensive income/loss   11,096         (639)     
Total Stockholders' Equity   169,897         141,415      
Total Liabilities and Stockholders' Equity  $1,302,682        $1,312,560      
Interest Rate Spread        4.17%        3.77%
Net Interest Income/Earning Assets        4.41%        4.05%
                     
Total Deposits (Interest-bearing and Demand)  $1,000,304        $1,002,017      

 

(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% in 2012 and 34% in 2011.

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

 

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TABLE IV - ANALYSIS OF VOLUME AND RATE CHANGES

 

(In Thousands)   3 Months Ended  3/31/12 vs. 3/31/11 
   Change in   Change in   Total 
  Volume   Rate   Change 
EARNING ASSETS               
Available-for-sale securities:               
Taxable  $40   $(62)  $(22)
Tax-exempt   18    (7)   11 
Total available-for-sale securities   58    (69)   (11)
Interest-bearing due from banks   1    11    12 
Loans held for sale   (6)   (6)   (12)
Loans receivable:               
Taxable   (282)   (199)   (481)
Tax-exempt   22    (6)   16 
Total loans receivable   (260)   (205)   (465)
Total Interest Income   (207)   (269)   (476)
                
INTEREST-BEARING LIABILITIES               
Interest-bearing deposits:               
Interest checking   (2)   (77)   (79)
Money market   2    (56)   (54)
Savings   6    (36)   (30)
Certificates of deposit   (91)   (124)   (215)
Individual Retirement Accounts   (101)   (738)   (839)
Other time deposits   0    (1)   (1)
Total interest-bearing deposits   (186)   (1,032)   (1,218)
Borrowed funds:               
Short-term   (4)   1    (3)
Long-term   (288)   (5)   (293)
Total borrowed funds   (292)   (4)   (296)
Total Interest Expense   (478)   (1,036)   (1,514)
                
Net Interest Income  $271   $767   $1,038 

 

(1) Changes in income on tax-exempt securities and loans are presented on a fully tax-equivalent basis, using the Corporation’s marginal federal income tax rate of 35% in 2012 and 34% in 2011.

 

(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 amount of the change in each.