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EXCEL - IDEA: XBRL DOCUMENT - CITIZENS FINANCIAL SERVICES INCFinancial_Report.xls
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - CITIZENS FINANCIAL SERVICES INCcfocert.htm
EX-32.1 - SECTION 350 CERTIFICATIONS - CITIZENS FINANCIAL SERVICES INCcertification.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - CITIZENS FINANCIAL SERVICES INCceocert.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q


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

For the quarterly period ended June 30, 2014
Or

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

For the transition period from_____________________ to ___________________

Commission file number 0-13222

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

Indicate by check mark whether the registrant (1) has filed all reports to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __X__ No_____

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes __X__ No_____

Indicate by check mark 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.

Large accelerated filer ____                                                                                                   Accelerated filer _X__

Non-accelerated filer ____                                                                                                   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 Exchange Act).  Yes____ No __X__

The number of outstanding shares of the Registrant’s Common Stock, as of July 29, 2014, was 3,041,911.

 
 

 

 
Citizens Financial Services, Inc.
Form 10-Q

INDEX
 
 
   
PAGE
Part I
FINANCIAL INFORMATION
 
Item 1.
Financial Statements (unaudited):
 
 
Consolidated Balance Sheet as of June 30, 2014 and December 31, 2013
1
 
Consolidated Statement of Income for the Three and Six Months Ended June 30, 2014 and 2013
2
 
Consolidated Statement of Comprehensive Income for the Three and Six Months ended June 30, 2014 and 2013
3
 
Consolidated Statement of Cash Flows for the Six Months ended June 30, 2014 and 2013
4
 
Notes to Consolidated Financial Statements
5-28
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
29-50
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
50-51
Item 4.
Controls and Procedures
51
     
Part II
OTHER INFORMATION
 
Item 1.
Legal Proceedings
51
Item 1A.
Risk Factors
51
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
51-52
Item 3.
Defaults Upon Senior Securities
52
Item 4.
Mine Safety Disclosures
52
Item 5.
Other Information
52
Item 6.
Exhibits
52
 
Signatures
53

 
 

 

CITIZENS FINANCIAL SERVICES, INC.
   
CONSOLIDATED BALANCE SHEET
   
(UNAUDITED)
   
     
 
June 30
December 31
(in thousands except share data)
2014
2013
ASSETS:
   
Cash and due from banks:
   
  Noninterest-bearing
 $             14,742
 $            8,899
  Interest-bearing
                     998
               1,184
Total cash and cash equivalents
                15,740
             10,083
Interest bearing time deposits with other banks
                  2,480
               2,480
Available-for-sale securities
              312,322
           317,301
Loans held for sale
                     545
                  278
 
   
Loans (net of allowance for loan losses:
   
  2014, $6,751 and 2013, $7,098)
              533,126
           533,514
 
   
Premises and equipment
                11,501
             11,105
Accrued interest receivable
                  3,557
               3,728
Goodwill
                10,256
             10,256
Bank owned life insurance
                14,921
             14,679
Other assets
                  9,721
             11,510
 
 
 
TOTAL ASSETS
 $           914,169
 $        914,934
 
 
 
LIABILITIES:
   
Deposits:
   
  Noninterest-bearing
 $             94,434
 $          85,585
  Interest-bearing
              671,022
           662,731
Total deposits
              765,456
           748,316
Borrowed funds
                43,075
             66,932
Accrued interest payable
                     735
                  895
Other liabilities
                  6,664
               6,735
TOTAL LIABILITIES
              815,930
           822,878
STOCKHOLDERS' EQUITY:
   
Preferred Stock
   
  $1.00 par value; authorized 3,000,000 shares June 30, 2014 and December 31, 2013;
   
   none issued in 2014 or 2013
                          -
                      -
Common stock
   
  $1.00 par value; authorized 15,000,000 shares;  issued 3,335,235 at June 30, 2014 and
   
  3,305,517 at December 31, 2013
                  3,335
               3,306
Additional paid-in capital
                25,142
             23,562
Retained earnings
                76,925
             74,325
Accumulated other comprehensive income (loss)
                  1,100
             (1,225)
Treasury stock, at cost:  296,758 shares at June 30, 2014
   
  and 290,468 shares at December 31, 2013
                 (8,263)
             (7,912)
TOTAL STOCKHOLDERS' EQUITY
                98,239
             92,056
TOTAL LIABILITIES AND
   
   STOCKHOLDERS' EQUITY
 $           914,169
 $        914,934
     
The accompanying notes are an integral part of these unaudited consolidated financial statements.
 

 
1

 

CITIZENS FINANCIAL SERVICES, INC.
       
CONSOLIDATED STATEMENT OF INCOME
       
(UNAUDITED)
       
 
       Three Months Ended
       Six Months Ended
 
       June 30
       June 30,
(in thousands, except share and per share data)
        2014
       2013
    2014
    2013
INTEREST INCOME:
       
Interest and fees on loans
 $        7,118
 $      7,141
 $       14,106
 $     14,278
Interest-bearing deposits with banks
                 13
                 9
                  26
               19
Investment securities:
   
 
 
    Taxable
               849
             936
             1,737
          1,899
    Nontaxable
               840
             844
             1,682
          1,713
    Dividends
                 69
               18
                119
               38
TOTAL INTEREST INCOME
           8,889
         8,948
          17,670
        17,947
INTEREST EXPENSE:
       
Deposits
           1,094
         1,287
             2,199
          2,615
Borrowed funds
               145
             310
                309
             668
TOTAL INTEREST EXPENSE
           1,239
         1,597
             2,508
          3,283
NET INTEREST INCOME
           7,650
         7,351
          15,162
        14,664
Provision for loan losses
               150
               75
                330
             225
NET INTEREST INCOME AFTER
       
    PROVISION FOR LOAN LOSSES
           7,500
         7,276
          14,832
        14,439
NON-INTEREST INCOME:
       
Service charges
           1,102
         1,114
             2,141
          2,168
Trust
               186
             169
                377
             370
Brokerage and insurance
               137
             121
                257
             213
Investment securities gains, net
                 75
               98
                246
             294
Gains on loans sold
                 30
               50
                  70
             161
Earnings on bank owned life insurance
               121
             126
                242
             250
Other
               104
             100
                209
             204
TOTAL NON-INTEREST INCOME
           1,755
         1,778
             3,542
          3,660
NON-INTEREST EXPENSES:
       
Salaries and employee benefits
           2,893
         2,795
             5,810
          5,600
Occupancy
               304
             312
                654
             654
Furniture and equipment
                 94
             113
                194
             215
Professional fees
               208
             188
                442
             417
FDIC insurance
               116
             113
                229
             225
Pennsylvania shares tax
               191
             182
                384
             365
Other
           1,194
         1,164
             2,378
          2,243
TOTAL NON-INTEREST EXPENSES
           5,000
         4,867
          10,091
          9,719
Income before provision for income taxes
           4,255
         4,187
             8,283
          8,380
Provision for income taxes
               890
             907
             1,742
          1,813
NET INCOME
 $        3,365
 $      3,280
 $         6,541
 $       6,567
 
       
PER COMMON SHARE DATA:
       
Net Income - Basic
 $          1.11
 $        1.07
 $            2.15
 $         2.14
Net Income - Diluted
 $          1.11
 $        1.07
 $            2.15
 $         2.14
Cash Dividends Paid
 $        0.385
 $      0.278
 $         0.770
 $       0.547
         
Number of shares used in computation - basic
   3,039,734
  3,060,998
     3,040,822
  3,062,210
Number of shares used in computation - diluted
   3,040,661
  3,062,576
     3,041,227
  3,062,991
         
The accompanying notes are an integral part of these unaudited consolidated financial statements.
   

 
2

 

CITIZENS FINANCIAL SERVICES, INC.
               
CONSOLIDATED STATEMENT OF
               
       COMPREHENSIVE INCOME
               
(UNAUDITED)
               
 
            Three Months Ended
Six Months Ended
 
June 30,
June 30,
(in thousands)
 
2014
 
2013
 
2014
 
2013
Net income
 
$  3,365
 
$  3,280
 
$   6,541
 
$ 6,567
Other comprehensive income (loss):
               
      Change in unrealized gains on available for sale securities
1,494
 
 (6,656)
 
3,743
 
(8,032)
 
      Income tax effect
 (508)
 
2,263
 
(1,272)
 
2,731
 
      Change in unrecognized pension cost
13
 
128
 
25
 
128
 
      Income tax effect
 (4)
 
 (44)
 
 (9)
 
 (44)
 
      Change in unrealized loss on interest rate swap
-
 
51
 
-
 
101
 
      Income tax effect
-
 
 (17)
 
-
 
 (34)
 
      Less:  Reclassification adjustment for investment
 (75)
 
 (98)
 
 (246)
 
 (294)
 
                 security gains included in net income
               
      Income tax effect
26
 
33
 
84
 
100
 
Other comprehensive income (loss), net of tax
 
946
 
 (4,340)
 
2,325
 
(5,344)
Comprehensive income (loss)
 
$  4,311
 
$ (1,060)
 
$   8,866
 
$ 1,223
                 
The accompanying notes are an integral part of these unaudited consolidated financial statements.
           
 
3

 

CITIZENS FINANCIAL SERVICES, INC.
   
CONSOLIDATED STATEMENT OF CASH FLOWS
   
(UNAUDITED)
Six Months Ended
 
June 30,
(in thousands)
2014
2013
CASH FLOWS FROM OPERATING ACTIVITIES:
   
  Net income
 $          6,541
 $          6,567
  Adjustments to reconcile net income to net
   
   cash provided by operating activities:
   
    Provision for loan losses
                330
                225
    Depreciation and amortization
                233
                216
    Amortization and accretion of investment securities
             1,100
             1,234
    Deferred income taxes
                498
                    9
    Investment securities gains, net
              (246)
              (294)
    Earnings on bank owned life insurance
              (242)
              (250)
    Originations of loans held for sale
           (5,286)
         (11,801)
    Proceeds from sales of loans held for sale
             5,089
           12,624
    Realized gains on loans sold
                (70)
              (161)
    Decrease (increase) in accrued interest receivable
                171
                  (5)
    Decrease in accrued interest payable
              (160)
              (179)
    Other, net
           (1,107)
                413
      Net cash provided by operating activities
             6,851
             8,598
CASH FLOWS FROM INVESTING ACTIVITIES:
   
  Available-for-sale securities:
   
    Proceeds from sales
           12,151
           15,773
    Proceeds from maturity and principal repayments
           29,294
           49,651
    Purchase of securities
         (33,822)
         (72,372)
  Proceeds from redemption of regulatory stock
             2,216
                513
  Purchase of regulatory stock
           (1,484)
              (207)
  Net increase in loans
              (113)
         (13,246)
  Purchase of premises and equipment
              (145)
              (203)
  Proceeds from sale of foreclosed assets held for sale
                296
                    -
      Net cash provided by (used in) investing activities
             8,393
         (20,091)
CASH FLOWS FROM FINANCING ACTIVITIES:
   
  Net increase in deposits
           17,140
           10,918
  Proceeds from long-term borrowings
             4,010
                    -
  Repayments of long-term borrowings
           (4,200)
         (10,800)
  Net decrease in short-term borrowed funds
         (23,667)
           (1,333)
  Purchase of treasury and restricted stock
              (733)
              (380)
  Dividends paid
           (2,137)
           (1,675)
      Net cash used in financing activities
           (9,587)
           (3,270)
          Net (decrease) increase in cash and cash equivalents
             5,657
         (14,763)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
           10,083
           26,333
CASH AND CASH EQUIVALENTS AT END OF PERIOD
 $        15,740
 $        11,570
     
Supplemental Disclosures of Cash Flow Information:
   
    Interest paid
 $          2,668
 $          3,462
    Income taxes paid
 $          1,885
 $          2,295
    Loans transferred to foreclosed property
 $             239
 $               54
    Premises and equipment transferred from other assets
 $             549
 $                 -
   
 
The accompanying notes are an integral part of these unaudited consolidated financial statements.

 
4

 
 CITIZENS FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1 - Basis of Presentation
 
Citizens Financial Services, Inc., (individually and collectively with its direct and indirect subsidiaries, the “Company”) is a Pennsylvania corporation organized as the holding company of its wholly owned subsidiary, First Citizens Community Bank (the “Bank”), and the Bank’s subsidiary, First Citizens Insurance Agency, Inc. (“First Citizens Insurance”).
 
The accompanying consolidated financial statements have been prepared pursuant to rules and regulations of the Securities and Exchange Commission (“SEC”) and in conformity with U.S. generally accepted accounting principles.  Because this report is based on an interim period, certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted.  Certain of the prior year amounts have been reclassified to conform with the current year presentation.  Such reclassifications had no effect on net income or stockholders’ equity.  All material inter-company balances and transactions have been eliminated in consolidation.
 
In the opinion of management of the Company, the accompanying interim financial statements for the periods ended June 30, 2014 and 2013 include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the financial condition and the results of operations for the period.  In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. The financial performance reported for the Company for the six month period ended June 30, 2014 is not necessarily indicative of the results to be expected for the full year.  This information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

Note 2 - Earnings per Share
 
The following table sets forth the computation of earnings per share.  Earnings per share calculations give retroactive effect to stock dividends declared by the Company.

 
 
 
    Three months ended
    Six months ended
 
    June 30,
    June 30,
 
    2014
    2013
    2014
    2013
Net income applicable to common stock
$3,365,000
$3,280,000
$6,541,000
$6,567,000
         
Basic earnings per share computation
       
Weighted average common shares outstanding
   3,039,734
   3,060,998
     3,040,822
   3,062,210
Earnings per share - basic
$1.11
$1.07
$2.15
$2.14
         
Diluted earnings per share computation
       
Weighted average common shares outstanding for basic earnings per share
   3,039,734
   3,060,998
     3,040,822
   3,062,210
Add: Dilutive effects of restricted stock
             927
          1,578
               405
             781
Weighted average common shares outstanding for dilutive earnings per share
   3,040,661
   3,062,576
     3,041,227
   3,062,991
Earnings per share - diluted
$1.11
$1.07
$2.15
$2.14

For the three months ended June 30, 2014, there were 2,188 shares related to the restricted stock program that were excluded from the diluted earnings per share calculations since they were anti-dilutive. These anti-dilutive shares had prices ranging from $50.15-$50.50. There were no anti-dilutive securities for the three month period ended June 30, 2013. For the six months ended June 30, 2014 and 2013, 2,409 and 1,415 shares, respectively, related to the restricted stock program were excluded from the diluted earnings per share calculations since they were anti-dilutive. These anti-dilutive shares had prices ranging from $34.70-$50.50 for the six month period ended June 30, 2014 and prices ranging from $36.00-$44.50 for the six month period ended June 30, 2013.

 
5

 
 
 Note 3 - Income Tax Expense
 
Income tax expense is less than the amount calculated using the statutory tax rate, primarily as a result of tax-exempt income earned from state and municipal securities and loans and investments in tax credits.

Note 4 – Investments
 
The amortized cost and fair value of investment securities at June 30, 2014 and December 31, 2013 were as follows (in thousands):

   
       Gross
       Gross
 
 
       Amortized
       Unrealized
       Unrealized
       Fair
June 30, 2014
       Cost
       Gains
       Losses
       Value
Available-for-sale securities:
       
  U.S. agency securities
 $    147,871
 $                  664
 $         (1,200)
 $       147,335
  U.S. treasury securities
         11,868
                          -
               (364)
            11,504
  Obligations of state and
       
    political subdivisions
         98,825
                  3,182
               (380)
          101,627
  Corporate obligations
         13,992
                     282
                 (59)
            14,215
  Mortgage-backed securities in
       
    government sponsored entities
         35,293
                     549
                 (74)
            35,768
  Equity securities in financial
       
     institutions
           1,138
                     737
                   (2)
              1,873
Total available-for-sale securities
 $    308,987
 $               5,414
 $         (2,079)
 $       312,322
         
December 31, 2013
       
Available-for-sale securities:
       
  U.S. agency securities
 $    153,896
 $                  702
 $         (2,409)
 $       152,189
  U.S. treasury securities
         11,856
                          -
               (547)
            11,309
  Obligations of state and
       
    political subdivisions
         94,113
                  2,146
            (1,254)
            95,005
  Corporate obligations
         16,651
                     341
               (190)
            16,802
  Mortgage-backed securities in
       
    government sponsored entities
         40,405
                     566
               (300)
            40,671
  Equity securities in financial institutions
              542
                     783
                      -
              1,325
Total available-for-sale securities
 $    317,463
 $               4,538
 $         (4,700)
 $       317,301

The following table shows the Company’s gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time, which individual securities have been in a continuous unrealized loss position, at June 30, 2014 and December 31, 2013 (in thousands). As of June 30, 2014, the Company owned 69 securities whose fair value was less than their cost basis.
 
 
6

 
 
June 30, 2014
    Less than Twelve Months
    Twelve Months or Greater
   Total
     
    Gross
 
    Gross
 
    Gross
   
    Fair
    Unrealized
    Fair
    Unrealized
    Fair
    Unrealized
   
    Value
    Losses
    Value
    Losses
    Value
    Losses
U.S. agency securities
 $        36,001
 $           (225)
 $        43,305
 $           (975)
 $        79,306
 $        (1,200)
U.S. treasury securities
                     -
                     -
         11,503
            (364)
11,503
(364)
Obligations of state and
           
    political subdivisions
5,770
(79)
           11,357
              (301)
17,127
(380)
Corporate obligations
507
(1)
             7,855
                (58)
8,362
(59)
Mortgage-backed securities in
           
   government sponsored entities
                     -
                     -
4,977
(74)
4,977
(74)
Equity securities in financial
           
     institutions
 
487
(2)
                     -
                     -
                487
                  (2)
               
    Total securities
 $        42,765
 $           (307)
 $        78,997
 $        (1,772)
 $      121,762
 $        (2,079)
               
December 31, 2013 
             
U.S. agency securities
 $        98,356
 $        (2,212)
 $          2,825
 $           (197)
 $      101,181
 $        (2,409)
U.S. treasury securities
           11,309
              (547)
                     -
                     -
           11,309
              (547)
Obligations of states and
           
     political subdivisions
           24,201
              (865)
             6,491
              (389)
           30,692
           (1,254)
Corporate obligations
             6,103
              (124)
             2,251
                (66)
             8,354
              (190)
Mortgage-backed securities in
           
     government sponsored entities
           23,920
              (266)
             1,164
                (34)
           25,084
              (300)
               
    Total securities
 $      163,889
 $        (4,014)
 $        12,731
 $           (686)
 $      176,620
 $        (4,700)
 
As of June 30, 2014, the Company’s investment securities portfolio contained unrealized losses on agency securities issued or backed by the full faith and credit of the United States government or are generally viewed as having the implied guarantee of the U.S. government, U.S treasuries, obligations of states and political subdivisions, corporate obligations, mortgage backed securities in government sponsored entities and equity securities in financial institutions. For fixed maturity investments management considers whether the present value of cash flows expected to be collected are less than the security’s amortized cost basis (the difference defined as the credit loss), the magnitude and duration of the decline, the reasons underlying the decline and the Company’s intent to sell the security or whether it is more likely than not that the Company would be required to sell the security before its anticipated recovery in market value, to determine whether the loss in value is other than temporary. Once a decline in value is determined to be other than temporary, if the Company does not intend to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of the security’s amortized cost basis, the charge to earnings is limited to the amount of credit loss. Any remaining difference between fair value and amortized cost (the difference defined as the non-credit portion) is recognized in other comprehensive income, net of applicable taxes. Otherwise, the entire difference between fair value and amortized cost is charged to earnings. For equity securities where the fair value has been significantly below cost for one year, the Company’s policy is to recognize an impairment loss unless sufficient evidence is available that the decline is not other than temporary and a recovery period can be predicted.  The Company has concluded that any impairment of its investment securities portfolio outlined in the above table is not other than temporary and is the result of interest rate changes, sector credit rating changes, or company-specific rating changes that are not expected to result in the non-collection of principal and interest during the period.

 
7

 
 
Proceeds from sales of securities available-for-sale for the six months ended June 30, 2014 and 2013 were $12,151,000 and $15,773,000, respectively.  For the three months ended June 30, 2014 and 2013, there were sales of $6,595,000 and $11,917,000, respectively, of available-for-sale securities. The gross gains and losses were as follows (in thousands):


 
    Three Months Ended
    Six Months Ended
 
     June 30,
     June 30,
 
    2014
    2013
    2014
    2013
Gross gains
 $             75
 $          238
 $              246
 $              434
Gross losses
                   -
         (140)
                      -
               (140)
Net gains
 $             75
 $            98
 $              246
 $              294
 
Investment securities with an approximate carrying value of $185.6 million and $194.7 million at June 30, 2014 and December 31, 2013, respectively, were pledged to secure public funds and certain other deposits.
 
Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.   The amortized cost and fair value of debt securities at June 30, 2014, by contractual maturity, are shown below (in thousands):

 
    Amortized
 
 
    Cost
    Fair Value
Available-for-sale debt securities:
   
  Due in one year or less
 $      12,560
 $             12,712
  Due after one year through five years
       123,887
              124,167
  Due after five years through ten years
         66,528
                66,174
  Due after ten years
       104,874
              107,396
Total
 $    307,849
 $           310,449

Note 5 – Loans
 
The Company grants loans primarily to customers throughout North Central Pennsylvania and Southern New York.  Although the Company had a diversified loan portfolio at June 30, 2014 and December 31, 2013, a substantial portion of its debtors’ ability to honor their contracts is dependent on the economic conditions within these regions. The following table summarizes the primary segments of the loan portfolio and how those segments are analyzed within the allowance for loan losses as of June 30, 2014 and December 31, 2013 (in thousands):

June 30, 2014
 
    Total Loans
    Individually
    evaluated for
    impairment
    Collectively
    evaluated for
    impairment
Real estate loans:
       
     Residential
 
 $                 187,183
 $                        330
 $                 186,853
     Commercial and agricultural
 
                    210,786
                        7,069
                    203,717
     Construction
 
                        3,474
                                -
                        3,474
Consumer
 
                        8,692
                             15
                        8,677
Other commercial and agricultural loans
                      58,090
                        2,323
                      55,767
State and political subdivision loans
 
                      71,652
                                -
                      71,652
Total
 
                    539,877
 $                     9,737
 $                 530,140
Allowance for loan losses
 
                        6,751
   
Net loans
 
 $                 533,126
   

 
8

 
 
December 31, 2013
 
    Total Loans
    Individually
    evaluated for
    impairment
    Collectively
    evaluated for
     impairment
Real estate loans:
       
     Residential
 
 $                 187,101
 $                        342
 $                 186,759
     Commercial and agricultural
 
                    215,088
                        8,310
                    206,778
     Construction
 
                        8,937
                                -
                        8,937
Consumer
 
                        9,563
                             15
                        9,548
Other commercial and agricultural loans
 
                      54,029
                        1,733
                      52,296
State and political subdivision loans
 
                      65,894
                                -
                      65,894
Total
 
                    540,612
 $                   10,400
 $                 530,212
Allowance for loan losses
 
                        7,098
   
Net loans
 
 $                 533,514
   
 
The segments of the Bank’s loan portfolio are disaggregated into classes to a level that allows management to monitor risk and performance. Residential real estate mortgages consists primarily of 15 to 30 year first mortgages on residential real estate, while residential real estate home equity loans are consumer purpose installment loans or lines of credit secured by a mortgage which is often a second lien on residential real estate with terms of 15 years or less. Commercial real estate loans are business purpose loans secured by a mortgage on commercial real estate. Agricultural real estate loans are loans secured by a mortgage on real estate used in agriculture production. Construction real estate loans are loans secured by residential or commercial real estate used during the construction phase of residential and commercial projects. Consumer loans are typically unsecured or primarily secured by something other than real estate and overdraft lines of credit connected with customer deposit accounts. Other commercial loans are loans for commercial purposes primarily secured by non-real estate collateral. Other agricultural loans are loans for agricultural purposes primarily secured by non-real estate collateral. State and political subdivisions are loans for state and local municipalities for capital and operating expenses or tax free loans used to finance commercial development.
 
Management considers commercial loans, other agricultural loans, state and political subdivision loans, commercial real estate loans and agricultural real estate loans which are 90 days or more past due to be impaired. Management will also consider a loan impaired based on other factors it becomes aware of, including the customer’s results of operations and cash flows or if the loan is modified in a troubled debt restructuring. In addition, certain residential mortgages, home equity and consumer loans that are cross collateralized with commercial relationships that are determined to be impaired may also be classified as impaired. Impaired loans are analyzed to determine if it is probable that all amounts will not be collected according to the contractual terms of the loan agreement. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allocation of the allowance for loan losses or a charge-off to the allowance for loan losses.
 
The following table includes the recorded investment and unpaid principal balances for impaired financing receivables by class, with the associated allowance amount, if applicable (in thousands):

 
9

 

 
   
    Recorded
    Recorded
   
 
    Unpaid
    Investment
    Investment
    Total
 
 
    Principal
    With No
    With
    Recorded
    Related
June 30, 2014
    Balance
    Allowance
    Allowance
    Investment
    Allowance
Real estate loans:
         
     Mortgages
 $       226
 $          131
 $            68
 $          199
 $          14
     Home Equity
          132
               64
               67
             131
             13
     Commercial
       9,283
          6,161
             908
          7,069
           101
     Agricultural
               -
                  -
                  -
                  -
                -
     Construction
               -
                  -
                  -
                  -
                -
Consumer
            15
               15
                  -
               15
                -
Other commercial loans
       2,535
          1,434
             889
          2,323
             30
Other agricultural loans
               -
                  -
                  -
                  -
                -
State and political
         
   subdivision loans
               -
                  -
                  -
                  -
                -
Total
 $  12,191
 $       7,805
 $       1,932
 $       9,737
 $        158
           
December 31, 2013
         
Real estate loans:
         
     Mortgages
 $       232
 $          138
 $            70
 $          208
 $          14
     Home Equity
          134
               65
               69
             134
             13
     Commercial
       9,901
          6,335
          1,975
          8,310
           305
     Agricultural
               -
                  -
                  -
                  -
                -
     Construction
               -
                  -
                  -
                  -
                -
Consumer
            15
               15
                  -
               15
                -
Other commercial loans
       1,794
          1,679
               54
          1,733
               1
Other agricultural loans
               -
                  -
                  -
                  -
                -
State and political
         
   subdivision loans
               -
                  -
                  -
                  -
                -
Total
 $  12,076
 $       8,232
 $       2,168
 $     10,400
 $        333
 
The following tables includes the average balance of impaired financing receivables by class and the income recognized on impaired loans for the three and six month periods ended June 30, 2014 and 2013(in thousands):
 
 
 For the Six Months ended
 
June 30, 2014
June 30, 2013
     
Interest
   
Interest
 
Average
Interest
Income
Average
Interest
Income
 
Recorded
Income
Recognized
Recorded
Income
Recognized
 
Investment
Recognized
Cash Basis
Investment
Recognized
Cash Basis
Real estate loans:
           
     Mortgages
 $       202
 $              4
 $               -
 $          330
 $            4
 $               -
     Home Equity
          132
                 2
                  -
             137
               2
                  -
     Commercial
       8,039
               44
                  -
          8,595
             84
35
     Agricultural
               -
                  -
                  -
                  -
                -
                  -
     Construction
               -
                  -
                  -
                  -
                -
                  -
Consumer
            15
                  -
                  -
                  -
                -
                  -
Other commercial loans
       2,000
               46
                  -
          1,786
             41
                  -
Other agricultural loans
               -
                  -
                  -
                  -
                -
                  -
State and political
           
   subdivision loans
               -
                  -
                  -
                  -
                -
                  -
Total
 $  10,388
 $            96
 $               -
 $     10,848
 $        131
 $            35


 
10

 
 
 
 For the Three Months Ended
 
June 30, 2014
June 30, 2013
     
Interest
   
Interest
 
Average
Interest
Income
Average
Interest
Income
 
Recorded
Income
Recognized
Recorded
Income
Recognized
 
Investment
Recognized
Cash Basis
Investment
Recognized
Cash Basis
Real estate loans:
           
     Mortgages
 $       200
 $              2
 $               -
 $          352
 $            2
 $               -
     Home Equity
          131
                 1
                  -
             136
               1
                  -
     Commercial
       7,544
               18
                  -
          8,406
             39
               21
     Agricultural
               -
                  -
                  -
                  -
                -
                  -
     Construction
               -
                  -
                  -
                  -
                -
                  -
Consumer
            15
                  -
                  -
                  -
                -
                  -
Other commercial loans
       2,108
               13
                  -
          1,916
             22
                  -
Other agricultural loans
               -
                  -
                  -
                  -
                -
                  -
State and political
           
   subdivision loans
               -
                  -
                  -
                  -
                -
                  -
Total
 $    9,998
 $            34
 $               -
 $     10,810
 $          64
 $            21

Credit Quality Information
 
For commercial real estate, agricultural real estate, construction, other commercial, other agricultural and state and political subdivision loans, management uses a nine point internal risk rating system to monitor the credit quality. The first five categories are considered not criticized and are aggregated as “Pass” rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The definitions of each rating are defined below:
 
·  
Pass (Grades 1-5) – These loans are to customers with credit quality ranging from an acceptable to very high quality and are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral.
 
·  
Special Mention (Grade 6) – This loan grade is in accordance with regulatory guidance and includes loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected.
 
·  
Substandard (Grade 7) – This loan grade is in accordance with regulatory guidance and includes loans that have a well-defined weakness based on objective evidence and be characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
 
·  
Doubtful (Grade 8) – This loan grade is in accordance with regulatory guidance and includes loans that have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, based on existing circumstances.
 
·  
Loss (Grade 9) – This loan grade is in accordance with regulatory guidance and includes loans that are considered uncollectible, or of such value that continuance as an asset is not warranted.
 
To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay loan as agreed, the Bank’s loan rating process includes several layers of internal and external oversight. The Company’s loan officers are responsible for the timely and accurate risk rating of the loans in each of their portfolios at origination and on an ongoing basis under the supervision of management.  All commercial, agricultural and municipal loans are reviewed annually to ensure the appropriateness of the loan grade. In addition, the Bank engages an external consultant on at least an annual basis. The external consultant is engaged to 1) review a minimum of 55% of the dollar volume of the commercial loan portfolio on an annual basis, 2) review new loans originated 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 or classified Special Mention, Substandard, Doubtful, or Loss, and 5) such other loans which management or the consultant deems appropriate.

 
11

 
 
The following tables represent credit exposures by internally assigned grades as of June 30, 2014 and December 31, 2013 (in thousands):
 
June 30, 2014
Pass
Special Mention
Substandard
Doubtful
Loss
Ending Balance
Real estate loans:
           
     Commercial
 $          162,474
 $           9,735
 $                  14,768
 $                   -
 $              -
 $          186,977
     Agricultural
               18,657
              2,991
                       2,161
                      -
                 -
               23,809
     Construction
                 3,474
                      -
                              -
                      -
                 -
                 3,474
Other commercial loans
               39,143
              5,233
                       3,574
                   58
                 -
               48,008
Other agricultural loans
                 7,667
                 468
                       1,947
                      -
                 -
               10,082
State and political
           
   subdivision loans
               71,652
                      -
                              -
                      -
                 -
               71,652
Total
 $          303,067
 $         18,427
 $                  22,450
 $                58
 $              -
 $          344,002
             
December 31, 2013
           
Real estate loans:
           
     Commercial
 $          166,956
 $           4,645
 $                  21,284
 $              202
 $              -
 $          193,087
     Agricultural
               15,923
              1,910
                       4,168
                      -
                 -
               22,001
     Construction
                 8,937
                      -
                              -
                      -
                 -
                 8,937
Other commercial loans
               40,798
              1,747
                       1,938
                     5
                 -
               44,488
Other agricultural loans
                 7,431
                 153
                       1,957
                      -
                 -
                 9,541
State and political
           
   subdivision loans
               65,894
                      -
                              -
                      -
                 -
               65,894
Total
 $          305,939
 $           8,455
 $                  29,347
 $              207
 $              -
 $          343,948
 
For residential real estate mortgages, home equity and consumer loans, credit quality is monitored based on whether the loan is performing or non-performing, which is typically based on the aging status of the loan and payment activity, unless a specific action, such as bankruptcy, repossession, death or significant delay in payment occurs to raise awareness of a possible credit event. Non-performing loans include those loans that are considered nonaccrual, described in more detail below and all loans past due 90 or more days. The following table presents the recorded investment in those loan classes based on payment activity as of June 30, 2014 and December 31, 2013 (in thousands):

June 30, 2014
       Performing
       Non-
       performing
       Total
Real estate loans:
     
     Mortgages
 $          121,682
 $              793
 $                122,475
     Home Equity
               64,557
                 151
                     64,708
Consumer
                 8,658
                   34
                       8,692
Total
 $          194,897
 $              978
 $                195,875
       
December 31, 2013
     
Real estate loans:
     
     Mortgages
 $          119,075
 $              809
 $                119,884
     Home Equity
               66,989
                 228
                     67,217
Consumer
                 9,547
                   16
                       9,563
Total
 $          195,611
 $           1,053
 $                196,664

 
12

 
 
Age Analysis of Past Due Financing Receivables
 
Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following table includes an aging analysis of the recorded investment of past due financing receivables as of June 30, 2014 and December 31, 2013 (in thousands):

   
30-59 Days
60-89 Days
90 Days
Total Past
 
Total Financing
90 Days and
June 30, 2014
Past Due
Past Due
Or Greater
Due
Current
Receivables
Accruing
Real estate loans:
             
     Mortgages
 $        575
 $        168
 $        535
 $     1,278
 $   121,197
 $           122,475
 $                -
     Home Equity
           605
           247
           119
           971
        63,737
                64,708
                 46
     Commercial
             88
             12
        2,021
        2,121
      184,856
              186,977
               301
     Agricultural
                -
                -
                -
                -
        23,809
                23,809
                   -
     Construction
                -
                -
                -
                -
          3,474
                  3,474
                   -
Consumer
             33
             90
             15
           138
          8,554
                  8,692
                   -
Other commercial loans
             55
           408
           485
           948
        47,060
                48,008
                   -
Other agricultural loans
           437
                -
                -
           437
          9,645
                10,082
                   -
State and political
             
   subdivision loans
                -
                -
                -
                -
        71,652
                71,652
                   -
 
Total
 $     1,793
 $        925
 $     3,175
 $     5,893
 $   533,984
 $           539,877
 $            347
                 
Loans considered non-accrual
 $        112
 $        407
 $     2,828
 $     3,347
 $       4,214
 $               7,561
 
Loans still accruing
        1,681
           518
           347
        2,546
      529,770
              532,316
 
 
Total
 $     1,793
 $        925
 $     3,175
 $     5,893
 $   533,984
 $           539,877
 
                 
December 31, 2013
             
Real estate loans:
             
     Mortgages
 $        362
 $          40
 $        739
 $     1,141
 $   118,743
 $           119,884
 $            301
     Home Equity
           632
               2
           229
           863
        66,354
                67,217
                 51
     Commercial
             88
           319
        3,091
        3,498
      189,589
              193,087
               344
     Agricultural
                -
                -
                -
                -
        22,001
                22,001
                   -
     Construction
                -
                -
                -
                -
          8,937
                  8,937
                   -
Consumer
             96
             36
             16
           148
          9,415
                  9,563
                   1
Other commercial loans
             29
             28
             49
           106
        44,382
                44,488
                   -
Other agricultural loans
                -
                -
                -
                -
          9,541
                  9,541
                   -
State and political
             
   subdivision loans
                -
                -
                -
                -
        65,894
                65,894
                   -
 
Total
 $     1,207
 $        425
 $     4,124
 $     5,756
 $   534,856
 $           540,612
 $            697
                 
Loans considered non-accrual
 $          98
 $        164
 $     3,427
 $     3,689
 $       4,408
 $               8,097
 
Loans still accruing
        1,109
           261
           697
        2,067
      530,448
              532,515
 
 
Total
 $     1,207
 $        425
 $     4,124
 $     5,756
 $   534,856
 $           540,612
 

Nonaccrual Loans
 
Loans are considered for non-accrual status upon reaching 90 days delinquency, although the Company may be receiving partial payments of interest and partial repayments of principal on such loans or if full payment of principal and interest is not expected. Additionally, if management is made aware of other information including bankruptcy, repossession, death, or legal proceedings, the loan may be placed on non-accrual status. If a loan is 90 days or more past due and is well secured and in the process of collection, it may still be considered accruing.
 
The following table reflects the financing receivables on non-accrual status as of June 30, 2014 and December 31, 2013, respectively. The balances are presented by class of financing receivable (in thousands):

 
13

 
 
   
June 30 2014
 
December 31, 2013
Real estate loans:
     
     Mortgages
 $                793
 
 $                   508
     Home Equity
                   105
 
                      177
     Commercial
                5,703
 
                   7,247
     Agricultural
                   -
 
                        -
     Construction
                   -
 
                        -
Consumer
                     34
 
                        15
Other commercial loans
                   926
 
                      150
Other agricultural loans
                      -
 
                        -
State and political subdivision
                   -
 
                        -
   
 $             7,561
 
 $                8,097

Troubled Debt Restructurings
 
In situations where, for economic or legal reasons related to a borrower's financial difficulties, management may grant a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the related loan is classified as a Troubled Debt Restructuring (TDR). Management strives to identify borrowers in financial difficulty early and work with them to modify more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where borrowers are granted new terms that provide for a reduction of either interest or principal, management measures any impairment on the restructuring by calculating the present value of the revised loan terms and comparing this balance to the Company’s investment in the loan prior to the restructuring. As these loans are individually evaluated, they are excluded from pooled portfolios when calculating the allowance for loan and lease losses and a separate allocation within the allowance for loan and lease losses is provided. Management continually evaluates loans that are considered TDRs, including payment history under the modified loan terms, the borrower’s ability to continue to repay the loan based on continued evaluation of their operating results and cash flows from operations.  Based on this evaluation management would no longer consider a loan to be a TDR when the relevant facts support such a conclusion. As of June 30, 2014 and December 31, 2013, included within the allowance for loan losses are reserves of $30,000 and $28,000 respectively, that are associated with loans modified as TDRs.
 
There were no loan modifications that were considered TDRs during the three months ended June 30, 2013. Loan modifications that are considered TDRs completed during the six months ended June 30, 2014 and 2013 and the three months ended June 30, 2014, were as follows (dollars in thousands):

 
For the Three Months Ended June 30, 2014
 
Number of contracts
Pre-modification Outstanding
Recorded Investment
Post-Modification Outstanding
Recorded Investment
 
    Interest
    Modification
    Term
    Modification
    Interest
    Modification
    Term
    Modification
    Interest
    Modification
    Term
    Modification
Real estate loans:
           
     Commercial
                     -
                          1
$                   -
$                28
$                  -
$             28
Total
                     -
                          1
 $                   -
 $                28
 $                  -
 $             28

 
14

 
 
 
For the Six Months Ended June 30, 2014
 
Number of contracts
Pre-modification Outstanding
Recorded Investment
Post-Modification Outstanding
Recorded Investment
 
    Interest
    Modification
    Term
    Modification
    Interest
    Modification
    Term
    Modification
    Interest
    Modification
    Term
    Modification
Real estate loans:
           
     Commercial
                     -
2
$                   -
$                153
$                  -
$             153
Total
                     -
                         2
 $                   -
 $                153
 $                  -
 $             153


 
For the Six Months Ended June 30, 2013
 
Number of contracts
Pre-modification Outstanding Recorded Investment
Post-Modification Outstanding Recorded Investment
 
    Interest
    Modification
    Term
    Modification
    Interest
    Modification
    Term
    Modification
    Interest 
    Modification
    Term
    Modification
Real estate loans:
           
     Mortgages
                    1
                       -
 $                     72
 $                   -
 $               72
 $                  -
     Commercial
                     -
                      2
                           -
              1,365
                     -
             1,365
Other commercial loans
                     -
                      2
                           -
              1,530
                     -
             1,530
Total
                    1
                       4
 $                     72
 $           2,895
 $               72
 $          2,895

Recidivism, or the borrower defaulting on its obligation pursuant to a modified loan, results in the loan once again becoming a non-accrual loan. Recidivism occurs at a notably higher rate than do defaults on new origination loans, so modified loans present a higher risk of loss than do new origination loans. The following table presents the recorded investment in loans that were modified as TDRs during each 12-month period prior to the current reporting periods, which begin January 1, 2014 and 2013 (six month periods) and April 1, 2014 and 2013 (3 month periods), respectively, and that subsequently defaulted during these reporting periods (dollars in thousands):

 
For the Three Months Ended
For the Six Months Ended
 
June 30, 2014
June 30, 2013
June 30, 2014
June 30, 2013
 
    Number of
    contracts
    Recorded
    investment
   Number of
  contracts
    Recorded
    investment
Number of contracts
    Recorded
    investment
Number of
contracts
Recorded
 investment
Real estate loans:
               
     Commercial
                   -
 $              -
             1
 $              535
             1
 $              483
                   -
 $              -
Total recidivism
                   -
 $              -
             1
 $              535
             1
 $              483
                   -
 $              -

Allowance for Loan Losses
 
The following table segregates the allowance for loan losses (ALLL) into the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of June 30, 2014 and December 31, 2013, respectively (in thousands):
 
 
June 30, 2014
 
 December 31, 2013
 
Individually evaluated for impairment
Collectively evaluated for impairment
Total
 
Individually evaluated for impairment
Collectively evaluated for impairment
Total
Real estate loans:
             
     Residential
 $           27
 $         852
 $         879
 
 $           27
 $           919
 $             946
     Commercial and agricultural
            101
         3,708
3,809
 
            305
           4,253
             4,558
     Construction
                 -
              13
13
 
                 -
                50
                  50
Consumer
                 -
              86
86
 
                 -
              105
                105
Other commercial and agricultural loans
              30
         1,121
1,151
 
                1
              941
                942
State and political
             
  subdivision loans
                 -
            455
455
 
                 -
              330
                330
Unallocated
                 -
            358
358
 
                 -
              167
                167
Total
 $         158
 $      6,593
 $      6,751
 
 $         333
 $        6,765
 $          7,098
 
 
15

 

The following tables roll forward the balance of the ALLL by portfolio segment for the three and six month periods ended June 30, 2014 and 2013, respectively (in thousands):
 
 
       Balance at 
       March 31, 2014
Charge-offs
Recoveries
Provision
Balance at
June 30, 2014
Real estate loans:
         
     Residential
 $         886
 $            (7)
 $              -
 $            -
 $         879
     Commercial and agricultural
         4,530
           (465)
                3
        (259)
         3,809
     Construction
                8
                 -
                 -
              5
              13
Consumer
              83
               (6)
                6
              3
              86
Other commercial and agricultural loans
         1,173
           (163)
                 -
          141
         1,151
State and political
         
  subdivision loans
            396
                 -
                 -
            59
            455
Unallocated
            157
                 -
                 -
          201
            358
Total
 $      7,233
 $        (641)
 $             9
 $       150
 $      6,751
           
 
       Balance at 
       December 31, 2013
Charge-offs
Recoveries
Provision
Balance at 
June 30, 2014
Real estate loans:
         
     Residential
 $         946
 $          (45)
 $              -
 $       (22)
 $         879
     Commercial and agricultural
         4,558
           (475)
                5
        (279)
         3,809
     Construction
              50
                 -
                 -
          (37)
              13
Consumer
            105
             (14)
              15
          (20)
              86
Other commercial and agricultural loans
            942
           (163)
                 -
          372
         1,151
State and political
         
  subdivision loans
            330
                 -
                 -
          125
            455
Unallocated
            167
                 -
                 -
          191
            358
Total
 $      7,098
 $        (697)
 $           20
 $       330
 $      6,751
           
 
       Balance at
       March 31, 2013
Charge-offs
Recoveries
Provision
Balance at
June 30, 2013
Real estate loans:
         
     Residential
 $         913
 $          (13)
 $              -
 $         34
 $         934
     Commercial and agricultural
         4,416
                 -
                 -
        (176)
         4,240
     Construction
              78
                 -
                 -
            13
              91
Consumer
            118
             (10)
                9
            (3)
            114
Other commercial and agricultural loans
            700
                 -
                 -
          257
            957
State and political
         
  subdivision loans
            303
                 -
                 -
              7
            310
Unallocated
            400
                 -
                 -
          (57)
            343
Total
 $      6,928
 $          (23)
 $             9
 $         75
 $      6,989
           
 
       Balance at 
       December 31, 2012
Charge-offs
Recoveries
Provision
Balance at 
June 30, 2013
Real estate loans:
         
     Residential
 $         875
 $          (13)
 $             2
 $         70
 $         934
     Commercial and agricultural
         4,437
                 -
                 -
        (197)
         4,240
     Construction
              38
                 -
                 -
            53
              91
Consumer
            119
             (30)
              21
              4
            114
Other commercial and agricultural loans
            728
                 -
                 -
          229
            957
State and political
         
  subdivision loans
            271
                 -
                 -
            39
            310
Unallocated
            316
                 -
                 -
            27
            343
Total
 $      6,784
 $          (43)
 $           23
 $       225
 $      6,989
 
 
 
16

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

·  
Level of and trends in delinquencies, impaired/classified loans
 
Change in volume and severity of past due loans
 
Volume of non-accrual loans
 
Volume and severity of classified, adversely or graded loans;
·  
Level of and trends in charge-offs and recoveries;
·  
Trends in volume, terms and nature of the loan portfolio;
·  
Effects of any changes in risk selection and underwriting standards and any other changes in lending and recovery policies, procedures and practices;
·  
Changes in the quality of the 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 / Consumer Price Index
 
Changes in values of underlying collateral for collateral-dependent loans;
·  
Industry conditions including the effects of external factors such as competition, legal, and regulatory requirements on the level of estimated credit losses; and
·  
Existence and effect of any credit concentrations, and changes in the level of such concentrations.
·  
Any change in the level of board oversight
 
The Company also maintains an unallocated allowance to account for any factors or conditions that may cause a potential loss but are not specifically addressed in the process described above. The Company analyzes its loan portfolio each quarter to determine the appropriateness of its allowance for loan losses.
 
Loans determined to be TDRs are impaired and for purposes of estimating the ALLL must be individually evaluated for impairment. In calculating the impairment, the Company calculates the present value utilizing an analysis of discounted cash flows. If the present value calculated is below the recorded investment of the loan, impairment is recognized by a charge to the provision for loan and lease losses and a credit to the ALLL.
 
 We continually review the model utilized in calculating the required allowance. The following qualitative factors experienced changes during the first six months of 2014:
 
·  
The qualitative factor for national, state, regional and local economic trends and business conditions was decreased for all loan categories due to a decrease in the unemployment rates in the local economy.
·  
The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans were decreased for commercial and agricultural real estate due to the decrease in the Company’s classified loans to its lowest level in three years.
·  
The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans were increased for other commercial loans due to an increase in classified loans during the quarter.
·  
The qualitative factor for levels of and trends in charge-offs and recoveries was increased for commercial real estate and other commercial loans due to the increase in charge-offs compared to historical norms for the Bank.
·  
The qualitative factor for experience, ability and depth of lending management and other relevant staff was decreased for all loan categories due to the length of time employees involved throughout the loan process have been in their positions.

 
17

 
 
The following qualitative factors experienced changes during the three months ended June 30, 2014:

·  
The qualitative factor for national, state, regional and local economic trends and business conditions was decreased for all loan categories due to a decrease in the unemployment rates in the local economy.
·  
The qualitative factor for levels of and trends in charge-offs and recoveries was increased for commercial real estate and other commercial loans due to the increase in charge-offs compared to historical norms for the Bank.
·  
The qualitative factor for experience, ability and depth of lending management and other relevant staff was decreased for all loan categories due to the length of time employees involved throughout the loan process have been in their positions.
·  
The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans were decreased for commercial real estate due to the decrease in the Company’s classified loans.
·  
The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans were increased for other commercial loans due to an increase in classified loans during the quarter.
 
The primary factor that resulted in negative provisions for certain portfolio segments for the three and six month periods ended June 30, 2014 is due to decreases in the outstanding balances for certain portfolio segments compared to December 31, 2013, a reduction in the amount of substandard loans and the decrease in the qualitative factor associated with the improvement in unemployment rates noted above.
 
The following qualitative factors experienced changes during the first six months of 2013:
 
·  
The qualitative factor for national, state, regional and local economic trends and business conditions was increased for all loan categories due to rising unemployment rates in the local economy as a result of the slowdown in Marcellus shale natural gas exploration activities.
·  
The qualitative factor for trends in volume, terms and nature of the loan portfolio was increased for commercial and agricultural real estate, other commercial and agricultural loans and state and political subdivision loan categories due to the increase of the number of loans that are participations that were purchased from other banks and therefore subject to different underwriting standards.
·  
The qualitative factor for the existence and effect of any credit concentrations and changes in the level of such concentrations was increased for other commercial and agricultural loans and was lowered for commercial and agricultural real estate as the loan growth has slowed in 2013.
 
The following qualitative factors experienced changes during the three months ended June 30, 2013:

·  
The qualitative factor for trends in volume, terms and nature of the loan portfolio was increased for commercial and agricultural real estate, other commercial and agricultural loans and state and political subdivision loan categories due to the increase of the number of loans that are participations that were purchased from other banks and therefore subject to different underwriting standards.
·  
The qualitative factor for the existence and effect of any credit concentrations and changes in the level of such concentrations was increased for other commercial and agricultural loans and was lowered for commercial and agricultural real estate as the loan growth has slowed in 2013.

 
18

 
 
Note 6 – Federal Home Loan Bank Stock
 
The Bank is a member of the FHLB of Pittsburgh and as such, is required to maintain a minimum investment in stock of the FHLB that varies with the level of advances outstanding with the FHLB. As of June 30, 2014 and December 31, 2013, the Bank holds $2,920,200 and $3,652,100, respectively. The stock is bought from and sold to the FHLB based upon its $100 par value.  The stock does not have a readily determinable fair value and as such is classified as restricted stock, carried at cost and evaluated by management.  The stock’s value is determined by the ultimate recoverability of the par value rather than by recognizing temporary declines. The determination of whether the par value will ultimately be recovered is influenced by criteria such as the following: (a) A significant decline in net assets of the FHLB as compared to the capital stock amount and the length of time this situation has persisted (b) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance (c) the impact of legislative and regulatory changes on the customer base of the FHLB and (d) the liquidity position of the FHLB. Management evaluated the stock and concluded that the stock was not impaired for the periods presented herein.  Management considered that the FHLB’s regulatory capital ratios have improved, liquidity appears adequate, new shares of FHLB stock continue to exchange hands at the $100 par value and the FHLB has repurchased shares of excess capital stock from its members and has reinstituted the dividend.

Note 7 - Employee Benefit Plans
 
For additional detailed disclosure on the Company's pension and employee benefits plans, please refer to Note 11 of the Company's Consolidated Financial Statements included in the 2013 Annual Report on Form 10-K.
 
Noncontributory Defined Benefit Pension Plan
 
The Bank sponsors a noncontributory defined benefit pension plan (“Pension Plan”) covering substantially all employees and officers.  The Bank’s funding policy is to make annual contributions, if needed, based upon the funding formula developed by the plan’s actuary. Any employee with a hire date of January 1, 2007 or later is not eligible to participate in the Pension Plan. In lieu of the Pension Plan, employees with a hire date of January 1, 2007 or later are eligible to receive, after meeting certain length of service requirements, an annual discretionary 401(k) plan contribution from the Bank equal to a percentage of an employee’s base compensation.  The contribution amount, if any, is placed in a separate account within the 401(k) plan and is subject to a vesting requirement.
 
For employees who are eligible to participate in the Pension Plan, the Pension Plan requires benefits to be paid to eligible employees based primarily upon age and compensation rates during employment.  Upon retirement or other termination of employment, employees can elect either an annuity benefit or a lump sum distribution of vested benefits in the Pension Plan.
 
The following sets forth the components of net periodic benefit costs of the Pension Plan for the three and six months ended June 30, 2014 and 2013, respectively (in thousands):

 
    Three Months Ended
    Six Months Ended
 
     June 30,
     June 30,
 
    2014
    2013
    2014
    2013
Service cost
 $               63
 $       76
 $             153
 $            177
Interest cost
                111
          79
                207
               185
Expected return on plan assets
              (215)
       (169)
              (393)
            (343)
Net amortization and deferral
                (43)
          86
                   25
               128
         
Net periodic benefit expense (income)
 $             (84)
 $       72
 $               (8)
 $            147

 
19

 
 
The Company expects to contribute $300,000 to the Pension Plan in 2014.
 
Defined Contribution Plan
 
The Company sponsors a voluntary 401(k) savings plan which eligible employees can elect to contribute up to the maximum amount allowable not to exceed the limits of IRS Code Sections 401(k).  Under the plan, the Company also makes required contributions on behalf of the eligible employees.  The Company’s contributions vest immediately. Contributions by the Company totaled $146,000 and $147,000 for the six months ended June 30, 2014 and 2013, respectively. For the three months ended June 30, 2014 and 2013, contributions by the Company totaled $88,000 and $92,000, respectively.
 
Directors’ Deferred Compensation Plan
 
The Company’s directors may elect to defer all or portions of their fees until their retirement or termination from service.  Amounts deferred under the plan earn interest based upon the highest current rate offered to certificate of deposit customers.  Amounts deferred under the plan are not guaranteed and represent a general liability of the Company.  At June 30, 2014 and December 31, 2013, an obligation of $956,000 and $981,000, respectively, was included in other liabilities for this plan in the Consolidated Balance Sheet. Amounts included in interest expense on the deferred amounts totaled $6,000 and $3,000 for each of the three months ended June 30, 2014 and 2013. For the six months ended June 30, 2014 and 2013, amounts included in interest expense on the deferred amounts totaled $11,000 and $7,000, respectively.
 
Restricted Stock Plan
 
The Company maintains a Restricted Stock Plan (the “Plan”) whereby employees and non-employee corporate directors are eligible to receive awards of restricted stock based upon performance related requirements.  Awards granted under the Plan are in the form of the Company’s common stock and are subject to certain vesting requirements including continuous employment or service with the Company.  A total of 100,000 shares of the Company’s common stock have been authorized under the Plan. As of June 30, 2014, 64,158 shares remain available to be issued under the Plan.  The Plan assists the Company in attracting, retaining and motivating employees to make substantial contributions to the success of the Company and to increase the emphasis on the use of equity as a key component of compensation.
 
The following table details the vesting, awarding and forfeiting of restricted shares during 2014 and 2013:

 
Three months ended June 30,
Six months ended June 30,
 
2014
2013
2014
2013
   
Weighted
 
Weighted
 
Weighted
 
Weighted
 
Unvested
Average
Unvested
Average
Unvested
Average
Unvested
Average
 
Shares
Market Price
Shares
Market Price
Shares
Market Price
Shares
Market Price
Outstanding, beginning of period
6,240
 $          43.55
   7,269
 $       35.16
7,172
 $          42.02
   8,646
 $       35.51
Granted
3,206
             53.10
   3,027
          48.21
3,598
             52.82
   3,027
          48.21
Forfeited
-
                     -
           -
                  -
-
                     -
       (55)
          37.10
Vested
 (2,259)
             42.06
  (2,830)
          31.35
 (3,583)
             40.30
  (4,152)
          33.26
Outstanding, end of period
7,187
 $          48.28
   7,466
 $       41.89
7,187
 $          48.28
   7,466
 $       41.89

Compensation cost related to restricted stock is recognized based on the market price of the stock at the grant date over the vesting period. Compensation expense related to restricted stock was $73,000 and $77,000 for the six months ended June 30, 2014 and 2013, respectively. For the three months ended June 30, 2014 and 2013, compensation expense totaled $37,000 and $39,000, respectively.
 
 
20

 
 
Supplemental Executive Retirement Plan
 
The Company maintains a non-qualified supplemental executive retirement plan (“SERP”) for certain executives to compensate those executive participants in the Company’s noncontributory defined benefit pension plan whose benefits are limited by compensation limitations under current tax law. At June 30, 2014 and December 31, 2013, an obligation of $1,122,000 and $1,046,000, respectively, was included in other liabilities for this plan in the Consolidated Balance Sheet. Expenses related to this plan totaled $76,000 and $72,000 for the six months ended June 30, 2014 and 2013, respectively. For the three months ended June 30, 2014 and 2013, expenses totaled $38,000 and $36,000, respectively.

Note 8 – Accumulated Comprehensive Income
 
The following tables present the changes in accumulated other comprehensive (loss) income by component net of tax for the three and six months ended June 30, 2014 and 2013 (in thousands):

 
Three months ended June 30, 2014
 
Unrealized gain (loss) on
available for sale securities
(a)
Unrealized gain
(loss) on interest
rate swap (a)
Defined Benefit
Pension Items (a)
Total
Balance as of March 31, 2014
 $                     1,264
 $                     -
 $             (1,110)
 $         154
Other comprehensive income before reclassifications (net of tax)
                           986
                        -
                        -
            986
Amounts reclassified from accumulated other
       
     comprehensive income (loss) (net of tax)
                           (49)
                        -
                         9
             (40)
Net current period other comprehensive income
                           937
                        -
                         9
            946
Balance as of June 30, 2014
 $                     2,201
 $                     -
 $             (1,101)
 $      1,100

 
Six months ended June 30, 2014
 
Unrealized gain (loss) on
available for sale securities (a)
Unrealized gain
(loss) on interest
rate swap (a)
Defined Benefit
Pension Items (a)
Total
Balance as of December 31, 2013
 $                      (108)
 $                     -
 $             (1,117)
 $     (1,225)
Other comprehensive income before reclassifications (net of tax)
                        2,471
                        -
                        -
         2,471
Amounts reclassified from accumulated other
       
     comprehensive income (loss) (net of tax)
                         (162)
                        -
                       16
           (146)
Net current period other comprehensive income
                2,309
                 -
                16
     2,325
Balance as of June 30, 2014
 $                     2,201
 $                     -