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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-32.1 - SECTION 350 CERTIFICATIONS - CITIZENS FINANCIAL SERVICES INCcertification.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, 2015
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 28, 2015, was 3,028,676.

 
 

 

 
 
Citizens Financial Services, Inc.
Form 10-Q

INDEX
 
 
   
PAGE
Part I
FINANCIAL INFORMATION
 
Item 1.
Financial Statements (unaudited):
 
 
Consolidated Balance Sheet as of June 30,2015 and December 31, 2014
1
 
Consolidated Statement of Income for the Three and Six months Ended June 30,2015 and 2014
2
 
Consolidated Statement of Comprehensive Income for the Three and Six months ended June 30, 2015 and 2014
3
 
Consolidated Statement of Cash Flows for the Six Months ended June 30, 2015 and 2014
4
 
Notes to Consolidated Financial Statements
5-29
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
30-51
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
51
Item 4.
Controls and Procedures
51-52
     
Part II
OTHER INFORMATION
 
Item 1.
Legal Proceedings
52
Item 1A.
Risk Factors
52
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
52
Item 3.
Defaults Upon Senior Securities
52
Item 4.
Mine Safety Disclosures
52-53
Item 5.
Other Information
53
Item 6.
Exhibits
53
 
Signatures
54

 
 

 

CITIZENS FINANCIAL SERVICES, INC.
   
CONSOLIDATED BALANCE SHEET
   
(UNAUDITED)
   
     
 
       June 30,
    December 31,
(in thousands except share data)
       2015
    2014
ASSETS:
   
Cash and due from banks:
   
  Noninterest-bearing
 $               9,910
 $          10,091
  Interest-bearing
                  1,002
               1,332
Total cash and cash equivalents
                10,912
             11,423
Interest bearing time deposits with other banks
                  5,960
               5,960
Available-for-sale securities
              304,792
           306,146
Loans held for sale
                  1,152
                  497
 
   
Loans (net of allowance for loan losses:
   
  2015, $6,959 and 2014, $6,815)
              564,692
           547,290
 
   
Premises and equipment
                12,582
             12,357
Accrued interest receivable
                  3,584
               3,644
Goodwill
                10,256
             10,256
Bank owned life insurance
                20,615
             20,309
Other assets
                  7,934
               7,166
 
 
 
TOTAL ASSETS
 $           942,479
 $        925,048
 
 
 
LIABILITIES:
   
Deposits:
   
  Noninterest-bearing
 $           100,469
 $          95,526
  Interest-bearing
              691,418
           678,407
Total deposits
              791,887
           773,933
Borrowed funds
                39,194
             41,799
Accrued interest payable
                     674
                  756
Other liabilities
                  7,499
               8,032
TOTAL LIABILITIES
              839,254
           824,520
STOCKHOLDERS' EQUITY:
   
Preferred Stock
   
  $1.00 par value; authorized 3,000,000 shares: none issued or outstanding at
   
   June 30, 2015 and December 31, 2014;
                          -
                      -
Common stock
   
  $1.00 par value; authorized 15,000,000 shares;  issued 3,335,236 at June 30, 2015 and
   
  December 31, 2014
                  3,335
               3,335
Additional paid-in capital
                25,124
             25,150
Retained earnings
                83,371
             79,512
Accumulated other comprehensive income
                     171
                  767
Treasury stock, at cost:  306,560 shares at June 30, 2015
   
  and 296,280 shares at December 31, 2014
                 (8,776)
             (8,236)
TOTAL STOCKHOLDERS' EQUITY
              103,225
           100,528
TOTAL LIABILITIES AND
   
   STOCKHOLDERS' EQUITY
 $           942,479
 $        925,048
     
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)
       2015
       2014
       2015
    2014
INTEREST INCOME:
       
Interest and fees on loans
 $        7,129
 $      7,118
 $       14,168
 $     14,106
Interest-bearing deposits with banks
                 39
               13
                  70
               26
Investment securities:
       
    Taxable
               765
             849
             1,519
          1,737
    Nontaxable
               801
             840
             1,649
          1,682
    Dividends
                 34
               69
                133
             119
TOTAL INTEREST INCOME
           8,768
         8,889
          17,539
        17,670
INTEREST EXPENSE:
       
Deposits
           1,035
         1,094
             2,044
          2,199
Borrowed funds
               172
             145
                347
             309
TOTAL INTEREST EXPENSE
           1,207
         1,239
             2,391
          2,508
NET INTEREST INCOME
           7,561
         7,650
          15,148
        15,162
Provision for loan losses
               120
             150
                240
             330
NET INTEREST INCOME AFTER
       
    PROVISION FOR LOAN LOSSES
           7,441
         7,500
          14,908
        14,832
NON-INTEREST INCOME:
       
Service charges
           1,028
         1,102
             2,004
          2,141
Trust
               180
             186
                374
             377
Brokerage and insurance
               255
             137
                382
             257
Gains on loans sold
                 60
               30
                  98
               70
Investment securities gains, net
               175
               75
                301
             246
Earnings on bank owned life insurance
               154
             121
                306
             242
Other
               103
             104
                218
             209
TOTAL NON-INTEREST INCOME
           1,955
         1,755
             3,683
          3,542
NON-INTEREST EXPENSES:
       
Salaries and employee benefits
           2,993
         2,893
             6,049
          5,810
Occupancy
               348
             304
                717
             654
Furniture and equipment
                 87
               94
                215
             194
Professional fees
               180
             208
                412
             442
FDIC insurance
               116
             116
                232
             229
Pennsylvania shares tax
               200
             191
                401
             384
Other
           1,504
         1,194
             2,737
          2,378
TOTAL NON-INTEREST EXPENSES
           5,428
         5,000
          10,763
        10,091
Income before provision for income taxes
           3,968
         4,255
             7,828
          8,283
Provision for income taxes
               779
             890
             1,519
          1,742
NET INCOME
 $        3,189
 $      3,365
 $         6,309
 $       6,541
 
       
PER COMMON SHARE DATA:
       
Net Income - Basic
 $          1.06
 $        1.11
 $            2.09
 $         2.15
Net Income - Diluted
 $          1.06
 $        1.11
 $            2.09
 $         2.15
Cash Dividends Paid
 $        0.405
 $      0.385
 $         0.810
 $       0.770
         
Number of shares used in computation - basic
   3,019,661
  3,039,734
     3,022,945
  3,040,822
Number of shares used in computation - diluted
   3,020,725
  3,040,661
     3,023,479
  3,041,227
         
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)
 
2015
 
2014
 
2015
 
2014
Net income
 
$ 3,189
 
 $ 3,365
 
 $ 6,309
 
 $   6,541
Other comprehensive income (loss):
               
      Change in unrealized gains on available
               
                 for sale securities
 (2,049)
 
1,494
 
 (704)
 
3,743
 
      Income tax effect
698
 
 (508)
 
240
 
 (1,272)
 
      Change in unrecognized pension cost
54
 
13
 
102
 
  25
 
      Income tax effect
 (19)
 
 (4)
 
(35)
 
   (9)
 
      Less:  Reclassification adjustment for investment
               
                 security gains included in net income
 (175)
 
 (75)
 
 (301)
 
 (246)
 
      Income tax effect
59
 
26
 
102
 
  84
 
Other comprehensive income (loss), net of tax
 
(1,432)
 
946
 
 (596)
 
2,325
Comprehensive income
 
 $ 1,757
 
 $ 4,311
 
 $ 5,713
 
 $   8,866
                 
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)
          2015
          2014
CASH FLOWS FROM OPERATING ACTIVITIES:
   
  Net income
 $          6,309
 $          6,541
  Adjustments to reconcile net income to net
   
   cash provided by operating activities:
   
    Provision for loan losses
                240
                330
    Depreciation and amortization
                236
                233
    Amortization and accretion of investment securities
                992
             1,100
    Deferred income taxes
                112
                498
    Investment securities gains, net
              (301)
              (246)
    Earnings on bank owned life insurance
              (306)
              (242)
    Originations of loans held for sale
           (7,479)
           (5,286)
    Proceeds from sales of loans held for sale
             6,922
             5,089
    Realized gains on loans sold
                (98)
                (70)
    Increase in accrued interest receivable
                  60
                171
    Decrease in accrued interest payable
                (81)
              (160)
    Other, net
           (1,158)
           (1,107)
      Net cash provided by operating activities
             5,448
             6,851
CASH FLOWS FROM INVESTING ACTIVITIES:
   
  Available-for-sale securities:
   
    Proceeds from sales
           18,393
           12,151
    Proceeds from maturity and principal repayments
           31,163
           29,294
    Purchase of securities
         (49,579)
         (33,822)
  Proceeds from redemption of regulatory stock
             1,513
             2,216
  Purchase of regulatory stock
           (1,342)
           (1,484)
  Net increase in loans
         (17,792)
              (113)
  Purchase of premises and equipment
              (514)
              (145)
  Proceeds from sale of foreclosed assets held for sale
                100
                296
      Net cash (used) provided by investing activities
         (18,058)
             8,393
CASH FLOWS FROM FINANCING ACTIVITIES:
   
  Net increase in deposits
           17,954
           17,140
  Proceeds from long-term borrowings
             5,286
             4,010
  Repayments of long-term borrowings
              (551)
           (4,200)
  Net decrease in short-term borrowed funds
           (7,340)
         (23,667)
  Purchase of treasury and restricted stock
              (997)
              (733)
  Dividends paid
           (2,253)
           (2,137)
      Net cash provided (used) by financing activities
           12,099
           (9,587)
          Net (decrease) increase in cash and cash equivalents
              (511)
             5,657
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
           11,423
           10,083
CASH AND CASH EQUIVALENTS AT END OF PERIOD
 $        10,912
 $        15,740
     
Supplemental Disclosures of Cash Flow Information:
   
    Interest paid
 $          2,472
 $          2,668
    Income taxes paid
 $          2,025
 $          1,885
    Loans transferred to foreclosed property
 $             241
 $             239
    Premises and equipment transferred from other assets
 $                  -
 $             549
    Investments purchased and not settled
 $             319
 $                 -
   
 
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 wholly owned 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 at June 30, 2015 and for the periods ended June 30, 2015 and 2014 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, 2015 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, 2014.

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,
 
    2015
    2014
    2015
    2014
Net income applicable to common stock
$3,189,000
$3,365,000
$6,309,000
$6,541,000
         
Basic earnings per share computation
       
Weighted average common shares outstanding
   3,019,661
   3,039,734
     3,022,945
   3,040,822
Earnings per share - basic
$1.06
$1.11
$2.09
$2.15
         
Diluted earnings per share computation
       
Weighted average common shares outstanding for basic earnings per share
   3,019,661
   3,039,734
     3,022,945
   3,040,822
Add: Dilutive effects of restricted stock
          1,064
             927
               534
             405
Weighted average common shares outstanding for dilutive earnings per share
   3,020,725
   3,040,661
     3,023,479
   3,041,227
Earnings per share - diluted
$1.06
$1.11
$2.09
$2.15
 
For the three months ended June 30, 2015 and 2014, there were 3,287 and 2,188 shares, respectively, related to the restricted stock plan that were excluded from the diluted earnings per share calculations since they were anti-dilutive. These anti-dilutive shares had prices ranging from $44.50-$53.15 for the three month period ended June 30, 2015 and prices ranging from $50.15-$50.50 for the three month period ended June 30, 2014. For the six months ended June 30, 2015 and 2014, 3,287 and 2,409 shares, respectively, related to the restricted stock plan were excluded from the diluted earnings per share calculations since they were anti-dilutive. These anti-dilutive shares had prices ranging from $44.50-$53.15 for the six month period ended June 30, 2015 and prices ranging from $34.70-$50.50 for the six month period ended June 30, 2014.
 
 
 
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.

Investments in Qualified Affordable Housing Projects
 
As of June 30, 2015 and December 31, 2014, the Company was invested in four partnerships that provide affordable housing. The balance of the investments, which is included within other assets in the Consolidated Balance Sheet, was $1,088,000 and $1,218,000 as of June 30, 2015 and December 31, 2014, respectively. Investments purchased prior to January 1, 2015, are accounted for utilizing the effective yield method. As of June 30, 2015, the Company has $1,143,000 of tax credits remaining that will be recognized over seven years. Tax credits of $49,000 and $99,000 were recognized as a reduction of tax expense during the three and six months ended June 30, 2015, respectively.

Note 4 – Investments
 
The amortized cost, gross unrealized gains and losses,  and fair value of investment securities at June 30, 2015 and December 31, 2014 were as follows (in thousands):

   
    Gross
    Gross
 
 
    Amortized
    Unrealized
    Unrealized
    Fair
June 30, 2015
    Cost
    Gains
    Losses
    Value
Available-for-sale securities:
       
  U.S. agency securities
 $    167,187
 $                  778
 $            (385)
 $       167,580
  Obligations of state and
       
    political subdivisions
         93,796
                  2,829
               (343)
            96,282
  Corporate obligations
         12,713
                     141
                 (49)
            12,805
  Mortgage-backed securities in
       
    government sponsored entities
         26,096
                     287
                 (33)
            26,350
  Equity securities in financial institutions
           1,318
                     457
                      -
              1,775
Total available-for-sale securities
 $    301,110
 $               4,492
 $            (810)
 $       304,792
         
December 31, 2014
       
Available-for-sale securities:
       
  U.S. agency securities
 $    150,847
 $                  638
 $            (600)
 $       150,885
  U.S. treasury securities
           4,944
                          -
                 (95)
              4,849
  Obligations of state and
       
    political subdivisions
       101,281
                  3,854
                 (99)
          105,036
  Corporate obligations
         13,853
                     190
                 (85)
            13,958
  Mortgage-backed securities in
       
    government sponsored entities
         29,397
                     368
                 (37)
            29,728
  Equity securities in financial institutions
           1,137
                     553
                      -
              1,690
Total available-for-sale securities
 $    301,459
 $               5,603
 $            (916)
 $       306,146

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, 2015 and December 31, 2014 (in thousands). As of June 30, 2015, the Company owned 72 securities whose fair value was less than their cost basis.
 
 
6

 
 
June 30, 2015
    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
 $        60,908
 $           (302)
 $        10,910
 $             (83)
 $        71,818
 $           (385)
Obligations of state and
           
    political subdivisions
23,486
(263)
             5,212
                (80)
28,698
(343)
Corporate obligations
             5,434
                (31)
             2,184
                (18)
7,618
(49)
Mortgage-backed securities in
           
   government sponsored entities
4,616
(21)
                273
                (12)
4,889
(33)
    Total securities
 $        94,444
 $           (617)
 $        18,579
 $           (193)
 $      113,023
 $           (810)
               
December 31, 2014
             
U.S. agency securities
 $        27,382
 $           (110)
 $        43,642
 $           (490)
 $        71,024
 $           (600)
U.S. treasury securities
                     -
                     -
             4,849
                (95)
             4,849
                (95)
Obligations of states and
           
     political subdivisions
             3,596
                (19)
             8,584
                (80)
           12,180
                (99)
Corporate obligations
                505
                  (1)
             7,707
                (84)
             8,212
                (85)
Mortgage-backed securities in
           
     government sponsored entities
             5,025
                  (4)
             2,229
                (33)
             7,254
                (37)
    Total securities
 $        36,508
 $           (134)
 $        67,011
 $           (782)
 $      103,519
 $           (916)
 
As of June 30, 2015, 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, obligations of states and political subdivisions, corporate obligations and mortgage backed securities issued by government sponsored entities. 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 issuer-specific rating changes that are not expected to result in the non-collection of principal and interest during the period.
 
Proceeds from sales of securities available-for-sale for the six months ended June 30, 2015 and 2014 were $18,393,000 and $12,151,000, respectively.  For the three months ended June 30, 2015 and 2014, there were sales of $3,770,000 and $6,595,000, 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,
 
       2015
       2014
       2015
    2014
Gross gains
 $           175
 $                    75
 $              312
 $              246
Gross losses
                   -
                          -
                 (11)
                      -
Net gains
 $           175
 $                    75
 $              301
 $              246
 

 
 
7

 
 
Investment securities with an approximate carrying value of $170.9 million and $186.4 million at June 30, 2015 and December 31, 2014, 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, 2015, by contractual maturity, are shown below (in thousands):

 
       Amortized
 
 
       Cost
       Fair Value
Available-for-sale debt securities:
   
  Due in one year or less
 $        3,420
 $               3,459
  Due after one year through five years
       166,695
              167,737
  Due after five years through ten years
         44,355
                45,146
  Due after ten years
         85,322
                86,675
Total
 $    299,792
 $           303,017

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, 2015 and December 31, 2014, a substantial portion of its debtors’ ability to honor their contracts is dependent on the economic conditions within these regions. The following table summarizes the primary segments of the loan portfolio and how those segments are analyzed within the allowance for loan losses as of June 30, 2015 and December 31, 2014 (in thousands):

June 30, 2015
 
    Total Loans
Individually
evaluated for
impairment
Collectively
evaluated for
 impairment
Real estate loans:
       
     Residential
 
 $                 181,566
 $                        333
 $                 181,233
     Commercial and agricultural
 
                    224,450
                        5,578
                    218,872
     Construction
 
                        8,025
                                -
                        8,025
Consumer
 
                        8,374
                                -
                        8,374
Other commercial and agricultural loans
                      64,506
                        2,248
                      62,258
State and political subdivision loans
 
                      84,730
                                -
                      84,730
Total
 
                    571,651
 $                     8,159
 $                 563,492
Allowance for loan losses
 
                        6,959
   
Net loans
 
 $                 564,692
   
         
December 31, 2014
       
Real estate loans:
       
     Residential
 
 $                 185,438
 $                        316
 $                 185,122
     Commercial and agricultural
 
                    215,584
                        6,112
                    209,472
     Construction
 
                        6,353
                                -
                        6,353
Consumer
 
                        8,497
                                -
                        8,497
Other commercial and agricultural loans
 
                      58,516
                        2,394
                      56,122
State and political subdivision loans
 
                      79,717
                                -
                      79,717
Total
 
                    554,105
 $                     8,822
 $                 545,283
Allowance for loan losses
 
                        6,815
   
Net loans
 
 $                 547,290
   
 
 
 
8

 
 
The segments of the Company’s loan portfolio are disaggregated into classes to a level that allows management to monitor risk and performance. Residential real estate mortgages consists primarily of 15 to 30 year first mortgages on residential real estate, while residential real estate home equity loans are consumer purpose installment loans or lines of credit secured by a mortgage which is often a second lien on residential real estate with terms of 15 years or less. Commercial real estate loans are business purpose loans secured by a mortgage on commercial real estate. Agricultural real estate loans are loans secured by a mortgage on real estate used in agriculture production. Construction real estate loans are loans secured by residential or commercial real estate used during the construction phase of residential and commercial projects. Consumer loans are typically unsecured or primarily secured by assets other than real estate and overdraft lines of credit are typically secured by customer deposit accounts. Other commercial loans are loans for commercial purposes primarily secured by non-real estate collateral. Other agricultural loans are loans for agricultural purposes primarily secured by non-real estate collateral. State and political subdivision loans are loans to state and local municipalities for capital and operating expenses or tax free loans used to finance commercial development.
 
Management considers commercial loans, other agricultural loans, state and political subdivision loans, commercial real estate loans and agricultural real estate loans which are 90 days or more past due to be impaired. Management will also consider a loan impaired based on other factors it becomes aware of, including the customer’s results of operations and cash flows or if the loan is modified in a troubled debt restructuring. In addition, certain residential mortgages, home equity and consumer loans that are cross collateralized with commercial relationships that are determined to be impaired may also be classified as impaired. Impaired loans are analyzed to determine if it is probable that all amounts will not be collected according to the contractual terms of the loan agreement. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allocation of the allowance for loan losses or a charge-off to the allowance for loan losses.

The following table includes the recorded investment and unpaid principal balances for impaired financing receivables by class, with the associated allowance amount, if applicable (in thousands):
 
   
Recorded
Recorded
   
 
Unpaid
Investment
Investment
Total
 
 
Principal
With No
With
Recorded
Related
June 30, 2015
Balance
Allowance
Allowance
Investment
Allowance
Real estate loans:
         
     Mortgages
 $       305
 $          118
 $          152
 $          270
 $          29
     Home Equity
            63
                  -
               63
               63
             12
     Commercial
       8,051
          5,469
             109
          5,578
             48
     Agricultural
               -
                  -
                  -
                  -
                -
     Construction
               -
                  -
                  -
                  -
                -
Consumer
               -
                  -
                  -
                  -
                -
Other commercial loans
       2,354
          1,164
          1,084
          2,248
           185
Other agricultural loans
               -
                  -
                  -
                  -
                -
State and political subdivision loans
               -
                  -
                  -
                  -
                -
Total
 $  10,773
 $       6,751
 $       1,408
 $       8,159
 $        274
           
December 31, 2014
         
Real estate loans:
         
     Mortgages
 $       222
 $          125
 $            66
 $          191
 $          13
     Home Equity
          130
               60
               65
             125
             12
     Commercial
       8,433
          5,708
             404
          6,112
             72
     Agricultural
               -
                  -
                  -
                  -
                -
     Construction
               -
                  -
                  -
                  -
                -
Consumer
               -
                  -
                  -
                  -
                -
Other commercial loans
       2,480
          2,346
               48
          2,394
               1
Other agricultural loans
               -
                  -
                  -
                  -
                -
State and political subdivision loans
               -
                  -
                  -
                  -
                -
Total
 $  11,265
 $       8,239
 $          583
 $       8,822
 $          98
 
 
 
9

 
 
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, 2015 and 2014(in thousands):

 
 For the Six Months ended
 
June 30, 2015
June 30, 2014
     
Interest
   
Interest
 
Average
Interest
Income
Average
Interest
Income
 
Recorded
Income
Recognized
Recorded
Income
Recognized
 
Investment
Recognized
Cash Basis
Investment
Recognized
Cash Basis
Real estate loans:
           
     Mortgages
 $       224
 $              4
 $              5
 $          202
 $            4
 $               -
     Home Equity
          114
                 2
                  -
             132
               2
                  -
     Commercial
       5,862
               32
                  -
          8,039
             44
                  -
     Agricultural
               -
                  -
                  -
                  -
                -
                  -
     Construction
               -
                  -
                  -
                  -
                -
                  -
Consumer
               -
                  -
                  -
               15
                -
                  -
Other commercial loans
       2,678
               49
                 3
          2,000
             46
                  -
Other agricultural loans
               -
                  -
                  -
                  -
                -
                  -
State and political
           
   subdivision loans
               -
                  -
                  -
                  -
                -
                  -
Total
 $    8,878
 $            87
 $              8
 $     10,388
 $          96
 $               -
             
 
 For the Three Months Ended
 
June 30, 2015
June 30, 2014
Real estate loans:
           
     Mortgages
 $       259
 $              2
 $              5
 $          200
 $            2
 $               -
     Home Equity
          103
                 1
                  -
             131
               1
                  -
     Commercial
       5,700
               19
                  -
          7,544
             18
                  -
     Agricultural
               -
                  -
                  -
                  -
                -
                  -
     Construction
               -
                  -
                  -
                  -
                -
                  -
Consumer
               -
                  -
                  -
               15
                -
                  -
Other commercial loans
       2,629
               24
                 2
          2,108
             13
                  -
Other agricultural loans
               -
                  -
                  -
                  -
                -
                  -
State and political
           
   subdivision loans
               -
                  -
                  -
                  -
                -
                  -
Total
 $    8,691
 $            46
 $              7
 $       9,998
 $          34
 $               -

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 grade internal risk rating system to monitor credit quality. The first five categories are considered not criticized and are aggregated as “Pass” rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The definitions of each rating are defined below:
 
·  
Pass (Grades 1-5) – These loans are to customers with credit quality ranging from an acceptable to very high quality and are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral.
 
·  
Special Mention (Grade 6) – This loan grade is in accordance with regulatory guidance and includes loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected.
 
·  
Substandard (Grade 7) – This loan grade is in accordance with regulatory guidance and includes loans that have a well-defined weakness based on objective evidence and be characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
 
 
10

 
 
·  
Doubtful (Grade 8) – This loan grade is in accordance with regulatory guidance and includes loans that have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, based on existing circumstances.
 
·  
Loss (Grade 9) – This loan grade is in accordance with regulatory guidance and includes loans that are considered uncollectible, or of such value that continuance as an asset is not warranted.
 
To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay the loan as agreed, the Company’s loan rating process includes several layers of internal and external oversight. The Company’s loan officers are responsible for the timely and accurate risk rating of the loans in each of their portfolios at origination and on an ongoing basis under the supervision of management.  All commercial and agricultural loans are reviewed annually to ensure the appropriateness of the loan grade. In addition, the Company engages an external consultant on at least an annual basis to 1) review a minimum of 55% of the dollar volume of the commercial loan portfolio on an annual basis, 2) review new loans originated for over $1.0 million in the last year, 3) review a majority of borrowers with commitments greater than or equal to $1.0 million,  4) review selected loan relationships over $750,000 which are over 30 days past due, classified Special Mention, Substandard, Doubtful, or Loss, and 5) such other loans which management or the consultant deems appropriate.
 
The following tables represent credit exposures by internally assigned grades as of June 30, 2015 and December 31, 2014 (in thousands):

June 30, 2015
Pass
Special
Mention
Substandard
Doubtful
Loss
Ending Balance
Real estate loans:
           
     Commercial
 $          177,073
 $           4,390
 $                  12,220
 $                44
 $              -
 $          193,727
     Agricultural
               27,638
              2,600
                          485
                      -
                 -
               30,723
     Construction
                 8,025
                      -
                              -
                      -
                 -
                 8,025
Other commercial loans
               45,715
                 817
                       5,443
                 145
                 -
               52,120
Other agricultural loans
               11,989
                 397
                              -
                      -
                 -
               12,386
State and political
           
   subdivision loans
               84,730
                      -
                              -
                      -
                 -
               84,730
Total
 $          355,170
 $           8,204
 $                  18,148
 $              189
 $              -
 $          381,711
             
December 31, 2014
           
Real estate loans:
           
     Commercial
 $          169,383
 $           8,948
 $                  12,614
 $                   -
 $              -
 $          190,945
     Agricultural
               19,575
              3,394
                       1,670
                      -
                 -
               24,639
     Construction
                 6,353
                      -
                              -
                      -
                 -
                 6,353
Other commercial loans
               40,683
              4,413
                       2,355
                      -
                 -
               47,451
Other agricultural loans
                 9,221
                 727
                       1,117
                      -
                 -
               11,065
State and political
           
   subdivision loans
               79,717
                      -
                              -
                      -
                 -
               79,717
Total
 $          324,932
 $         17,482
 $                  17,756
 $                   -
 $              -
 $          360,170
 
For residential real estate mortgages, home equity and consumer loans, credit quality is monitored based on whether the loan is performing or non-performing, which is typically based on the aging status of the loan and payment activity, unless a specific action, such as bankruptcy, repossession, death or significant delay in payment occurs to raise awareness of a possible credit event. Non-performing loans include those loans that are considered nonaccrual, described in more detail below and all loans past due 90 or more days and still accruing. The following table presents the recorded investment in those loan classes based on payment activity as of June 30, 2015 and December 31, 2014 (in thousands):

 
11

 

June 30, 2015
Performing
Non-performing
Total
Real estate loans:
     
     Mortgages
 $          119,649
 $             1,160
 $                120,809
     Home Equity
               60,608
                 149
                     60,757
Consumer
                 8,320
                   54
                       8,374
Total
 $          188,577
 $           1,363
 $                189,940
       
December 31, 2014
     
Real estate loans:
     
     Mortgages
 $          121,968
 $              890
 $                122,858
     Home Equity
               62,296
                 284
                     62,580
Consumer
                 8,444
                   53
                       8,497
Total
 $          192,708
 $           1,227
 $                193,935

Aging Analysis of Past Due Financing Receivables
 
Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following table includes an aging analysis of the recorded investment of past due financing receivables as of June 30, 2015 and December 31, 2014 (in thousands):

               
90 Days or
   
30-59 Days
60-89 Days
90 Days
Total Past
 
Total Financing
Greater and
June 30, 2015
Past Due
Past Due
Or Greater
Due
Current
Receivables
Accruing
Real estate loans:
             
     Mortgages
 $        502
 $        154
 $        866
 $     1,522
 $   119,287
 $           120,809
 $            380
     Home Equity
           395
             84
           136
           615
        60,142
                60,757
                 80
     Commercial
           114
           524
        4,034
        4,672
      189,055
              193,727
               104
     Agricultural
             39
           170
                -
           209
        30,514
                30,723
                   -
     Construction
                -
                -
                -
                -
          8,025
                  8,025
                   -
Consumer
             38
             30
             12
             80
          8,294
                  8,374
                   1
Other commercial loans
           526
             56
           919
        1,501
        50,619
                52,120
               261
Other agricultural loans
                -
             97
                -
             97
        12,289
                12,386
                   -
State and political subdivision loans
                -
                -
                -
                -
        84,730
                84,730
                   -
 
Total
 $     1,614
 $     1,115
 $     5,967
 $     8,696
 $   562,955
 $           571,651
 $            826
Loans considered non-accrual
 $        524
 $        496
 $     5,141
 $     6,161
 $          406
 $               6,567
 
Loans still accruing
        1,090
           619
           826
        2,535
      562,549
              565,084
 
 
Total
 $     1,614
 $     1,115
 $     5,967
 $     8,696
 $   562,955
 $           571,651
 
                 
December 31, 2014
             
Real estate loans:
             
     Mortgages
 $        318
 $        230
 $        675
 $     1,223
 $   121,635
 $           122,858
 $            214
     Home Equity
           442
             99
           260
           801
        61,779
                62,580
               132
     Commercial
             97
           231
        1,432
        1,760
      189,185
              190,945
               310
     Agricultural
                -
                -
                -
                -
        24,639
                24,639
                   -
     Construction
                -
                -
                -
                -
          6,353
                  6,353
                   -
Consumer
           119
               4
               7
           130
          8,367
                  8,497
                   6
Other commercial loans
           503
           258
           476
        1,237
        46,214
                47,451
               174
Other agricultural loans
                -
                -
                -
                -
        11,065
                11,065
                   -
State and political subdivision loans
                -
                -
                -
                -
        79,717
                79,717
                   -
 
Total
 $     1,479
 $        822
 $     2,850
 $     5,151
 $   548,954
 $           554,105
 $            836
Loans considered non-accrual
 $          48
 $        181
 $     2,014
 $     2,243
 $       4,356
 $               6,599
 
Loans still accruing
        1,431
           641
           836
        2,908
      544,598
              547,506
 
 
Total
 $     1,479
 $        822
 $     2,850
 $     5,151
 $   548,954
 $           554,105
 

 
 
12

 
 
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, 2015 and December 31, 2014, respectively. The balances are presented by class of financing receivable (in thousands):

   
       June 30, 2015
 
       December 31, 2014
Real estate loans:
     
     Mortgages
 $                780
 
 $                   676
     Home Equity
                     69
 
                      152
     Commercial
                4,547
 
                   5,010
     Agricultural
                      -
 
                        -
     Construction
                      -
 
                        -
Consumer
                     53
 
                        47
Other commercial loans
                1,118
 
                      714
Other agricultural loans
                      -
 
                        -
State and political subdivision loans
                      -
 
                        -
   
 $             6,567
 
 $                6,599

Troubled Debt Restructurings
 
In situations where, for economic or legal reasons related to a borrower's financial difficulties, management may grant a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the related loan is classified as a Troubled Debt Restructuring (TDR). Management strives to identify borrowers in financial difficulty early and work with them to modify more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where borrowers are granted new terms that provide for a reduction of interest or principal, or both, management measures any impairment on the restructuring by calculating the present value of the revised loan terms and comparing this balance to the Company’s investment in the loan prior to the restructuring. As these loans are individually evaluated, they are excluded from pooled portfolios when calculating the allowance for loan and lease losses and a separate allocation within the allowance for loan and lease losses is provided. Management continually evaluates loans that are considered TDRs, including payment history under the modified loan terms, the borrower’s ability to continue to repay the loan based on continued evaluation of their operating results and cash flows from operations.  Based on this evaluation management would no longer consider a loan to be a TDR when the relevant facts support such a conclusion. As of June 30, 2015 and December 31, 2014, included within the allowance for loan losses are reserves of $41,000 and $26,000 respectively, that are associated with loans modified as TDRs.
 
Loan modifications that are considered TDRs completed during the three and six months ended June 30, 2015 and 2014 were as follows (dollars in thousands):


 
13

 
 

 
For the Three Months Ended June 30, 2015
 
Number of contracts
Pre-modification Outstanding
Recorded Investment
Post-Modification
Outstanding Recorded
Investment
 
Interest
 Modification
Term Modification
Interest
Modification
Term Modification
Interest Modification
Term
Modification
Real estate loans:
           
     Mortgages
                     -
                          1
 $                    -
  $                  19
 $                  -
  $              19
Total
                     -
                          1
 $                    -
 $                  19
 $                  -
 $              19

 
For the Six Months Ended June 30, 2015
 
Number of contracts
Pre-modification Outstanding
 Recorded Investment
Post-Modification
Outstanding Recorded
Investment
 
Interest
Modification
Term Modification
Interest
Modification
Term
Modification
Interest
Modification
Term
Modification
Real estate loans:
           
     Mortgages
                    1
                          1
 $                 71
 $                  19
 $               71
  $               19
Total
                    1
                          1
 $                 71
 $                  19
 $               71
 $               19

 
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

 
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
 
Recidivism, or the borrower defaulting on its obligation pursuant to a modified loan, results in the loan once again becoming a non-accrual loan. Recidivism occurs at a notably higher rate than do defaults on new origination loans, so modified loans present a higher risk of loss than do new origination loans. The following table presents the recorded investment in loans that were modified as TDRs during each 12-month period prior to the current reporting periods, which begin January 1, 2015 and 2014 (six month periods) and April 1, 2015 and 2014 (3 month periods), respectively, and that subsequently defaulted during these reporting periods (dollars in thousands):
 
 
14

 

 
For the Three Months Ended
For the Six Months Ended
 
June 30, 2015
June 30, 2014
June 30, 2015
June 30, 2014
 
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
 $              483
Total recidivism
                   -
 $              -
                   -
 $              -
                   -
 $              -
             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 30,2015 and December 31, 2014, respectively (in thousands):
 
 
June 30, 2015
 
 December 31, 2014
 
Individually
evaluated for impairment
Collectively
evaluated for impairment
Total
 
Individually evaluated for impairment
Collectively
evaluated for impairment
Total
Real estate loans:
             
     Residential
 $           41
 $         890
 $         931
 
 $           25
 $           853
 $             878
     Commercial and agricultural
              48
         3,631
3,679
 
              72
           3,798
             3,870
     Construction
                 -
              14
14
 
                 -
                26
                  26
Consumer
                 -
              89
89
 
                 -
                84
                  84
Other commercial and agricultural loans
            185
         1,317
1,502
 
                1
           1,223
             1,224
State and political subdivision loans
                 -
            568
568
 
                 -
              545
                545
Unallocated
                 -
            176
176
 
                 -
              188
                188
Total
 $         274
 $      6,685
 $      6,959
 
 $           98
 $        6,717
 $          6,815
 
The following tables roll forward the balance of the ALLL by portfolio segment for the three and six month periods ended June 30, 2015 and 2014, respectively (in thousands):
 
 
Balance at March 31, 2015
Charge-offs
Recoveries
Provision
Balance at June 30, 2015
Real estate loans:
         
     Residential
 $         923
 $          (17)
 $              -
 $         25
 $         931
     Commercial and agricultural
         3,699
             (56)
                3
            33
         3,679
     Construction
              11
                 -
                 -
              3
              14
Consumer
              82
             (17)
                4
            20
              89
Other commercial and agricultural loans
         1,286
                 -
                 -
          216
         1,502
State and political subdivision loans
            572
                 -
                 -
            (4)
            568
Unallocated
            349
                 -
                 -
        (173)
            176
Total
 $      6,922
 $          (90)
 $             7
 $       120
 $      6,959
           
 
Balance at December 31, 2014
Charge-offs
Recoveries
Provision
Balance at June 30, 2015
Real estate loans:
         
     Residential
 $         878
 $          (34)
 $              -
 $         87
 $         931
     Commercial and agricultural
         3,870
             (56)
                7
        (142)
         3,679
     Construction
              26
                 -
                 -
          (12)
              14
Consumer
              84
             (24)
              12
            17
              89
Other commercial and agricultural loans
         1,224
               (1)
                 -
          279
         1,502
State and political subdivision loans
            545
                 -
                 -
            23
            568
Unallocated
            188
                 -
                 -
          (12)
            176
Total
 $      6,815
 $        (115)
 $           19
 $       240
 $      6,959

 
15

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

·  
Level of and trends in delinquencies, impaired/classified loans
 
Change in volume and severity of past due loans
 
Volume of non-accrual loans
 
Volume and severity of classified, adversely or graded loans;
·  
Level of and trends in charge-offs and recoveries;
·  
Trends in volume, terms and nature of the loan portfolio;
·  
Effects of any changes in risk selection and underwriting standards and any other changes in lending and recovery policies, procedures and practices;
·  
Changes in the quality of the Company’s loan review system;
·  
Experience, ability and depth of lending management and other relevant staff;
 
 
16

 
 
·  
National, state, regional and local economic trends and business conditions
 
General economic conditions
 
Unemployment rates
 
Inflation rate/ Consumer Price Index
 
Changes in values of underlying collateral for collateral-dependent loans;
·  
Industry conditions including the effects of external factors such as competition, legal, and regulatory requirements on the level of estimated credit losses; and
·  
Existence and effect of any credit concentrations, and changes in the level of such concentrations; and
·  
Any change in the level of board oversight.
 
The Company also maintains an unallocated allowance to account for any factors or conditions that may cause a potential loss but are not specifically addressed in the process described above. The Company analyzes its loan portfolio each quarter to determine the appropriateness of its ALLL.
 
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 ALLL. The following qualitative factors experienced changes during the first six months of 2015:
 
·  
The qualitative factor for national, state, regional and local economic trends and business conditions was increased for all loan categories due to an increase in the unemployment rates in the local economy during the first six months of 2015.
·  
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 amount of loans classified as substandard.
·  
The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans were increased for other commercial and agricultural loans due to an increase in the amount of loans classified as substandard.
·  
The qualitative factor for levels of and trends in charge-offs and recoveries was decreased for commercial and agricultural real estate and other commercial and agricultural loans due to the decrease in charge-offs compared to the prior year as charge-offs returned to historical levels for the Bank.
·  
The qualitative factor for experience, ability and depth of lending management and other relevant staff was decreased for commercial real estate, agricultural real estate, other commercial and other agricultural loans due to the length of time employees involved throughout the loan process have been in their positions.
·  
The qualitative factor for industry conditions, including the effects of external factors such as competition, legal, and regulatory requirements on the level of estimated credit losses was increased for commercial and agricultural related loans due to the decrease in the price received for product sold and the increase in feed costs that has occurred in 2015, which negatively affected customer earnings.
·  
The qualitative factor for levels of and trends in charge-offs and recoveries was increased for residential real estate loans due to the increase in charge-offs compared to historical norms for the Company.
·  
The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans was increased for residential mortgages due to increases in the amount of delinquent loans.
 
The following qualitative factors experienced changes during the three months ended June 30, 2015:

·  
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 amount of loans classified as substandard.
·  
The qualitative factors for changes in levels of and trends in delinquencies, impaired/classified loans were increased for other commercial and agricultural loans due to an increase in the amount of loans classified as substandard.
 
 
17

 
 
·  
The qualitative factor for levels of and trends in charge-offs and recoveries was decreased for commercial and agricultural real estate and other commercial and agricultural loans due to the decrease in charge-offs compared to the prior year as charge-offs returned to historical levels for the Bank.
·  
The qualitative factor for experience, ability and depth of lending management and other relevant staff was decreased for all commercial real estate, agricultural real estate, other commercial and other agricultural loans due to the length of time employees involved throughout the loan process have been in their positions.
 
The primary factor that resulted in negative provision for commercial and agricultural loans for the six month period ended June 30, 2015 was the reduction in the amount of special mention and substandard loans since December 31, 2014.
 
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 and agricultural 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 and agricultural real estate and other commercial and agricultural 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 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 and agricultural real estate and other commercial and agricultural 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 and agricultural 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 and agricultural 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 was 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.
 
 
18

 
 
Foreclosed Assets Held For Sale
 
Foreclosed assets acquired in settlement of loans are carried at fair value, less estimated costs to sell, and are included in other assets on the Consolidated Balance Sheet. As of June 30, 2015 and December 31, 2014 included with other assets are $1,815,000 and 1,792,000, respectively, of foreclosed assets. As of June 30, 2015, included within the foreclosed assets is $422,000 of consumer residential mortgages that were foreclosed on or received via a deed in lieu transaction prior to the period end. As of June 30, 2015, the Company has initiated formal foreclosure proceeds on $1,329,000 of consumer residential mortgages, which have not yet been transferred into foreclosed assets.

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, 2015 and December 31, 2014, the Bank’s investment in FHLB stock was $1,590,000 and $1,761,000, respectively. 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 paid a quarterly cash 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 2014 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 that were hired prior to January 1, 2007. 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, 2015 and 2014, respectively (in thousands):
 
 
19

 

 
Three Months Ended
Six Months Ended
 
 June 30,
 June 30,
 
2015
2014
2015
2014
Service cost
 $               78
 $   63
 $             132
 $                  153
Interest cost
                   90
    111
                153
                     207
Expected return on plan assets
              (172)
  (215)
              (290)
                    (393)
Net amortization and deferral
                   45
    (43)
                   76
                       25
Net periodic cost (benefit)
 $               41
 $ (84)
 $               71
 $                     (8)
 
The Company expects to contribute $400,000 to the Pension Plan in 2015.
 
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 $155,000 and $146,000 for the six months ended June 30, 2015 and 2014, respectively. For the three months ended June 30, 2015 and 2014, contributions by the Company totaled $93,000 and $88,000, 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, 2015 and December 31, 2014, an obligation of $945,000 and $969,000, respectively, was included in other liabilities for this plan in the Consolidated Balance Sheet. Amounts included in interest expense on the deferred amounts totaled $5,000 and $6,000 for each of the three months ended June 30, 2015 and 2014. For the six months ended June 30, 2015 and 2014, amounts included in interest expense on the deferred amounts totaled $12,000 and $11,000, 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, which terminates in April 2016. As of June 30, 2015, 60,662 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 2015 and 2014:

 
Three months ended June 30,
Six months ended June 30,
 
2015
2014
2015
2014
   
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
6,998
 $          48.61
   6,240
 $       43.55
6,971
 $          48.55
   7,172
 $       42.02
Granted
3,340
             49.87
   3,206
          53.10
3,496
             50.02
   3,598
          52.82
Forfeited
-
                     -
           -
                  -
-
                     -
           -
                  -
Vested
 (3,320)
             45.62
  (2,259)
          42.06
 (3,449)
             45.80
  (3,583)
          40.30
Outstanding, end of period
7,018
 $          50.63
   7,187
 $       48.28
7,018
 $          50.63
   7,187
 $       48.28
 
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 $85,000 and $73,000 for the six months ended June 30, 2015 and 2014, respectively. For the three months ended June 30, 2015 and 2014, compensation expense totaled $43,000 and $37,000, respectively. At June 30, 2015 the total compensation cost related to nonvested awards that has not yet been recognized was $355,000, which is expected to be recognized over the next 2.83 years.

 
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, 2015 and December 31, 2014, an obligation of $1,269,000 and $1,198,000, respectively, was included in other liabilities for this plan in the Consolidated Balance Sheet. Expenses related to this plan totaled $71,000 and $76,000 for the six months ended June 30, 2015 and 2014, respectively. For the three months ended June 30, 2015 and 2014, expenses totaled $36,000 and $38,000, respectively.

Note 8 – Accumulated Comprehensive Income
 
The following tables present the changes in accumulated other comprehensive income by component net of tax for the three and six months ended June 30, 2015 and 2014 (in thousands):

 
Three months ended June 30, 2015
 
Unrealized gain (loss) on
available for sale securities (a)
Defined Benefit
Pension Items (a)
Total
Balance as of March 31, 2015
 $                     3,897
 $     (2,294)
 $      1,603
Other comprehensive income (loss) before reclassifications (net of tax)
                      (1,351)
               -
        (1,351)
Amounts reclassified from accumulated other
     
     comprehensive income (net of tax)
                         (116)
              35
             (81)
Net current period other comprehensive income (loss)
                      (1,467)
              35
        (1,432)
Balance as of June 30, 2015
 $                     2,430
 $     (2,259)
 $         171
       
 
Six months ended June 30, 2015
 
Unrealized gain (loss) on
available for sale securities (a)
Defined Benefit
Pension Items (a)
Total
Balance as of December 31, 2014
 $                     3,093
 $     (2,326)
 $         767
Other comprehensive income (loss) before reclassifications (net of tax)
                         (464)
               -
           (464)
Amounts reclassified from accumulated other
     
     comprehensive income (net of tax)
                         (199)
              67
           (132)
Net current period other comprehensive income (loss)
                  (663)
          67
       (596)
Balance as of June 30, 2015
 $                     2,430
 $     (2,259)
 $         171
       
 
Three months ended June 30, 2014
 
Unrealized gain (loss) on available
for sale securities (a)
Defined Benefit
Pension Items (a)
Total
Balance as of March 31, 2014
 $                     1,264
 $     (1,110)
 $         154
Other comprehensive income (loss) before reclassifications (net of tax)
                           986
               -
            986
Amounts reclassified from accumulated other
     
     comprehensive income (net of tax)
                           (49)
                9
             (40)
Net current period other comprehensive income (loss)
                           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)
Defined Benefit
Pension Items (a)
Total
Balance as of December 31, 2013
 $                      (108)
 $     (1,117)
 $     (1,225)
Other comprehensive income (loss) before reclassifications (net of tax)
                        2,471
               -
         2,471
Amounts reclassified from accumulated other
     
     comprehensive income  (net of tax)
                         (162)
              16
           (146)
Net current period other comprehensive income (loss)
                2,309
          16
     2,325
Balance as of June 30, 2014
 $                     2,201
 $     (1,101)
 $      1,100
       
(a) Amounts in parentheses indicate debits to the Consolidated Balance Sheet 
   

 
21

 
 
The following table presents the significant amounts reclassified out of each component of accumulated other comprehensive income for the three and six months ended June 30, 2015 and 2014 (in thousands):

Details about accumulated other comprehensive income
Amount reclassified from accumulated
comprehensive income (a)
 
Affected line item in the
statement where net Income is
presented
 
Three Months Ended  June 30,
   
 
2015
2014
   
Unrealized gains and losses on available for sale securities
       
 
 $                          175
 $                      75
 
Investment securities gains, net
 
                             (59)
                       (26)
 
Provision for income taxes
 
 $                          116