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EX-32.2 - SECTION 1350 CERTIFICATION OF CHIEF FINANCIAL OFFICER - CITIZENS FINANCIAL SERVICES INCcertcfo.htm
EX-32.1 - SECTION 1350 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - CITIZENS FINANCIAL SERVICES INCcertceo.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - CITIZENS FINANCIAL SERVICES INCcfocert.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - CITIZENS FINANCIAL SERVICES INCceocert.htm
EX-21 - LIST OF SUBSIDIARIES - CITIZENS FINANCIAL SERVICES INCsubsidiaries.htm
EX-23 - CONSENT OF SR SNODGRASS CERTIFIED PUBLIC ACCOUNTS - CITIZENS FINANCIAL SERVICES INCsnodgrassconsent.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K
(Mark One)

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

For the fiscal year ended
 
     December 31, 2010

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
     000-13222

CITIZENS FINANCIAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Pennsylvania
 
23-2265045
State or other jurisdiction of
incorporation or organization
 
(I.R.S. Employer
Identification No.)
15 South Main Street, Mansfield, Pennsylvania
 
16933
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code
(570) 662-2121
         
Securities registered pursuant to Section 12(b) of the Act:
None
 
         
Securities registered pursuant to Section 12(g) of the Act:
         
Common Stock, par value $1.00 per share
(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
  Yes       No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
  Yes       No
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       No
Indicate by check mark whether the registrant has submitted electronically and posted on its website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.
  Yes       No

 
 

 
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
                
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer  o                                                                                     Accelerated filer  £
 
 
Non-accelerated filer  o                                                                           Smaller reporting company  
 
(Do not check if a smaller reporting company)

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

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. $71,824,693 as of June 30, 2010.
 
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date. 2,887,367 as of February 28, 2011.

DOCUMENTS INCORPORATED BY REFERENCE
Certain information required by Part III is incorporated by reference to the Registrant’s Definitive Proxy Statement for the 2011 Annual Meeting of Shareholders.



 
II

 

 

 
Citizens Financial Services, Inc.
Form 10-K
INDEX
 
Page
PART I
 
ITEM 1 – BUSINESS
1 – 5
ITEM 1A – RISK FACTORS
5 – 10
ITEM 1B – UNRESOLVED STAFF COMMENTS
10
ITEM 2 – PROPERTIES
10
ITEM 3 – LEGAL PROCEEDINGS
10
ITEM 4 – [REMOVED AND RESERVED]
10
PART II
 
ITEM 5 – MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS        AND ISSUER PURCHASES OF EQUITY SECURITIES
11 – 12
ITEM 6 – SELECTED FINANCIAL DATA
13
ITEM 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS  OF OPERATION
14 – 42
ITEM 7A – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
43
ITEM 8 – FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
44 – 87
ITEM 9 – CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND  FINANCIAL DISCLOSURE
88
ITEM 9A – CONTROLS AND PROCEDURES
88
ITEM 9B– OTHER INFORMATION
88
PART III
 
ITEM 10 – DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
89
ITEM 11 – EXECUTIVE COMPENSATION
89
ITEM 12 – SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
89 – 90
ITEM 13 – CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
90
ITEM 14 – PRINCIPAL ACCOUNTING FEES AND SERVICES
90
PART IV
 
ITEM 15 – EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
91 – 92
SIGNATURES
93

 
III

 


 
PART I
 
ITEM 1 – BUSINESS.
 
CITIZENS FINANCIAL SERVICES, INC.
 
Citizens Financial Services, Inc. (the “Company”), a Pennsylvania corporation, was incorporated on April 30, 1984. The Company is registered with the Board of Governors of the Federal Reserve System (“FRB”) as a bank holding company under the Bank Holding Company Act of 1956, as amended.  Simultaneous with establishment of the Company in 1984, First Citizens National Bank (the “Bank”) became a wholly-owned subsidiary of the Company.   The Company is subject to regulation, supervision and examination by the FRB.  In general, the Company is limited to owning or controlling banks and engaging in such other bank related activities.
 
Our Company is primarily engaged in the ownership and management of the Bank and the Bank’s wholly-owned insurance agency subsidiary, First Citizens Insurance Agency, Inc.
 
FIRST CITIZENS NATIONAL BANK
 
The Bank’s main office is located at 15 South Main Street, Mansfield, (Tioga County) Pennsylvania.  The Bank’s primary market area consists of the Pennsylvania Counties of Bradford, Potter and Tioga in North Central Pennsylvania.  It also includes Allegany, Steuben, Chemung and Tioga Counties in Southern New York.  The economy is diversified and includes manufacturing industries, wholesale and retail trade, service industries, family farms and the production of natural resources of gas and timber.  We are dependent geographically upon the economic conditions in north central Pennsylvania and the southern tier of New York.  In addition to the main office, the Bank has 17 other full service branch offices in its market area and a loan production office located in Clinton County, Pennsylvania, which was opened in December 2010. Included in the 18 full service branch offices is an office that was opened in January 2011 in Rome, Pennsylvania.
 
The Bank is a full-service bank engaging in a broad range of banking activities and services for individual, business, governmental and institutional customers.  These activities and services principally include checking, savings, time and deposit accounts; real estate, commercial, industrial, residential and consumer loans; and a variety of other specialized financial services.  The Trust and Investment division of the Bank offers a full range of client investment, estate and retirement services through First Citizens Insurance Agency, Inc.
 
As of December 31, 2010, the Bank employed 156 full time employees and 30 part-time employees, resulting in 170 full time equivalent employees at our corporate offices and other banking locations.
 
COMPETITION
 
The banking industry in the Bank’s service area continues to be extremely competitive, both among commercial banks and with financial service providers such as consumer finance companies, thrifts, investment firms, mutual funds, insurance companies, credit unions and internet banks.  The increased competition has resulted from changes in the legal and regulatory guidelines as well as from economic conditions, specifically, the additional wealth resulting from the exploration of the Marcellus Shale in our primary market.  Mortgage banking firms, financial companies, financial affiliates of industrial companies, brokerage firms, retirement fund management firms and even government agencies provide additional competition for loans and other financial services.  The Bank is generally competitive with all competing financial institutions in its service area with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans.
 
Additional information related to our business and competition is included in Part II, Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations”.
 
SUPERVISION AND REGULATION
 
1

 

GENERAL
 
The Company is registered as a bank holding company and is subject to supervision and regulation by the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956, as amended.  The Company is considered a bank holding company.  Bank holding companies are required to file periodic reports with and are subject to examination by the Federal Reserve Board.  The Federal Reserve Board has issued regulations under the Bank Holding Company Act that require a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks.  As a result, the Federal Reserve Board, pursuant to such regulations, may require the Company to use its resources to provide adequate capital funds to its bank subsidiary during periods of financial stress or adversity.
 
The Bank Holding Company Act prohibits the Company from acquiring direct or indirect control of more than 5% of the outstanding shares of any class of voting stock, or substantially all of the assets of, any bank, or from merging or consolidating with another bank holding company, without prior approval of the Federal Reserve Board.  Additionally, the Bank Holding Company Act prohibits the Company from engaging in or from acquiring ownership or control of more than 5% of the outstanding shares of any class of voting stock of any company engaged in a non-banking business, unless such business has been determined by the Federal Reserve Board to be so closely related to banking as to be a proper incident thereto or, for financial holding companies, to be financial in nature or incidental thereto.
 
The Bank is a national bank and a member of the Federal Reserve System, and its deposits are insured (up to applicable limits) by the Federal Deposit Insurance Corporation (the “FDIC”).  The Bank is subject to regulation and examination by the Office of the Comptroller of the Currency (OCC), and to a much lesser extent, the Federal Reserve Board and the FDIC.  The Bank is also subject to requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, and the interest that may be charged on loans, and limitations on the types of investments that may be made and the types of services that may be offered.  The Bank is subject to extensive regulation and reporting requirements in a variety of areas, including helping to prevent money laundering, to preserve financial privacy and to properly report late payments, defaults and denials of loan applications.  The Community Reinvestment Act requires the Bank to help meet the credit needs of the entire community where the Bank operates, including low and moderate income neighborhoods.  The Bank's rating under the Community Reinvestment Act, assigned by the Comptroller of the Currency pursuant to an examination of the Bank, is important in determining whether the bank may receive approval for, or utilize certain streamlined procedures in, applications to engage in new activities.  The Bank’s present CRA rating is “Satisfactory.”  Various consumer laws and regulations also affect the operations of the Bank.  In addition to the impact of regulation, commercial banks are affected significantly by the actions of the Federal Reserve Board as it attempts to control the money supply and credit availability in order to influence the economy.

CAPITAL ADEQUACY GUIDELINES
 
Bank holding companies are required to comply with the Federal Reserve Board's risk-based capital guidelines.  The required minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) is 8%.  At least half of the total capital is required to be “Tier 1 capital,” consisting principally of common shareholders' equity, less certain intangible assets.  The remainder (“Tier 2 capital”) may consist of certain preferred stock, a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, and a limited amount of the general loan loss allowance.  The risk-based capital guidelines are required to take adequate account of interest rate risk, concentration of credit risk, and risks of nontraditional activities.
 
In addition to the risk-based capital guidelines, the Federal Reserve Board requires a bank holding company to maintain a leverage ratio of a minimum level of Tier 1 capital (as determined under the risk-based capital guidelines) equal to 3% of average total consolidated assets for those bank holding companies which have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion.  All other bank holding companies are required to maintain a ratio of at least 4%.  The Bank is subject to largely similar capital requirements adopted by the OCC.


 
2

 
 
PROMPT CORRECTIVE ACTION RULES
 
The federal banking agencies have regulations defining the levels at which an insured institution would be considered “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.”  Institutions that are classified as undercapitalized, significantly undercapitalized or critically undercapitalized are subject to various supervision measures based on the degree of undercapitalization.  The applicable federal bank regulator for a depository institution could, under certain circumstances, reclassify a “well-capitalized” institution as “adequately capitalized” or require an “adequately capitalized” or “undercapitalized” institution to comply with supervisory actions as if it were in the next lower category.  Such a reclassification could be made if the regulatory agency determines that the institution is in an unsafe or unsound condition (which could include unsatisfactory examination ratings).  The Bank satisfies the criteria to be classified as “well capitalized” within the meaning of applicable regulations.

REGULATORY RESTRICTIONS ON DIVIDENDS
 
The Bank may not, under the National Bank Act, declare a dividend without approval of the OCC, unless the dividend to be declared by the Bank's Board of Directors does not exceed the total of:  (i) the Bank's net profits for the current year to date, plus (ii) its retained net profits for the preceding two years, less any required transfers to surplus.  In addition, the Bank can only pay dividends to the extent that its retained net profits (including the portion transferred to surplus) exceed its bad debts.  The Federal Reserve Board, the OCC and the FDIC have formal and informal policies which provide that insured banks and bank holding companies should generally pay dividends only out of current operating earnings, with some exceptions.  The Prompt Corrective Action Rules, described above, further limit the ability of banks to pay dividends, because banks which are not classified as well capitalized or adequately capitalized may not pay dividends and no dividend may be paid which would make the Bank undercapitalized after the dividend. Those rules also authorize the Federal Reserve Board to prohibit a bank holding company from paying dividends under certain circumstances if its subsidiary bank is undercapitalized.
 
Under these policies and subject to the restrictions applicable to the Bank, the Bank could have declared, during 2010, without prior regulatory approval, aggregate dividends of approximately $15.2 million, plus net profits earned to the date of such dividend declaration.

BANK SECRECY ACT
 
Under the Bank Secrecy Act (BSA), banks and other financial institutions are required to retain records to assure that the details of financial transactions can be traced if investigators need to do so.  Banks are also required to report most cash transactions in amounts exceeding $10,000 made by or on behalf of their customers.  Failure to meet BSA requirements may expose the Bank to statutory penalties, and a negative compliance record may affect the willingness of regulating authorities to approve certain actions by the Bank requiring regulatory approval, including new branches.

INSURANCE OF DEPOSIT ACCOUNTS
 
The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund (DIF) of the FDIC.  Under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors, with less risky institutions paying lower assessments.  An institution’s assessment rate depends upon the category to which it is assigned, and certain adjustments specified by FDIC regulations.  Assessment rates currently range from seven to 77.5 basis points of assessable deposits.  The FDIC may adjust the scale uniformly, except that no adjustment can deviate more than three basis points from the base scale without notice and comment.  No institution may pay a dividend if it is in default of the federal deposit insurance assessment.
 
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) requires the FDIC to revise its procedures to base its assessments upon average consolidated total assets less average tangible equity instead of deposits. On February 7, 2011, the FDIC issued final rules, effective April 1, 2011, implementing changes to the assessment rules from the Dodd-Frank Act.  Initially, the base assessment rates will range from 2.5 to 45 basis points.  The rate schedules will automatically adjust in the future when the DIF reaches certain milestones.
 
 
3

 
 
The FDIC imposed on all insured institutions a special emergency assessment of five basis points of total assets minus Tier 1 capital (as of June 30, 2009), capped at ten basis points of an institution’s deposit assessment base, in order to cover losses to the DIF.  That special assessment was collected on September 30, 2009.  The FDIC provided for similar assessments during the final two quarters of 2009.
 
In lieu of further special assessments, however, the FDIC required insured institutions to prepay estimated quarterly risk-based assessments for the fourth quarter of 2009 through the fourth quarter of 2012.  The estimated assessments, which included an assumed annual assessment base increase of 5%, were recorded as a prepaid expense asset as of December 30, 2009.  As of December 31, 2009, and each quarter thereafter, a charge to earnings is recorded for each regular assessment with an offsetting credit to the prepaid asset.
 
Due to the recent difficult economic conditions, deposit insurance per account owner has been raised to $250,000.  That coverage was made permanent by the Dodd-Frank Act.  In addition, the FDIC adopted an optional Temporary Liquidity Guarantee Program by which, for a fee, noninterest-bearing transaction accounts would receive unlimited insurance coverage until June 30, 2010, subsequently extended to December 31, 2010, and certain senior unsecured debt issued by institutions and their holding companies between October 13, 2008 and October 31, 2009 would be guaranteed by the FDIC through June 30, 2012, or in some cases, December 31, 2012.
 
In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation to recapitalize a predecessor deposit insurance fund. That payment is established quarterly and during the four quarters ended December 31, 2010 averaged 1.04 basis points of assessable deposits.
 
The Dodd-Frank Act increased the minimum target DIF ratio from 1.15% of estimated insured deposits to 1.35% of estimated insured deposits.  The FDIC must seek to achieve the 1.35% ratio by September 30, 2020.  Insured institutions with assets of $10 billion or more are supposed to fund the increase.  The Dodd-Frank Act eliminated the 1.5% maximum fund ratio, instead leaving it to the discretion of the FDIC and the FDIC has recently exercised that discretion by establishing a long range fund ratio of 2%.
 
The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank.  Management cannot predict what insurance assessment rates will be in the future.
 
Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or regulatory condition imposed in writing.  The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
 
EFFECT OF GOVERNMENT MONETARY POLICIES
 
The earnings and growth of the banking industry are affected by the credit policies of monetary authorities, including the Federal Reserve System.  An important function of the Federal Reserve System is to regulate the national supply of bank credit in order to control recessionary and inflationary pressures.  Among the instruments of monetary policy used by the Federal Reserve to implement these objectives are open market activities in U.S. Government Securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits.  These operations are used in varying combinations to influence overall economic growth and indirectly, bank loans, securities, and deposits.  These variables may also affect interest rates charged on loans or paid on deposits.  The monetary policies of the Federal Reserve authorities have had a significant effect on the operating results of commercial banks in the past and are expected to continue to have such an effect in the future.
 
In view of the changing conditions in the national economy and in the money markets, as well as the effect of actions by monetary and fiscal authorities including the Federal Reserve System, no prediction can be made as to possible changes in interest rates, deposit levels, loan demand or their effect on the business and earnings of the Company and the Bank.   Additional information is included under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing in this Annual Report on Form 10-K.
 
 
4

 
 
REGULATORY RESTRUCTURING LEGISLATION
 
On July 21, 2010, President Obama signed the Dodd-Frank Act, which is legislation that restructures the regulation of depository institutions.  In addition to eliminating the Office of Thrift Supervision and creating the Consumer Financial Protection Bureau, the Dodd-Frank Act, among other things, requires changes in the way that institutions are assessed for deposit insurance, requires that originators of securitized loans retain a percentage of the risk for the transferred loans, directs the Federal Reserve Board to regulate pricing of certain debit card interchange fees, reduces the federal preemption afforded to national banks and contains a number of reforms related to mortgage originations.  Many of the provisions of the Dodd-Frank Act contain delayed effective dates and/or require the issuance of regulations.  As a result, it will be some time before their impact on operations can be assessed by management.  However, there is a significant possibility that the Dodd-Frank Act will, at a minimum, result in an increased regulatory burden and higher compliance, operating, and possibly, interest costs for the Company and the Bank.
 
ITEM 1A – RISK FACTORS.
 
Changing interest rates may decrease our earnings and asset values.
 
Our net interest income is the interest we earn on loans and investments less the interest we pay on our deposits and borrowings.  Our net interest margin is the difference between the yield we earn on our assets and the interest rate we pay for deposits and our other sources of funding.  Changes in interest rates—up or down—could adversely affect our net interest margin and, as a result, our net interest income.  Although the yield we earn on our assets and our funding costs tend to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, causing our net interest margin to expand or contract.  Our liabilities tend to be shorter in duration than our assets, so they may adjust faster in response to changes in interest rates.  As a result, when interest rates rise, our funding costs may rise faster than the yield we earn on our assets, causing our net interest margin to contract until the asset yields catch up.   Changes in the slope of the “yield curve”—or the spread between short-term and long-term interest rates—could also reduce our net interest margin.  Normally, the yield curve is upward sloping, meaning short-term rates are lower than long-term rates.  Because our liabilities tend to be shorter in duration than our assets, when the yield curve flattens or even inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets.
 
Changes in interest rates also affect the value of the Bank’s interest-earning assets, and in particular the Bank’s securities portfolio.  Generally, the value of fixed-rate securities fluctuates inversely with changes in interest rates.  Unrealized gains and losses on securities available for sale are reported as a separate component of equity, net of tax.  Decreases in the fair value of securities available for sale resulting from increases in interest rates could have an adverse effect on shareholders’ equity.
 
A continuation or worsening of economic conditions could result in increases in our level of nonperforming loans and/or reduced demand for our products and services, which would lead to lower revenue, higher loan losses and lower earnings.
 
Our business activities and earnings are affected by general business conditions in the United States and in our primary market area.  These conditions include the level of short-term and long-term interest rates, inflation, deflation, unemployment levels, real estate values, monetary supply, consumer confidence and spending, fluctuations in both debt and equity capital markets, and the strength of the economy in the United States generally and in our market area in particular.  The national economy has recently experienced a recession, with rising unemployment levels, declines in real estate values and an erosion in consumer confidence.  Dramatic declines in the U.S. housing market over the past few years, with decreasing home prices and increasing foreclosures, have negatively affected the credit performance of mortgage loans and other loans and investments tied to the residential housing market and have resulted in significant write-downs of asset values by many financial institutions.  Our local economy has experienced similar economic conditions, although the deterioration may not be as severe in some respects as the national economy overall.  A prolonged or more severe economic downturn, continued elevated levels of unemployment, further declines in the values of real estate, or other events that affect household and/or corporate incomes could impair the ability of our borrowers to repay their loans in accordance with their terms.  Nearly all of our loans are secured by real estate and a majority of our loans are made to individuals and businesses in the localities in which we have offices.  As a result of this concentration, a prolonged or more severe downturn in the local economy could result in significant increases in nonperforming loans, which would negatively impact our interest income and result in higher provisions for loan losses, which would hurt our earnings.  The economic downturn could also result in reduced demand for credit, which would hurt our revenues.

 
5

 
 
Turmoil in the financial markets could have an adverse effect on our financial position or results of operations.

Beginning in 2008, United States and global financial markets experienced severe disruption and volatility, and general economic conditions have declined significantly.  Adverse developments in credit quality, asset values and revenue opportunities throughout the financial services industry, as well as general uncertainty regarding the economic, industry and regulatory environment, have had a negative impact on the industry.  The United States and the governments of other countries have taken steps to try to stabilize the financial system, including investing in financial institutions, and have implemented programs intended to improve general economic conditions.  The U.S. Department of the Treasury created the Capital Purchase Program under the Troubled Asset Relief Program (“TARP”), pursuant to which the Treasury Department provided additional capital to participating financial institutions through the purchase of preferred stock or other securities.  We did not participate in the TARP Capital Purchase Program.  Other measures include homeowner relief that encourages loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the federal funds rate; regulatory action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector.  Factors that could continue to pressure financial services companies, including us, are numerous and include (1) worsening credit quality, leading among other things to increases in loan losses, (2) continued or worsening disruption and volatility in financial markets, leading among other things to continuing reductions in asset values, (3) capital and liquidity concerns regarding financial institutions generally, (4) limitations resulting from or imposed in connection with governmental actions intended to stabilize or provide additional regulation of the financial system, or (5) weakened economic conditions that are deeper or last longer than currently anticipated.
 
Higher loan losses could require us to increase our allowance for loan losses through a charge to earnings.
 
When we loan money we incur the risk that our borrowers do not repay their loans. We reserve for loan losses by establishing an allowance through a charge to earnings. The amount of this allowance is based on our assessment of loan losses inherent in our loan portfolio. The process for determining the amount of the allowance is critical to our financial results and condition. It requires subjective and complex judgments about the future, including forecasts of economic or market conditions that might impair the ability of our borrowers to repay their loans. We might underestimate the loan losses inherent in our loan portfolio and have loan losses in excess of the amount reserved. We might increase the allowance because of changing economic conditions. For example, in a rising interest rate environment, borrowers with adjustable-rate loans could see their payments increase. There may be a significant increase in the number of borrowers who are unable or unwilling to repay their loans, resulting in our charging off more loans and increasing our allowance. In addition, when real estate values decline, the potential severity of loss on a real estate-secured loan can increase significantly, especially in the case of loans with high combined loan-to-value ratios. A decline in the national economy and the local economies of the areas in which the loans are concentrated could result in an increase in loan delinquencies, foreclosures or repossessions resulting in increased charge-off amounts and the need for additional loan loss allowances in future periods. In addition, our determination as to the amount of our allowance for loan losses is subject to review by our primary regulator, the Office of the Comptroller of the Currency, as part of its examination process, which may result in the establishment of an additional allowance based upon the judgment of the Office of the Comptroller of the Currency after a review of the information available at the time of its examination. Our allowance for loan losses amounted to $5.9 million, or 1.25% of total loans outstanding and 47.15% of nonperforming loans, at December 31, 2010. Our allowance for loan losses at December 31, 2010 may not be sufficient to cover future loan losses. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would decrease our earnings. In addition, at December 31, 2010, we had a total of 15 loan relationships with outstanding balances that exceeded $3.0 million, 13 of which were performing according to their original terms. However, the deterioration of one or more of these loans could result in a significant increase in our nonperforming loans and our provision for loan losses, which would negatively impact our results of operations.
 
 
6

 
 
Our emphasis on commercial real estate, agricultural and construction lending may expose us to increased lending risks.
 
At December 31, 2010, we had $152.5 million in loans secured by commercial real estate, $19.1 million in agricultural loans and $9.8 million in construction loans.  Commercial real estate loans, agricultural and construction loans represented 32.2%, 4.0% and 2.1%, respectively, of our loan portfolio.  At December 31, 2010, we had $3.4 million of reserves specifically allocated to these loan types.  While commercial real estate, agricultural  and construction loans are generally more interest rate sensitive and carry higher yields than do residential mortgage loans, these types of loans generally expose a lender to greater risk of non-payment and loss than single-family residential mortgage loans because repayment of the loans often depends on the successful operation of the property, the income stream of the borrowers and, for construction loans, the accuracy of the estimate of the property’s value at completion of construction and the estimated cost of construction.  Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to single-family residential mortgage loans.
 
If we conclude that the decline in value of any of our investment securities is other than temporary, we are required to write down the value of that security through a charge to earnings.
 
We review our investment securities portfolio monthly and at each quarter-end reporting period to determine whether the fair value is below the current carrying value. When the fair value of any of our investment securities has declined below its carrying value, we are required to assess whether the decline is other than temporary. If we conclude that the decline is other than temporary, we are required to write down the value of that security through a charge to earnings. As of December 31, 2010, our investment portfolio included available for sale investment securities with a carrying value of $248.1 million and an estimated fair value of $251.3 million, which included unrealized losses on 85 securities totaling $2.3 million.  Changes in the expected cash flows of these securities and/or prolonged price declines may result in our concluding in future periods that the impairment of these securities is other than temporary, which would require a charge to earnings to write down theses securities to their fair value. Any charges for other-than-temporary impairment would not impact cash flow, tangible capital or liquidity.
 
The Company’s financial condition and results of operations are dependent on the economy in the Bank’s market area.
 
The Bank’s primary market area consists of the Pennsylvania Counties of Bradford, Potter and Tioga in North Central Pennsylvania and Allegany, Steuben, Chemung and Tioga Counties in Southern New York.  As of December 31, 2010, management estimates that approximately 93% of deposits and 81% of loans came from its market area.  Because of the Bank’s concentration of business activities in its market area, the Company’s financial condition and results of operations depend upon economic conditions in its market area.  Adverse economic conditions in our market area could reduce our growth rate, affect the ability of our customers to repay their loans and generally affect our financial condition and results of operations.  Conditions such as inflation, recession, unemployment, high interest rates and short money supply and other factors beyond our control may adversely affect our profitability.  We are less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies.  Any sustained period of increased payment delinquencies, foreclosures or losses caused by adverse market or economic conditions in the States of Pennsylvania and New York could adversely affect the value of our assets, revenues, results of operations and financial condition.  Moreover, we cannot give any assurance we will benefit from any market growth or favorable economic conditions in our primary market areas if they do occur.
 
Local economic conditions are being increasingly impacted by the exploration of the Marcellus Shale natural gas exploration and drilling activities.
 
The economy in a large portion of our market areas is becoming increasingly influenced by the natural gas industry. Our market area is predominately centered in the Marcellus Shale natural gas exploration and drilling area.  These natural gas exploration and drilling activities have significantly impacted the overall interest in real estate in our market area due to the related lease and royalty revenues associated with it.  The natural gas activities have had a positive impact on the value of local real estate. Additionally, many of our customers provide transportation and other services and products that support natural gas exploration and production activities.  Moreover, we have experienced an increase in deposits as a result of this natural resource exploration and have developed products specifically targeting those that have benefited from this activity. Exploration and drilling of the natural gas reserves in the Marcellus Shale in our market area may be affected by federal, state and local laws and regulations such as restrictions on production, permitting, changes in taxes and environmental protection, which could negatively impact our customers and, as a result, negatively impact our loan and deposit volume.  If there is a significant downturn in this industry, as a result of regulatory action or otherwise, the ability of our borrowers to repay their loans in accordance with their terms could be negatively impacted and/or reduce demand for loans. Finally, the borrowing needs of some of the residents in our market area have been limited due to the economic benefits afforded them as a result of the Marcellus Shale.  These factors could have a material adverse effect on our business, prospects, financial condition and results of operations.
 
 
7

 
 
Increased and/or special FDIC assessments will hurt our earnings
 
During 2010 and 2009, the United States experienced a high level of bank failures, which has dramatically increased FDIC resolution costs and led to a significant reduction in the balance of the DIF. As a result, the FDIC has significantly increased the initial base assessment rates paid by financial institutions for deposit insurance. Increases in the base assessment rate have increased our deposit insurance costs and negatively impacted our earnings. In lieu of imposing a special assessment, in the fourth quarter of 2009, the FDIC required all institutions to prepay their assessments for all of 2010, 2011 and 2012. Additional increases in the base assessment rate or additional special assessments would negatively impact our earnings.
 
Recently enacted regulatory reform may have a material impact on our operations.

On July 21, 2010, the President signed into law The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).  The Dodd-Frank Act restructures the regulation of depository institutions.  Under the Dodd-Frank Act, the Office of Thrift Supervision will be merged into the Office of the Comptroller of the Currency.  Also included is the creation of a new federal agency to administer consumer protection and fair lending laws, a function that is now performed by the depository institution regulators.  The federal preemption of state laws currently accorded federally chartered depository institutions will be reduced as well and State Attorneys General will have greater authority to bring a suit against a federally chartered institution, such as First Citizens National Bank, for violations of certain state and federal consumer protection laws.  The Dodd-Frank Act contains various other provisions designed to enhance the regulation of depository institutions and prevent the recurrence of a financial crisis such as occurred in 2008-2009.  The full impact of the Dodd-Frank Act on our business and operations will not be known for years until regulations implementing the statute are written and adopted.  The Dodd-Frank Act may have a material impact on our operations, particularly through increased regulatory burden and compliance costs.
 
In addition to the enactment of the Dodd-Frank Act, the federal bank regulatory agencies recently have begun to take stronger supervisory actions against financial institutions that have experienced increased loan losses and other weaknesses as a result of the current economic climate.  These actions include entering into written agreements and cease and desist orders that place certain limitations on their operations.  Federal bank regulators recently have also been using with more frequency their ability to impose individual minimum capital requirements on banks, which requirements may be higher than those imposed under the Dodd-Frank Act or which would otherwise qualify the bank as being “well capitalized” under the FDIC’s prompt corrective action regulations.  If the Bank or the Company were to become subject to a supervisory agreement or higher capital requirements, such action may have a negative impact on our ability to execute our business plans, as well as our ability to grow, pay dividends or engage in mergers and acquisitions and may result in restrictions in our operations.
 
The Company and the Bank operate in a highly regulated environment and may be adversely affected by changes in laws and regulations.
 
The Bank is subject to extensive regulation, supervision and examination by the Office of the Comptroller of the Currency, our chartering authority, and by the FDIC, as insurer of its deposits.  The Company is subject to regulation and supervision by the Federal Reserve Board.  Such regulation and supervision govern the activities in which an institution and its holding company may engage, and are intended primarily for the protection of the insurance fund and for the depositors and borrowers of the Bank.  The regulation and supervision by the Office of the Comptroller of the Currency, the Federal Reserve Board and the FDIC are not intended to protect the interests of investors in the Company’s common stock.  Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses.  Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations.
 
 
8

 
 
Strong competition within the Bank’s market area could hurt profits and slow growth.
 
The Bank faces intense competition both in making loans and attracting deposits.  This competition has made it more difficult for the Bank to make new loans and at times has forced the Bank to offer higher deposit rates.  Price competition for loans and deposits might result in the Bank earning less on loans and paying more on deposits, which would reduce net interest income.  Competition also makes it more difficult to increase loans and deposits.  As of June 30, 2010, which is the most recent date for which information is available, we held 34.1% of the deposits in Bradford, Potter and Tioga Counties, Pennsylvania , which was the second largest share of deposits out of eight financial institutions with offices in the area, and 6.6% of the deposits in Allegany County, New York, which was the fourth largest share of deposits out of five financial institutions with offices in this area.  Competition also makes it more difficult to hire and retain experienced employees.  Some of the institutions with which the Bank competes have substantially greater resources and lending limits than the Bank has and may offer services that the Bank does not provide.  Management expects competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry.  The Bank’s profitability depends upon its continued ability to compete successfully in its market area.
 
We rely on our management and other key personnel, and the loss of any of them may adversely affect our operations.
 
We are and will continue to be dependent upon the services of our executive management team. In addition, we will continue to depend on our ability to retain and recruit key commercial loan officers. The unexpected loss of services of any key management personnel or commercial loan officers could have an adverse effect on our business and financial condition because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.
 
Environmental liability associated with lending activities could result in losses.
 
In the course of our business, we may foreclose on and take title to properties securing our loans.  If hazardous substances were discovered on any of these properties, we could be liable to governmental entities or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage.  Many environmental laws can impose liability regardless of whether we knew of, or were responsible for, the contamination.  In addition, if we arrange for the disposal of hazardous or toxic substances at another site, we may be liable for the costs of cleaning up and removing those substances from the site even if we neither own nor operate the disposal site.  Environmental laws may require us to incur substantial expenses and may materially limit use of properties we acquire through foreclosure, reduce their value or limit our ability to sell them in the event of a default on the loans they secure.  In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability.
 
Failure to implement new technologies in our operations may adversely affect our growth, profits or reputation.
 
The market for financial services, including banking services and consumer finance services, is increasingly affected by advances in technology, including developments in telecommunications, data processing, computers, automation, Internet-based banking and telebanking. Our ability to compete successfully in our markets may depend on the extent to which we are able to exploit such technological changes. However, we can provide no assurance that we will be able properly or timely to anticipate or implement such technologies or properly train our staff and customers to use such technologies.  Any failure to adapt to new technologies could adversely affect our business, financial condition or operating results. 
 
Our ability to pay dividends is limited by law.
 
Our ability to pay dividends to our shareholders largely depends on our receipt of dividends from the Bank. The amount of dividends that the Bank may pay to us is limited by federal laws and regulations. We also may decide to limit the payment of dividends even when we have the legal ability to pay them in order to retain earnings for use in our business.
 
 
9

 
 
Federal and state banking laws, our articles of incorporation and our by-laws may have an anti-takeover effect.
 
Federal law imposes restrictions, including regulatory approval requirements, on persons seeking to acquire control over us.  Pennsylvania law also has provisions that may have an anti-takeover effect.  These provisions may serve to entrench management or discourage a takeover attempt that shareholders consider to be in their best interest or in which they would receive a substantial premium over the current market price.
 
ITEM 1B – UNRESOLVED STAFF COMMENTS.
 
Not applicable.
 
ITEM 2 – PROPERTIES.
 
The headquarters of the Company and Bank are located at 15 South Main Street, Mansfield, Pennsylvania. The building contains the central offices of the Company and Bank. Our bank owns fifteen banking facilities and leases five other facilities. All buildings owned by the Bank are free of any liens or encumbrances.
 
The net book value of owned properties and leasehold improvements totaled $11,688,250 as of December 31, 2010.  The properties are adequate to meet the needs of the employees and customers. We have equipped all of our facilities with current technological improvements for data and word processing.
 
ITEM 3 - LEGAL PROCEEDINGS.
 
The Company is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business.  Such routine legal proceedings in the aggregate are believed by management to be immaterial to the Company's financial condition or results of operations.

ITEM 4 – [REMOVED AND RESERVED]
 
 
10

 
 
PART II
 
ITEM 5 - MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
 
The Company's stock is not listed on any stock exchange, but it is quoted on the OTC Bulletin Board under the trading symbol CZFS.  Prices presented in the table below are bid prices between broker-dealers published by the OTC Bulletin Board and the Pink Sheets Electronic Quotation Service.  The prices do not include retail markups or markdowns or any commission to the broker-dealer.  The bid prices do not necessarily reflect prices in actual transactions.  Cash dividends are declared on a quarterly basis and are summarized in the table below (also see dividend restrictions in Note 14 of the consolidated financial statements).
 
 
Dividends
   
Dividends
 
2010
declared
2009
declared
 
High
Low
per share
High
Low
per share
First quarter
 $      29.50
 $      25.50
 $      0.250
 $    19.80
 $     16.93
 $        0.240
Second quarter
         29.50
         26.50
         0.255
       22.77
        18.32
           0.245
Third quarter
         33.50
         27.00
         0.255
       24.00
        20.79
           0.245
Fourth quarter
         40.00
         32.00
         0.335
       25.30
        23.05
           0.300
 
The Company has paid dividends since April 30, 1984, the effective date of our formation as a bank holding company. The Company's Board of Directors expects that comparable cash dividends will continue to be paid by the Company in the future;  however, future dividends necessarily depend upon earnings, financial condition, appropriate legal restrictions and other factors in existence at the time the Board of Directors considers a dividend policy. Cash available for dividend distributions to stockholders of the Company comes from dividends paid to the Company by the Bank. Therefore, restrictions on the ability of the Bank to make dividend payments are directly applicable to the Company.  See “Note 15 – Regulatory Matters” to the consolidated financial statements.
 
Under the Pennsylvania Business Corporation Law of 1988, the Company may pay dividends only if, after payment, the Company would be able to pay debts as they become due in the usual course of our business and total assets will be greater than the sum of total liabilities.  The Federal Reserve Board has issued a policy statement regarding the payment of dividends by bank holding companies.  In general, the Federal Reserve Board’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital needs, asset quality, and overall financial condition.  The Federal Reserve Board’s policies also require that a bank holding company serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary.  Furthermore, the Federal Reserve Board has authority to prohibit a bank holding company from paying a capital distribution where a subsidiary bank is undercapitalized. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions.
 
The Company distributed a 1% stock dividend on July 28, 2010 to all shareholders of record as of July 14, 2010.
 
As of February 28, 2011, the Company had approximately 1,506 stockholders of record.  The computation of stockholders of record excludes individual participants in securities positions listings. The following table presents information regarding the Company’s stock repurchases during the three months ended December 31, 2010:
 
 
11

 
 
 
Period
Total Number of
Shares (or units
Purchased)
Average Price Paid
per Share (or Unit)
Total Number of Shares (or
Units) Purchased as Part of
Publicly Announced Plans of
Programs
Maximum Number (or
Approximate Dollar Value) of
Shares (or Units) that May Yet
Be Purchased Under the Plans
or Programs (1)
         
10/1/10 to 10/31/10
                                -
                              -
                                         -
                               37,002
11/1/10 to 11/30/10
                                -
                              -
                                         -
                               37,002
12/1/10 to 12/31/10
                            140
$36.00
                                     140
                               36,862
Total
                            140
$36.00
                                     140
                               36,862
 
(1)  
On January 7, 2006, the Company announced that the Board of Directors authorized the Company to repurchase up to 140,000 shares.  The repurchases will be conducted through open-market purchases or privately negotiated transactions and will be made from time to time depending on market conditions and other factors.  No time limit was placed on the duration of the share repurchase program.  Any repurchased shares will be held as treasury stock and will be available for general corporate purposes.
 
 
12

 

ITEM 6 - SELECTED FINANCIAL DATA.
 
The following table sets forth certain financial data as of and for each of the years in the five year period ended December 31, 2010:
 
(in thousands, except share data)
2010
2009
2008
2007
2006
Interest income
 $     39,000
 $     38,615
 $    37,238
 $     36,024
 $     32,851
Interest expense
        11,340
        13,231
        14,058
        16,922
        14,953
Net interest income
        27,660
        25,384
        23,180
        19,102
        17,898
Provision for loan losses
          1,255
              925
             330
              365
              330
Net interest income after provision
         
  for loan losses
        26,405
        24,459
        22,850
        18,737
        17,568
Non-interest income
          5,911
          5,708
          5,245
          5,114
          4,712
Investment securities gains (losses), net
                99
              139
        (4,089)
              (29)
                  4
Non-interest expenses
        17,757
        17,759
        15,877
        15,314
        15,027
Income before provision for income taxes
        14,658
        12,547
          8,129
          8,508
          7,257
Provision for income taxes
          3,156
          2,683
          1,224
          1,772
          1,457
Net income
 $     11,502
 $       9,864
 $       6,905
 $       6,736
 $       5,800
           
Return on assets (net income to average total assets)
1.50%
1.42%
1.13%
1.16%
1.05%
Return on equity (net income to average total equity)
18.13%
17.65%
13.51%
14.38%
13.21%
Dividend payout ratio (dividends declared divided by net income)
27.50%
29.92%
40.77%
37.86%
42.10%
Equity to asset ratio (average equity to average total assets,
8.25%
8.02%
8.33%
8.10%
7.98%
  excluding other comprehensive income)
         
           
Per share data:
         
Net income (1)
 $         3.97
 $         3.40
 $         2.38
 $         2.30
 $         1.96
Cash dividends (1)
             1.09
             1.02
            0.97
             0.87
             0.83
Book value (1) (2)
          23.38
          20.51
          18.17
          16.80
          15.43
           
Total investments
 $  251,303
 $  198,582
 $  174,139
 $  120,802
 $  109,743
Loans, net
      467,602
      451,496
     428,436
      419,182
      410,897
Total assets
      812,526
      729,477
     668,612
      591,029
      572,168
Total deposits
      680,711
      605,559
     546,680
      456,028
      446,515
Stockholders' equity
        68,690
        61,527
        52,770
        48,528
        43,500
           
(1) Amounts were adjusted to reflect stock dividends.
         
(2) Calculation excludes accumulated other comprehensive income.
   
           
 
 
13

 

ITEM 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.
 
CAUTIONARY STATEMENT
 
Forward-looking statements may prove inaccurate. We have made forward-looking statements in this document, and in documents that we incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of operations of the Company, the Bank, First Citizens Insurance Agency, Inc. or the Company on a consolidated basis. When we use words such as “believes,” “expects,” “anticipates,” or similar expressions, we are making forward-looking statements.  For a variety of reasons, actual results could differ materially from those contained in or implied by forward-looking statements:
 
 
·
Interest rates could change more rapidly or more significantly than we expect.
 
·
The economy could change significantly in an unexpected way, which would cause the demand for new loans and the ability of borrowers to repay outstanding loans to change in ways that our models do not anticipate.
 
·
The stock and bond markets could suffer a significant disruption, which may have a negative effect on our financial condition and that of our borrowers, and on our ability to raise money by issuing new securities.
 
·
It could take us longer than we anticipate implementing strategic initiatives designed to increase revenues or manage expenses, or we may be unable to implement those initiatives at all.
 
·
Acquisitions and dispositions of assets could affect us in ways that management has not anticipated.
 
·
We may become subject to new legal obligations or the resolution of litigation may have a negative effect on our financial condition.
 
·
We may become subject to new and unanticipated accounting, tax, or regulatory practices or requirements.
 
·
We could experience greater loan delinquencies than anticipated, adversely affecting our earnings and financial condition.  We could also experience greater losses than expected due to the ever increasing volume of information theft and fraudulent scams impacting our customers and the banking industry.
 
·
We could lose the services of some or all of our key personnel, which would negatively impact our business because of their business development skills, financial expertise, lending experience, technical expertise and market area knowledge.
 
·
Exploration and drilling of the natural gas reserves in the Marcellus Shale in our market area may be affected by federal, state and local laws and regulations such as restrictions on production, permitting, changes in taxes and environmental protection, which could negatively impact our customers and, as a result, negatively impact our loan and deposit volume and loan quality.
 
Except as required by applicable law and regulation, we assume no obligation to update or revise any forward-looking statements after the date on which they are made.
 
INTRODUCTION
 
The following is management’s discussion and analysis of the significant changes in financial condition, the results of operations, capital resources and liquidity presented in its accompanying consolidated financial statements for the Company. Our Company’s consolidated financial condition and results of operations consist almost entirely of the Bank’s financial condition and results of operations. Management’s discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes. Except as noted, tabular information is presented in thousands of dollars.
 
Our Company currently engages in the general business of banking throughout our service area of Potter, Tioga and Bradford counties in North Central Pennsylvania and Allegany, Steuben, Chemung and Tioga counties in Southern New York. We maintain our central office in Mansfield, Pennsylvania. Presently we operate 20 banking facilities, 18 of which operate as bank branches.  In Pennsylvania, these offices are located in Mansfield, Blossburg, Ulysses, Genesee, Wellsboro, Troy, Sayre, Canton, Gillett, Millerton, LeRaysville, Towanda, Rome, the Wellsboro Weis Market store and the Mansfield Wal-Mart Super Center.  In New York, our office is in Wellsville.  We opened a loan production office in Lock Haven, Pennsylvania in December of 2010 and Rome, Pennsylvania branch was opened in January 2011, which are included in the 20 banking facilities.
 
 
14

 
 
Risk identification and management are essential elements for the successful management of the Company.  In the normal course of business, the Company is subject to various types of risk, including interest rate, credit, liquidity and regulatory risk.
 
Interest rate risk is the sensitivity of net interest income and the market value of financial instruments to the direction and frequency of changes in interest rates.  Interest rate risk results from various re-pricing frequencies and the maturity structure of the financial instruments owned by the Company.  The Company uses its asset/liability and funds management policies to control and manage interest rate risk.
 
Credit risk represents the possibility that a customer may not perform in accordance with contractual terms.  Credit risk results from loans with customers and the purchasing of securities.  The Company’s primary credit risk is in the loan portfolio.  The Company manages credit risk by adhering to an established credit policy and through a disciplined evaluation of the adequacy of the allowance for loan losses.  Also, the investment policy limits the amount of credit risk that may be taken in the investment portfolio.
 
Liquidity risk represents the inability to generate or otherwise obtain funds at reasonable rates to satisfy commitments to borrowers and obligations to depositors.  The Company has established guidelines within its asset/liability and funds management policy to manage liquidity risk.  These guidelines include, among other things, contingent funding alternatives.
 
Reputational risk, or the risk to our business, earnings, liquidity, and capital from negative public opinion, could result from our actual or alleged conduct in a variety of areas, including legal and regulatory compliance, lending practices, corporate governance, litigation, ethical issues, or inadequate protection of customer information. We expend significant resources to comply with regulatory requirements. Failure to comply could result in reputational harm or significant legal or remedial costs. Damage to our reputation could adversely affect our ability to retain and attract new customers, and adversely impact our earnings and liquidity.
 
Regulatory risk represents the possibility that a change in law, regulations or regulatory policy may have a material effect on the business of the Company and its subsidiary.  We can not predict what legislation might be enacted or what regulations might be adopted, or if adopted, the effect thereof on our operations.  We can not anticipate additional requirements or additional compliance efforts regarding the Bank Secrecy Act or USA Patriot Act, or regulatory burdens regarding the ever increasing information theft and fraudulent activities impacting our customers and the banking industry in general.
 
Readers should carefully review the risk factors described in other documents our Company files with the SEC, including the annual reports on Form 10-K, the quarterly reports on Form 10-Q and any current reports on Form 8-K filed by us.
 
TRUST AND INVESTMENT SERVICES
 
Our Investment and Trust Services Division is committed to helping our customers meet their financial goals.  The Trust Division offers professional trust administration, investment management services, estate planning and administration, custody of securities and individual retirement accounts.  Assets held by the Bank in a fiduciary or agency capacity for its customers are not included in the consolidated financial statements since such items are not assets of the Bank.  As of December 31, 2010 and 2009, non-deposit investment products under management totaled $70.1 million and $46.2 million, respectively.  Additionally, as summarized in the table below, the Trust Department had assets under management as of December 31, 2010 and 2009 of $95.1 million and $85.9 million, respectively.  The increase is primarily due to an increase in the fair value of plan assets given the overall market increase in equity securities and mutual funds during 2010.


 
15

 
 
(market values - in thousands)
2010
2009
INVESTMENTS:
   
Bonds
 $         20,503
 $         21,007
Stock
            21,700
            18,754
Savings and Money Market Funds
            14,189
            10,396
Mutual Funds
            36,617
            34,001
Mortgages
                 879
                 836
Real Estate
              1,243
                 931
Miscellaneous
                     1
                     8
TOTAL
 $         95,132
 $         85,933
ACCOUNTS:
   
Trusts
            29,901
            27,478
Guardianships
              1,401
                 552
Employee Benefits
            33,358
            31,781
Investment Management
            29,975
            25,678
Custodial
                 497
                 444
TOTAL
 $         95,132
 $         85,933

Our financial consultants offer full service brokerage services throughout the Bank’s market area.  Appointments can be made at any Bank branch.  The financial consultants provide financial planning with their choice of mutual funds, annuities, health and life insurance.  These products are made available through our insurance subsidiary, First Citizens Insurance Agency, Inc.
 
In addition to the Trust and Brokerage services offered we have created an oil and gas management team, which will serve as a network of experts that will assist our customers through the process from lease negotiations to establishing a successful approach to personal wealth management.  We have partnered with a professional firm from Oklahoma to provide mineral management expertise and services to our market. Through this relationship, we can now help customers negotiate their lease payments and royalty percentages, protect their property, resolve problems when conditions in their lease are not being met, account for and ensure the accuracy of royalty checks, distribute revenue to satisfy investment objectives and provide customized reports outlining payment and distribution information.
 
RESULTS OF OPERATIONS
 
Net income for the twelve months ended December 31, 2010 was $11,502,000, which represents an increase of $1,638,000, or 16.6%, when compared to the 2009 related period.  Net income for the twelve months ended December 31, 2009 totaled $9,864,000, an increase of $2,959,000 from the 2008 related period.  Earnings per share were $3.97, $3.40 and $2.38 for the years ended 2010, 2009 and 2008, respectively.
 
The following table sets forth certain performance ratios of our Company for the periods indicated:

 
 
2010
2009
2008
Return on Assets (net income to average total assets)
1.50%
1.42%
1.13%
Return on Equity (net income to average total equity)
18.13%
17.65%
13.51%
Dividend Payout Ratio (dividends declared divided by net income)
27.50%
29.92%
40.77%
Equity to Asset Ratio (average equity to average total assets, excluding accumulated other comprehensive income)
8.25%
8.02%
8.33%

Net income is influenced by five key components: net interest income, provision for loan losses, non-interest income, non-interest expenses, and the provision for income taxes.
 
 
16

 
 
Net Interest Income
 
The most significant source of revenue is net interest income; the amount of interest earned on interest-earning assets exceeding interest incurred on interest-bearing liabilities.  Factors that influence net interest income are changes in volume of interest-earning assets and interest-bearing liabilities as well as changes in the associated interest rates.
 
 
The following table sets forth our Company’s average balances of, and the interest earned or incurred on, each principal category of assets, liabilities and stockholders’ equity, the related rates, net interest income and rate “spread” created:
 
 
17

 
 
 
Analysis of Average Balances and Interest Rates (1)
     
 
2010
2009
2008
 
Average
 
Average
Average
 
Average
Average
 
Average
 
Balance (1)
Interest
Rate
Balance (1)
Interest
Rate
Balance (1)
Interest
Rate
(dollars in thousands)
$
$
%
$
$
%
$
$
%
ASSETS
                 
Short-term investments:
                 
   Interest-bearing deposits at banks
       31,495
           90
0.29
      21,496
         43
0.20
        7,118
         57
0.80
Total short-term investments
       31,495
           90
0.29
      21,496
         43
0.20
        7,118
         57
0.80
Investment securities:
                 
  Taxable
     147,242
     4,923
3.34
    131,620
    6,072
4.61
      99,872
    5,013
5.02
  Tax-exempt (3)
       69,928
     4,463
6.38
      51,588
    3,325
6.45
      36,016
    2,235
6.21
  Total investment securities
     217,170
     9,386
4.32
    183,208
    9,397
5.13
    135,888
    7,248
5.33
Loans:
                 
  Residential mortgage loans
     201,842
   14,254
7.06
    203,526
  14,743
7.24
    211,958
  15,726
7.42
  Commercial & agricultural loans
     208,596
   13,903
6.67
    182,326
  12,606
6.91
    156,873
  11,872
7.57
  Loans to state & political subdivisions
       46,719
     2,750
5.89
      46,415
    2,844
6.13
      47,766
    2,998
6.28
  Other loans
       11,463
        994
8.67
      11,484
    1,020
8.88
      11,849
    1,079
9.11
  Loans, net of discount (2)(3)(4)
     468,620
   31,901
6.81
    443,751
  31,213
7.03
    428,446
  31,675
7.39
Total interest-earning assets
     717,285
   41,377
5.77
    648,455
  40,653
6.27
    571,452
  38,980
6.82
Cash and due from banks
          9,537
   
        9,315
   
        9,548
   
Bank premises and equipment
       12,659
   
      11,876
   
      12,390
   
Other assets
       29,311
   
      27,408
   
      19,756
   
Total non-interest earning assets
       51,507
   
      48,599
   
      41,694
   
Total assets
     768,792
   
    697,054
   
    613,146
   
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Interest-bearing liabilities:
                 
  NOW accounts
     155,157
     1,020
       0.66
    123,225
       971
      0.79
    106,694
    1,314
      1.23
  Savings accounts
       55,241
        166
       0.30
      46,457
       147
      0.32
      41,494
       153
      0.37
  Money market accounts
       46,878
        259
       0.55
      42,186
       337
      0.80
      45,073
       828
      1.84
  Certificates of deposit
     320,504
     8,115
       2.53
    305,777
    9,767
      3.19
    242,751
    9,197
      3.79
Total interest-bearing deposits
     577,780
     9,560
       1.65
    517,645
  11,222
      2.17
    436,012
  11,492
      2.64
Other borrowed funds
       54,071
     1,780
       3.29
      58,133
    2,009
      3.46
      64,858
    2,566
      3.96
Total interest-bearing liabilities
     631,851
   11,340
       1.79
    575,778
  13,231
      2.30
    500,870
  14,058
      2.81
Demand deposits
       65,654
   
      56,628
   
      54,438
   
Other liabilities
          7,841
   
        8,754
   
        6,735
   
Total non-interest-bearing liabilities
       73,495
   
      65,382
   
      61,173
   
Stockholders' equity
       63,446
   
      55,894
   
      51,103
   
Total liabilities & stockholders' equity
     768,792
   
    697,054
   
    613,146
   
Net interest income
 
   30,037
   
  27,422
   
  24,922
 
Net interest spread (5)
   
3.98%
   
3.97%
   
4.01%
Net interest income as a percentage
                 
  of average interest-earning assets
   
4.19%
   
4.23%
   
4.36%
Ratio of interest-earning assets
                 
  to interest-bearing liabilities
   
       1.14
   
      1.13
   
      1.14
                   
(1) Averages are based on daily averages.
               
(2) Includes loan origination and commitment fees.
               
(3) Tax exempt interest revenue is shown on a tax equivalent basis for proper comparison using
       
       a statutory federal income tax rate of 34%.
           
(4) Income on non-accrual loans is accounted for on a cash basis, and the loan balances are included in interest-earning assets.
   
(5) Interest rate spread represents the difference between the average rate earned on interest-earning assets
   
      and the average rate paid on interest-bearing liabilities.
             
 
 
18

 
 
Tax exempt interest revenue is shown on a tax-equivalent basis for proper comparison using a statutory, federal income tax rate of 34%.  For purposes of the comparison, as well as the discussion that follows, this presentation facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Company’s 34% Federal statutory rate.  Accordingly, tax equivalent adjustments for investments and loans have been made accordingly to the previous table for the years ended December 31, 2010, 2009 and 2008, respectively (in thousands):

 
2010
2009
2008
Interest and dividend income
     
    from investments and short term investments (non-tax adjusted)
 $          7,958
 $          8,310
 $        6,528
Tax equivalent adjustment
             1,518
             1,130
              777
Interest and dividend income
     
    from investments and short term investments (tax equivalent basis)
 $          9,476
 $          9,440
 $        7,305
       
       
 
2010
2009
2008
Interest and fees on loans (non-tax adjusted)
 $        31,042
 $        30,305
 $      30,710
Tax equivalent adjustment
                859
                908
              965
Interest and fees on loans (tax equivalent basis)
 $        31,901
 $        31,213
 $      31,675
       
       
 
2010
2009
2008
Total interest income
 $        39,000
 $        38,615
 $      37,238
Total interest expense
           11,340
           13,231
         14,058
Net interest income
           27,660
           25,384
         23,180
Total tax equivalent adjustment
             2,377
             2,038
           1,742
Net interest income (tax equivalent basis)
 $        30,037
 $        27,422
 $      24,922
 
 The following table shows the tax-equivalent effect of changes in volume and rates on interest income and expense (in thousands):

 
19

 
 
Analysis of Changes in Net Interest Income on a Tax-Equivalent Basis (1)
 
 
 2010 vs. 2009 (1)
 2009 vs. 2008 (1)
 
 Change in
 Change
 Total
 Change in
 Change
 Total
 
 Volume
 in Rate
 Change
 Volume
 in Rate
 Change
Interest Income:
           
Short-term investments:
           
  Interest-bearing deposits at banks
 $             25
 $            22
 $            47
 $          (22)
 $              8
 $          (14)
Investment securities:
           
  Taxable
              870
         (2,019)
         (1,149)
          1,421
            (362)
         1,059
  Tax-exempt
           1,171
              (33)
          1,138
          1,001
               89
         1,090
Total investment securities
           2,041
         (2,052)
              (11)
          2,422
            (273)
         2,149
Total investment income
           2,066
         (2,030)
               36
          2,400
            (265)
         2,135
Loans:
           
  Residential mortgage loans
             (121)
            (368)
            (489)
           (617)
            (366)
           (983)
  Commercial & agricultural loans
           1,729
            (432)
          1,297
          1,571
            (837)
            734
  Loans to state & political subdivisions
               19
            (113)
              (94)
             (84)
              (70)
           (154)
  Other loans
                (2)
              (24)
              (26)
             (32)
              (27)
             (59)
Total loans, net of discount
           1,625
            (937)
             688
            838
         (1,300)
           (462)
Total Interest Income
           3,691
         (2,967)
             724
          3,238
         (1,565)
         1,673
Interest Expense:
           
Interest-bearing deposits:
           
  NOW accounts
              136
              (87)
               49
            258
            (601)
           (343)
  Savings accounts
               26
               (7)
               19
              33
              (39)
              (6)
  Money Market accounts
               45
            (123)
              (78)
             (50)
            (441)
           (491)
  Certificates of deposit
              501
         (2,153)
         (1,652)
          1,440
            (870)
            570
Total interest-bearing deposits
              708
         (2,370)
         (1,662)
          1,681
         (1,951)
           (270)
Other borrowed funds
             (137)
              (92)
            (229)
           (251)
            (306)
           (557)
Total interest expense
              571
         (2,462)
         (1,891)
          1,430
         (2,257)
           (827)
Net interest income
 $        3,120
 $         (505)
 $        2,615
 $       1,808
 $          692
 $       2,500
             
 (1) The portion of total change attributable to both volume and rate changes, which cannot be separated, has been allocated proportionally to the change due to volume and the change due to rate prior to allocation.
 
2010 vs. 2009
 
Tax equivalent net interest income for 2010 was $30,037,000 compared with $27,422,000 for 2009, an increase of $2,615,000 or 9.5%.  The increased volume of interest earning assets of $68.8 million generated an increase in interest income of $3,691,000.  The average rate on interest earning assets decreased from 6.27% in 2009 to 5.77% in 2010, which had the effect of decreasing interest income by $2,967,000.
 
Total tax equivalent interest income from investment securities decreased $11,000 in 2010 from 2009.  The average balance of investment securities increased $34.0 million, which had an effect of increasing interest income by $2,041,000 due to volume.  The average tax-effected yield on our investment portfolio decreased from 5.13% in 2009 to 4.32% in 2010.  This had the effect of decreasing interest income by $2,052,000 due to rate, the majority of which was related to taxable securities whose yield decreased from 4.61% in 2009 to 3.34% in 2010. The Company’s strategy in 2010 was to invest available funds primarily in shorter term, one-time callable agency securities that offer higher coupon rates, as well as agency securities that mature in two to four years and longer term municipal securities. During 2010 as part of this strategy, we purchased $86.0 million of U.S. agency obligations and $21.9 million of municipal obligations.  While this strategy resulted in a decrease in the overall yield on our investments, it was implemented to stabilize the effective duration and average life of the portfolio in an upward rate environment.  The shorter term investments, while having lower yields, will likely provide sufficient cash flows that will permit reinvestment opportunities as market conditions improve.
 
 
20

 
 
Loan income increased $688,000 in 2010 from 2009.  The average balance of our loan portfolio increased by $24.9 million in 2010 compared to 2009 resulting in an increase in interest income of $1,625,000 due to volume.  Offsetting this was a decrease in yield on total loans from 7.03% in 2009 to 6.81% in 2010 resulting in a decrease in interest income of $937,000 due to rate.
 
Interest income on residential mortgage loans decreased $489,000, of which $121,000 was due to volume and $368,000 was due to rate. The average balance decreased $1.7 million due to the fact that more customers are qualifying for conforming loans, which the Bank  sells, and local economic conditions related to the exploration of the Marcellus Shale, which has limited the borrowing needs of some of the residents in our primary market. The Company continues to strive to be the top mortgage lender within our service area by providing competitive products and exemplary service to our customers. During 2010, conforming loans totaling $16,243,000 were closed and sold due to the continuing historically low residential mortgage rates offered during 2010 from 2009. The average balance of commercial and agricultural loans increased $26.3 million from 2010 to 2009 primarily due to our emphasis to grow this segment of the loan portfolio. This had the positive impact of $1,729,000 on total interest income due to volume. Offsetting this, the average yield on commercial and agricultural loans decreased from 6.91% in 2009 to 6.67% in 2010, decreasing interest income by $432,000 due to rate. The decreasing yield was the result of competitive pressures to obtain and retain quality credits in the current economic environment.
 
Total interest expense decreased $1,891,000 in 2010 compared to 2009.  The decrease is primarily attributable to a change in rate from 2.30% in 2009 to 1.79% in 2010, which had the effect of decreasing interest expense by $2,462,000. The continued low interest rate environment supported by the Federal Reserve and current economic conditions had the effect of decreasing our short-term borrowing costs as well as rates on deposit products, including shorter-term certificates of deposit and rate sensitive NOW and money market accounts. The average balance of interest bearing liabilities increased $56.1 million from 2009 to 2010.  This had the effect of increasing interest expense by $571,000 due to volume.
 
The average balance of certificates of deposit increased $14.7 million causing an increase in interest expense of $501,000.  Offsetting the increase in average balance was a decrease in the rate on certificates of deposit from 3.19% to 2.53% resulting in a decrease in interest expense of $2,153,000.  The average balance of NOW accounts also increased $31.9 million accounting for an increase of $136,000 in interest expense. The change in rate from 79 basis points to 66 basis points, contributed to an offset in interest expense of $87,000 resulting in an overall increase of $49,000. The average balance of Money Market accounts increased $4.7 million accounting for an increase of $45,000 in interest expense. The change in rate from 80 basis points to 55 basis points also contributed to a decrease in interest expense of $123,000 resulting in an overall decrease of $78,000.  The average balance of borrowed funds decreased by $4.1 million, resulting in a decrease in interest expense of $137,000.  The average interest rate paid on borrowed funds also decreased by 17 basis points accounting for a decrease in interest expense of $92,000 due to rate. 
 
Our net interest spread for 2010 was 3.98% compared to 3.97% in 2009.  The current economic situation has resulted in a relatively steep yield curve. Should short-term and/or long-term interest rates move in such a way that results in a flattened or inverted yield curve, we would anticipate pressure on our margin.
 
2009 vs. 2008
 
Tax equivalent net interest income for 2009 was $27,422,000 compared with $24,922,000 for 2008, an increase of $2,500,000 or 10.0%.  The increased volume of interest earning assets of $77.0 million generated an increase in interest income of $3,238,000.  The average rate on interest earning assets decreased from 6.82% in 2008 to 6.27% in 2009, which had the effect of decreasing interest income by $1,565,000.
 
Total tax equivalent interest income from investment securities increased $2,149,000 in 2009 from 2008.  The average balance of investment securities increased $47.3 million, which had an effect of increasing interest income by $2,422,000 due to volume.  The average tax-effected yield on our investment portfolio decreased from 5.33% in 2008 to 5.13% in 2009.  This had the effect of decreasing interest income by $273,000 due to rate.
 
 
21

 
 
Loan income decreased $462,000 in 2009 from 2008.  The average balance of our loan portfolio increased by $15.3 million in 2009 compared to 2008 resulting in an increase in interest income of $838,000 due to volume.  Offsetting this was a decrease in yield on total loans from 7.39% in 2008 to 7.03% in 2009 resulting in a decrease in interest income of $1,300,000 due to rate.
 
Interest income on residential mortgage loans decreased $983,000, of which $617,000 was due to volume and $366,000 was due to rate. The average balance decreased $8.4 million due to the economic recession, higher unemployment rates and other negative economic factors that resulted in lower loan demand for non-conforming residential mortgages and home equity lines. The average balance of commercial and agricultural loans increased $25.5 million from 2008 to 2009 primarily due to our emphasis to grow this segment of the loan portfolio. This had the positive impact of $1,571,000 on total interest income due to volume. Offsetting this, the average yield on commercial and agricultural loans decreased from 7.57% in 2008 to 6.91% in 2009, decreasing interest income by $837,000 due to rate.
 
Total interest expense decreased $827,000 in 2009 compared to 2008.  The decrease is primarily attributable to change in rate from 2.81% in 2008 to 2.30% in 2009, which had the effect of decreasing interest expense by $2,257,000. The actions of the Federal Reserve and the economic downturn experienced then had the effect of decreasing short-term borrowing costs as well as rates on deposit products, including shorter-term certificates of deposit and rate sensitive NOW and money market accounts. The average balance of interest bearing liabilities increased $74.9 million from 2008 to 2009.  This had the effect of increasing interest expense by $1,430,000 due to volume.
 
Our net interest spread for 2009 was 3.97% compared to 4.01% in 2008.
 
PROVISION FOR LOAN LOSSES
 
For the year ended December 31, 2010, we recorded a provision for loan losses of $1,255,000, which represents an increase of $330,000 or 35.7% over the same time period in 2009.  This is the result of current economic conditions and an increase in non-performing loans as of December 31, 2010, which have impacted management's quarterly review of the allowance for loan losses (see also “Financial Condition – Allowance for Loan Losses and Credit Quality Risk”).
 
For the year ended December 31, 2009, we recorded a provision for loan losses of $925,000, which represented an increase of $595,000 over the same time period in 2008.  This was due to the economic conditions in place at that time and the increase in non-performing loans as of December 31, 2009 in comparison to December 31, 2008.
 
NON-INTEREST INCOME
 
The following table reflects non-interest income by major category for the periods ended December 31 (dollars in thousands):
 
 
2010
2009
2008
Service charges
 $          3,639
 $          3,612
 $          3,489
Trust
                542
                521
                561
Brokerage and insurance
                439
                284
                240
Investment securities gains (losses), net
                  99
                139
            (4,089)
Gains on loans sold
                341
                430
                  84
Earnings on bank owned life insurance
                504
                492
                362
Other
                446
                369
                509
Total
 $          6,010
 $          5,847
 $          1,156

 
 2010/2009
 2009/2008
 
Change
Change
 
Amount
%
Amount
%
Service charges
 $               27
                 0.7
 $             123
                 3.5
Trust
                  21
                 4.0
                 (40)
                (7.1)
Brokerage and insurance
                155
               54.6
                  44
               18.3
Investment securities gains, (losses), net
                 (40)
(28.8)
             4,228
103.4
Gains on loans sold
                 (89)
              (20.7)
                346
             411.9
Earnings on bank owned life insurance
                  12
                 2.4
                130
               35.9
Other
                  77
               20.9
               (140)
              (27.5)
Total
 $             163
                 2.8
 $          4,691
             405.8
 
 
22

 
 
2010 vs. 2009
 
Non-interest income increased $163,000 in 2010 from 2009, or 2.8%.  We recorded investment securities gains totaling $99,000 compared with net gains of $139,000 in 2009. During 2010, we elected to sell one U.S. Treasury note, three agency securities and one mortgage backed security for total gains of $99,000 due to favorable market conditions. There were no sales in 2010 that resulted in a realized loss. During 2009, we elected to sell an agency bond that was likely to be called, several higher coupon mortgage-backed securities that were prepaying very quickly, and two corporate bonds for total gains of $253,000. These gains were offset by losses incurred on the sales of three municipal securities and the sale of certain bank equity securities totaling $60,000. Additionally in 2009, we recorded an additional $54,000 other than temporary impairment charge on our Freddie Mac preferred stock.
 
Service charge income increased by $27,000 in 2010 compared to 2009 and continues to be the Company’s primary source of non-interest income. Service charge fees related to customers’ usage of their debit cards increased by $192,000 and continues to become a larger percentage of service charge income as the Company is encouraging its customers to use their debit cards for making purchases. This was offset by decreases in statement service charges of $32,000 and fees charged to customers for non-sufficient funds of $140,000. The decrease in statement service charges is the result of more customers meeting compensating balance requirements that eliminate or reduce their service charges. The decrease in fees charged to customers for non-sufficient funds was the result of changes to Regulation E effective in August of 2010 that limits the ability of the Bank to charge overdraft fees for debit card purchases and ATM withdrawals that are in excess of the customers deposit balance. Management continues to monitor regulatory changes including the Durbin amendment to the Dodd-Frank Act, which regulates the level of interchange fee income the Bank is able to charge on debit card transactions, to determine the level of impact that these regulations will have on the fees that the Company realizes.
 
Gains on loans sold decreased $89,000 compared to last year, which is the result of the smaller amount of refinancing done in 2010 versus 2009, although as discussed previously there was a significant amount of refinancing performed in 2010 as a result of the favorable rates in the secondary markets during both 2010 and 2009. Brokerage and insurance revenue increased by $155,000 in 2010, as we continue to increase the principal amounts invested through us by our customers. Other income increased $77,000 primarily due to an increase in rental income from other real estate owned properties as well an increase in the gain from the sale of these properties in 2010 compared with last year.
 
2009 vs. 2008
 
Non-interest income increased $4,691,000 in 2009 from 2008, or 405.8%.  We recorded investment securities gains totaling $139,000 compared with a $4,089,000 loss in 2008.  In the third quarter of 2008, we recorded a non-recurring $2,336,000 million other than temporary impairment charge related to our investment in Freddie Mac preferred stock and a $1,796,000 other than temporary impairment charge on a Lehman Brothers corporate bond.  The Lehman Brothers corporate bond was subsequently sold in the fourth quarter of 2008. During 2009, we elected to sell an agency bond that was likely to be called, several higher coupon mortgage-backed securities that were prepaying very quickly, and two corporate bonds for total gains of $253,000. These gains were offset by losses incurred on the sales of three municipal securities and the sale of certain bank equity securities totaling $60,000. Additionally, we recorded an additional $54,000 other than temporary impairment charge on our Freddie Mac preferred stock.
 
Service charge income increased by $123,000 in 2009 compared to 2008 and was the Company’s primary source of non-interest income. Service charge fees related to customers’ usage of their debit cards increased by $87,000, statement service charges increased by $9,000 and fees charges to customers for non-sufficient funds increased by $27,000.
 
Gains on loans sold increased $346,000 compared to 2008 year, which was the result of the amount of refinancing due to favorable rates in the secondary markets.  Earnings on bank owned life insurance (BOLI) increased from $362,000 in 2008 to $492,000 in 2009 due to additional investments made in the 4th quarter of 2009. Brokerage and insurance revenue increased by $44,000 in 2009, as we continue to increase the principal amounts invested through us by our customers. Trust income decreased by $40,000 in 2009 due to the economy’s downturn and the affect it has had on the values of trust assets under management for the first half of 2009.  Other income decreased $140,000 primarily due to a decrease in rental income from other real estate owned properties as well a decrease in the gain from the sale of these properties in 2009 compared with 2008.
 
 
23

 
 
Non-interest Expenses
 
The following tables reflect the breakdown of non-interest expense and professional fees for the periods ended December 31 (dollars in thousands):
 
 
2010
2009
2008
Salaries and employee benefits
 $         9,850
 $         9,472
 $         8,725
Occupancy
            1,219
            1,179
            1,162
Furniture and equipment
               454
               437
               479
Professional fees
               681
               660
               625
Amortization of intangibles
                 16
               160
               145
FDIC insurance
               950
            1,200
               156
ORE expenses
               382
               447
               224
Other
            4,205
            4,204
            4,361
Total
 $       17,757
 $       17,759
 $       15,877

 
 2010/2009
 2009/2008
 
Change
Change
 
Amount
%
Amount
%
Salaries and employee benefits
 $            378
                4.0
 $            747
                8.6
Occupancy
                 40
                3.4
                 17
                1.5
Furniture and equipment
                 17
                3.9
               (42)
              (8.8)
Professional fees
                 21
                3.2
                 35
                5.6
Amortization of intangibles
             (144)
            (90.0)
                 15
              10.3
FDIC insurance
             (250)
            (20.8)
            1,044
            669.2
ORE expenses
               (65)
            (14.5)
               223
              99.6
Other
                   1
                0.0
             (157)
              (3.6)
Total
 $              (2)
              (0.0)
 $         1,882
              11.9

 
2010
2009
2008
Other professional fees
 $           338
 $           299
 $           316
Legal fees
              160
              129
              129
Examinations and audits
              183
              232
              180
Total
 $           681
 $           660
 $           625

 
 2010/2009
 2009/2008
 
Change
Change
 
Amount
%
Amount
%
Other professional fees
 $             39
             13.0
 $            (17)
              (5.4)
Legal fees
                31
             24.0
                   -
                  -
Examinations and audits
               (49)
            (21.1)
                52
             28.9
Total
 $             21
               3.2
 $             35
               5.6
 
2010 vs. 2009
 
Non-interest expenses for 2010 totaled $17,757,000 which represents a decrease of $2,000, compared with 2009 costs of $17,759,000.  Salary and benefit costs increased $378,000.  Base salaries and related payroll taxes increased $232,000, primarily due to merit increases.  Full time equivalent staffing was 168 and 169 employees for 2010 and 2009, respectively. Incentive costs increased $87,000 compared to 2009 primarily due to the attainment of certain corporate goals and objectives.  Insurance costs for employees increased by $68,000 attributable to the Bank becoming self insured for employee health insurance expenses. Supplemental executive retirement plan (SERP) expenses increased $137,000. These increases were offset by a decrease in pension expense of $253,000 compared to 2009, mostly attributable to an increase in the market value of plan assets during 2009 and the impact it had on the actuarial calculation of pension costs for 2010.
 
 
24

 
 
FDIC insurance decreased $250,000 in 2010 primarily due to the fact that 2009 included a special assessment of $330,000, which was related to the continued failing of many banks across the country. In lieu of imposing an additional special assessment, the FDIC required all institutions to prepay their assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. These prepayments will be recognized as a charge to operations over the applicable three year period. Due to the uncertainty involving the viability of many financial institutions, the Company cannot predict whether the prepayment made in December 2009 will be sufficient to cover its future obligations through 2012 or whether an additional assessment will be required.
 
Expenses related with other real estate owned properties decreased $65,000 from 2009 to 2010. This decrease was the result of the fact that expenses in 2009 included significant costs associated with a non-performing assets of a customer with properties in New York State that have significant real estate taxes associated with them. We are in the process of liquidating the properties obtained through foreclosure from this customer.
 
Amortization of intangibles decreased $144,000 from 2009 to 2010. This is the result of certain intangibles becoming fully amortized in 2009 and thus no amortization expense was recognized in 2010.
 
2009 vs. 2008
 
Non-interest expenses for 2009 totaled $17,759,000 which represents an increase of $1,882,000, or 11.9%, compared with 2008 costs of $15,877,000.  Much of the increase was attributable to salary and benefit costs which increased $747,000.  Base salaries and related payroll taxes increased $262,000, primarily due to merit increases.  Full time equivalent staffing was 169 employees for 2009 and 2008. Incentive costs increased $165,000 compared to 2008 primarily due to the attainment of certain corporate goals and objectives.  Insurance costs for employees increased by $101,000 attributable to a significant increase in insurance premiums.  Pension expense increased by $229,000 compared to 2008, mostly attributable to a significant decline in the market value of plan assets during 2008 and the impact it had on the actuarial calculation of pension costs for 2009.
 
FDIC Insurance increased $1,044,000 in 2009 primarily due to an increase in our FDIC deposit insurance assessments and a five basis point special assessment based on assets as of June 30, 2009, which was related to the continued failing of many banks across the country. The impact of the special assessment was approximately $330,000. Also, in 2008 we recognized approximately $209,000 in credits as a result of the Federal Deposit Insurance Reform Act of 2005.  Credits related to this legislation were fully utilized by the end of 2008 with no remaining credits available for 2009.  In lieu of imposing an additional special assessment, the FDIC required all institutions to prepay their assessments for the fourth quarter of 2009 and all of 2010, 2011 and 2012. These prepayments will be recognized as a charge to operations over the applicable three year period.
 
Expenses related with other real estate owned properties increased $223,000 from 2008 to 2009. This increase was the result of a general increase in non-performing assets, with a significant component related to a customer with properties in New York State that had significant real estate taxes associated with them.
 
Furniture and equipment expenses decreased $42,000 mainly due to a reduction in depreciation expense from assets that became fully depreciated during the year.
 
Exams and audits expenses increased by $52,000 due to general increases and $18,000 of costs incurred related to our audit of internal controls for Sarbanes Oxley.  Although the audit requirement was delayed later in 2009 until 2010, audit fees and related expenses were already incurred.
 
Provision For Income Taxes
 
 
25

 
 
The provision for income taxes was $3,156,000 during 2010, $2,683,000 during 2009 and $1,224,000 for the 2008 related periods.   The effective tax rates for 2010, 2009 and 2008 were 21.6% 21.4% and 15.1%, respectively. The tax rate for 2008 was impacted by the Emergency Economic Stabilization Act of 2008, which permitted the write-down of the Freddie Mac preferred stock to be treated as an ordinary loss, allowing a tax benefit of approximately $1,000,000.
 
Income before the provision for income taxes increased by $2,111,000 in 2010 compared to 2009, while the provision for income taxes increased by $473,000 when compared to 2009. This increase is attributable to the increase in income before tax.  We have managed our effective tax rate by remaining invested in tax-exempt municipal loans and bonds.  As such, the provision was impacted in 2010 by an increase in tax exempt bond and loan revenue.
 
We are also involved in three limited partnership agreements that established low-income housing projects in our market area.  For tax purposes, we have recognized $913,000 out of a total $913,000 in tax credits from one project, $346,000 out of a total $385,000 in tax credits on the second project and $230,000 out of a total of $574,000 tax credits on the third project.  $383,000 in tax credits remain and will be taken over the next seven years.    
 
FINANCIAL CONDITION
The following table presents ending balances (dollars in millions), growth and the percentage change during the past two years:

 
 2010
 
 %
 2009
 
 %
 2008
 
 Balance
 Increase
 Change
 Balance
 Increase
 Change
 Balance
 Total assets
 $        812.5
 $           83.0
           11.4
 $      729.5
 $           60.9
             9.1
 $      668.6
 Total loans, net
           467.6
              16.1
             3.6
         451.5
              23.1
             5.4
         428.4
 Total investments
           251.3
              52.7
           26.5
         198.6
              24.5
           14.1
         174.1
 Total deposits
           680.7
              75.1
           12.4
         605.6
              58.9
           10.8
         546.7
 Total stockholders' equity
             68.7
                7.2
           11.7
           61.5
                8.7
           16.5
           52.8

Cash and Cash Equivalents
 
Cash and cash equivalents totaled $44.0 million at December 31, 2010 compared with $31.4 million at December 31, 2009. The increase in cash and cash equivalents is the result of the Company’s deposit growth and cash flows from the investment portfolio, as discussed in more detail below. Management actively measures and evaluates its liquidity through our Asset – Liability committee and believes its liquidity needs are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources, Federal Home Loan Bank financing, federal funds lines with correspondent banks, brokered certificates of deposit and the portion of the investment and loan portfolios that mature within one year.  Management expects that these sources of funds will permit us to meet cash obligations and off-balance sheet commitments as they come due.
 
Investments
 
2010
 
The Company’s investment portfolio increased by $52,721,000, or 26.5%, during the past year.  During 2010, we purchased approximately $3.0 million U.S Treasury notes, $86.0 million U.S. agency obligations, $1.3 million of mortgage-backed securities, $21.9 million of state and local obligations, $5.4 million of corporate bonds and $543,000 of equity securities, which help offset the $24.1 million of principal repayments and $30.0 million of calls and maturities that occurred during the year. We also selectively sold $8.9 million of bonds and equities at a net gain of $99,000. The market value of our investment portfolio decreased approximately $1.6 million in 2010 due to market fluctuations. Significant market decreases were experienced in our state and local obligations and mortgage backed securities, offset by market increases in U.S. agency, corporate and equity securities. Excluding our short term investments consisting of monies held primarily at the Federal Reserve, the effective yield on our investment portfolio for 2010 was 4.32% compared to 5.13% for 2009 on a tax equivalent basis.
 
As mentioned above and seen in the table below, due to the continued low interest rate environment, we have experienced significant prepayments of our mortgage backed securities of $24.1 million and calls on our agency bonds of $30.0 million.  Due to the amount of cash flow from the investment portfolio as well as an increase in deposits and a lack of opportunities in other investment types, our strategy has been to reinvest funds mainly in short-term agency and corporate bonds via purchases of $86.0 million and $5.4 million, respectively, and longer-term high quality municipal bond purchases of $21.9 million.  We believe this strategy will enable us to reinvest cash flows in the next one to four years with improved investment opportunities.
 
 
26

 
 
2009
 
The Company’s investment portfolio increased by $24,443,000, or 14.1%, from 2008 to 2009. During 2009, we purchased approximately $61.4 million U.S. agency obligations, $7.4 million of mortgage-backed securities, $18.5 million of state and local obligations and $125,000 of equity securities, which help offset the $29.0 million of principal repayments and $25.1 million of calls and maturities that occurred during the year. We also selectively sold $10.7 million of bonds and equities at a net gain of $193,000. We also recorded an additional $54,000 other than temporary impairment charge on our Freddie Mac preferred stock. The market value of our investment portfolio increased approximately $2.2 million in 2009 due to market fluctuations. Significant market recoveries were seen in our mortgage backed securities, state and local obligations and our corporate bonds. Excluding our short term investments consisting of monies held primarily at the Federal Reserve, the effective yield on our investment portfolio for 2009 was 5.13% compared to 5.33% for 2008 on a tax equivalent basis.
 
The following table shows the year-end composition of the investment portfolio for the five years ended December 31 (dollars in thousands):
 
2010
% of
2009
% of
2008
% of
2007
% of
2006
% of
 
Amount
Total
Amount
Total
Amount
Total
Amount
Total
Amount
Total
Available-for-sale:
                   
  U. S. Agency securities
 $    118,484
      47.1
 $   65,223
      32.8
 $   28,942
    16.6
 $   17,236
    14.3
 $   16,651
    15.2
  Obligations of state & political
                   
     subdivisions
         76,922
      30.6
      59,574
      30.0
      44,132
    25.3
      30,844
    25.4
      22,562
    20.5
  Corporate obligations
           8,681
        3.5
        3,166
        1.6
        5,296
      3.0
        7,813
      6.5
        7,997
      7.3
  Mortgage-backed securities
         46,015
      18.3
      70,194
      35.3
      95,407
    54.8
      62,642
    51.9
      59,875
    54.6
  Equity securities
           1,201
        0.5
           425
        0.3
           362
      0.3
        2,267
      1.9
        2,658
      2.4
Total
 $    251,303
    100.0
 $ 198,582
    100.0
 $ 174,139
  100.0
 $ 120,802
  100.0
 $ 109,743
  100.0
 
The expected principal repayments (amortized cost) and average weighted yields for the investment portfolio as of December 31, 2010, are shown below (dollars in thousands). Expected principal repayments, which include prepayment speed assumptions for mortgage-backed securities, are significantly different than the contractual maturities detailed in Note 3 of the consolidated financial statements. Yields on tax-exempt securities are presented on a fully taxable equivalent basis, assuming a 34% tax rate.

     
After One Year
After Five Years
       
 
One Year or Less
to Five years
to Ten Years
After Ten Years
Total
 
Amortized
Yield
Amortized
Yield
Amortized
Yield
Amortized
Yield
Amortized
Yield
 
Cost
%
Cost
%
Cost
%
Cost
%
Cost
%
Available-for-sale securities:
                   
  U.S. Agency securities
 $     48,794
     1.8
 $      67,144
     2.0
 $        1,452
     5.5
 $             -
        -
 $    117,390
     1.9
  Obligations of state & political
 
 
 
 
 
 
 
 
 
 
    subdivisions
         5,497
     5.8
         35,222
     6.1
         36,645
     6.4
            800
     6.4
         78,164
     6.2
  Corporate obligations
                -
        -
           6,408
     2.1
          2,007
     5.7
                -
        -
          8,415
     3.0
  Mortgage-backed securities
        11,482
     3.5
         31,701
     4.8
                 -
     5.7
                -
        -
         43,183
     4.5
Total available-for-sale
 $     65,773
     2.4
 $     140,475
     3.7
 $      40,104
     6.3
 $         800
     6.4
 $    247,152
     3.8

Approximately 83.4% of the amortized cost of debt securities is expected to mature, call or pre-pay within five years or less.  The Company expects that earnings from operations, the levels of cash held at the Federal Reserve and other correspondent banks, the high liquidity level of the available-for-sale securities, growth of deposits and the availability of borrowings from the Federal Home Loan Bank and other third party banks will be sufficient to meet future liquidity needs.  Excluding, U.S Agency and Mortgage-backed securities, there are no securities from a single issuer representing more than 10% of stockholders’ equity.
 
 
27

 
 
Loans
 
The Bank’s lending efforts are focused within its market area located in North Central Pennsylvania and Southern New York. We originate loans primarily through direct loans to our existing customer base, with new customers generated by referrals from real estate brokers, building contractors, attorneys, accountants, existing customers and the Bank’s website.  The Bank offers a variety of loans although historically most of our lending has focused on real estate loans including residential, commercial, agricultural, and construction loans.  As of December 31, 2010, approximately 77% of our loan portfolio consisted of real estate loans.  All lending is governed by a lending policy that is developed and maintained by us and approved by the Board of Directors.
 
The Bank offers fixed rate residential mortgage loans with terms of up to 25 years at a fixed rate and adjustable rate mortgage loans (with amortization schedules based up to 30 years) with interest rates and payments that adjust based on one, three, and five year fixed periods.  Loan to value ratios are usually 80% or less with exceptions for individuals with excellent credit and low debt to income and/or high net worth. Adjustable rate mortgages are tied to a margin above the comparable Federal Home Loan Bank of Pittsburgh borrowing rate.  Home equity loans are written with terms of up to 15 years at fixed rates.  Home equity lines of credit are variable rate loans tied to the Prime Rate generally with a ten year draw period followed by a ten year repayment period. Home equity loans are typically written with a maximum 80% loan to value.
 
Commercial real estate loan terms are generally 20 years or less with one to five year adjustable rates.  The adjustable rates are tied to a margin above the comparable Federal Home Loan Bank of Pittsburgh borrowing rate with a maximum loan to value ratio of 80%. Where feasible, the Bank works with the United States Department of Agriculture’s (USDA) and Small Business Administration (SBA) guaranteed loan programs to offset risk and to further promote economic growth is our market area.  During 2010, we originated $9.6 million in USDA and SBA guaranteed commercial real estate loans.
 
Agriculture, and particularly dairy farming, is an important industry in our market area. Therefore the Bank has developed an agriculture lending team with significant experience that has a thorough understanding of this industry. Agricultural loans focus on character, cash flow and collateral, while also taking into account the particular risks of the industry.  Loan terms are generally 20 years or less with one to five year adjustable rates.  The adjustable rates are tied to a margin above the comparable Federal Home Loan Bank of Pittsburgh borrowing rate with a maximum loan to value of 80%. The Bank is a preferred lender under the USDA’s Farm Service Agency (FSA) and participates in the FSA guaranteed loan program.
 
The Bank, as part of its commitment to the communities it serves, is an active lender for projects by our local municipalities and school districts. These loans range from short term bridge financing to 20 year term loans for specific projects. These loans are typically written at rates that adjust at least every five years.
 
Over the past year, we have experienced an increase in loan demand from companies and businesses associated with, and serving, the exploration of the Marcellus Shale gas field.  We have developed specific policies and procedures for lending to these entities.  Specifically, the Bank has lowered the loan to value threshold for loans, shortened amortization periods, and expanded our monitoring of loan concentrations associated with this activity.
 
2010
 
Total loans grew $17.1 million in 2010 from a balance of $456.4 million at the end of 2009 to $473.5 million at the end of 2010.  Total loans grew 3.8% in 2010 compared with a 5.4% loan growth rate in 2009.
 
Commercial real estate loans increased $18.5 million in 2010 or 13.8% while commercial and other loans increased $3.1 million, or 6.9%.  Construction loans increased $4.1 million in 2010 or 73.8%, while loans to state and political subdivisions increased $2.4 million or 5.1%.  The growth in commercial real estate, construction real estate, other commercial loans and municipal loans, despite the current economic conditions, reflects the Company’s focus on commercial lending as a means to increase loan growth and obtain deposits from farmers and small businesses throughout our market area.  We believe we have a strong team of experienced professionals that enable us to meet the needs of these customers within our service area.  Commercial real estate and other commercial loan demand is subject to significant competitive pressures, the local economy which is currently being impacted significantly by the Marcellus Shale gas exploration area, the yield curve and the strength of the overall regional and national economy.
 
 
28

 
 
Residential real estate loans decreased $10.0 million while loans to individuals for household family and other purchases decreased $610,000. There has been a decrease in loan demand for residential real estate and consumer loans due to several economic factors.  Recessionary pressures, higher unemployment, and a depressed housing market have had a negative impact on nonconforming, residential real estate mortgage and home equity loan growth.  Conversely, loan demand for conforming mortgages, which the Company sells on the secondary market, has remained stable. We sold $16.2 million of loans in the secondary market in 2010 compared to $21.7 million in 2009, a decrease of $5.5 million but still significantly higher than historical levels.   Residential mortgage lending is a principal business activity and our Company continues to offer a variety of competitively priced conforming, nonconforming and home equity mortgages that positions us a leading mortgage lender in our service area.
 
2009
 
Total loans grew $23.6 million in 2009 from a balance of $432.8 million at the end of 2008 to $456.4 million at the end of 2009.  Total loans grew 5.4% in 2009 compared with a 2.2% loan growth rate in 2008.
 
Commercial real estate loans increased $26.2 million in 2009 or 24.3% while commercial and other loans increased $6.1 million, or 16.2%.  Agricultural loans increased $2.4 million in 2009 or 14.2%.
 
Residential real estate loans decreased $4.1 million, while construction loans decreased $5.5 million or 49.5%. During 2009, there was a decrease in loan demand for residential real estate, construction and consumer loans due to various factors including recessionary pressures, higher unemployment, and a depressed housing market, which specifically had a negative impact on nonconforming, residential real estate mortgage and home equity loan growth.  Conversely, loan demand for conforming mortgages, which the Company sells on the secondary market, increased dramatically. We sold $21.7 million of loans in the secondary market compared to $4.5 million in 2008, an increase of $17.2 million.
 
Five Year Breakdown of Loans by Type as of December 31,
 
 
2010
2009
2008
2007
2006
(dollars in thousands)
Amount
%
Amount
%
Amount
%
Amount
%
Amount
%
Real estate:
                   
  Residential
 $   185,012
    39.1
 $  194,989
    42.7
 $  199,118
    46.0
 $  201,861
    47.7
 $  206,059
    49.7
  Commercial
      152,499
    32.2
     133,953
    29.4
     107,740
    24.9
     100,380
    23.7
       94,122
    22.7
  Agricultural
        19,078
      4.0
       19,485
      4.2
       17,066
      3.9
       16,891
      4.0
       17,054
      4.1
  Construction
          9,766
      2.1
         5,619
      1.2
       11,118
      2.6
       11,330
      2.7
         7,027
      1.7
Consumer
        11,285
      2.4
       11,895
      2.6
       11,651
      2.7
       13,082
      3.1
       12,482
      3.0
Commercial and other loans
        47,156
    10.0
       44,101
      9.7
       37,968
      8.8
       34,664
      8.2
       32,766
      7.9
State & political subdivision loans
        48,721
    10.3
       46,342
    10.2
       48,153
    11.1
       45,171
    10.6
       45,263
    10.9
Total loans
      473,517
  100.0
     456,384
  100.0
     432,814
  100.0
     423,379
  100.0
     414,773
  100.0
Less allowance for loan losses
          5,915
 
         4,888
 
         4,378
 
         4,197
 
         3,876
 
Net loans
 $   467,602
 
 $  451,496
 
 $  428,436
 
 $  419,182
 
 $  410,897
 

 
 2010/2009
2009/2008
 
Change
Change
 
Amount
%
Amount
%
Real estate:
       
  Residential
 $     (9,977)
    (5.1)
 $    (4,129)
    (2.1)
  Commercial
        18,546
    13.8
       26,213
    24.3
  Agricultural
           (407)
    (2.1)
         2,419
    14.2
  Construction
          4,147
    73.8
       (5,499)
  (49.5)
Consumer
           (610)
    (5.1)
            244
      2.1
Commercial and other loans
          3,055
      6.9
         6,133
    16.2
State & political subdivision loans
          2,379
      5.1
       (1,811)
    (3.8)
Total loans
 $     17,133
      3.8
 $    23,570
      5.4

 
29

 
 
The following table shows the maturity of state and political subdivision loans, commercial business and agricultural and commercial real estate loans as of December 31, 2010, classified according to the sensitivity to changes in interest rates within various time intervals (in thousands).  The table does not include any estimate of prepayments which significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below.  Demand loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.  The amounts shown below exclude net deferred loan costs or fees.

 
Commercial,
   
 
municipal,
Real estate
 
 
agricultural
construction
Total
Maturity of loans:
     
  One year or less
 $             8,774
 $                    -
 $             8,774
  Over one year through five years
              36,041
                   208
              36,249
  Over five years
            222,639
                9,558
            232,197
Total
 $         267,454
 $             9,766
 $         277,220
Sensitivity of loans to changes in interest
     
   rates - loans due after December 31, 2010:
     
  Predetermined interest rate
 $           43,874
 $             1,491
 $           45,365
  Floating or adjustable interest rate
            214,806
                8,275
            223,081
Total
 $         258,680
 $             9,766
 $         268,446

Allowance For Loan Losses and Credit Quality Risk
 
The allowance for loan losses is maintained at a level, which in management’s judgment is adequate to absorb probable future loan losses inherent in the loan portfolio.  The provision for loan losses is charged against current income.  Loans deemed not collectable are charged-off against the allowance while subsequent recoveries increase the allowance.  The following table presents an analysis of the change in the allowance for loan losses and a summary of our non-performing assets for the years ended December 31, 2010, 2009, 2008, 2007 and 2006:
 
 
December 31,
 
2010
2009
2008
2007
2006
Balance
         
  at beginning of period
 $          4,888
 $          4,378
 $          4,197
 $          3,876
 $          3,664
Charge-offs:
         
  Real estate:
         
     Residential
                147
                  76
                  31
                  64
                  37
     Commercial
                  53
                236
                  36
                    6
                  86
     Agricultural
                     -
                    1
                  20
                     -
                     -
     Construction
                     -
                     -
                     -
                     -
                     -
  Consumer
                  35
                  80
                  44
                103
                103
  Commercial and other loans
                173
                153
                115
                  13
                  64
Total loans charged-off
                408
                546
                246
                186
                290
Recoveries:
         
  Real estate:
         
     Residential
                    4
                    1
                    6
                    2
                    6
     Commercial
                  11
                    1
                     -
                  79
                115
     Agricultural
                     -
                     -
                  20
                     -
                     -
     Construction
                     -
                     -
                     -
                     -
                     -
  Consumer
                  45
                  52
                  19
                  52
                  39
  Commercial and other loans
                120
                  77
                  52
                    9
                  12
Total loans recovered
                180
                131
                  97
                142
                172
           
Net loans charged-off
                228
                415
                149
                  44
                118
Provision charged to expense
             1,255
                925
                330
                365
                330
Balance at end of year
 $          5,915
 $          4,888
 $          4,378
 $          4,197
 $          3,876
           
Loans outstanding at end of period
 $      473,517
 $      456,384
 $      432,814
 $      423,379
 $      414,773
Average loans outstanding, net
 $      468,620
 $      442,921
 $      423,382
 $      411,927
 $      400,507
Non-performing assets:
         
    Non-accruing loans (1)
 $        11,853
 $          5,871
 $          2,202
 $          1,915
 $          1,668
    Accrual loans - 90 days or more past due
                692
                884
                383
                275
             1,690
      Total non-performing loans
 $        12,545
 $          6,755
 $          2,585
 $          2,190
 $          3,358
    Foreclosed assets held for sale
                693
                302
                591
                203
                758
      Total non-performing assets
 $        13,238
 $          7,057
 $          3,176
 $          2,393
 $          4,116
Net charge-offs to average loans
0.05%
0.09%
0.04%
0.01%
0.03%
Allowance to total loans
1.25%
1.07%
1.01%
0.99%
0.93%
Allowance to total non-performing loans
47.15%
72.36%
169.36%
191.64%
115.43%
Non-performing loans as a percent of loans
         
   net of unearned income
2.65%
1.48%
0.60%
0.52%
0.81%
Non-performing assets as a percent of loans
       
  net of unearned income
2.80%
1.55%
0.73%
0.57%
0.99%
(1) Included in non-accruing loans as of December 31, 2010 is one troubled debt restructuring with a balance of $130,000.

 
30

 

The Company utilizes a disciplined and thorough loan review process based upon our internal loan policy approved by the Company’s Board of Directors.  The purpose of the review is to assess loan quality, analyze delinquencies, identify problem loans, evaluate potential charge-offs and recoveries, and assess general overall economic conditions in the markets served.  An external independent loan review is performed on our commercial portfolio semi-annually for the Company.  The external consultant is engaged to 1) review a minimum of 60% of the dollar volume of the commercial loan portfolio on an annual basis, 2) review new loans originated in the last year, 3) review all relationships in aggregate over $500,000, 4) review all aggregate loan relationships over $100,000 which are over 90 days past due, classified Special Mention, Substandard, Doubtful, or Loss, and 5) such other loans which management or the consultant deems appropriate. As part of this review, our underwriting process and loan grading system is evaluated.
 
Management believes it uses the best information available to make such determinations and that the allowance for loan losses is adequate as of December 31, 2010.  However, future adjustments could be required if circumstances differ substantially from assumptions and estimates used in making the initial determination.  A prolonged downturn in the economy, continued high unemployment rates, significant changes in the value of collateral and delays in receiving financial information from borrowers could result in increased levels of non-performing assets, charge-offs, loan loss provisions and reduction in income.  Additionally, bank regulatory agencies periodically examine the Bank’s allowance for loan losses.  The banking agencies could require the recognition of additions to the allowance for loan losses based upon their judgment of information available to them at the time of their examination.
 
On a monthly basis, problem loans are identified and updated primarily using internally prepared past due reports.  Based on data surrounding the collection process of each identified loan, the loan may be added or deleted from the monthly watch list.  The watch list includes loans graded special mention, substandard, doubtful, and loss, as well as additional loans that management may choose to include.  Watch list loans are continually monitored going forward until satisfactory conditions exist that allow management to upgrade and remove the loan from the watchlist.  In certain cases, loans may be placed on non-accrual status or charged-off based upon management’s evaluation of the borrower’s ability to pay.  All commercial loans, which include commercial real estate, agricultural real estate, state and political subdivision loans and commercial business loans, on non-accrual are evaluated quarterly for impairment.
 
The adequacy of the allowance for loan losses is subject to a formal, quarterly analysis by management of the Company.  In order to better analyze the risks associated with the loan portfolio, the entire portfolio is divided into several categories.  As stated above, loans on non-accrual status are specifically reviewed for impairment and given a specific reserve, if appropriate.  Loans evaluated and not found to be impaired are included with other performing loans, by category, by their respective homogenous pools.  Three year average historical loss factors are calculated for each pool and applied to the performing portion of the loan category. In previous years, the historical loss factor was based on a five year average. This was changed in the current year as management believes the three year average is a better representative of the inherent risks in the loan portfolio.  The historical loss factors for both reviewed and homogeneous pools are adjusted based upon the following qualitative factors:
 
 
31

 
 
·  
Level of and trends in delinquencies, impaired/classified loans
§  
Change in volume and severity of past due loans
§  
Volume of non-accrual loans
§  
Volume and severity of classified, adversely or graded loans
·  
Level of and trends in charge-offs and recoveries
·  
Trends in volume, terms and nature of the loan portfolio
·  
Effects of any changes in risk selection and underwriting standards and any other changes in lending and recovery policies, procedures and practices
·  
Changes in the quality of the Bank’s loan review system
·  
Experience, ability and depth of lending management and other relevant staff
·  
National, state, regional and local economic trends and business conditions
§  
General economic conditions
§  
Unemployment rates
§  
Inflation / CPI
§  
Changes in values of underlying collateral for collateral-dependent loans
·  
Industry conditions including the effects of external factors such as competition, legal, and regulatory requirements on the level of estimated credit losses.
·  
Existence and effect of any credit concentrations, and changes in the level of such concentrations
 
See also “Note 4 – Loans and Related Allowance for Loan Losses” to the consolidated financial statements.
 
The balance in the allowance for loan losses was $5,915,000 or 1.25% of total loans as of December 31, 2010 as compared to $4,888,000 or 1.07% of loans as of December 31, 2009.  The $1,027,000 increase is a result of a $1,255,000 provision for loan losses less net charge-offs of $228,000.  The following table shows the distribution of the allowance for loan losses and the percentage of loans compared to total loans by loan category (dollars in thousands) as of December 31:
 
 
2010
2009
2008
2007
2006
 
Amount
%
Amount
%
Amount
%
Amount
%
Amount
%
Real estate loans:
                   
  Residential
 $         969
      39.1
 $       801
      42.7
 $       694
      46.0
 $       599
      47.7
 $       614
      49.7
  Commercial, agricultural
         3,380
      36.2
       2,864
      33.6
       2,303
      28.8
       2,128
      27.7
       1,676
      26.8
  Construction
              22
        2.1
            20
        1.2
              5
        2.6
              -
        2.7
              -
        1.7
Consumer
            108
        2.4
          131
        2.6
          449
        2.7
          424
        3.1
          734
        3.0
Commercial and other loans
            983
      10.0
          918
        9.7
          807
        8.8
          736
        8.2
          582
        7.9
State & political subdivision loans
            137
      10.2
            93
      10.2
            19
      11.1
            22
      10.6
            22
      10.9
Unallocated
            316
 N/A
            61
 N/A
          101
 N/A
          288
 N/A
          248
 N/A
Total allowance for loan losses
 $      5,915
    100.0
 $    4,888
    100.0
 $    4,378
    100.0
 $    4,197
    100.0
 $    3,876
    100.0
 
The following table identifies amounts of loans contractually past due 30 to 90 days and non-performing loans by loan category, as well as the change from December 31, 2009 to December 31, 2010 in non-performing loans (dollars in thousands).  Non-performing loans include those loans that are contractually past due 90 days or more and non-accrual loans.  Interest does not accrue on non-accrual loans.  Subsequent cash payments received are applied to the outstanding principal balance or recorded as interest income, depending upon management's assessment of its ultimate ability to collect principal and interest.
 
 
32

 
 
 
December 31, 2010
 
December 31, 2009
   
Non-Performing Loans
   
Non-Performing Loans
 
30 - 90 Days
90 Days Past
Non-
Total Non-
 
30 - 90 Days
90 Days Past
Non-
Total Non-
(in thousands)
Past Due
Due Accruing
accrual
Performing
 
Past Due
Due Accruing
accrual
Performing
Real estate:
                 
  Residential
 $             1,436
 $                 220
 $          491
 $              711
 
 $            1,629
 $               75
 $           775
 $           850
  Commercial
               1,834
                   426
7,735
8,161
 
               1,558
                635
1,863
2,498
  Agricultural
                      -
                       -
2,241
2,241
 
                   75
                    -
2,094
2,094
  Construction
                      -
                       -
                 -
                     -
 
                      -
                    -
749
749
Consumer
                    87
                       6
12
18
 
                   88
                 10
36
46
Commercial and other loans
                  116
                     40
1,374
1,414
 
                  610
                164
354
518
Total loans
 $             3,473
 $                 692
 $      11,853
 $          12,545
 
 $            3,960
 $             884
 $        5,871
 $        6,755
                 
 
   
 
Change in Non-Performing Loans
 
 December 31, 2010 / 2009
(in thousands)
Amount
%
Real estate:
   
  Residential
 $              (139)
                 (16.4)
  Commercial
               5,663
                 226.7
  Agricultural
                  147
7.2
  Construction
                 (749)
 -
Consumer
                   (28)
                 (60.9)
Commercial and other loans
                  896
                 173.0
Total nonperforming loans
 $             5,790
                  85.7

For the year ended December 31, 2010 we recorded a provision for loan losses of $1,255,000 which compares to $925,000 for the same period in 2009, an increase of $330,000 or 35.7%.  The increase is attributable to current economic conditions and an increase in non-performing loans as of December 31, 2010. Non-performing loans increased $5.8 million, or 85.7%, from December 31, 2009. Approximately 88.9% of the Bank’s non-performing loans are associated with the following five customer relationships:
 
 
·  
A commercial customer with a total loan relationship of $6.2 million secured by 140 residential properties and one commercial building requested a debt restructuring due to losses incurred as a result of investment losses unrelated to the customer’s operations. This loan was placed on non-accrual status in the third quarter of 2010. Management of the Bank continues to gather additional information including updated appraisals on the collateral securing the debt and an understanding of the customer’s current operations and cash flow from those operations to determine the extent, if any, of any loan impairment. During the third quarter 2010, the Bank received 23 updated appraisals. The valuations calculated in the new appraisals approximated 84.9% of the original appraisal. For a separate 70 properties, management of the Bank performed an analysis of the collateral based upon an observation of the collateral. Based on this observation, we assigned a percentage ranging from 50% to 100% depending on the condition of the collateral. This process resulted in a valuation that was approximately 85% of the original appraisals. Based on these two considerations, for the remaining properties, the Bank discounted the original appraisals by 15%. Utilizing the revised collateral values, the relationship has a loan to value ratio of approximately 82.3%.  As of December 31, 2010, a specific allocation of the allowance for loan losses of $167,000 was allocated for these loans. This amount was determined by utilizing the revised collateral values and discounting for selling and holding costs. Subsequent to year end, the Bank and the customer  entered into a forbearance agreement that resulted in $5.6 million of the $6.2 million balance being restructured. Under this agreement, the Bank received cash of $160,000 and additional collateral with a county assessed value of approximately $1.2 million for agreeing to payments based on new interest rates through February 2020 at which time the loans will be paid in full or will pay an increased rate for an 11 additional years. The Bank estimates that the troubled debt restructuring charge will be less than $550,000.  This relationship accounts for the significant increase in the Bank’s non-performing loans from December 31, 2009.
 
 
33

 
 
·  
An agricultural customer with total loans of $3.2 million, $2.2 million of which are agricultural real estate loans and $1.0 million are other commercial loans is considered non-accrual as of December 31,2010. Included within this relationship is $1.1 million of loans which are subject to Farm Service Agency guarantees. The current economic struggles of dairy farmers, caused primarily from decreased milk prices, have created cash flow difficulties for this customer.  While we are hopeful that increased milk prices would significantly improve cash flows for this borrower, there is no certainty that this will occur.  Without a sizable and sustained increase in milk prices, we may need to rely upon the collateral for repayment of interest and principal.  A real estate appraisal was completed in October, 2009, which together with a collateral analysis on equipment and livestock, resulted in an updated collateral value of approximately $4.0 million.  Based upon this analysis and the customer being current with payments since March of 2010, management determined not to allocate a specific reserve to this loan.
·  
A commercial customer with a relationship of approximately $1.0 million is considered non-accrual as of December 31, 2010. The current recessionary economic conditions have significantly impacted the cash flows from the customer’s activities. Management has reviewed the collateral and has determined that no specific reserve is required as of December 31, 2010. The customer has a signed sales agreement to sell the collateral securing this loan, which will result in the loan being paid off in full. The closing of the sale is expected to take place in the first quarter of 2011.
·  
A real estate rental customer with a total loan relationship of $352,000 is considered non-accrual as of December 31, 2010. The current recessionary economic conditions have significantly impacted the cash flows from the customer’s rental properties. Based upon an analysis of the collateral value, the loan was found to be impaired in the fourth quarter of 2010 and was subsequently written down by $60,000, to the net realizable value. In a related matter with this customer, in the second quarter of 2010, the Bank completed a foreclosure action on another  loan this customer had with the Bank that had a balance of $678,000 at the time the foreclosure was completed. As of December 31, 2010, other assets include $406,000 related to this foreclosure as certain properties obtained as part of the foreclosure were sold in the second half of 2010.
·  
A commercial customer with a total relationship of $359,000 composed of commercial real estate and other commercial loans was placed on non-accrual in 2010 due to inadequate cash flows as a result of the downturn in the economy, which has had a significant impact on his modular home business. Based upon an analysis of the collateral value, management determined not to allocate a specific reserve to this loan.

We have not experienced the significant decrease in the collateral values of local residential, commercial or agricultural real estate loan portfolios as seen in other parts of the country.  Real estate market values in our service area did not realize the significant, and sometimes speculative, increases as seen in other parts of the country.  As such, the collateral value of our real estate loans has not significantly deteriorated during 2010 or 2009. In addition, our market area is predominately centered in the Marcellus Shale natural gas exploration and drilling area. These natural gas exploration and drilling activities have significantly impacted the overall interest in real estate in our market area due to the related lease and royalty revenues associated with it.  The natural gas activities have had a positive impact on the value of local real estate.  Due to the relatively stable or increasing collateral values in our service area, management determined not to increase the provision for loan losses and allowance for loan losses at the same magnitude as the increase in non-performing loans.
 
Bank Owned Life Insurance
 
In 2008 and 2003 the Company purchased $3.4 and $7.0 million, respectively, of bank owned life insurance to offset future employee benefit costs.  The Bank is the sole beneficiary on the policies, and will provide the Bank with an asset that will generate earnings to partially offset the current costs of benefits, and eventually (at the death of the insured’s) provide partial recovery of cash outflows associated with the benefits.  As of December 31, 2010 and 2009, the cash surrender value of the life insurance was $13.2 and $12.7 million, respectively.  The change in cash surrender value, net of purchases, is recognized in the results of operations.  The amounts recorded as non-interest income totaled $504,000 $492,000 and $362,000 in 2010, 2009 and 2008, respectively.  The Company evaluates annually the risks associated with the life insurance policies, including limits on the amount of coverage and an evaluation of the various carriers’ credit ratings.
 
 
34

 
Other Assets
 
2010
 
Other assets increased 6.03% in 2010 to $10.2 million.  The majority of this increase is the result of increases in other real estate owned obtained through foreclosure proceedings of $391,000, a transfer from premises and equipment into other assets due to a reclassification of a building into assets held for sale of $307,000 and an increase in deferred income tax assets of $778,000. These were offset by a decrease in prepaid federal depository insurance and regulatory stock of $860,000 and $184,000, respectively. The increase in deferred tax assets was primarily attributable to activity related the change in unrealized gains on investments, goodwill amortization, the allowance for loan losses, the change in the unrealized loss on the interest rate swap and the change in the pension obligation. The decrease in the prepaid federal depository insurance was the result of actions taken by the FDIC, which are described above. The decrease in regulatory stock was due to the return of capital as a result of the improved financial results of the Federal Home Loan Bank of Pittsburgh (the “FHLB”).
 
2009
 
Other assets increased 19.6% in 2009 to $9.7 million.  The majority of this increase was the result of increases in prepaid federal depository insurance and regulatory stock of $2,814,000 and $586,000, respectively, offset by a decrease in the deferred income tax asset of $1,288,000. The increase in the prepaid federal depository insurance was the result of actions taken by the FDIC, which are described above. The increase in regulatory stock was due to purchases made to meet the requirements of the FHLB and correspondent banks. The majority of the decrease in the deferred income tax asset was the result of the activity related to the change in unrealized gains on investments, goodwill amortization and the change in the pension obligation.
 
Deposits

2010
 
As can be seen in the tables below, total deposits increased $75.2 million in 2010, or 12.4%.  The increase in deposits is due to several reasons.  In particular our market has been positively impacted from the Marcellus Shale gas exploration activities and we have developed products specifically targeting those that have benefited from this activity.  Furthermore, the overall turbulence and volatility of the financial markets on a national and local level has resulted in customers seeking stability with strong, local community banks. Furthermore, we believe that our historical financial performance, reputation as a strong, local community bank, acquisitions of local competitors from institutions outside of our general market area and the fact that the Company did not participate in the Troubled Asset Relief Program Capital Purchase Program has positioned the Company as a leading financial institution within our service area with the ability to meet our customers’ needs and expectations. .
 
Non-interest bearing deposits increased $15.5 million, or 25.9% in 2010.  As a percentage of total deposits, non-interest bearing deposits totaled 11.1% as of the end of 2010, which compares to 9.9% at the end of 2009.  In order to manage our overall cost of funds, the Company continues to focus on adding low cost deposits by having a free checking product available for retail customers. Additionally, our business development officers and branch personnel are focused on providing outstanding customer service and developing larger deposit relationships with our commercial customers.
 
NOW accounts increased by $40.5 million, or 29.7%, money market deposit accounts increased by $8.0 million or 18.9% and savings deposits increased $12.6 million, or 25.8%, since the end of 2009.  The majority of the increase NOW accounts was from local municipality deposits from customers whose balances increased by $15.8 million from 2009 to 2010 and an increase the interest bearing checking account offered by the Bank that rewards the customer based upon the usage of their debit cards and participation in other electronic services in order to qualify for higher interest rates earned on their deposits, which increased $13.2 million.  During 2010, the Company offered a new money market product geared to natural resource exploration occurring in our local market area. As of December 31, 2010, the balance in this money market product was approximately $7.0 million. Certificates of deposit decreased $1.5 million, or .5% from 2009. The decrease in certificates of deposit is primarily due to customers shifting balances from CD’s into other deposit accounts due to the decreasing interest rates being paid on CDs. Gas exploration activities continue to have a significant impact on this segment as well, with approximately $27 million specifically in a gas CD product as of December 31, 2010.
 
 
35

 
 
Our deposit growth funded our growth in loans of $16.1 million, and in investments of $52.7 million while providing us with liquidity in this challenging economy.
 
2009
 
Total deposits increased $58.9 million in 2009, or 10.8%.  The increase in deposits was due to several reasons.  Activities related to the development of the Marcellus Shale have significantly impacted the Company and the Company has developed products specifically targeting those that have benefited from this activity.  Our financial performance, reputation as a strong, local community bank, acquisitions of local competitors from institutions outside of our general market area and the fact that the Company did not participate in the Troubled Asset Relief Program Capital Purchase Program has positioned the Company as a leading financial institution within our service area.
 
Non-interest bearing deposits increased $4.5 million, or 8.1% in 2009.  As a percent to total, non-interest bearing deposits totaled 9.9% as of the end of 2009, which compared to 10.2% at the end of 2008.  NOW accounts increased by $20.8 million, or 18.0%, and savings deposits increased $4.6 million, or 10.4%, since the end of 2008.  The increase in NOW accounts was due to state and local governmental agencies and our ability to meet their financial needs.  Additionally, in 2009, the Company implemented a new interest bearing checking account that rewards the customer based upon the usage of their debit cards and participation in other electronic services in order to qualify for higher interest rates earned on their deposits.  Certificates of deposit increased $28.5 million, or 9.8% from 2008. The increase in certificates of deposit was primarily due to customers shifting balances from lower paying deposit accounts into CD’s in order to increase their return.  As mentioned, gas exploration activities also has had a significant impact on this segment as well, with approximately $26 million specifically in our gas CD product as of December 31, 2009.
 
Our deposit growth funded our growth in loans of $23.6 million, and in investments of $24.4 million, and enabled us to decrease our borrowed funds by $7.1 million while providing us with ample liquidity.
 
The following table shows the breakdown of deposits by deposit type (dollars in thousands):
 
 
2010
2009
2008
 
Amount
%
Amount
%
Amount
%
Non-interest-bearing deposits
 $       75,589
     11.1
 $       60,061
       9.9
 $       55,545
     10.2
NOW accounts
        176,625
     25.9
        136,153
     22.5
        115,338
     21.1
Savings deposits
          61,682
       9.1
          49,049
       8.1
          44,447
       8.1
Money market deposit accounts
          50,201
       7.4
          42,210
       7.0
          41,752
       7.6
Certificates of deposit
        316,614
     46.5
        318,086
     52.5
        289,598
     53.0
Total
 $     680,711
   100.0
 $     605,559
   100.0
 $     546,680
   100.0
 
         
 
 2010/2009
 2009/2008
 
Change
Change
 
Amount
%
Amount
%
Non-interest-bearing deposits
 $       15,528
     25.9
 $         4,516
       8.1
NOW accounts
          40,472
     29.7
          20,815
     18.0
Savings deposits
          12,633
     25.8
            4,602
     10.4
Money market deposit accounts
            7,991
     18.9
               458
       1.1
Certificates of deposit
          (1,472)
     (0.5)
          28,488
       9.8
Total
 $       75,152
     12.4
 $       58,879
     10.8

 
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Remaining maturities of certificates of deposit of $100,000 or more are as follows (dollars in thousands):
 
 
2010
2009
2008
3 months or less
 $       11,189
 $       9,161
 $       7,152
Over 3 months through 6 months
            9,857
        14,914
        13,706
Over 6 months through 12 months
          45,822
        33,702
        26,554
Over 12 months
          61,828
        62,775
        50,297
Total
 $     128,696
 $   120,552
 $     97,709
As a percent of total
     
  certificates of deposit
40.65%
37.90%
33.74%
 
Deposits by type of depositor are as follows (dollars in thousands):

 
2010
2009
2008
 
Amount
%
Amount
%
Amount
%
Individual, partnerships
           
  & corporations
 $      574,705
       84.4
 $    517,503
      85.5
 $    465,234
      85.1
United States government
             1,239
         0.2
              907
        0.1
           2,069
        0.4
State & political subdivisions
         104,767
       15.4
         87,149
      14.4
         79,377
      14.5
Total
 $      680,711
     100.0
 $    605,559
    100.0
 $    546,680
    100.0

Borrowed Funds

2010
 
Borrowed funds increased $1.8 million during 2010, or 3.5% as a result of additional customers utilizing sweep repurchase agreements. As of December 31, 2010 and 2009, we had $39.0 million of term loans with the Federal Home Loan Bank (see Note 10 of the consolidated financial statements for additional information).  During 2010, $3.0 million of term loans matured, which we strategically replaced with new term loans at various maturities as a means of reducing our cost of funds, given the lower interest rates that prevailed during 2010.  The significant increase in our deposits continued to limit our need for short term borrowings from the Federal Home Loan Bank during 2010 as the outstanding balance on these arrangements was $0 at December 31, 2010 and 2009.
 
2009
 
Borrowed funds decreased $7.1 million during 2009, a decrease of 11.6%.  As of December 31, 2009 we had $39.0 million of term loans with the Federal Home Loan Bank compared with $46.0 million outstanding as of December 31, 2008.  During 2009, $17.0 million of term loans matured.  We replaced those funds with $10.0 million of new term loans at various maturities, given the lower interest rates that prevailed during 2009.  The significant increase in our deposits limited our need for short term borrowings from the Federal Home Loan Bank during 2009 as the outstanding balance on these arrangements was $0 at December 31, 2009 and 2008.
 
Stockholders’ Equity

We evaluate stockholders’ equity in relation to total assets and the risk associated with those assets. The greater our capital resources, the greater the likelihood of meeting our cash obligations and absorbing unforeseen losses.  For these reasons, capital adequacy has been, and will continue to be, of paramount importance.
 
 
37

 
 
Our Board of Directors determines our dividend rate after considering our capital requirements, current and projected net income, and other factors. In 2010 and 2009, the Company paid out 27.5% and 29.9% of net income in dividends, respectively.
 
For the year ended December 31, 2010, the total number of common shares outstanding was 2,892,367. For comparative purposes, outstanding shares for prior periods were adjusted for the July 2010 stock dividend in computing earnings and cash dividends per share as detailed in Note 1 of the consolidated financial statements.  During 2010, we also purchased 13,863 shares of treasury stock at a weighted average cost of $27.84 per share. The Company awarded 5,350 shares of restricted stock to employees, which was offset by 467 shares as a result of employees leaving prior to the shares vesting and 800 shares to the Board of Directors under equity incentive programs. The Company also awarded 810 shares of stock to employees as a  bonus for 2010.
 
There are currently three federal regulatory measures of capital adequacy. The Company’s ratios meet the regulatory standards for well capitalized for 2010 and 2009, as detailed in Note 14 of the consolidated financial statements.
 
2010
 
Stockholders’ equity increased 11.6% in 2010 to $68.7 million.  Excluding accumulated other compreh